Monday, April 3, 2017

Will Gold Ride Again ?


What happened to gold the last six months could best be called being shot out of the saddle. But is it dead? If you look closely, it could be crawling back into the saddle to continue the crazy ride of 2016. Gold has been a bit schizophrenic lately, not knowing if it's a bear or a bull. Although thought of as a dog since Trump's election, it actually has outperformed all the Trump commodities YTD and has trounced the Dow by almost double so far this year - seeming determined to disguise its true identity.

Back on Feb. 14, 2016 as gold was threatening to go on a tear from its long 4 year slide, I published an article here, at TalkMarkets, and at Seeking Alpha called "Gold's Bull/Bear Status". To understand this update, you need to go back and read this. The article correctly suggested a rampage upward in gold, which is what it did throughout most of 2016. But are we still in the large scale twin parabola fractal pattern that was the premise of the article? Gold has a very strong tendency to follow fractal patterns, as do a lot of big bull markets, as I illustrated in the article.

I drew a broad sweep diagram of this twin parabola fractal over a year ago that predicted last year's gold fireworks. Where are we on that map now?


I have added the black dot to update this as of April, 2017. Despite all the short-term schizophrenia of the last few months, in the bigger picture, gold seems to still be on track to do a roughly 2x scale up of the 1970s gold bull market. If we are to replicate the previous gold bull with its downtrend in the midst of the parabolic rises, we need to replicate this:

And so far we are doing this:


The two downtrends look similar in that there is churning against the resistance early on, then a sharp resignation to the downward move well below the resistance, then a return to churning on the resistance again, which is where we're at now. MAPS is what I call Moving Average Pairs for the 140 day and 200 day EMA that I find is a good separator of bull and bear moves. If GLD does a convincing break to 125-130 soon with high volume, a second parabolic rise starts to come into play.

But it is so hard to imagine gold going into a big bull market when its natural enemy, higher interest rates, are surely on the way. We seem to be going in the direction of all of gold's natural enemies - a good stock market, a defense of the dollar, an improving global economy, and a political sea change in Washington similar to the Reagan Revolution of 1981 that accompanied the death of the previous gold bull.

But gold can be very contrary to what it's supposed to be doing. For example, you can have bull markets in both stocks and gold at the same time, as in 2002 to 2007. In 1979, the year gold went ballistic in the last bull, the Dow was actually up 4.2%. And as for interest rates, if the last gold bull market is any indication, we should anticipate ramping gold alongside ramping rates:



The price of gold is very complicated and contrary, and maybe something like the science of fractals
is the best guide to what it will do.

The lead practitioner of fractal analysis of gold that I discussed in my aforementioned article back in February, 2016, is David Nichols, who publishes the Gold Fractal Report. His short-term calls on gold are somewhat hit or miss, but for long-term moves (say over two years) his accuracy is uncanny. He correctly was saying for months in 2010, when silver and gold seemed unstoppable, that precious metals would turn into a major bear move, and he gauged the time to be February/March, 2011. Silver hit its blow-off top in April and gold closely followed with its top in August, and the great four year slide began.

What is Nichols saying for our present timeframe? In August he published an article with his call for two things - the US stockmarket and gold. In August, if you will recall, we had just suffered a brutal pair of sell-offs, one in late 2015 and the plastering of early 2016. This was before the election and few were thinking run away bull, no matter who won. Nichols bad-mouthed the bears and predicted a nice bull market in stocks:
They are expecting a repeat of 2008, with a deflationary spiral that sends assets crashing down. Many seem downright gleeful at the prospect of the market doling out a brutal punishment to those holding long positions. But that was last decade's battle. The world has moved on ...
And he had this to say about gold:
Gold is responding to the switch to tangible assets. It's got some work left to do to put the multi-year correction in the rear view mirror, but once that happens the "hot money" will pour right back into gold.
Since August, gold has indeed done some "work" just as he said, being shot out of the saddle and perhaps now clawing back to put the four year slide "in the rear view mirror" and setting the stage for gold's next run. Giddyup.


Friday, March 24, 2017

The New Paradigm In Restaurants And Retail

It's well known that the brick and mortar retailers are suffering in today's ebullient markets. The internet is changing the way we shop. And, it's changing the way we dine as well, giving a twin abysmal effect in the restaurant world. The restaurant stocks are generally flat and the big box retail stocks are falling off a cliff. People today are seeking a generous serving of digital experience with their meals as well as their merchandise.

A man with some thoughts on this digital-tom-foolery/food thing is the guiding light behind what has to be considered the most successful restaurant chain of our time. This outfit has seen its stock do over a ten fold gain the last seven years since Jim Cramer first recommended him as "bankable". I am referring to Patrick Doyle of Domino's Pizza, what Cramer has called a technology company that also happens to sell good pizzas.

From the Mad Money of 3/6/17, Jim Cramer interviewed Patrick Doyle, CEO of Domino's Pizza after they reported yet another stunning quarter from the badly suffering restaurant group. Cramer asked him about what he has dubbed the new stay-at-home economy, despite growing disposable income, and how Domino's is beating this new attitude. Doyle then relates how Domino's has used the new digital age and everyone's fascination with it to deal with what he sees as the "new" consumer, telling us that fully half of the staff at the home office of Domino's are technicians that oversee the new order options where hungry customers simply order food while on Facebook, Google, Netflix, or whatever. Cramer just shakes his head at this. As for "getting out" foot traffic, the traditional life blood of restaurants, Doyle sees a great new divide now developing in consumer-land. In his words from the interview:
I think what's happening, Jim, is there is a great convenience now ... what you're seeing is people still clearly go out, but it's got to be special. There's got to be something in a restaurant or retailer that's drawing people in, that's giving them this experience that's different than simply going in and buying ... In restaurants, if you're giving someone a really special experience, then I think you're going to continue to drive traffic into your restaurant ... I think if you've got a restaurant that's a sit-down restaurant that's not doing something really special, then I think you're going to hurt." 
Doyle noted that his company is one of the few that has gone from a majority over-the-phone to a majority digital operation. "That's not a long list" he said. Cramer responded, "It's not a long list, and you are at the top of it."

Investors tend to think of Domino's as the great leader in this march of eateries into the new digital entertainment world. But there is a much more obscure name that perhaps is even more of an example of this powerful revolution, and seems to be exactly what Patrick Doyle was talking about in the above quote. That name is Dave and Buster's. You've probably heard of them because they've been around since 1982, went public in 1995 and were taken private in 2005.

In October, 2014, they have resurfaced as a public company again with a new mission and the name Dave and Buster's Entertainment, Inc. with the Nasdaq symbol PLAY. And play is what now sets them apart - digital play. About half their typical store floor space is the latest and best digital arcade games. They renew about 10% of their games each year at a cost of about 2% of their sales. These videotronical games seem like so much foolishness to me, and I've never wasted a moment of my time with one. But I've learned to never underestimate how popular they are with everyone else and I take their investment implications quite seriously.

Dave and Buster's does the big screen TV sports thing as well, even being a corporate sponsor of the UFC. But from Buffalo Wild Wings to my neighborhood Applebee's, you see the bar/TV thing everywhere these days. It's the games that now are making Dave and Buster's "special" to those cocooned in the house, and as Doyle said above, this is drawing them out. How does all this show up in their results? Well, it has propelled them to an industry leading Average Unit Volume - and the games are why:
 (Source of all results images: Investor presentation)
 The 2% of sales going to buy the games each year is well worth it as it sends the unit volume soaring past virtually all of their competition. Soldier of Fortune at Seeking Alpha has an excellent article titled "Press PLAY On A Dave And Buster's Investment" from back in November, 2015 showing these investor presentations by the company - just about a year after PLAY began trading. The stock has gone from $37 to $60 since then. Mind you this was precisely during the big swoon in both retailer and restaurant stocks since late 2015. And this has everything in the world to do with Cramer's stay-at-home economy, a corollary to his FANG acronym (Facebook, Amazon, Netflix, Google) he invented some four years ago. Jayson Lusk, a food and agri economist has a blog where he describes the Restaurant Performance Index comparing it to food spending away from home:
Here we see the tale of woe for the eateries starting in mid 2015 - about the same time when PLAY's results went ballistic:

 

 The "spending away from home" in the previous chart appears to be stampeding away from restaurants in general and into Dave and Buster's - a clear case of highway robbery in market share. And the same could be said of Domino's, which has a TV ad out now imploring customers to not deal with them by phone anymore, even smashing, with a crane, a big box with a phone image shown on it. Deal with us by the internet, they demand in the ad.

The growth shown above remains pretty cheap with just a 2.7 multiple on the revenue and just 10.8 on the cash flow from operations, whose growth looks similar to the EBITDA cash flow. Forward PE is 24.8 per Morningstar numbers.

The results at Dave and Buster's really began peeling away from the restaurant group in 2013 while they were still a private company:



I suspect this was a prime reason for the public offering of PLAY in October, 2014. It was almost like offering a new public equity launched into a new growth story - just what IPO lovers like. And they are in the fast growth part of the curve geographically, having a fraction of the store count of most major chains, just 1.7 stores per state.



If the digital traffic draw is such a good idea, why won't everybody be immediately doing it? Well, the gradual use of about 2% of sales to refresh 10% of their games each year has produced something of a competitive moat for Dave and Buster's. Each of their stores has about 150 games. And Soldier of Fortune gives this estimate:
Any competitor wishing to enter the space at any sort of scale would be facing a massive capital outlay (I estimate $165-175 M) in order to match Dave and Buster's gaming arsenal.
And as if to play dealer's advocate to the gaming junkies, they dispense:
... a pre-loaded card that one swipes to play a given game, removing the headache associated with keeping track of the coins to play with and the paper tickets won. Importantly, this is an experience that is not easily replicated at home (or at a competitor, for that matter) - most people/restaurants don't have even one full-size arcade game, much less 150+ to choose from.
For their part, Domino's has, the last seven years or so, made the massive investment to make half their main office workforce internet technicians. It would be a stretch for any competitor to suddenly make that change.

The games habit is high margin. It produces a gross margin of 86% vs 73.4% for their food and a combined average total store gross margin for their nine chief competitors of 71.3% (2015 figures). Clearing away some bookkeeping issues and just looking at EBITDA margins:



Floor space is an item that makes the business model hard for competitors to copy. A Dave and Buster's store is something around 44,000 square foot, about what the first Walmart stores were. Even if a competitor wanted to dish out the near $200 million for the state-of-the-art games, where would they put 150 of them?

As the big box mall spaces currently being occupied by J.C. Penney, Sears, Macy's, and the like become available via hundreds of closings, something like a Dave and Buster's may snap up some of this space as they would divide it up. There isn't much competitive bidding at their store size as everything this big is looking to get out of their spaces.

In the '60s, big box was good, a mega draw. Now the big boxes are making dotcom their draw and dragging the big box as dead weight. Taking the average mall annual lease rate of $41 per square foot and applying it to a typical bigger Macy's being closed at something like 260,000 sq. ft. you have about $10.7 million a year being chopped out of a big store's profit before you even pay anyone to work there. That's bad when the per store TTM profit for Macy's is currently less than $1 million. And J.C. Penney and Sears are in much worse shape.

Moving into mall space vacated by a big box retailer isn't a new idea to Dave and Buster's. Last month, the Baltimore Business Journal reported them swooping into the space at White Marsh Mall left by a Sports Authority as that company collapses into bankruptcy. If a recent CNBC story is any indication, big floor space ventures are going to have their pick of vacancies as a historic wave of big box mall closings are on the way:
"I expect the closures to be worse, and I expect the malls to be hit more than any other shopping center type," Cushman and Wakefield's Brown said. His firm keeps a list of the major store closures announced each year. Until 2016, the highest number it had tracked was in 2010, when about 3,000 closings were announced. That number grew to 4,000 last year, and Brown predicts it will balloon to 5,000 this year. "There's no way around [it]," Brown said, referring to what he considers an inevitable drop in the occupancy rate this year. While many argue that turnover and other changes have always been a part of the retail industry, "the pace at which it's changing is more rapid than has ever been the case," Green Street's Sullivan said.
Mall owners like the big floor space "anchor" tenants,  and welcome big replacements when one closes. The many smaller tenants often have contingency clauses linked to the anchors, many times governing whether they stay or leave, and at what price. This gives an operation like Dave and Buster's some bargaining power. This mall opportunity is a two edged sword for Dave and Buster's. It affords them a fast and likely cheaper path to expansion, but it also gives their competition the same physical path to copy their business model and expand.

However, as mentioned above, Dave and Buster's has just a fraction of the store count as their main competitors, and they can more easily make a higher portion of their stores mall takeovers. And all their existing stores are already that big!  Their competitors have a great mass of stores too small to populate with games, and a big learning curve with them in new places. Dave and Buster's has 35 years of experience with the games.

They are already establishing a presence in the revolution as was noted in the 3/23/17 Investor's Business Daily article about how to "Amazon proof" your mall. Sandeep Mathrani saw a vision of the future on a trip to Dubai, where he saw malls with KidZania in them - entire kid size towns with currency and role playing. Mathrani is head of the U.S. mall giant General Growth Properties (GGP) and is bringing these new concepts here. The article echoes Patrick Doyle's "special experience" theme:
For Mathrani, KidZania is part of a shift toward "experiential retail" - away from department stores ... Other concepts have taken their place, including supermarkets like Wegmans Food Markets, entertainment hub Dave and Buster's Entertainment ..."
GGP owns 126 malls in 40 states and has gone on the offensive:
"Instead of just waiting for stores to go vacant, it has bought out leases and physical property from chains like Macy's (M), Sears Holdings (SHLD) and J.C. Penney (JCP). The company has now reclaimed more than 100 stores over the past five years, Mathrani said."
Could this mall revolution be a growth engine for PLAY? I would say yes. You could say that all this videotronical stuff is just a two year fad with the kids. But be careful. You're calling Cramer's FANG and Doyle's "new convenience" a fad, and will probably wind up looking like those that called the horseless carriage and telephone fads. I think "paradigm shift" is not too strong a description.

 

 

Sunday, March 5, 2017

Is A Major Copper Bull Being Unleashed?


When the earthquake hit in Washington last November, sliding everything to a more business friendly world, copper went on a Trump tear along with several other things. Does this have any staying power? Is there something in the world's wiring to back it up?

Jesse Moore has an excellent series of reports on copper at Seeking Alpha. He began predicting a bear-to-bull turn in copper back in March, 2016, when copper was in everyone's doghouse, including mine. He was saying that within 12-24 months the bear would be a bull. We are now 12 months from his call, and copper is stirring from its bear slumber. His first in the series was a country-by-country look at copper mining projects, and he compares his result with that of Chili's government. Why should we care about Chili's copper work? Because they are the biggest copper supply in the world, giving us about one third of the metal. The whole Chilean economy centers on copper. Then there is the International Copper Study Group (ICSG) that does a projection as well. Moore's summary:
I believe both groups have not taken proper account for delays in a startup or ramp of new mines, grade reductions in Chile, water shortages leading to unplanned shutdowns, reduced capital expenditure, and the replacement of risk taking CEOs with risk averse CEO's who have slashed budgets across the world. Copper is not iron ore, and it is not nearly as easy to find and produce. The current copper price does not support growing supplies, and it appears that some producers have begun to put their collective shovels down ... In reality, the world needs another mega-project before 2020, and we just don't have one coming. The major deposits are, for the most part, found. $3.00 will easily bring on plenty of supply, but again, my belief is it will be too late. My guess is that we start to see the shortage become obvious near the end of the first half of 2017, prices will overshoot and what we saw during the China boom won't be out of the question
"The China boom" he is talking about is what happened back in 2004, when China went ballistic building the future China - and over did it. China has been notorious for commodity hoarding to insure supply for their plans. And they did this with copper in 2004, when their Shanghai inventories did a rare thing. They rose above the LME (London Metal Exchange) inventories, the world's standard for metal storage, just in front of the crazy copper bull market that ensued back then. Moore shows on a chart that this rare occurrence has just now happened again, the first time since 2004.

 Don't Ignore China

We need to pay attention to China and Asian copper usage in general because it accounts for about 62% of total copper usage, the Americas just 14% according to the ICSG pie chart shown in Moore's article treating copper demand. So forget Trump's building ambitions, copper began its breakout before the election. We need to know what's up in China.

China's construction contracts have continued a high rate of growth despite their economic slump, as have car sales. A lot of China's recent copper interest may lie in the aluminum vs copper wiring battle. They have been using a lot of the aluminum wire, because it is a very abundant metal with stable pricing running a fraction of that for copper. But aluminum wire has its problems. It must be alloyed to make it strong enough for wiring and this makes it less conductive. Copper can be used in a more pure form, especially pure, newly mined copper as opposed to the 50% of annual copper usage that is recycled. Only about 8% of scrap is made into wiring. So copper wire places nearly all its demand on the newly mined half of supply. Aluminum is also is subject to corrosion from moisture and other things and must be replaced much more often than copper. China is considering going to all copper for its wires, and this Moore says, will make a big, abrupt difference in copper demand:
Nearly half of all China's copper consumption goes towards grid infrastructure, and China has recently been discussing abandoning aluminum wiring in favor of more expensive, but reliable, copper wire. The outcome of which could drastically effect the demand for copper over the short term
Altogether, 75% of global copper demand is for electrical wires. But a big problem with copper wire is price instability. This may explain a good bit of the stockpiling going on now in China.

Copper's Supply

On the supply side, copper mining has been suffering a pronounced decline in ore grades. In "Copper: A Bullish Decade Is Coming" Moore shows a graph for global mining revealing that copper content of ore coming out of the ground is half of what it was in 2008. The best fruit has been picked, and, unlike oil, there is no big shale bump to come to the rescue. Shale, as I have written about in other articles, is keeping oil prices moderate for at least a couple of years.

If nothing suddenly shows up like a copper shale, the projected departure of demand curve from supply curve is slated to transpire around 2019 according to mining.com and their infographic tour of copper. For 50 years, they've known about shale and the other "dreg oil" (bottom of the barrel) that would be flooded onto the market by a quantum leap to higher prices. There is no such thing for copper - just a continuous slide to more and more expensive grades of normal ore. The current labor problems of Escondida, the world's biggest copper mine and other disruptions may be bringing a looming copper deficit closer at hand. Mining.com isn't the only one projecting this timeframe. Moore includes an RBC Capital Markets chart saying the same thing.

These could be some of the reasons for "Doctor Copper Hiding in Shanghai Warehouse" as a Wall Street Journal online piece from about a year ago proclaimed, saying that, "the pickup in the price of copper isn't driven by a stronger Chinese economy." You could argue that all the price surge is from Chinese stockpiling and thus it will simply reverse when they figure they have enough. But as Jesse Moore points out, they did this same stockpiling thing in 2004, to the same level relative to the LME, after which copper did a huge climb. China probably knows the copper market better than about anyone, being much more dependent on it than any country. They seem to know that they will have to buy higher later.

So are we running out of copper? No we are not. In fact we have mined way less than half of what's in the ground and almost all of that is still in circulation! Roughly half of copper usage is recycled metal. Even for silver, the recycled portion of demand is just about one fourth. Copper is by far the most reused resource on the earth. We don't burn it up like oil. It's relatively rare and doesn't rust into oblivion like iron. It only takes 15% of the energy to recycle copper as it does to mine it. How much gets recycled and refined is a function of the copper price. How much of the low grade, expensive ore that gets dug out is also a function of the copper price. We should perhaps draw a distinction here between peak oil and peak copper. We are enjoying a reprieve from peak normal oil with shale, tar sands, and so on. This could be for years, but there isn't that much of it to be exploited compared to the normal copper that's left to be recycled and still in the ground. We are not running out of copper.

We Are Running Out Of Cheap Copper

The looming supply deficit being projected is all a matter of copper pricing. It will be about market pricing and what that will be bringing to the plate. And it will be about any sudden changes to copper demand, like a China switch away from the aluminum electrical wiring. Added mine capacity doesn't come quick or cheap. And 92% of new copper wire must be pure, newly mined copper.

This aluminum/copper wire problem in China is being further aggravated by the massive internet speed bottle neck going on now in our last mile networking. I discuss this in detail in my article "The Impending Super-Cycle In The All Glass Internet" noting that as China struggles to become a superpower, their internet speed ranks #82 in the world. As all new buildings everywhere are becoming very populated with our new web connected devices, wiring material is being pushed beyond its limits now.

The disruptive switch-over from copper hybrids to an all fiber last-mile in urban areas means a very expensive mess. So ever increasing speeds have dictated a next generation of DSL on the very old copper that's already there. This new standard known as G.fast is being deployed. It is a nice speed improvement, and often compared to broadband fiber based on lab results, but will suffer the usual shortcomings of anything imposed on copper. The fade with distance is very bad relative to fiber.  Also, there is a vast difference in the normal existing copper and what they are using in the lab for these tests. I refer you to Jim Wegat for this. He was an optics engineer for Terabeam, and when I asked him about this supposed equality of G.fast copper to fiber, he said it:
... is confusing the wiring in homes and neighborhoods with the high quality wire used in the study by Alcatel-Lucent. It is a bit like saying that a specially designed car broke the land speed record and since most Americans have cars they should be able to break the land speed record with their cars too.

If we are needing this super pure, pristine copper to handle our new last mile, the cruddy, slow aluminum is out of the question. No wonder they are wanting to tear out the aluminum.

Fiber vs Copper

If I were vice president in charge of China's building programs, I would just cut to the chase and future proof my structures with all fiber and not even mess with copper. But I suppose when you must deal with a complicated budgetary mess and calendar of progress that dictate less than ideal science, it's not as simple as that.

There is a lot of debate on the pros and cons of fiber vs copper for LAN and building cables. Copper cabling suffers from electromagnetic interference between cables, fiber is immune to electric or magnetic interference. Copper is subject to disruption from lightening and water. Fiber is immune to that. I am not an expert on all this. I will just offer what Commscope has to say per a write-up titled "Will Fiber Ever Replace Copper Cable" on their website concerning what's happening in China.

Data centers in China are averaging 40% fiber and 60% copper while the very large data centers are about 70% fiber. But with "intelligent buildings" copper still dominates in-building networks:

"This is mainly due to the high cost of fiber-to-the-desk (FTTD) system as well as fiber’s high requirements for application environment and routine maintenance. Therefore, in the market of intelligent buildings, the percentage of fiber usage is only around 30 percent, while copper cabling occupies the remaining 70 percent market share. "

The Chinese seem to be very cost sensitive, having put in a lot of the aluminum wire, and now are averse to the high cost of FTTD. And that 70% copper market share may be looking better because of a new technology they are developing called Power over Ethernet (PoE):
"...when it comes to the intelligent buildings market, copper cable is facing new opportunities brought on by the fast landing of the Power over Ethernet (PoE) application"
The extraordinary copper stockpiling pointed out by Moore that took place in 2005 and just recently in 2015 was done with little fan fare or publicity, as important as it is to investors. But in a Reuters report from 2015, cited in Moore's part two article on copper (demand) China's government gives us a glimpse of their plans for copper. China does things by five year plans, and this report covers the 2015-2020 plan with the title "UPDATE 1 - China Targets $300 bln Power Grid Spend Over 2015-2020 - Report" and cites government sources in China. That's a third of a $trillion spent on wires, a big number, but to put the numbers in perspective, the plan calls for installing transmission line length over 2015-2020 equal to more than twice the 2014 level. That's over twice the cable strung in five years than was strung in the previous one hundred. The report, in what would seem to be an understatement, said all this is “likely to provide a boost for sectors like copper.” And it also makes pretty clear the choice in the aluminum vs copper battle:
“The plan was aimed at increasing the reliability of power transmission, which would favour copper-based cables over cheaper alternative aluminium-based cables, said Yang Changhua, senior analyst at state-backed research firm Antaike.”
If you look at a historical chart of China's copper imports, as in this report, you see an interesting connection to these five year plans. Over the 5 year plan 2000-2005, copper importing was flattish going from 70 to 50 (10 thousand tons). Then after the unusual stockpiling blitz by China in 2005, when the Shanghai inventories exceeded the LME the first time, the 2005-2010 five year plan saw copper imports do a massive climb from 50 to 300. This was accompanied by a strong climb in copper from $1.43 to $4.27. In the five years since, the imports have again been flat, going from 300 to 300, with the price of copper drifting back down. In fact, if you overlay this China copper import chart with the copper price chart, you get a remarkable correlation except briefly for the 2008 financial crisis. Now, the Shanghai inventories have exceeded LME once again, and you have to wonder what's up with China's plans. Keep in mind that they probably know the copper market better than anyone.
 
So a big new wave of demand could be coming for newly mined wire grade copper. The supply projections above may have a tough time keeping up with it.

The supply would have to be accomplished with higher pricesA lot of what's going on in China probably applies to other emerging Asian countries, and that block is 62% of copper's demand. China apparently sees this as a big enough problem to justify a whole new round of stockpiling.

Another consideration with copper supply is its relation to gold. Copper is usually found wherever gold has formed, and you can't read much geology on miners without seeing "gold-copper, copper-gold" and similar terminology. The basic fact is that much copper is mined as a co-product or by-product with the vastly more lucrative gold content. If the price of gold is cutting production, a copper shortage has to run a ways before operations are being ramped up just for the copper. Thus you have to be mindful of the relative status of gold and copper bulls and bears. Right now we have gold looking bearish since late last year while a copper bull may be on its way. Almost always in history, gold and copper bulls have run in tandem. If now they are to run in opposite directions, it would be an oddity. Technically, gold is in limbo now between long-term bull and possible new bear in the $1250 area. So this bears watching. We will probably have a copper shortage if gold continues its long-term bull market, but if gold continues its retreat from last year, the copper shortage could become severe.


Friday, March 3, 2017

Insiders And The New Medicine


Biotech was the big outperformer for years up until mid 2015. After a big cool down, it looks to be reigniting.

There is a new medicine slowly taking hold over the years. To see it, you should be aware of the little project that, in 1990, the Department of Energy, The National Institutes of Health, and some international organizations began - The Human Genome Project. It was to be a 15 year globally coordinated effort that would map and sequence the human genome completely so that we could begin practicing this medicine.

And they did it. It was pretty much completed around 2003, two years ahead of the 15 year schedule and under budget. It was worth every penny of the roughly $3 billion the US government spent on it (in 1991 money). By the tabulations of FasterCures every $1 spent on the Project has triggered $178 in US economic activity. "An investment in knowledge always pays the best interest" they quote from Ben Franklin. They conclude that "As the largest, single undertaking in the history of life sciences, the Human Genome Project has paid back extraordinary dividends on the U.S. government’s investment." That total investment of $3 billion has produced, in 2012 alone, genomic endeavors resulting in $31 billion in US GDP, $19 billion in personal income, at a cost of about $2 a year for each US resident. Now that's a stimulus package.

The Project was pronounced done in 2003, and genomic medicine was eagerly anticipated. But practical, disease killing applications have not exactly been sprinkled on us like magical fairy dust. There is a kind of Moore's Law at work in getting genomic medicine into our every day life. In the early 2000s it cost about $50 million to get your genome mapped. That has steadily declined to less than $1000 now - something akin to getting a tooth pulled, but less painful. Getting your genome mapped is rapidly becoming a common part of good healthcare.

Investing In Modern Medicine

The approach in "modern" medicine has been to introduce chemicals concocted for a mass audience into your particular body to stop some bad thing it is doing. Because we're all different, that typically is done at the expense of upsetting the body's intricate chemical balances, producing a new set of problems. The era of side effects has resulted. The old school drug industry profits, and it's a whole new wing of the legal profession. Have you noticed that about every third commercial on TV now is a disclaimer that drones on ad nauseam about every bad thing some drug has ever done to anyone? From bleeding, pain with or without vomiting, to other unseemly discussions, it's getting so you can't even enjoy a meal while watching your TV. You don't take two aspirin and call in the morning anymore, you call 1-800-BAD DRUG. A hundred years from now, all this will seem like applying leeches.

Genomic medicine has a basically new approach in that it seeks to fix problems by having our body just do what it was designed to do - genetically. And this can now be tailored to each of our individual genomes. It uses the body's own processes to fix problems. "Immunotherapy" is all the rage now in biotech and it uses the body's own immune system to search and destroy disease. A genetically correct body would never get most of our debilitating disorders. It is only when genes are damaged or not working right that we are programmed to problems. As they say in this science, we will stop endlessly treating symptoms, and simply fix the programs.

Unless you're a doctor, probably the best way is to analyze, not these stocks, but the insiders buying the stocks. There are, of course, the officers of the company; and a sudden rash of buying or selling by them is often a good tell. But I like to focus on another type of buyer - the cross company career buyer. These are the very few who are often highly educated in the medical field and also are 10% owners and/or sit on the boards of several of these companies, and do massive, informed buying.

They also like to run biotech hedge funds and, because they know not only medicine, but the business of medicine, they tend to have dazzling track records of performance. There funds are not for everyone as the downdrafts are huge and the sector risk is extreme. But the buying by these very smart people should command your attention. Kevin Tang is one of those people. He founded Tang Capital Management in 2002. My personal favorite for medical insiders to watch is the Fabulous Baker Brothers (no relation to the 1989 musical). Felix Baker owns a Phd in Immunology and is the most massive inside buyer I know of. Julian Baker holds an A.B. Magna Cum Laude from Harvard (social studies) and this blend of intelligence founded Baker Brothers Investments in 2000, which offers their hedge fund, Baker Brothers Advisors, among a family of funds for institutional investing. Together, they are on the boards of several medical companies.

The Bakers' fund tends to run just a handful of heavy-weighted positions although they spread the money out over nearly a hundred names. What strikes me about the names they buy heavily is the high buyout rate. For example, as tabulated by J3 Information Services, the fund's holdings, in heavy positions at the end of 2013 were : ACAD, SLXP, XOMA, GHDX, SGEN, PCYC, INCY, and GEVA. Of those eight, four have been bought out at fat premiums. That's a .500 batting average for takeout homeruns in just three years.

The Bakers' Personal Shopping

These funds do well, but I find it more helpful to look at the yearly progression of the personal buying by the Bakers as they seem to not only know what to buy but when to buy it. When total yearly buying goes over around $20 million, the Bakers tend to do massive personal buying of select stocks, and very big climbs tend to start within three years or so. This only happens with about a half dozen stocks, but when it does, you should pay attention. As an example, let's look at Incyte Corp.
(click images to view)



After declining to flat stock action for many years, the Bakers began $30 M plus yearly buying in '07, '08, and '11, accumulating something like a $10 cost basis before the run to over $100. They apparently think the run is far from over with Julian buying an astonishing $260 million worth in '16, not to mention 10.6 million shares in non open market buys in February, 2017 per Morningstar, worth roughly $1.4 billion.

The Bakers seem to gravitate to the new genetic medicine. Incyte was a groundbreaking leader in the genomic revolution as Incyte Genomics, Inc. and was going about selling its library of mapping until the Moore's Law effect mentioned above made this an impractical business model. So they morphed into one of the best disease fighters after 2004, currently ranked  #4 on Forbes The World's Most Innovative Companies list.

Synageva BioPharma Corp. (GEVA) does recombinant genetics, and it also caught the attention of the Bakers. The company was formed when a Genzyme executive "was approached in early 2008 by Baker Bros. Investments to be the CEO of privately held Avigenics, Inc." according to the Wikipedia account, and this later went public as GEVA. If you construct a chart as above for the Bakers' buying, you find that after a decade of declining to flat stock performance, they bought $75 M of GEVA in '12, $200M in '13, and $267 M in '14 at an average stock price ranging from roughly $110 to $150. I bought GEVA based on this Baker activity and was rewarded with a $230 buyout of GEVA in May, 2015 by Alexion Pharmaceuticals. It "was the one of the largest premiums paid to any company over $5 billion in market cap since 1995" (Wikipedia).

Another rare case of Baker yearly buying going over the $20 M mark was Pharmacyclics (PCYC) where, after a decade of slumber, they bought a little over $15 M in '11 followed by about $24 M in '12 at prices ranging roughly between $10 and $60. PCYC was bought out in early 2015 at $261. And in mid 2013, Felix forked over $58 M at about $14 to buy some ACAD; it's now worth over twice that. Of course the Bakers are human, and they can buy losers as well, especially in the funds they operate. But when they go much over $20 M in personal yearly purchases, the success rate is extraordinary.

The Current Favorite Of The Bakers

There is one stock that has received the most intense Baker insider buying I have ever seen, and they operate squarely in the new medicine area. Genomic medicine is crossing an important threshold as noted in an article "Casey Analyst Forecasts Explosive Biotech Growth", from late 2012. In this interview with Casey's Research, they were asked about breakthroughs in the concept of using the body's immune system to deliver engineered cancer killers. Two were discussed:
The first is the recently approved use of antibody-drug conjugates (ADCs). Seattle Genetics (SGEN:NASDAQ) is the leader in this space, and its ADCs are created by bonding traditional chemo with antibodies selected from our own bodies that target very specific cancer cells. Chemotherapy, which is known as the "poison" in the oncological lingua franca "slash, burn, and poison," does precisely that to the entire body, causing horrific side effects in many patients. By piggybacking on the body's own mechanism for targeted immune response, chemotherapy can be rendered basically inert except when it comes in contact with cancer cells. This means more chemo can be delivered safely, working wonders on metastatic cancers and other difficult-to-target, small, multiple-growth cancers.
From the SGEN site, we see that genomic science is facilitating all this as they:
:... have also formed a strategic collaboration with Oxford BioTherapeutics to jointly discover novel ADCs for cancer. Under the collaboration, OBT will generate panels of monoclonal antibodies against novel tumor-specific antigens identified using its proprietary Oxford Genome Anatomy Project database
Seattle Genetics is a small speculation enamored with science, not profits. But a development in 2010 could change that. From an Xconomy article in 2011 "Seattle Genetics, On The Verge Of Going Commercial, Seeks To Keep Its Scientific Soul":
A little science background is required to see why this matters. Other biotech companies have had a lot of success with targeted therapies over the past decade, making genetically engineered antibodies that specifically zero in on markers on tumor cells, while mostly sparing healthy cells - unlike typical chemotherapy. Seattle Genetics has gone a step further, by turning genetically engineered antibodies into what amounts to a “smart bomb” against cancer. The company’s technology links the targeting antibody to a potent toxin, which gets unleashed on the tumor.
This idea of putting a cancer poison warhead on a genetically crafted antibody missile isn't new. As the article explains:
Most of these efforts to soup-up antibodies have failed over the years, but Seattle Genetics proved it had solved the puzzle last year in a pair of clinical trials.
So this 2011 piece claimed that Seattle Genetics "proved it had solved the puzzle last year" inducing the company to "start putting together a commercial plan." This was 2010, which interestingly enough was the year the Bakers began their massive buying of the stock in earnest:



You have to wonder what's up with that. This is the most intensive buying I have seen from the Bakers, or anyone. That's about $1 billion of one person's personal bank account invested in one dangerous stock.

Since the Bakers began buying up shares of INCY and SGEN hand over fist, INCY has not only been placed in the top five World's Most Innovative Companies list by Forbes, they have been added to the Standard and Poor's 500 index as announced on Feb 24, 2017. This will dictate some index fund buying. The Motley Fool announcement went on to say:
Incyte will be a fine addition to the S&P 500. It has a fast-growing drug franchise in Jakafi, a decent pipeline, and after a string of high-profile pipeline failures from competitors, faces close to zero competition for the drug's market opportunity. The company has staying power -- and so does today's move.
And the "going commercial" plans of SGEN have been proceeding with a Feb 10, 2017 announcement of a major deal with Immunomedics to license one of the cancer "smart bombs" that has received Breakthrough Therapy Designation from the FDA. According to Cynthia Sullivan, CEO of Immumomedics:
"After a long and robust process, we concluded that licensing our lead asset, sacituzumab govitecan, to Seattle Genetics, the leading ADC company, would give us the best opportunity to advance this product on behalf of advanced stage cancer patients."
Looking at the massive buying figures like those above may prompt one to sell the kids and bet the farm on whatever people like Tang and Baker are buying heavily. But as in the '90s with the revolutionary internet, genetic medicine is here to stay, but most of the stocks will go away. The key insiders will likely be our best guess for the stocks that will be the mega winners.

















Sunday, February 26, 2017

The Impending Super-Cycle In The All-Glass Optical Internet

Technology lagged the Trump rally at first, but now appears to be coming to life. There is one area of tech that may be contributing to that.

There is a Gigabahn in our information superhighway that has been compared to Germany's famous Autobahn, where there is no speed limit except for urbanized or congested stretches, and they typically fly at around 100 mph. Their trips are badly bottlenecked by the last few miles to their home or office. (click on images for full view)

The biggest problem facing the age of the web, other than perhaps security, has always been the immense difference in data speed as light waves vs electricity waves. They built the main trunks of our network with plenty of fiber optic overcapacity, and they have been doing the local switching into our computers by converting the lightwaves into electrical waves and pretending they are to be dealt with as in the party line era. With a lot of cleverness, that has worked OK, but with net traffic doubling every year, we have now come to the limits of that optical denial.

Local area networking with optics is an inevitable revolution of the future. Fortunately, smart minds have been developing light wave switching to do what the very old school electricity switching has always done. If the experts are right, we are about to enter a quantum leap closer to the lighted "cathedrals of glass" in George Gilder's all glass view of the future. There are several public companies involved in "last mile" fiber optics that are the can openers that let the 100 gigabit light speed shining across the globe into our neighborhoods. A lot of this is done with the simple prism effect. There is a super cycle in this can opener function coming as explained in the Investor's Business Daily article "Fiber Optic Super Cycle: Raising The Speed Limit On The Gigabahn's Last Mile."

Clearfield, Inc. (CLFD) Oclaro Inc. (OCLR) EXFO Inc. (EXFO) Ciena Corp. (CIEN) and Acacia Communications (ACIA) are some of the small pure play investments in this anticipated super cycle. The experts think this super cycle is just beginning.

I have traded Clearfield over the years twice for 44% and 130% profits, but I would have done many times better had I just held it after my first buy. The growth, despite all the cycles, has been that massive.

What's all the crazy explosion about? You could say it's a leftover (or maybe "hangover" would be a better term) from the internet bust of over 10 years ago. If you will recall, everything went nuts over the future growth of traffic on the 'net. The telcos frantically laid a fiber-optic backbone to replace the hopelessly slow copper, and mindful of the high cost of continual upgrades, laid in a pretty vast oversupply of capacity. This is commonly referred to as "dark fiber" until end-user demand eventually lights it up.

There is still dark fiber and excess capacity left in the backbones. But the internet traffic growth has been catching up to the last mile distribution systems. This part of the network was sped up with many different half measures using on-demand switching strategies that worked well on the old copper or copper/fiber combos. The basic problem with all the combos is that information on light travels at the speed of light, which is umpteen thousand times the speed of electricity in copper, or silver or any conductor. It has always been cheaper and a little more convenient to speed up the combo switching than tearing up the neighborhood and installing pure optic to the premises.

Is there really a "super-cycle" coming in optical last mile?  Metro traffic jams and upgrades do tend to run in erratic cycles. But they say a super-cycle happens about every 10-15 years, and a big new one is emerging being fueled greatly by the "Web 2.0" phenomenon - Netflix, Facebook, and the whole FANG revolution. They have started buying their own net equipment to squeeze product to their customers. This isn't your teenage daughter's web anymore. Now we have presidential campaigns being waged on Twitter, and our new president has a full blown audience before his first old fashioned press conference. The IBD piece above states:
During "every prior optical cycle, there has been one major driver and a couple of minor drivers," said Needham analyst Alex Henderson, who as argued that the uptrend could be a telecom industry "super cycle." "This cycle looks quite different than that in the sense that there are at least three major drivers and a couple of smaller drivers as well." As a result, the fiber-optics group ranked No. 3 on Thursday among the 197 industries tracked by IBD, up from a No. 95 ranking six months ago
The huge new FANG imposed driver is being complemented by another major driver - a pressing upgrade cycle in China. As they try to emerge as a superpower, their net speed is ranked #82 in the world, and they are seriously attacking that.

Local systems, foreign and domestic are being strained to keep up with traffic on the internet.  According to Wikipedia, the traffic pouring out of the fiber backbones is doubling every 9 months. According to the above IBD article:
The problem is, we've now got these fibers that have 90 channels of 100-gig traffic on them, and they're dumping into a metro core that's 10, 15, 20 years old that can accommodate 10 to 40 gigs of traffic, Henderson said. "That's like trying to drink out of a fire hydrant with a sippy straw.
FTTH stands for Fiber To The Home, which is about the same as FTTP (Fiber To The Premises) and other FTTs that are sometimes collectively called FTTx - or simply last mile fiber. There is now a sharpening need for all-fiber last mile installations.
The disruptive switch-over from copper hybrids to an all fiber last-mile in urban areas means an expensive mess. So ever increasing speeds have dictated a next generation of DSL on the very old copper that's already there. This new standard known as G.fast is being deployed. It is a nice speed improvement, and often compared to broadband fiber based on lab results, but will suffer the usual shortcomings of anything imposed on copper. The fade with distance is very bad relative to fiber.  Also, there is a vast difference in the normal existing copper and what they are using in the lab for these tests. I refer you to Jim Wegat for this. He was an optics engineer for Terabeam, and when I asked him about this supposed equality of G.fast to fiber, he said it:
:... is confusing the wiring in homes and neighborhoods with the high quality wire used in the study by Alcatel-Lucent. It is a bit like saying that a specially designed car broke the land speed record and since most Americans have cars they should be able to break the land speed record with their cars too.
Still, it's just been too much mess to upgrade all the copper we've built into our advanced countries. Thus, if you look at a global fiber penetration chart, it's the emerging markets where they are enjoying higher FTTP rates. The United Arab Emirates already has all fiber to 75% of premises with South Korea at 68% and Hong Kong at 57%. At the other end of the scale, there is France with 3%, and both the US and China with a mere 9%. In the copper infested nations, the switchover is a complicated mess. What we need is simplification!

This is Clearfield's heart and soul. In a story, on this company, Bloomberg starts off with the statement "Clearfield Simplifies Fiber Distribution." Putting all the moving parts together in a last mile light-wave distribution system is an incredibly complicated, disruptive, and costly thing. In the Bloomberg article, they give us the general description of Clearfield's offerings. I am no tech geek, but the thing that stands out to me is the phrase "delivering the industry's only fiber management platform that is built upon a single architecture. Scaling from 12 to 1728 ports". This ease of assembly and a gradual scaling of a customer's build out (so as not to bankrupt the premises) all on one platform (no big interfaces and what have you) is exactly what you see stressed at Clearfield's website. If you go there, the first thing plastered on your screen in big letters is "Scalable Fiber Management". They say:
Based on the patented Clearview™ Cassette, our unique single-architected, modular fiber management platform is designed to lower the cost of broadband deployment and maintenance while enabling our customers to scale their operations as their subscriber revenues increase...No matter which product line you are using….or whether you're networking in the Inside Plant, Outside Plant or In-Building, everything we do is based on the architecture of the Clearview Cassette. While it's designed to fulfill all the "musts" of fiber management, the cool thing is that your technicians learn it once and then the cassette becomes like using legos….simply rearranging the pieces, depending on your fiber network solution!

Clearfield's selling point is that they are the least painful way to get the limitless bandwidth and "future proof" nature of light waves sent to your screen. Clearfield has the kind of insider ownership I like. With CLFD, you actually have more insider ownership (18%) than mutual fund ownership (11%) and almost as much as institutional ownership (23%). It is somewhat undiscovered, except by the insiders. Despite all the cycling fiber has done, this company has produced steady, strong growth over the years:

If these are the results just before a super cycle, there's a chance they may get even better! This, of course applies to, EXFO, CIEN, CSCO, LPTH, and the whole local optical group.





 
 
 
 
     
 



Thursday, December 29, 2016

The Mega Fractal Turns In The Markets I Wrote About In June Have Made Themselves Known

Back in June I posted "Fractal Condition of Several Key Markets At Mega Turn Points" where I submitted that there was about to be a big turn into either bull or bear mode (I was thinking bear at the time) and since then, these markets have indeed made a decisive turn. I have reposted the original article in black, and I have added in red what each of these has done since June.


Recently I wrote an article on gold's fractal dimension showing that it had built to a high level not seen for at least 10 years. Well you may be scratching your head asking "fractal what?" I briefly explained that it is a "high math" way of quantifying any moving object's reversion-to-mean force after it has been in a trendless state for awhile.

For something that can be charted, like a market, there are two dimensions. The fractal dimension at any point is a mathematical summation of something's behavior as either something that can be described with one dimension (a strong, straight-line trend) or by two dimensions (a meandering, chaotic range). Thus the dimension is calculated as being between 1.0 and 2.0 (between one and two dimensions).  We typically just take the decimal portion and refer to it like basis points.  So a fractal dimension of 1.35 is just called "35".  This "line vs chaos" thing in theory happens at all different time scales, minutes, years, what have you, and you have to divide all this rightly for it to mean anything in the scale that's significant to you.  The guiding mantra of all fractals is always "same thing, different scale". 

This also applies to the geometrical rescaling and repeating that markets tend to do.  Back in early February, I wrote an article, "Gold's Bull/Bear Status" on gold's apparent "new" bull market, which is likely just a repetition of a rescaled, typical, and oft repeated bull market fractal that is really all one bull market

Anyway, enough math.  After looking at gold, and seeing that it currently has a very unusual fractal condition, I looked at several other key markets and found that there is a similar fractal abnormality in them as well. First, let's look again at gold: (click on image to view)

As the graph shows, gold is currently at 55, highest in 10 plus years, presaging a very strong trend coming, either up or down.

Since June, gold has moved down from the top of the range shown, but the fractal dimension is still at 55. So gold is still moving in a range, undecided how to dissipate the 55.

Gold is linked to many other markets, so let's take a look at the US dollar with this measure:

"Historically unstable" would be a good description of the dollar's fractal behavior since the 2014 power move up and subsequent chaotic range. The peg-to-peg gyration from 30 to 60 is very unusual for a major index, especially a supposedly stable currency, even on the weekly scale as this fractal dimensioning is calculated.

Since June, the dollar quickly reversed this formation break back to the upside, reflated the fractal dimension back to 60, and the dollar has been on a tear since, dissipating its fractal dimension down to 45. 

Of course gold is also supposed to be an inverse play to the stock market, although I beg to differ with that take as there have been extended periods with both rising gold and stocks, with 2002 to 2007 being a prime example.  But historically, and especially lately, gold is inversely related.  So let's look at stocks via the Russell 2000, because it is a broad stock market and it is a leading group. Let's calculate some fractal dimensions:

Amazingly, we find that the stock market is also jam packed with the highest fractal energy level in over 10 years.  But just from this, we don't really know which way it wants to go, up or down, from looking at these graphs as they just show its fractal condition. 

Since June, the Russell has blitzed to the upside, deflating its dimension down to 52. This is still very high for a major index and suggests a lot more upside to come.


Is there something that we could check that could be more suggestive of the direction ? 

Consider copper.  "Every bull market has a copper top" is ancient wisdom, noting that copper puts in a top somewhere in the late stages of a bull.  And it is referred to as Dr. Copper because it has a PhD in economics.  It did indeed peak clear back in 2011 before the transports, European banks or any other leader.  Copper has put in attempts at bottoming ranges amidst a pronounced decline, and recently it has attracted attention to the $2.00 level as a major line in the sand.

There is the technical read where $2.00 is a Fibonacci level.  But then there is the basic fact that the world's biggest trafficker in dangerous derivatives, Deutsche Bank, is highly levered to Glencore, and Glencore is very highly levered to copper staying above $2.00 a pound.  An article, from Business Insider recently explained "Barclays: Glencore Is In Big Trouble If Copper Gets $0.30 Cheaper".  Copper was $2.34 at the time. The article states at the top:
Glencore is a strange hybrid company, both a commodities trader and a mining company, and it has a complicated balance sheet loaded up with different kinds of debt.  There are a lot of different ways to analyze the company but perhaps the best way to think of it is like a bank that's hitting a crisis, like Lehman Brothers ... if the price of copper falls below $2/lb, you begin to get some seriously sweaty palms in Glencore's finance department
If this level gives way, it will be a serious debt problem with the banking system.  And because $2.00 is also a psychological level, breached only in the March, 2009 and January, 2016 market debacles, it would also involve a confidence shock to all the other markets.  In fractal terms, this is how copper looks now:

Each of the ranges in the decline where the fractal dimension went to over 50 resulted in a sharp collapse downward.  The $2.00 per pound line in the sand is right at the red arrow I've drawn illustrating the current range.  And currently we have copper at a fractal dimension of 55, the highest of the entire decline, strongly suggesting another sharp drop, this time through the $2.00 barrier.  Of course, the direction could be up from here, but there is a very strong primary trend at work with copper, so the more likely outcome of the fractal situation is a continuation of this primary trend. It's showing no signs of reversal.

Since June, copper's dimension continued to build and slammed hard on 60 (the upper peg) and has since gone into a power climb with current dimension at 45 - still a lot of room to power climb.

Oil is in a similar but much less profound state of weakness.  It went to an extreme fractal dimension of 60 (monthly) in mid 2014 with oil seemingly stable at around $105.  The massive move to $45 in just 6 months that followed sent the fractal dimension to below 40 in a flash.  On the weekly scale, the fractal dimension went to 52 in mid 2015 with oil steady at $60, went back down to 30 as oil plummeted to $28, and is swiftly going back up as oil struggles in the $40s.  It is a similar plateau and plummet progression as copper, but not nearly as fractally strong, and with the primary down trend in question as oil is trading well above its 200 day moving average.

But there is yet another market index with a once-in-10 year fractal event going on where the direction is probably more clear.  Let's take a look at the VIX:

The fractal dimension reacted strongly to the 2008 event with a big build to 53, then a big dissipation clear down to 34.  It didn't seem to react as strongly to the 2011 Greece scare, as if it knew it was just a passing cry of "wolf".  But it has again gone to an extreme level, being violently pegged at 60 for some time now.  So there would seem to be an extremely large move coming. But if it were down, it would be to an absurd VIX level of around 10 or less. 

Not that this hasn't happened before.  We were cruising into 2007 up until March with the VIX at 10-12 before hardly anyone was worried about housing, or anything.  But in our day, this would imply that stock markets will sudden go to a PE of 30, or an unprecedented burst of earnings will suddenly materialize from a weak economy seemingly beyond the resuscitation of monetary policy, the rising debt defaults will suddenly stop from the mountain of shaky loans, interest rates will "normalize", the lion shall lie down with the lamb, and pigs will fly.

Since June, the VIX has stayed pegged about as low as it can go and its dimension is still pegged at 60.

It may not be just your imagination that the global economy, markets, and interest rates are going into some kind of twilight zone. The cold science of fractal analysis backs you up on that.


The collective fractal wisdom is saying buckle your seat belts, and the VIX is saying a big move will either be another big decline in stocks or a sudden trip to nirvana. I guess we could be going to nirvana, but until the evidence is convincing, it may be wise to make some preparation the other way.


Since June, we have gone to nirvana. How long will that last? I don't know, but there is a lot of fractal energy that says enjoy the ride!


If you would like more information on the fractal dimension in markets, you can read the works of Benoit Mandelbrot, who discovered and wrote about this phenomena in all areas of science. He coined the label "fractal" and founded the Chaos Theory approach to analyzing markets.  His book The (Mis)Behavior of Markets has been called "the deepest and most realistic finance book ever published".  There are a few product offerings that give you an FDI (fractal dimension index or indicator) along with the RSI and other technical indicators. One is from QUANTSHARE  Trading
Software.  If you are a programmer, there is code written for this calculation by AmiBroker and others.  You can also use someone's code at MetaStock with their Indicator Builder feature.


Friday, December 16, 2016

From The Makers Of Wal-Mart And Bank Of The Ozarks Comes Bear State Bank

What's up with these regional US banks? So many of them are growth stories nowadays with crazy stock climbs in a weak economy. And that was before the election. Since then, the small banks have been amazing - the best performing group .

Banks are certainly Trump stocks, but there was something cooking with them even before this year. As Thomas Michaud, CEO of the investment banking firm KBW said on CNBC's 12/21/15 interview, "there is a rise of regional champions" going on with merger activity among the well run regional banks looking to grow. Some of these growth stories have been stunning with stocks tripling or more despite junk debt and lack of economic growth.
 
There is your basic economic cycle. As rates rise, banks will benefit from a return to the classic business model of making profit from the yield curve between deposits and loans. But a big difference in this rate cycle could be our escape from the aberrant zero interest era. As explained in this article, the Fed is now paying interest to banks over the prevailing rate to keep the massive QE flood on banks' balance sheets and out of lending into the economy to prevent inflation from going out of control. The Fed is "bribing" banks to keep a lid on inflation.

This will be $24 billion yearly per 1/4 point rate increase. This was described as a problem back in 2013 as the commercial banks' reserves held at the Fed ballooned to over $2 trillion as noted in the Wikipedia account on this feature of the Fed:
As the economy began to show signs of recovery in 2013, the Fed began to worry about the public relations problem that paying dozens of billions of dollars in interest on excess reserves (IOER) would cause when interest rates rise. St. Louis Fed president James B. Bullard said, "paying them something of the order of $50 billion [is] more than the entire profits of the largest banks."
This fallout from the Fed's tom foolery with creating an artificial market in everything looks like a windfall "subsidy" for the banks. There is another megatrend that makes this development more significant - the drastic shrinkage in the number of banks as featured in a Wall Street Journal piece. Since 1985, the number of U.S. banks has shrunk from 18000 to around 6500 while squeezing deposit assets up from $3 trillion to about $10 trillion.

The weak banks being gobbled up by the strong is making the players left fewer and stronger. On top of that, not all commercial banks get this interest from the Fed, just the ones who are Fed member banks. You have to meet certain qualifications for that, and only about one out of three are member banks. This federally guaranteed largess, being funneled into select banks, is perhaps one reason why the fast growing "regional champions" are doing so great the last couple years. The Trump effect is looking to amplify all this. So we're seeing the post election jumps in these stocks.
 
I have been very negative on banks in some of my other writings. Have I changed my mind? Well, banks are like Italian families. Some are involved in the mafia and are neck deep in nefarious global doings. And some families just like toughening up their kids as they raise them, like Frank Barone of  Everybody Loves Raymond. They're all tough Italian families - but there is a huge difference in the mortality rate. It's the big global banks I am avoiding. There is a vast difference in the growing U.S. regionals run by tough, smart people, and the big banks drowning in derivatives and bad debt.

But do we want to buy banks into what appears to be a down debt cycle? The gloomy side of banking is centered around the commodity/junk debt problem that I wrote about in my 2015 article "The Debt Cycle And Rhymes of Lehman Brothers". In that article last year, I said of this gloom,"Personally I suspect this lopsided view of next year's stock market will be wrong" and I pointed out that "history has seen stock and debt markets act independently before, and next year [2016] may well be a case of that (hopefully) as was the year 1980." And I made this obsevation:
There we saw a nice climb for stocks even though we were entering the weak economy of '80-'82. The debt cycle was down as with any recession, and in fact snowballed into the Savings and Loan Crisis of the '80s that eventually saw one third of these banks go under! ... 1980 was an election year as is next year. To the extent you believe market forces are politically controlled, you have to put those forces all to the upside for 2016.
After the earthquake in Washington November 9, you must suspect, as in the early '80s, that we could see a down debt cycle with an up stock market, including the best run regional banks not being destroyed by debt.

Enter Bear State. It's a trick to find them before they have done big climbs and attracted attention. I offer Bear State Financial as such a find. It is a Fed member bank. Although it is obscure to say the least, it has started on a growth track being orchestrated by some most able growth people on the planet. It was formulated as a dramatic reorganization of a struggling bank, First Federal of Harrison, in 2011. A corporate raider restructure was done by one Rick Massey. As the Bear State Financial website describes it:
On May 3, 2011, Bear State Financial Holdings made a $46.3 million investment in the Company to recapitalize First Federal Bank. Company Chairman Richard N. Massey led the Bear State group, which brought a new management team to the Bank. In June 2014, First Federal Bancshares of Arkansas, Inc. changed its name to Bear State Financial, Inc. (NASDAQ:BSF). Bear State Financial is the parent company for Bear State Bank.
In the Form SC13D (Statement of beneficial ownership) filed May 11, 2011 in conjunction with this $46 million "investment" in First Federal, it's clear it was a one man takeover by Massey. The name officially changed from First Federal with ticker FFBH to Bear State Financial with ticker BSF in June, 2014. The name Bear State is for all the black bears in Arkansas.
So how has this heavy handed takeover worked out so far?

 

Not too bad. Overall, there seems to be a turn into fast growth taking hold.

These results, as nice as they are, may not be the star attraction here. It's the Board. The Board of Directors for Bear State is an intriguing mix of success and power with Little Rock's movers and shakers. The Stephens Group, a diversified investment banker, officed in Little Rock, is the largest brokerage outside of Wall Street, New York. It has had a strange, bipartisan habit of rubbing shoulders with presidential power ever since Jackson Stephens attended the US Naval Academy and became friends with Jimmy Carter. He later became financially involved with his administration. Then the "king maker" was a big backer of Reagan in the early '80s and has been given varying degrees of credit for installing Arkansas Governor Bill Clinton in the White House.
Jack Stephens epitomizes winning friends and influencing people. The football field at the US Naval Academy is named Jack Stephens Field to honor him. He underwrote the initial public offering for Wal-Mart Stores. Wal-Mart is now the largest company in the world by revenue. The Stephens Group also had a hand in building Tyson Foods and Alltel into giants. Alltel started in 1943 putting up telephone poles in Arkansas. By the mid 2000s, Alltel operated the largest network in the United States by area. Then Verizon gobbled them up.

Stephens and friends know growth. As the Wikipedia write up on him states it:
Jack began to grow Stephens by providing private equity to many young growing companies, much in the way of the British Merchant Bank investing model, predating by decades the private equity endeavors of Wall Street firms. Jack's acumen as an investor was combined in remarkable fashion with his ability to form enduring personal relationships with his partners. Several generations of companies and business leaders came to know Jack as not only a smart investment banker, but as a loyal and reliable friend as well. Jack's influence grew well beyond Arkansas to the boardrooms of corporate America and to the halls of Washington D.C.
What does this Arkansas power connection have to do with Bear State? Wal-Mart and Alltel are old news with this bunch, What they seem to be into now are regional banks. Many of the growth stories in the regional banks are launching from here including Home Bancshares, Inc. (NASDAQ:HOMB) of Conway and Bank of the Ozarks (NASDAQ:OZRK) of Little Rock. If you peek at what these two stocks have done the last 5 years, you see HOMB growing four fold and OZRK five fold.

Bank Director, the premier bankers' industry magazine, does a yearly ranking of banks by small, mid, and large size categories, and OZRK has held the number one ranking in the nation for the last four years running in its small, then mid size categories including its current number one rank in mid size. They rank the 300 best run banks out of about 6500 banks in the country. That's the top 1/2 of one % - it's an honor to even be in their ranking list.
In the SEC Prospectus filing for the 1997 IPO for Bank of the Ozarks, Stephens, Inc. is the chief underwriter. In this filing, it is amazing to read that the two main banks that came together to form Bank of the Ozarks were headquartered in Jasper, population 498, just a few miles south of Harrison, and Ozark, population 3525, just a few more miles south of Harrison. Wal-Mart's ground zero was actually this same Harrison.

After setting up shop in Rogers, AR, where I live, Wal-Mart's first store in 1962 labored as a local loner for almost 3 years. We didn't even think of it as a chain. Sam Walton himself described it in his book as an "experiment", trying his lower cost mass merchandising in a modest, unappealing building just to see if the concept itself would work. There's an antique mall in there today. I shop there.



They put gigantic "W A L - M A R T" letters on top - the first appearance of this name on a building on the planet. In 1965, when this store proved very popular and profitable, the Waltons began the real building and expansion blitz we know of today, opening over 20 stores between 1965 and 1967 - starting with store #2 in Harrison, population 13,000. The Rogers "store" was still in the flea market as the building spree blasted into the '70s. Stephens took the company public in 1970.

What is it with Harrison anyway? I go over there a lot, and it's beautiful, but it's a real cultural throwback. There's a joke that says if the world were to end, you'd want to be there, because it would end 30 years later. Why does the business elite of Little Rock like launching some of Wall Street's biggest growth behemoths from these backward hills? Is Harrison an alter ego of New York - the phantom Wall Street of the Ozarks?
Will The Phantom Strike Again with Bear State? Little Bear State is also from Harrison. Bear State could now almost be considered a branch of the Stephen's Group. For years before 2011, First Federal was thought of as a "Stephens controlled bank". And this piece from the Bear State website back in 2011 suggests a Stephens orchestrated rescue of First Federal in describing Bear's new board. Both Massey and Scott Ford had been key chiefs at Alltel, and Massey was Managing Director at Stephens for six years.

With Home Bancshares Inc. and Bank of the Ozarks, the role of Stephens was the public launch of those companies. With Bear State in 2011, there was no public launch, First Federal was already public. But Stephens supplied the board leadership that has essentially launched a new company. As promising as Bear State is, you see almost nothing being written about them. Bear State is already on a buying spree as detailed in this story published at Talk Business and Politics when they acquired Metropolitan National Bank last year. This was a quantum leap for Bear State as the MNB banks headquartered in Springfield, Mo. pushed total assets up by about a third, and breached the Missouri state line.
 
Already, a scant four years from reorganizing a failing bank, they are into the elite Banking Director list at #127 in the small category - a remarkable feat in and of itself. So could this tiny backwoods regional bank be another embryonic Stephens growth beast springing from the Arkansas Outback?  Watching the green Bear State signs popping up in front of banks around here is starting to remind me of the very early days of the Wal-Marts, taking first steps in and around Harrison and here in Rogers, then creeping over the state lines of Missouri and Oklahoma with zero national attention.