It is now time to show you how I find my investment specialisations and companies. I will introduce you to different ideas and opportunities from which you can glean your own investment opportunities. These opportunities are everywhere, but you must have a trained eye to see them. You have to learn to see what is invisible to the masses. There are investment opportunities coming across your path every day of the week, but you are currently blind to most of them. You have to think outside the mental box that we are all taught to think within as social beings. You are taught from a young age by the media to consume, be silent, and eventually die. Instead, as an investor you must become a saver and a keen observer of your political, cultural and economic environment. You must become a visionary who can see into the future. Every single thing you purchased this week could be an investment opportunity for you. After all, you bought it so how many others were doing the same! Below are just a few ideas to help jolt your thinking and open your eyes to the abundance of opportunities around you. Once you train your mind to see them, you will be like Neo in “The Matrix” movie, who could observe the green lines of code stream past him while everyone else was blind to it.
If you are not an Australian I apologise up-front for this chapter being so Australian-centric. By the time you finish reading you will be tired of references to Australian economic conditions, investment opportunities and listed companies. I can only speak from my own experience, but I have travelled extensively and lived overseas for over 4 years. I am very confident that you will be able to take the general principles from what is written below and apply them to your country-specific situation. The world is merging rapidly and a single international youth culture is emerging for the first time in history. People, capital, trade and investment opportunities are more international in nature than even a decade ago. So read on and keep thinking of how the situations I mention translate into your particular investment circumstance.
If you would like to read in more detail about the opportunities for investment that surround you every day then I suggest the classic book “One Up On Wall Street” by Peter Lynch. Peter was the manager of a top performing managed fund for many years and in his book he shares how he found many of his investment opportunities by carefully scrutinising every day trends.
1. Technologies That Will Transform Us
Enormous wealth has been created from the technological advances of the last hundred years. Think of the medical, communications, chemical, agricultural, financial, computing, space, energy and transport breakthroughs you have witnesses just in your lifetime, or just in the last 10 years! Mobile phones, apps, personal computers, the internet, digital phones, nanotechnology, ATM’s, airbags, fibre optics and hybrid cars are a few on a list of thousands of everyday items we lived without a mere 20 years ago. Each of these will have made a lot of people enormously wealthy through the discovery and commercialisation process.
The speed of technological change is actually accelerating so if you are an average citizen like me, you can still profit from new technological developments, especially if they are developed outside the big corporate world. The modern commercialisation process usually gets the best of the crop of new ideas to the stock market very quickly. Budding technological entrepreneurs with a head full of ideas need a bucket full of money to reach their dream. You, as an investor have the cash, but lack a big-shot idea. A stock market float is the marriage between you and these nerds. After the initial float, the broader market decides if it is a good idea. Hitch a ride on these growing companies. But be careful, for every great and commercially successful new technology there are many failed attempts. In fact it has been my painful experience that most of them flop, so be very careful when investing in this space. There is no need to fear being left behind in this investment niche, as the rate of technological development is accelerating and a new technology company will float every other week. But do be careful not to get in too early. The closer the new technology is to commercialisation, mass production and profit when you invest, the less risk you face. Personally, after the money I have lost on technology stocks, I would wait until I saw positive cash-flow from these companies because they can have a shocking cash-burn rate when still perfecting their product. It usually takes twice as long and four times the money to get a new piece of technology to market than what the prospectus initially tells you. All of their figures are only guestimates.
I now prefer not to invest in new technology as I am not a quick adopter of gadgets. This is not in my comfort or knowledge zone. However, if you are alert to this aspect of modern culture, if you have an avid interest in new gadgets, and if you love to read up on the latest and greatest developments then you may have an investment niche staring you in the face.
2. Technologies That Solve Big Problems
Did you know that there is an army of government and private researchers out there trying to find an answer to climate change, future energy supplies, future water supply and global security, to name a few. These are obvious areas for investment ideas. Because I am a global thinker and early adopter of new economic paradigms, I often see investment opportunities in this sector. A classic example that comes to mind is Dyesol (DYE). Dyesol floated on the Australian Stock Exchange (ASX) in 2006. It aims to supply all the chemicals needed for the emerging solar office window market. Advance Braking Technology (ABV) has re-invented the braking system for trucks so there is no leakage of break-drum dust to the environment. There are hundreds of other emerging ideas just in Australia. I find them in newspapers, magazines, web sites and through friends. Some others recently dug up include a company that can produce 750kg of grass from a 12m shipping container per day, a company that can take water out of air and a company that can turn diesel engines into natural gas engines with the addition of a computerised black box. Ideas are everywhere. Keep your eyes open and you will find them every week.
3. Emerging Global Shortages
An apology up front: I love emerging shortages in commodities, as this is where I specialise in the precious metals sector. However, I do not enjoy looking at global shortages in the area of food as I am aware of the great pain it brings to the two billion poor who spend over 50% of their income on food. Understanding global shortages comes from lots of big-picture reading on international trends. As a rookie stock investor in 2003 I read of an emerging shortage of nickel, then, natural gas, gold, uranium, oil and silver due to the China boom. My antenna for emerging shortages has been in overdrive ever since! Unfortunately I missed the zinc and iron ore booms. I took a caning on an emerging natural gas shortage in the USA that never turned up when shale gas emerged to save the day. So it doesn’t work every time! As I write there is a graphite and rare earths shortage emerging. My strategy after finding the shortage is to simply find a quality junior emerging miner in a commodity with an emerging shortage, park some funds there and wait for the crowd to turn up. I keep a very close eye on China to make sure I will know when this global commodity shortage will end. The experts thought it would end in 2005, then 2006, then 2008 with the Global Financial Crisis. It is still going and should continue for a good while yet.
Emerging energy shortages will be a consistent investment theme for many years to come, regardless of the emergence of shale oil in the USA. When it is written, the history of the first half of this century will include a large chapter about energy shortages and the transition from fossil fuels to renewable energies, and the transition will not be pretty. Bingo! Here is an investment bonanza for the few with their sharpened mind. We have already seen the first oil war for the century in Iraq. Then there was the uranium market spike. The liquid natural gas and coal seam gas market is also going ballistic with LNG terminals popping up like mushrooms as the first truly integrated global LNG market emerges. Oil had the first of its multiple tops in 2008. All this happened before we reached the end of the first decade! The Australian stock market has literally scores of companies scrambling to meet these new needs.
Another looming shortage is young workers in western countries. The workforce is aging and we have decided that having a flat screen TV and a smart phone are cooler than having kids. Companies that specialise in labour hire, skill development, international recruitment and retraining are already doing well. Open your eyes and look beyond the pathetic “bread & circuses” viewing on commercial TV or Youtube. Who is your company using to help them find new workers? Are they a listed company? Have they got a history of profit growth? Do they have a great manager? Will their stock price grow in the next 12 months? This is the sequence of questions you can ask of any looming shortage.
Shortages are also the reason why people whine about higher prices all the time at BBQ’s and in supermarket check out lines. Listen to them, find the source and invest in those companies who are about to come up with a solution to the problem. Ah, I love capitalism! One mans problem is another’s opportunity.
1. Countries Emerging From Communism or Dysfunction
The fall of the “iron curtain” and the resulting economic integration of the former European communist countries in the early nineties set off a shock wave that is still resonating around the world’s economies and financial markets. Not only did the former Soviet Union emerge, limping badly, into the western way of thinking and doing business, but all sorts of dictators and sundry left-leaning scoundrels lost their nerve and started opening up their economies. Specifically this has meant the opening up foreign investment restrictions, adoption of more company-friendly legal structures, entry into the EU or the World Trade Organisation, the formation of new trading blocks, bilateral trade agreements, huge increases in capital flows and increased trade in intellectual material. I can sum up the above list in one word: China!
How this colossal economic tsunami has changed our lives can be seen in the number of people you know personally who are now working and living in these countries, or the number of them living in your city. My brother has been a geologist in Kazakhstan for 15 years since the break-up of the former Soviet Union. He describes these countries as similar to the wild west of America; the locals don’t know what is under their feet. He finds another mineralised deposit every six months or so. I was in Almaty in 2012 to visit him. The city is booming on the back of the China story.
Other countries in Africa, Asia and Latin America are also emerging from flirtations with socialism and trying to entice foreign investment to kick start their economies. Look at how Brazil has tamed its inflation bogyman and is growing. Be careful though. An Australian exploration company spent millions proving up a base metals deposit in Iran between 2004 and 2006, only to see the government revoke its licence to operate. The culture of jealousy is still rife, corruption is huge and the risks high in certain parts of the developing world, so be circumspect and do not take big bets on those companies you see moving into these countries.
2. Countries Lowering Red Tape
Did you know it is easier to get a mining project through the government in Mexico than it is in Australia! It is the same for a host of countries including Chili, Peru and Cambodia. As part of their entry into the North American Free Trade Association, Mexico had to adopt western legal procedures for the development of mining projects and decided to do it even better than the west. Here in Australia we have recently developed a minefield of legal and environmental and taxation obstacles to the development of a mineral deposit. Look for countries which are hungry for western investment dollars and you will find countries that are lowering their red tape hurdles. Shrinking red tape is like a welcome mat to a company looking to manufacture more cheaply offshore and so get the edge on its competitors.
3. Countries Beginning Their Industrial Revolution
There are currently three phases of economic development that we have seen in human history. The agrarian revolution, the industrial revolution and, now we are in the information revolution. During the agrarian age land was the most valuable asset. During the industrial revolution factories were the most valuable asset, while today intellectual property and knowledge are the most prized assets. When Britain worked its way out of the agrarian age and into the industrial revolution it not only caused social dislocation and hardship, it actually improved the standard of living, educational and health outcomes for its people. This process is now being repeated all around the world. Vietnam, china, India, Thailand and a host of other countries are one huge construction zone as they work their way through their own industrial revolutions. Money is flowing in. Incomes are rising. Infrastructure is emerging. People are working furiously. They sense this is their opportunity to finally get ahead financially. Asia is an exciting place to visit, but bring a pollution mask. For the brave investor, exciting opportunities exist in many of these countries. Perhaps the safest option is to invest in western companies who are about to move production to these countries. Their costs will shrink and profits rise significantly.
4. Countries Opening Up To Competition
Nationalism is a very strong deterrent to free trade. The Australia of today is vastly different from the Australia of the 60,s and 70’s because of the wise decisions taken by our governments to open up the economy to foreign competition, sell off a large number of government run corporations, and to reduce import barriers through the 80’s and 90’s. We originally created these barriers to foreign competition as a politically expedient exercise in protecting inefficient but politically powerful local industries and workers. We are a far richer and more transparent nation because of our move away from the protection of local industry.
Australian companies can compete with the best in the world in a large number of industries now because of their exposure to foreign competition within Australia. This in turn has helped our more progressive companies focus their energies on creating export income. Some 25% of Australian companies now export. Look for local companies in your area or country who are experiencing consistent earnings growth from exports. Vehicle component manufacturers, wineries, exotic food producers, software developers, communications specialists, financial intermediaries, education and giant catamarans are just a few of the industries that have blossomed with the opening up of our economies and the economies of those we trade with. Look into the nuts and bolts of every free trade agreement your own country signs with another country and there may be an investment gem being overlooked by the majority of investors.
5. Countries with Falling Inflation
In the upcoming chapter titled “Inflation” I spell out in detail what inflation really is, how it adversely affects the investment decision making process, and how you can profit from it in the years to come. Simply put, inflation is the continued dilution of the money supply by the government and banking authorities. The higher the real inflation rate, the less disciplined the government and the greater the people’s distrust in that government’s economic management. Anywhere in the world where a nation is progressively reducing its inflation rate will be a good place to invest.
Let’s take the USA as an example. If you subtract the inflation rate from the Dow Jones Index (the Dow would have to rise faster than inflation for it to register positive growth), then the stock market in America went backwards from 1965 until 1982 by about 60% even though the raw index stood still. Industrial stocks are lousy to own during times of high inflation. By 1980 the US inflation rate was running at over 10%. Most of this inflation was caused by the abandonment of the gold standard, with its built-in fiscal discipline. Paul Volker then took charge of the Federal Reserve with a mandate to break the back of this politically and economically crippling rate of currency dilution. To do this he raised interest rates to 15% at which point credit creation stalled. People just refused to borrow at these interest rates. The recession that followed around the world was the only recession we had to have. All through the 1980’s and 90’s inflation continued to slowly fall in the western world. In Australia I watched it fall in fits and spurts without the faintest idea what was causing it. The long boom in the US stock market that began in 1982 ran out of puff in 2000 when inflation took off again. Looking back, even the crash of 1987 was just a blip on the radar screen.
Inflation is bad for business. It squeezes input prices and reduces profits. Price rises have to be passed on and eventually sales drop. Real profits fall as the value of dollar earnings are diluted through excess credit creation. Falling inflation, on the other hand, reduces input costs and companies can fatten the bottom line before passing the efficiencies on to consumers. Real profits rise as companies can secure raw materials and funding at ever cheaper rates.
Look for countries where inflation is falling, there you will find a bonanza of investment opportunities. In these countries you should invest in industrial companies as they do well from falling inflation. When inflation begins to stir its ugly head again it is time to go for hard asset investments, such as commodities. The value of these will keep up with inflation. As you already know now from reading the chapter on inflation and tax, we are in the middle of a 15-20 year secular inflationary era. So, many of the best opportunities of this decade will come from investments that hedge against inflation.
SECTOR AND INDUSTRY OPPORTUNITIES
1. New Industries in Growth Phase
Fortunes are made with tomorrow’s technology, careers are made from today’s technology, and jobs are made from yesterday’s technology. To make a profit investing in other peoples ideas you have to be looking at industries that are young. These are full of youth and energy, and have managers with vision and entrepreneurial spirit. Think of the early years of shipping in the 1700’s, railways in the 1800’s, radio in the 1930’s, chemicals in the 50’s, automobiles in the 60’s, aviation in the 70’s, the personal computer in the 80’s, the internet in the 90’s, mobile phones in the 00’s and apps in the 10’s. Each of these industries followed a common growth path where they were birthed, incubated, launched and grew over a generation or two to become ubiquitous. Even the venerable Forest Gump did well buying a fruit company called Apple early on!
The ideal time to invest in a new industry is after the teething problems have been sorted out. From this point there will be a long and uneven phase of growth where the uses for the technology grow, sales increase, markets surge, consumers are educated, costs plummet, profits emerge and then explode. This phase often bubbles along under the radar of most people until a tipping point occurs. Then suddenly the whole technology is main-stream and everyone has to get a part of the action. For a great illustration think of the phenomenal success of I-phones from when they were launched on June the 29th 2007 until now. Cosmetic surgery, solar panels and electric bikes have also enjoyed amazing success in recent years. Many companies have increased their value 5, 10, or 20 fold from infancy to maturity. I have seen it happen with regularity in the mining boom: Independence Group rose 50 fold from bottom to top. Bolnisi went up 10 fold. Silver Lake is up 15 fold from its float to the present day, with more to come. Sirius, the bolter of the group, shot up 40 fold in just 2 months after a major nickel discovery in 2012.
2. New Revenue Streams in Old Industries
Perhaps the telephone industry is the shining example of the rebirth of an industry due to new technology. Telco’s were old-world and old-hat until just a few years ago. Very few saw the revolution coming, even in the early nineties. One company that did was then involved in the European rubber and TV manufacturing industries. Under the visionary leadership of Jorma Ollila in the early 1990’s it boldly embraced change and the rest is history for Nokia, until the I-phone came along!
Water supply used to be a tired old industry filled with government inertia and ownership. Within a few years of the turn of this century water security has become a matter of life or death for major global cities. Water is now a hot industry. Desalination plants are built and owned by someone, why not become an owner yourself.
Another crisis is about to emerge in global food supplies. Food was a boring industry for investors until recently. Then, when the global string of droughts all started biting, the world stopped feeding itself. Since early in the new century we have been raiding the global pantry to keep our tables stocked. Adding to the dilemma is the conversion of food to fuel. There will be many opportunities in this area of food security investment in the years ahead. I have tackled this problem myself by converting my back yard to a small scale farm. We now have chooks, organic produce that is fresh and our supply is becoming more secure. My brother is a wheat grower and has recently bought the local private 10,000 tonne silo complex so he can better secure his future by becoming a trader as well as a grower. Any company that is embarking on vertical integration program is worth a look at.
3. Industries Where Your Country Has an Advantage
David Ricardo was the first to give the world a detailed understanding of comparative advantage in 1817. He explained that some countries have a natural competitive advantage in certain industries. Think Italians and fashion houses. The Italians have the critical mass of designers and marketers to dominate the world. The USA dominates semi-conductor manufacture, and Australia dominates…surf fashion! All three giant global surf brands: Billabong, Quicksilver and Ripcurl, originated in Australia. We were the natural birthplace for this industry and we were able to keep two of the three brands onshore.
No other country in the world, with the possible exception of Canada, can match Australia in the field of mining. We have a long and colourful history with this industry. Then along came the Mabo Indigenous land rights decision. Shortly after this court decision Rio Tinto sacked 400 geologists in a single day, my other brother among them. This landmark court case, along with the flooding of the local labour market with unemployed geologists, forced many exploration companies to stop development of local projects. They now had to look off-shore for growth. In time, the Mabo decision turned out to be to our national advantage. Australian mining companies started turning up in odd places with very promising projects. When the mining industry’s fortunes turned up in the early 2000’s, our miners were set up with deposits all over the globe. Talk to any two foreign geologists in an overseas mining province today and one of them will have an Australian accent talking to his Canadian mate. This new global perspective has been fattening the budget of our state and federal governments handsomely these last few years. It is no accident that the Australian Stock Exchange hosts the world’s biggest and second biggest mining companies in BHP Billiton and Rio Tinto.
There are other industries too where Australia has a competitive advantage. One of the finest is the financial services industry. In 1986 Australia’s then Prime Minister, Paul Keating made one of his rare visionary decisions. He established compulsory national superannuation laws that required workers to start saving for their retirement with designated private pension schemes. This nationally-mandated private savings industry mushroomed to over 1.3 trillion dollars by 2012 and represented at that time some 25% of all institutional savings in all of Asia. It is still growing handsomely today. At present growth rates, Australia’s superannuation pool will represent over 50% of all Asian institutional savings by 2020. This industry employs hundreds of thousands of people and, combined with the banking and insurance industry, represents 8% of our economy. The largest single block of investment in the Australian stock market comes from the superannuation industry.
With an industry so large you could be forgiven for thinking that all the growth opportunities are over. This is far from the case. It has a guaranteed supply of funds, and we now export this home grown expertise to newly industrialising countries to our north that are setting up compulsory retirement schemes. Ever larger pools of cash are being parked offshore for growth, and in so doing, Australia’s economy is being further knitted into the economic fabric of Asia. There are many listed investment vehicles on the stock market that seek to lure super savings from institutions into investment projects both here and overseas. Why don’t you check them out?
Small investors can profit handsomely from these institutional investors in another unexpected way. One of the marks of a small listed company having made it to the big league is to have the share registry start to fill up with institutional investors and managed funds. Small companies who grow to reach the top ASX 200 index start to attract the institutional pool of funds that do not invest any further down into the murky depths of the small-caps and micro-caps. Because of their deep pockets, this arrival of new money gives a free kick to the stock price of any company that makes it into the top 200. To have a company you own slowly grind its way up from 30c to $1.50, and then double in no time, because it is now on the radar of the institutions, is a heady experience.
1. The Strong Company That Stumbles
When a good large-cap company makes a few mistakes it can be punished severely by short-term traders who do not look beyond the magic 12 month time frame, and these short term thinkers are often the institutions. Their short-sightedness is due to their need to produce quarterly earnings figures. The stock price plunge for a large-cap stumbler might be in the 20-40% mark. The problem with the new price is that it carries a built-in expectation that the future profits will be at the new subdued level. This is usually a false fear. The current year’s profit may be affected badly, and then it will be back to business as normal. Expect a quick turnaround from these stumbles on most occasions. Buy when the worst of the news is in and the price has just begun to turn north again. Don’t try to catch the “falling knife”. Don’t try to anticipate the bottom. Wait until the low is confirmed on the charts. When it starts recovering though, it will rise quickly.
2. Follow the Successful Entrepreneur
People grow assets and expanding assets will lift a company’s stock price. Assets do not grow good managers. The most valuable asset a company will ever have is the chief executive officer, the CEO. Boards have their place, but to have a CEO with vision, experience and giftedness is rare. We usually call them entrepreneurs, which is a French term that means someone who originates, organises and takes responsibility for the success or failure of an economic venture. They are usually born not made, and are often the naughty kid in school who is always questioning the system. I know as I used to teach them!
Entrepreneurs do not often beg for positions in companies, they usually take them. They see gaps in markets that the rest of us would never see in a thousands lifetimes. They imagine cities and suburbs and create them. They invent systems of doing business that were never thought of before. They think years into the future. The rest of us buy from them when they create. They are the Walt Disney’s, Warren Buffet’s, Henry Ford’s, Richard Branson’s, Dick Smith’s, Andrew Forrest’s and Steve Jobs’ of the world. These men and women can build a company from scratch, move on and repeat the process as many times as they wish. They might not have been the smartest kid at school but they would have been one of the most determined and independent.
Entrepreneurs are a lot like scientists. They perform experiments to confirm a hypothesis that has been bouncing around in their head. The difference is that the hypothesis is economic, not scientific. If the experiment is a success, they are rewarded by the community with a fist full of dollars for providing a service that was much needed or wanted. If the hypothesis is wrong, they go broke. Many will go broke several times and this is they way they learn. The best of them will find their way into leadership positions in listed and private corporations. They create new companies, they place themselves in companies that suit their plans, or they take over companies that have the corporate shell that suits them. They also dominate the board of any company they are on as they are not often given to consensus decision making. They can naturally see further into the future than the other board members. They usually own a lot more of the company than the rest of the board too. They are old fashioned business owners in the new world of corporate managers. They rarely have a flashy head office and lots of corporate toys. They are builders of wealth, not consumers of wealth.
Once an entrepreneur has a successful track record, investors will follow them from company to company. Join them and you will prosper too. A good stock broker is also an entrepreneur of sorts. They have the knack of being able to pick companies and business plans that will float well. If a broker has a track record of bringing floats to the market that have gone on to multiply in value, consider seriously about investing in their next float. They will protect their reputation by only bringing into the market the best offers they find. To participate, you will have to become a private client of the firm.
3. Companies Undergoing Financial Reorganisation
The “Dogs of the Dow” is a great contrarian investment tactic. It is an adaptation of the saying; “buy straw hats in winter and gumboots in a drought”. I added the second half of that myself! The “Dogs of the Dow” concept takes the one or two companies in the elite American Dow Jones Industrials Index with the lowest PE ratio at the end of the year, invests in them for one year, and then re allocates the funds to the next one or two worst performing companies in the index the next year. The logic of this tactic is that these companies are huge, will definitely not go bust, and are suffering under bad management decisions. Markets punish poor managers so the likelihood of a company turn around in performance in the next year is high. Followers of this investment idea continually out perform the Dow Jones average.
If you can see a company in financial stress and are comfortable with the risks involved then this is one of the most rewarding investment avenues open to you. Even mildly underperforming companies can see their stock price swing wildly in a given 12 month period. There are risks to this way of investing. Lots of due-diligence must be performed because it is being marked down for a very good reason. Make sure it is a rebound story and not a death-by-debt story
4. Companies Spinning Off Valuable Assets
Companies often spin off divisions of their enterprise to more fully realise the value of these assets. Mining companies will spin off emerging deposits, retain some ownership, take the cash and use it to develop their core assets. Industrial companies often take other companies over and part of the new entity is not a core asset to the corporate predator, so it is offloaded to the market. BHP Billiton unloaded its steel division several years back and Bluescope Steel (BSL) has been prospering ever since. Pacific Brands (PBG) and Repco (RCL) were unloaded from Dunlop Pacific. So was the now world famous Cochlear Limited (COH), which I know they would love to still own as they sold it for a few dollars and it is now worth around $80.00. In 2006 Coles Myer spun off the Myers chain of department stores to private owners and they immediately prospered without the headache of being stuck with middle management level vision. Westfarmers Limited (WES) subsequently acquired the Coles supermarket (CGL) side of the company and sold off several unwanted assets. The list of spin-offs is endless and will continue for as long as capitalism, trade and money exist, which I believe will be quite a long time.
5. Companies Tuned to the Current Cycle
Even though the 15-20 secular inflation/deflation cycle will only occur twice during your entire investing lifetime I feel that I need to explain it a little more it as it is so important for individual investment decisions. These multi-decade trends are formed by rising and lowering inflation and interest rate cycles. The last deflationary cycle, which is really a gentle reduction in inflation rather than outright deflation, finished in the year 2000 with a great top in PE ratios that is still in place 13 years later as global stock markets grind sideways to chew up the excessive PE ratios of the last era. We are now in an era of rising inflation in currencies and commodities. We do not see this inflation turning up in government figures or interest rates because they are manipulated, as I explained in the chapter on inflation. Yet it is there if you have eyes to see the currency debasement on a scale that is unprecedented in the modern era. Equities are now in a secular bear market that will end sometime late this decade. A particularly succinct way of looking at this super-cycle is to do a Google search for the “Dow-gold ratio”. It is the best sine wave I have ever seen in financial markets.
In the decades leading up to the beginning of the 2000 change of cycle I was constantly on the wrong side of the inflationary/deflationary investment road and I got nowhere financially. Once I parked myself on the friendly side in 2003 I have never looked back. Get this understanding wrong and it will cost you up to two decades in bad decisions and underperformance.
Within this super-cycle is the shorter 6-9 year business/recession cycle which is created by central banks manipulating interest rates. It pays to invest in financials, builders, materials and infrastructure companies as a recession comes to an end, then to go into the safer food and utilities companies when the economy is just past the peak of the cycle. Under sound money management of an economy this cycle should not exist, but with fiat currencies dominating the world, the 6-9 year business cycle seems to be a fixed feature of our lives. Instead of suffering through it as a consumer paying higher interest rates or losing your job in a recession, profit from it through wise investment decisions.
6. Companies Coming off Their Deathbed
The recession of 1990-91 was particularly savage in Australia. Unemployment was hovering around 10% and the silly lending practices of the late 1980’s, when greed was good, were biting the banks hard. Westpac, one of the big four banks, nearly went under and dropped to a price around $2.50. When he sensed the worst was over, the late Kerry Packer swooped down and picked up enough of the company to get himself a seat on the board. The banking community was outraged while Packer was laughing all the way…to the bank! A year or so later, when the recession was over, he had moved on with a handsome return on his investment after selling at around $4.00. In the heady days of the late eighties he sold Channel Nine to Alan Bond for $900 million and then bought it back again in the 1990 recession for half that price. He pocketed hundreds of millions from each deal. In the late 90’s he repeated the whole exercise again with Crown Casino.
So the lesson is that when companies come close to death, don’t go near them until a large player swoops who has a lot more experience, money and inside knowledge than you. Then, and only then, is a good time to invest. Death-bed companies are hard to find in a boom, but with a recession there is a paddock full of them to choose from. However, never try to pick the bottom, leave that to the fools. I have personally experienced the nightmare of watching my investment drop to exactly zero when a company did not get off its death bed until it was put in a coffin.
1. The Depression Generation
Investment success can be found in the needs of the elderly. They went through the Great Depression and World War II and are in the process of passing away. The have enormous health needs and they also have enormous wealth. They were the last generation to save a lot and spend a little. This is because their childhood was one of deprivation and lack. Security is everything to these people so they have saved up a big nest egg. They are now providing the greatest generational transfer of wealth in the history of western nations, and it will go to the baby boomers! There are investment opportunities here for the finely tuned antenna. Health care is the obvious one. Then there are nursing homes, funeral needs, estate planning etc.
2. The Baby Boomers (1946-1964)
Demographic trends effect markets more than we will ever realise. Because we live in the prevailing culture and it only moves one day at a time we often do not have eyes to see the cultural changes slipping past our door. Spending patterns peak when people are in their late 40’s. I should know, in 2006 I was 46 years of age and money was being sucked out of our bank accounts with a vacuum cleaner! In every wave of history the generation that forms a bubble like the boomers did will dictate political, religious and economic trends for that culture. With the peak years of spending coming in the late 40’s of a person’s life, and the peak of the boomer cohort being born in 1960, it is no accident that the western economic machine peaked in 2007. What does this say for the future? Know the spending trends of this demographic and move your investment decisions to a place where they are just starting to arrive.
I know form my experience that the baby boomers are desperate for a secure financial future. This is because most of them are spend-thrifts and leisure-seekers who have not prepared themselves well for their old age. Harley Davidson dealers are making a killing from them as we speak. Their rampage into the housing market early in the 2000’s was one very obvious move to secure their collective financial future. In the process they priced “Generation X and Y” out of the home market in Australia. This in itself is creating an alternative market in unit developments.
Health preservation will be a rising concern for the boomers. The typical person costs the community more in health costs in their last ten years than in all their years before that. With baby boomers comprising such a large component of the population they could sink the national budget if we are not careful. Wise investments in this area will do very well. Seek and you shall find! The Australian health system’s cost base is growing at over 7% a year, way above all tax growth. When the disaster begins in earnest, there will be a hundred ways to invest in health service companies that are gunning for a share of this monstrous pie, and trying to save the government a dollar in the process. Nutritional supplements, alternative medicine, gym memberships, health clubs and anti-aging products are all a growth market for this demographic. They want to live for ever, and indeed many will live into their 90’s. That thought is what scares the rest of us, especially the government!
In terms of employment trends the signs are ominous. Approximately half of all teachers, farmers, nurses and police in Australia will retire between 2010 and 2020. There is a looming crisis in so many professions that any company which is connected to labour importing will boom. One in three adults will be over 50 by 2010 in Australia. Many will be taking time off, then returning to the workforce part-time, like I am.
Downsizing is also a popular move for these boomers, as is entertainment, comfort, divorce, travel and estate planning. Just look at the number of “grey nomads” on the road. Fleetwood Corporation (FWD) is a West Australian listed caravan manufacturer that has been riding this boom. The grey nomads need four wheel drives, insurance, a place to stay and a multitude of other services. Open your eyes to these patterns and you will begin to see many investment opportunities open up in front of you. But be careful, don’t go to where the action is now and the market is mature, think of where the action is obviously going to, invest your money there, and wait. A friend of a friend of mine has just started importing discount coffins for the boomers from China and is doing very nicely!
The boomers are a godsend to marketers. They are cashed up and ready to re-live their youth. This time round they want to do it in style. The big bands of the sixties all seemed to have reformed, Retro marketing is cool and boutique travel agencies are booming. The boomers all want to see the world one more time before it is too late. Look at the needs of the boomers, find out who is supplying them and jump on board. For more detailed information on demographics and its coming effect on the economic and religious world please check out my You Tube clip called “Future Demographics”, which is a combined summary of Harry S. Dent’s great book “The Great Depression Ahead” and insights I gained from “Operation World”, an encyclopaedic book on global religious developments. To the uninitiated this sounds like an odd combination of source material. However religion drives culture and culture drives economics.
3. Generation Y (1980-2000 the children of the baby boomers)
This is perhaps the first generation since Australia was settled by Europeans that will grow old poorer than their parents. These are the people who have such short time horizons that they can’t commit to anything over 12-18 months as they might just decide to go trekking the in Andes or cycling through Europe next year. The world is their playground. Their employment and business markets are global, not national. They are also very creative and entrepreneurial. These guys were the first casual employment generation. They are so used to casual jobs and full employment that they think nothing of swapping jobs or starting a business. What they lack in terms of job and family security enjoyed by their boomer parents they make up for in creative business skills. They are service oriented. Factory work would be alien to them. They are also an emotionally wounded generation. Many of them will never know the stability of a spouse, a family, children and a home. Others will drift from one relationship to another, from one job to another, from one career to another, from one continent to another.
This generation has grown up never having lived without faxes, mobile phones, voice mail, email, bottled water, pay TV, chat rooms, ATM’s, VCR’s, AIDs, ecstasy, working mums and terrorists. They were so media-saturated that they find it hard to wind down. They live life like it is a drop down menu. They are impatient and easily frustrated with life lived at a slower pace. They need to be entertained and life is all about having fun. They are pleasure and thrill seekers. They invented extreme games. They are also adaptable and innovative. They take up new ideas and technology with lightening speed. They see elders as equals unless they have actually done something worthy of respect. They are even reinvigorating the volunteer sector of society. Their parents, the boomers were left-leaning intellectual planet destroyers. Their kids are right leaning, soft-hearted, capitalist greenies. On the one hand the love their junk food and on the other they are into organic and alternative medicine.
Tune your ears and eyes to the needs of this demographic and it will only take days before you will begin to see opportunities staring you in the face. Webjet (WEB) rose from 5c to $1.40 in 4 years on the strength of cheap online air travel for the young and the restless. Online dating agencies are booming. Brand label companies involved in image marketing are feasting on the felt needs of Gen Y’s to belong to their herd.
WHEN THE CHARTS SAY “BUY!”
We turn now from the fundamentals of finding a good company to invest in to the technical of when to buy said company. As I have mentioned several times before, the “tide” is the general stock market and your boat is the company you have invested in. A rising tide will lift most boats so a good percentage of your final profits will come from overall market sentiment. With that thought in mind I would like to introduce you now to a group of technical indicators that will give you clues that a major bear market is about to finish and a bull market begin. If you are aware of these indicators and have had the foresight to set some capital aside you can mentally prepare yourself to enter your chosen company in the sweetest spot of all.
During the global financial crisis I saw good mining companies slaughtered by the rampant fear raging through the global markets. Some have described it as the worst conditions since 1907. I have read that we came within a week of a total collapse of the global banking system. This would have seen most banks close and half the developed world’s workers unemployed within a month. Henny Penny’s sky really was falling. I can still vividly recall one company called Medusa Mining which fell to 37 cents. This was its cash flow for that year and it had no debt! Its Price/Earnings ratio was close to two! Alas I didn’t have any cash to buy in and I was not about to break my cardinal rule of never borrowing to buy stocks. That crash was very rare for the market as a whole, but mini-crashes do occur quite regularly. That is an extreme example but if you can wait until the market trips over you too can buy in at great discounts to average prices. Just last year in 2012 one of my investments was selling at 62 cents in the middle of the year and six months later it was $1.59. Timing is everything.
Markets are simply the collective actions of millions of people, so charts and indicators of national stock markets are just barometers of what everyone else is thinking and feeling. They indicate mood. So here are some tips for taking advantage of collective depression. These days a plunging stock market in your country will probably coincide with one in my country so you should be able to see confirmations all around the world of major changes in trend. I will not be using charts here to explain the ending of a bear market as you can simply Google them in a few seconds, so I will try to be as clear as possible. I will also be doubling up a little on some of the lessons you learned in the chapter on charting but, if you were like me, it probably didn’t sink in all that well the first time and another look from a different angle will definitely help. All the indicators mentioned here can also be used to track individual stocks so you can use them to know when to buy your own cherished investment.
A typical bear market is one that has been dropping steadily and makes a series of lower highs and lower lows over many months. A major bear market will last about a year. Rarely do they last longer this is because the market drops much faster than it rises. They often start out by falling slowly. The descent then gathers pace as the economic fundamentals continue to deteriorate and smarter people sense that this downturn could last a lot longer than most people anticipate.
A glaringly obvious sign I look for when expecting a major market low very soon after a multi-month decline is to wait for a sharp and near vertical drop in the overall stock market on huge volume. Not all bear markets are like this but if they are then this will nearly always represent the last flush out of weak owners who are being panicked out of their positions. This is then followed very quickly by a counter-trend rally that significantly penetrates the declining trend channel. This tells me that strong and seasoned hands have entered the market to take advantage of the fear of others. A perfect example of the very end of a vertical plunge would be to see a huge spike low for a few days only to see the market then rise sharply and penetrate the weekly trading range. The volume for the week would need to be at least 100% above normal.
The relative strength index, or the RSI, is another reading of momentum that tracks the speed and change in price movements. Readings above 70 indicate a market has reached an overbought position and will correct very soon. On rare occasions the indicator will rise to above 80. A reading below 30 suggests it is a great time to buy. A reading around 20 is a screaming buy signal. The RSI is much more responsive to daily fluctuations in markets than the moving averages so it is a good indicator to use to find the few days of an exact low in a market. Large scale market reversals rarely take place without some prior neutralisation of rate of change indicators. So the RSI must be used in conjunction with moving averages. This is very different to how the RSI works with individual companies. With my long term holdings I watch this indicator with interest. The RSI is especially predictive when it is slowly rising while prices are still slowly declining. This indicates the number of up days is increasing so the market is getting stronger. However, I do not usually act on the RSI as I have learned to stay with a company through thick and thin for years, not months. RSI’s are very handy for shorter term traders.
After a spike low is in place, the proof that the overall stock market has turned up is to watch for the next move downward will fail to take out the previous low. This is followed by the market rising sharply to penetrate the top of the trend channel. A trend channel is a pattern with the top of major market pulses and the lows of major market pulses form consistent parallel lines on a chart when joined. Penetration of the upper line of a declining trend channel is a great indicator of a new bull market being birthed. Not often but sometimes the new low will be equal to the previous low and then shoot up decisively to break the upper resistance line. We call this a double bottom. Perhaps it should just be called a human bottom! A strong bounce of a higher low or a second double bottom low is a great place to enter the market.
Remember reading about moving averages in the chapter on charting? Unfortunately moving averages are better at confirming a bull market has ended than a bear market has ended. Nevertheless, a crossover of these averages will be one of the last confirmations that a bear market is over. The key to watch out for that will show a major change in market direction is when the 50 day MA rises up through the 200 day MA instead. This will be some time after the market plunge described above and it will probably be obvious to you that the low is in by the time this crossover occurs.
On rare occasions the stock market will give us a bottoming pattern characterised by selling pulses that show diminishing depth, slope and momentum. In other words the market is flattening off and going to sleep in the horizontal position. This only happens on declining volume and is more typical of individual companies than whole stock markets. After some months the company/market begins to awaken and move up slowly. Then it will rise faster as time goes on. This is what we call a rounded bottom or a cup and handle pattern, and is one of the strongest and most reliable indicators of a new trend developing.
A falling wedge is yet another visual clue that a market is gathering strength even though prices are still falling. In this formation new lows become visually shallower with time while the tops continue to decline at the old steeper angle. This shows a willingness of many buyers to get on board while less informed sellers are still unloading. In my experience the falling wedge is a very reliable indicator of an approaching change in direction. Make sure when you spot one that it is associated with declining volume.
The good old upside down head and shoulders formation is another to watch out for, but make sure it has developed on declining volume. As the name suggests this pattern has a left shoulder of a significant low in prices followed by a significant rise. Then the bear market resumes and the major low, called the head, forms a few weeks or months later on large volume. This is followed by a right shoulder where the market has tried to make one more plunge down but failed at a higher low. This pattern is only confirmed after neutralisation of the all-important declining trend channel.
Warning: A false breakdown is very common in today’s overly manipulated global markets where the professionals like to scalp small profits at key junctions in the market. This running of the stops often occurs at areas of obvious resistance, such as significant old lows where traders place their stop loss orders. In a false breakdown the market will make a significant low and begin to rise on good volume. Everyone thinks that was the final low so the stops are set just below that number. Then the pros will enter when the market is very thin, such as overnight or during a holiday, and punch prices down so they briefly penetrate the lows. The stop loss orders are triggered and the pros clean up. Once The market wakes up the next day it immediately springs back to life and reverses strongly. These false breakdowns are a variant of the double bottom and often precede major market recoveries.
Timing is also very important when calculating when a significant low should form. Where there is cluster of market cycles, such as the monthly cycle, the extremely important yearly cycle, the four yearly American presidential cycle where markets rise in the year of the election and fall the year after, the regular three year cyclical bear rallies inside the 15-20 year secular inflation/deflation cycles, the quarter year or 13 week cycles, or even the weekly and monthly cycles. If a bucket full of these look like they are coming in during a single month and the market has been trending lower for some time, then the odds of a reversal of trend are high. Particularly watch out for anniversaries of significant market events. It is no accident that the 1987 Wall street crash was echoed in the 1997 Asian financial crash and again in the 2007 sub-prime mortgage disaster. Keep your powder dry for 2017, which is also the year after the next US presidential election and year 17 of the inflationary bull cycle!
Now let’s look at the one indicator the average Joe Six-pack looks at, the media. At the end of every significant bear market all you see and hear about in the media and on the internet will be bad news and pessimistic rationalizations about why we are plunging into a new permanent financial deep freeze. News flow becomes super-bearish at these major interim lows and this is a great contrarian indicator that lets you know the next bull market is very close to starting. Journalists are paid to sensationalise things and are the worst of investors so they will nearly always get it wrong. A famous example is the headline in the August 13th, 1979 edition of Business Week titled “The Death of Equities” after the Dow Jones had ground sideways for 14 years. This came in very close to the low. Three years later marked the end of the secular bear market as the Dow finally broke through its 1000 point glass ceiling and rose for 17 of the next 20 years. So when everyone wants to slash their financial wrists it is time to look at buying. By the time a financial trend has lasted long enough and been powerful enough to make it onto the front page of a magazine, that trend is typically ending or is already over or and reversed direction.
Finally I would suggest always checking the VIX indicator for a signal that a major low is near. The VIX indicator tells you how much fear is in the market. At market tops the VIX goes to sleep and drops below 18. This suggests not enough fear is in the market’s collective mind. At the end of a violent bear market the VIX levels will reach 40-50 which means there is too much fear in the market. It is the storm before the calm. This is the perfect time to buy up big, but it will be very, very, VERY hard to do! The VIX indicator is better at finding exact bottoms and entries than exact tops and exits.
A PERSONAL EXAMPLE OF BUYING IN
To give you an idea of what all this advice on which company to buy and when to buy looks like in practice I will describe my the purchase process I went through to get hold of what is now the core of my portfolio. I was sitting in cash for a few months from a previous sale as I watched the global stock markets sink into a low during August-September of 2011 on the fear of a new global recession. In response to this the United States central bank announced another round of money printing, called QE2 in November. I then decided to re-enter the junior precious metals market on the belief that money printing can only be good for the long term price of gold. So that is the big-picture logic behind the search. The fact that I had taken profits and had well over half a million dollars in cash on the sides when I saw the storm clouds back in March brewing helped me immensely in staying calm during this period. Calmness creates clear thinking. Hopefully there are some lessons there for you to take away.
Next, I always have a stable of companies on my watch list that could be of interest in the future if the price was right. They had all taken a tumble as rising fears of a global economic meltdown had sunk the price of all my prospective companies, regardless of how much profit they are making. One company, Northern Star resources (NST) had been recommended to me by a friend a few months earlier so I had it on my watch list. Any company anyone tells me about is always given a 10 minute investigation. The best are added to my list. I had been eyeing off Northern Star Resources for some time and now it was time to re-enter the market I gave it and several other companies a thorough read.
After deciding it was the best of the list, was compellingly cheap and had huge potential to grow in price I took the plunge. Why was it a good buy? Well the price had dropped from 60 cents to 45 cents. The gold grades were extremely high by modern standards and the management who had run the mine for five years had bought the mine from the owners which gave me great confidence for the future. In addition they had paid off their $40 million debt in about 8 months. Production was expanding, costs of mining were dropping, profits were abnormally high for the given market capitalisation, and they had just bought into a 700,000 ounce deposit some 100km away for an extremely low price. The only downside was the very low resource base which I believed would have been already factored in by a management that was willing to take the plunge and buy the mine.
So I started buying into a dull market at around 50 cents. I drip fed my purchases in over a week or so as not to upset a thin market and push the price up. I finished purchasing at 52.5 cents and bought 1.4 million shares out of 400 million in total. Nearly all of that was in my superannuation account. I spent a total of over $700,000 on this one company which was most of my capital. I have learned over the years not to diversify when the story is so compelling and the timing is great. It felt great to be buying when everyone else was asleep. The market moved up immediately after my purchase so I had confirmation coming through from the charts that I was on the right track. As of this writing I am up 120% on that purchase and have sold just over 200,000 of my shares into strength at around a dollar and then at $1.30 to purchase a million shares in another junior gold company that is about to start production and whose price is suppressed. When you do the apprenticeship in the investment arena the rewards are outstanding.
WHERE TO FROM HERE?
So now you know where I look for companies to invest in and how to time the market for entry. It is a lot more complicated than purchasing an investment product from a financial adviser, but it is so much more rewarding and fun! If you spend 10-20 minutes a day training your mind to see these opportunities, then the time invested will come back to you very richly indeed. I make more money from my own 30-60 minutes of research a day than I could ever dream of through a job. I am now paid for the quality of the information I possess rather than the amount of time I put into my job.
So let’s pretend you have now bought in to a company or similar investment. The next chapter in this series is titled “Selling Out” and it will help you understand how to exit your new best friend. Investing is only half the coin, selling is the other half. Below is a little chart I drew up to help you think rationally about prospective purchases.
|Whose idea was it to purchase?|
|How long did you actively study the company before purchase?|
|Why is the company expected to do well?|
|Is the general market and sector in an uptrend or downtrend?|
|What was the buy price compared to one day, week, month earlier?|
|Were you chasing strength or worried about missing out?|
|What is the price target for the sell?|
|What is the time target for the sell?|
|What is the actual or mental stop loss?|
|Where were the RSI/volume moving average indicators when you bought?|
|Did purchase take place after a steep drop or a rise in price?|
|How emotional/rational was the purchase process?|
|How much has the market/sector moved since purchase?|
|How much has the company moved since purchase relative to the market?|
|Is the market/sector still in a bull phase?|
|Is the stock price still moving up in a major move?|
|Why continue holding the stocks?|
|Has the time or price target had to be modified?|