There are many things the market can plan for. A planet-altering earthquake sending a 30-foot Pacific tsunami into a Japanese nuclear reactor is not one of them.
And so it was for the market this week, dealing with the latest incident in what is turning out to be one heck of an interesting year for the global economic scene.
The uncertainty of Japan’s nuclear situation definitely weighed on stocks, sending the averages to their second consecutive weekly loss and back to the breakeven point for the year.
Although nobody who owns stocks wants to see a weak market, what it has done is reinforce our decision to use a conservative deployment strategy. Our sizeable cash position of the last two weeks has shielded the portfolio from the weak market and also gives us a chance to buy more shares of our favorite stocks at a relative discount. So no doubt the action has been a bit bumpy lately, but we were prepared for volatility and we’re well positioned to deal with it when it came.
Let’s Talk about Agriculture
Our portfolio is all about identifying long-term trends in the global economy and finding the best stocks to benefit from them. The strongest theme in the portfolio is energy, but close behind is our commitment to agriculture.
The simple math says that we have a surging global population and limited agricultural production capacities. That has definitely played out over the last six months in key Ag commodities as corn, beans and wheat jump higher on growing demand, weak production and concerns about inflation. The United Nations is also beating the drum, with its latest food-price index jumping 23% from last year to its highest level ever.
Clearly, this is a story that bears listening.
So even though the recent wave of volatility has pushed our Ag stocks around a little bit, we have a very powerful long-term trend supporting our investments.
Let’s take a closer look.
CF Industries (CF) finished the week in the green but remains a bit of a laggard. As a fertilizer producer that specializes in nitrogen, this stock has a very strong correlation to underlying corn and wheat prices. There were two very key events that occurred in these markets over the last month that have weighed on CF. The first has to do with tension in the Middle East, where countries like Egypt, Libya and Tunisia are huge net importers of grain. That caused concern that civil unrest would crimp demand. At just about the same time, the USDA (United States Department of Agriculture) came out and raised its domestic production estimates, a virtual one-two punch for lower prices, sending both corn and wheat to some of their sharpest losses in six months.
But don’t worry, there is reason to be optimistic, here’s the upshot. Thursday and Friday saw corn and wheat prices screaming higher on most of the same supply/demand issues we discussed above. There’s the long-term trend working in our favor. That movement should support Ag stocks and give CF a nice shot in the arm. We’ve also seen estimates grinding higher over the last month, which means analysts have become more bullish on CF while shares have traded lower, another bullish feather in CF’s cap.
Deere & Company (DE), however, was on the upswing, bucking the trend and closing the week with a solid gain. That is a testament to investor demand and says a lot about the strength and popularity of the Ag trade. John Deere is a great way to play the entire global Ag scene, with a strong domestic and international business and diverse customer base. Shares of DE are up pretty big over the last 6 months, so when shares hit an all-time high in February, we saw a good amount of profit taking as the overall market weakened. But that belies the fundamental story, which is well intact and only getting stronger. We see that showing up in estimates here too, with analyst now looking for full-year earnings of $6.17, up from $5.57 only last month. That is most definitely a long-term buying opportunity as the chart diverges from the fundamentals.
Gold in the Mix
Another area where we have seen some volatility over the last few weeks is gold, hitting a new all-time high in mid February before recently pulling back a bit on a temporary reprieve from tension in the Middle East. This provides the perfect backdrop for a look at how our two gold picks are designed to work with each other.
Market Vectors Junior Gold Miners (GDXJ) is our more aggressive play on gold, consisting of a basket of small-cap gold and silver mining companies. Even though we saw gold finish modestly green this week, shares of GDXJ closed in the red. That might seem like a bit of a head scratcher, but the short story is that gold mining stocks chose to follow the overall stock market instead of actual gold prices. That’s not totally unusual under the circumstances, where we saw a modest gain in gold and weakness in equities as an asset class. But on a longer-term basis, if we see a bullish gold market, the small-cap gold miners will do very well and give GDXJ a very nice boost.
This divergence between gold stocks and the price of gold is the reason we have exposure to SPDR Gold Shares (GLD), an ETF that is designed to precisely track the underlying price of gold. So if gold is up 2%, GLD will be up 2%. Tracing back to GDXJ, that is a much higher-beta instrument, which means if gold is up 2%, it could potentially be up 6% or 8%. So having these two gold plays living in the same house makes a lot of sense, because it’s an excellent diversification strategy to benefit from higher gold prices in a weak equity market.
But the shining star of the week was VeriFone Systems, Inc. (PAY) , jumping more than 10% in one day after announcing Google will buy thousands of its POS (Point-of-Sales) systems. The deal with Google revolves around a hot new technology in electronic financial transactions called NFC (Near Field Communications) that replaces the traditional credit card swipe with a simple tap. The question mark for the success of NFC has to do with the infrastructure involved in supporting the technology, and with Google stepping up and buying thousands of specially designed POS systems that support NFC transactions, you have a big player and big money behind the trend. That’s a step in the right direction.
What’s Next?
Moving into the back half of the month, our solid cash position means we have room for new picks or increased allocations. So how about a little of both?
On the new picks front we’re looking at iPath US Treasury Long Bond Bear (DLBS), an ETF that will do well if it becomes more expensive for the Federal Government to borrow money. Another way to think of this one is that if interest rates go up, so will DLBS. Although legions of analysts and investors have been shocked that US Treasury rates have remained low for as long as they have, there are a number of very compelling reasons to be in an investment like this. At the very top, the Federal government is running a massive 11% annual deficit, and as far as I know, no modern economy has ever emerged from this deep of a hole without getting hammered on interest rates. That deficit has led to a staggering national debt, making the US an increased financial liability, a key factor when analyzing interest rates and the cost of borrowing.
But this isn’t a layup investment; there is definitely risk at hand. It comes in the form of the Federal Reserve’s QE (Quantitative Easing) programs, where it has thrown $2 trillion at Treasuries over the last two years to keep interest rates down. The other factor is “flight to safety.” Even though most of the world is keenly aware of the US’s battered financial condition, when things get ugly, Dollars and Treasuries still fall into favor with the market because of their safe-haven legacy. That’s a trend that should have died a long time ago, but for the time being it’s something DLBS’ers need to be aware of.
We’re also going to be looking at the Brazilian ETF iShares MSCI Brazil Index (EWZ), an ETF that is tied to a basket of Brazilian stocks. We are going to go into more detail on Brazil down the line, but for the time being I wanted to get this one on the board so we would have it at our disposal if we see some real strength move back into the market.
Increase Allocations
Shifting into increasing allocations, we already have some awesome stocks in the portfolio that give us an opportunity to benefit from long-term economic and social trends. So in order to get the most bang for our buck we will also be focused on increasing allocations to our favorite picks to between 5% and 7%. Deere & Co. , Baker Hughes, Transocean, Amerisource Bergen, Cimarex, and CF Industries are all on the list.
The medium-term goal is to have the portfolio almost fully deployed right around the end of the first quarter (Mar 31). That will have us well positioned and invested ahead of spring and summer, where things in our two strongest themes (energy/agriculture) could get interesting.
This was a long update but there is a lot going on in the market right now. We knew that 2011 was going to be an interesting year and that’s exactly what’s happening right now. We’ve got some great stocks and ideas in the portfolio, so let’s just stay optimistic and look for the long-term trend to support that
Until next week, here are two articles for everyone to take a look at. The first discusses the S&P 500’s awesome profit margins, while the other takes a look at the value of strong long-term investing to support retirement needs.
S&P 500 Profit Margin at 18-Year High
Worker Confidence to Retire at 20-Year Low
Your Investment Partner,
Mike
