Want to learn the biggest lesson of 2016? Look no further than commodity prices. The first 10 months of the year have seen an extraordinary rebound in sentiment towards commodities, particularly coal. There was a lot of money to be made as well as an important lesson to be learned.
But first, let’s set the scene.
Successful contrarian investing involves going against the crowd. And sentiment is a measure of what the crowd is thinking. How to measure sentiment? One way is to read media articles, particularly newspaper headlines. This gives us a qualitative insight as to what stage sentiment is at.
Stage 1: High Uncertainty and Investor Hatred –
January-March 2016
At the start of 2016 miners and the contractors who service them were the most out of favour part of the market. Uncertainty as to whether many mining operations were a going concern was rife. A large chunk of the best performing fund managers from 2012 to 2015 had a simple and effective strategy. Short mining, long everything else.
Sentiment couldn’t have been much worse during the first quarter of the year. And of all commodities, coal seemed to bear most of the brunt of this negative sentiment. Its price had been on a downward slope for years.
Headlines in the Australian Financial Review (AFR) during the first quarter of 2016 included “Coal set for dramatic shake-out”, “Australian coal ‘high risk’ on exports”, and “China coal demand tipped to fall further.”
Perhaps the bell ringing moment was an AFR article about Chinese coal miner Yankuang establishing an e-commerce platform. Its new goal? To sell Australian beef, milk powder and vitamins to mainland Chinese consumers. In China, a tonne of coal had become cheaper than a tonne of water.
Negative sentiment led to valuations that implied disaster scenarios. A number of mining and mining services stocks were trading at large discounts to book value. Some were trading at cash backing or even less. And this provided the opportunity for those with intestinal fortitude.
Stage 2: Disbelief, Followed by Panic Buying –
April-October 2016
As mining stocks and commodity prices began to rally, the initial market reaction was disbelief. In March, one large broking house believed that the rally was running ahead of reality and downgraded a number of its recommendations.
Fast forward to today and sentiment is turning. Brokers have almost universally revised their coal price forecasts higher. Much higher. Anywhere from 25% to 65%. Just a month ago, the above mentioned broker materially upgraded its commodity price forecasts as well as its recommendations for those same stocks it had downgraded six months earlier.
It’s as though Mr Market is saying “I can’t believe the coal price is going up, but I’d better buy some coal stocks in case it goes up more.” AFR headlines in September tend to support this view. These include: “Panic buying: coking coal prices surge”, “Temporary coking coal rally might hang around for a while” and “New Hope cautious on coal price rally.”
Stage 3: Future Euphoria?
Despite the coal price rally, there are a few coal bears hanging around. Should these bears capitulate, we could see them provide the fuel to drive the rally further.
Many of the fund manager stars of 2015 have now started buying mining and mining services stocks. Perhaps not so much because they believe their future prospects are bright but because they don’t want to risk not owning them as commodity prices rise. While sentiment is slowly turning positive, it is not quite at euphoric levels yet.
The Biggest Lesson of 2016
The final lesson, then, is an old one: Wait and see is not an option. Many investors wanted to see a recovery in the coal price before buying coal mining stocks. By the time that happened, share prices had already tripled and more.
“Investors hate uncertainty” is something you will frequently read in the financial press. That may be true in general. But when is the future ever certain? It is the perception of uncertainty that changes, rather than uncertainty itself. If you want to be successful, investing at times when the future seems unclear is essential.
This blog post contains excerpts from the Forager Funds September 2016 Quarterly Report. Email [email protected] if you would like to be added to the distribution list.
A year ago, when everything was doom and gloom, I had about two thirds of my SMSF in resources or resources services stocks.
The need for fortitude wasn’t in holding those stocks, but rather in not throwing Kelly’s principle out of the window and allocating 100% of the capital that I had available to those ideas.
Although I never foresaw the current rally, prices back then were at no-brainer levels. In some respects the value was even more obvious than at the depths of the GFC.
Anyone who failed to seize any of those multitudinous opportunities is fundamentally unsuited to investing.
For a verifiable prognostication (I’ve made a few in the past on this blog): Uranium will make its recovery from here. Silex (SLX) is now my third biggest holding, it is currently trading at just above cash backing, and in a perfect scenario, it could very easily be a hundred-bagger from here. It is the perfect lopsided bet, the floor on the present valuation has to be the value of its current assets, which is roughly equal to the current SP, and the ceiling is unknown, but it is certainly a large multiple of the present price. As for the probabilities of these outcomes: G.O.K., but I know for sure that they are not reflected in the current SP.
i noticed the other day that SLX was trading at cash backing, didn’t enter my mind to throw any money at it, thats a hell of a call.
nice post guys..
off topic but i almost collapsed with laughter when I read MAH’s proxy form yesterday. The best bit was where they claimed that the 2016 renumeration report, essentially identical the one from 2015, was “necessary and appropriate”. Out of interest was Forager one of the “shareholders and stakeholders” consulted with regard to that.
Maybe a board spill coming up
That’s why I went against all proposals and am waiting for the board spill
If there is a spill would Forager get involved I wonder
“Investors hate uncertainty” – the kind of thing published in newspapers because it makes more column inches of prognostications of rubbish.
If the world and the market were certain, nobody would ever celebrate over or under performance because returns would be well known, stable, and predictable any period you liked into the future. The world does not quite work like that, in the sharemarket or down at your local farmers market.
The final lesson might also end up being, dont get carried away with rising share prices and be sure to take profits as prices escalate. A reversal of a meaningful portion of the recent sector run up is emanently possible (although a return to prior lows is improbable).
I say this having been a big buyer of mining services though 2015. Ive dumped two thirds of my exposure in recent months.