Time to sell gold?

According to the Editor of Investment U, this guy Louis Basenese (inset) has been dead on with his predictions. He called the U.S. dollar bottom versus the euro within 26 days… oil’s peak within 24 days… and the top in U.S. Treasuries within two days. So when he makes a big call like this, we listen. And while Lou thinks gold is going down, there’s another asset class he thinks is going straight up - small caps. To get access to his five best small-cap picks, go to The White Cap Report His other recent article includes Time to Invest in China stocks which was posted here before. Anyway, here are his reasons for being bearish with gold.

Shorting Gold: 12 Reasons Making The Case For This Contrarian Investment by Louis Basenese, Advisory Panelist Senior Analyst, The Oxford Club

If you’re a self-professed “Goldbug,” feel free to read no further. Or at least spare me your hate mail. Because no matter what I say today, I know you’ll cry foul… or something much more colorful.

But for those of you with an open mind - especially after my last three contrarian predictions proved dead accurate, read on.

Because it’s time to start shorting gold!

You won’t find many, if anyone else, making this case. But as the first reason of 12 below reveals, that’s precisely why you should give it more credence.

12 Reasons To Start Shorting Gold

1. It’s decidedly contrarian. If a contrarian investor is someone who deliberately decides to go against the prevailing wisdom of other investors, shorting gold certainly fits the bill. Right now, everyone else is buying gold, or at least recommending it. If you have any doubt we’ve reached such fever pitch levels, consider No. 2.

2. The infomercial factor. The best indicator of a turning point for any investment, in my experience, is infomercials. If an investment gets so popular it invades the pre-dawn hours with non-stop but-wait-there’s-more offers, it’s time to get out. And that’s exactly what’s happening now. So much so companies like Cash4Gold.com are invading primetime television. They even splurged for a Super Bowl ad spot. And they recruited washed-up celebrities Ed McMahon and M.C. Hammer to boot. In case you forgot, the Hammer filed bankruptcy in 1996. And Eddie boy almost lost his 7,000 square-foot, $6.5 million Beverly Hills pad to foreclosure. No offense, if you take investment cues from these two, you deserve to lose money.

3. There is always some truth in a rumor. Recent news reports suggested Germany, the world’s second-largest holder of gold, was selling some from its vaults to trim its deficit. It turned out to be a rumor. But you gotta wonder if there’s some truth behind it. After all, high gold prices would be an easy way to raise cash. In other words, the scenario is completely plausible. And if Germany’s considering it, even remotely, so, too, are plenty of other deficit-ridden governments. It goes without saying that a government dumping supply on the market will send prices lower, quickly.

4. The gold-to-oil ratio is out of whack. Historically, an ounce of gold will buy you about 14 barrels of oil. But with oil around $40 per barrel, an ounce of gold gets you almost 23 barrels - a whopping 64% above the historical mean. If you believe in statistics, a reversion to the mean is imminent!

5. So is the gold-to-silver ratio. Historically, an ounce of gold will buy you 31 ounces of silver. But now the ratio stands at 73 - an unbelievable 134% above the historical mean. Here, too, a reversion to the mean is imminent. And I’d rather place my bets on a 57% decrease in the price of gold, than silver more than doubling to make it happen.

6. The HGNSI index is too high at 60.9%. For the past 25 years, Hulbert Financial Digest has tracked the average recommended gold market exposure among a subset of gold-timing newsletters. It usually fleshes out around 32.6%. But now it rests at 60.9%, a level it’s only exceeded 13% of the time. The key - Hulbert found an inverse correlation exists between his proprietary index and the short-term market direction of gold. In other words, if the index is high, like now, gold is headed lower.

7. Trinkets drive demand, not governments or speculators. Nearly 75% of gold demand comes from the jewelry market. And if Indian brides balk at buying above $750 per ounce as the Bombay Bullion Association reports - India’s gold imports cratered 81% in December - look out below. And don’t be fooled into thinking investors (governments or speculators) will pick up the slack. As HSBC reports, rising demand from investors, particularly from ETFs, only offset half of the 33% decline in jewelry market demand since 2001.

8. What makes now “different?” If the global economic crisis keeps getting worse, as goldbugs like to point out, why hasn’t gold tested last March’s high of $1,030.80 per ounce? Or blown right by it? After all, gold is supposed to increase in value as economic conditions worsen. But it hasn’t lived up to expectations, not one bit. And I don’t think it ever will. Ultimately, when you factor in the massive amounts of stimulus being injected into the markets, on a global level, we’re close to the worst of times… and the peak for gold.

9. Analysts love it. According to Bloomberg, 16 of 24 analysts surveyed by the London Bullion Market Association believe gold will reach a minimum of $1,032 per ounce this year. As we all know, analysts’ track records are deplorable. Instead of just ignoring them, why not bet against them? The odds are definitely in our favor.

10. Hedge fund buying dried up. Institutional speculators (hedge funds) played a large part in gold’s run-up. But 920 of them went Kaplooey last year, according to Hedge Fund Research, Inc. Not to mention, hundreds of others hemorrhaged capital as investors demanded their money back, while those left standing ratcheted down borrowing to close to nothing, according to Rasini & C., a London-based investment adviser. In the end, gold prices will eventually reflect the absence of these former heavyweights.

11. Gold is schizophrenic and the wrong personality is in control. Multiple motivations exist to buy gold including the desire for a safe haven, currency, adornment, raw material, or inflation hedge. But much like Treasuries, the bulk of buyers come from the safe haven camp today. And once the economy shows any signs of perking up, we can expect these same investors to flee for more risky assets. And don’t be so quick to rule out a second half recovery…

12. The Fed, the President, history and the Baltic Dry Index concur - the economy’s on the mend. Despite dismal data, both the Fed and President Obama point to the current recession ending by the second half of 2009. Moreover, the average recession only lasts 14.4 months. So even if this one is longer than usual, we’re still near the tail end of it. A fact underscored by the recent 61.4% rally in the Baltic Dry Index from its early December low. As I wrote in November 2008, the index is the first pure indicator of an uptick in global activity. And once the economy gets back into gear, the Fed will act quickly to reign in the money supply and curb inflation.

Cleary the gold rush is on. But that’s all the more reason to move in the opposite direction, against the herd. I realize this might be the most unpopular recommendation right now, but that means it could also be the most profitable.

And before you brandish me a fool for recommending shorting Treasuries and gold in the span of two months, here’s the intersection. The driving force behind both assets in recent months has been safe haven buying. And it will remain the dominant variable in determining price in the months ahead. So when investors go back on the attack for more risky assets, prices for both assets will fall.

It’s already happening for Treasuries. And I’m convinced gold is next.

Good (and contrarian) investing,

* RGE Monitor: Chinese exports contracted by 17.5% y/y in January, the steepest in 13 years, and the third month of contraction. Imports contracted even more (43.1%, the worst since data begun being collected in 1995). The deep import contraction took China's trade surplus to the third highest of all time $39.11b (record $40.09b in November and $39.98b in December)

* China to stick with US bonds.

* Bloomberg: House, Senate agree on USD789B stimulus, setting stage for final vote.

* Bloomberg: South Korea cuts interest rate to record low 2% as economy nears recession.

Watch out for the volume

(click chart for larger version)

It has been a while since our market's daily volume exceeds 1 billion shares. As I checked back, the 1 billion mark was last recorded sometime back in January 2008, almost 9 months ago. Some of the brave hearted investors/traders would have already gone into the sea since the last few trading sessions braving stormy and violent waves. For the brave, they were rewarded handsomely(so far), for the less brave, they were contemplating to joining in the fun. Is it really safe going into the water and continue to swim, hopefully without encountering hugh and violent waves or sharks? This is probably the question in many people's mind these days.

Fundamentally, nothing really change except investors' confidence came back stronger and there are some improvement in the bankers' lending activities. Concerted effort by countries(eg interest rate cuts) together with their financial stimulus plans and financial aids from IMF do help to alleviate the worries of market participants. There is a general consensus that the markets have probably seen its worst in the last 2 weeks and markets have bottomed. The world's economy however remains in the doldrums egs EU countries technically in recession and many countries like Malaysia cutting back its growth forecast ie from 5.4% to 3.5%. In fact some analysts like UBS are predicting zero growth for Malaysia next year in view of declining demand from G7 countries etc. In general, the prediction for the next year is very gloomy indeed and economies will at best register a small growth or a "stand still" growth.

So back to the question of whether it is safe to go back into the market?

In my opinion, the market right now is at best a trading market only. It is great to place your trades in early or low and square off the trades later and higher, if we are lucky enough! The daily MACD for the KLCI(and the rest of the world leading markets) are now slightly bullish(refer above charts) and it would be good if trend indicators eg ADX is to show such positive indications soon. This will reinforces the confidence of investors/traders to go into the markets in the short term. For the longer term, I am of the opinion the markets will not be better than now as we still have to ride through this long term bearish cycle first, probably another year from now? Volatility will be back and confidence will be at its low again. Meanwhile, while the sun is smiling at us again, let us all enjoy a break from "selling pressure" and make some money in the markets! Remember to look out for any decline in the volume as it may indicates "sell"! Good Luck!

* If Obama wins the US presidential election, will the bankers/insurers etc brace for more regulations in the industry? You bet.

* Bloomberg: Australia's Central Bank cuts key interest rate by 75 basis points to 5.25%(its third reductions in many months).

* BT: Credit Suisse: Malaysian banking stocks most expensive and will maintains its "UnderWeight" call on the banks.

* The Standard: South Korea's reserves fall by most since 1997. The reserves dropped to USD212.3b in October from USD239.7b in September. The reasons were due to selling of USD to aid banks struggling to access overseas funds and defending the Korean won.

* Rio Tinto admits China's demand slowing down.

* RM7b enough or not to stimulate Malaysia's economy? See details

Do Share Buybacks matter?

Some interesting conclusions by the most bearish broker in town regarding share buyback. It is good to refer back to this report whenever there is a need to refresh our minds about common thoughts of share buybacks by companies and its impact on the underlying conpany's share price.

TheEdge: Analysts frequently argue that share buybacks provide a form of share price support and serve as a leading indicator of value as company share buyback activity is interpreted as ‘insider’ buying and as signs of management’s belief that the stock is undervalued. In this report, we examine the veracity of this thesis within the Malaysian context for the stocks under our coverage. About 36% of the stocks, by market capitalisation, under CLSA Malaysia’s stock universe have a share buyback programme in place. In attempting to answer this question, we examine in detail the individual corporate buyback activity over a one-year period from July 1, 2007 and also on two six-monthly periods, 2H07 and 1H08, as these correspond to different market cycles — in 2H07 the market was in an upward trend while in 1H08 it reversed sharply downwards. We then compare these results against its relative share price performance vs the KLCI.

Bull market buybacks (2H07)

In 2H07, companies collectively bought back 0.7% of outstanding shares. Ann Joo, Resorts and Top Glove bought back the most shares in the upcycle in 2H07, between 1.4%-2.8% of shares outstanding. However, the companies with the best six-month relative performance were those with zero buyback activity — Parkson, IOI and Sunway.

Bear market buybacks (1H08)

In 1H08, as markets fell, companies have been twice as active buying back shares, accumulating 1.2% of share outstanding versus 0.7% in 2H07. The most aggressive buyers were Sunway, IOI and YTL Power which did little in 2H07. But the best performers in the market, Ann Joo, Public and Berjaya Sports Toto, were again not those which were most active. In fact, Sunway was among the worst performing companies in 1H08, despite strong buyback momentum.

And the winners and the losers are…

Aggregating the results for the past 12 months and comparing share price performance with companies’ average purchase price yields some interesting results. Of the 13 companies under CLSA coverage, only Public Bank is currently in the money, while all other companies bought back shares at average prices above current share prices. The worst performing in terms of percentage losses are Sunway Holdings, Top Glove and Resorts (with current share price over 30% down from its average buyback purchase price). Among the big caps, the most active buyback companies are YTL Power, Resorts and IOI Corp, which have bought back between between 2.5%-3% of outstanding shares.

The conclusion is clear: share buybacks cannot be used with great reliability as an indicator for short-term performance. We estimate only a modest 0.4x correlation between relative outperformance versus KLCI against the percentage of shares bought back over the past year.

As a form of capital management, companies have three options to choose from in dealing with its treasury shares: a) Cancel the shares, b) Share distribution back to shareholders as dividend-in-specie and c) Sell/place shares at a higher price. As buybacks are a relatively new form of capital management in Malaysia (corporate Malaysia has only started actively buying back shares in the past two years), not many companies have a track record of visibility with how it treats treasury shares. We believe that the most value-enhancing action is to cancel shares, thereby boosting EPS or returning stock as dividend-in-specie (as a form of tax-free dividend). However, many corporates have not made decisions on what it will do with its treasury shares. Of the 13 companies under coverage, many have also chosen or are indicating intentions to sell shares at higher prices when prices rebound. It is unclear how this benefits minority shareholders directly, as cash accrues back to the company and any benefits remain one step removed from minorities. Only Bumi-Commerce cancels shares on a regular basis, while YTL Power distributes its treasury shares to shareholders. In the current bear scenario where the average cost of buyback is above current share prices, companies have even fewer options available to maximise value — 1) distributing shares could cause further sell down as minorities perceive these to be ‘free’ shares without capital outlay; 2) Placing shares below cost is a value-destroying move, leaving share cancellation as the only viable option, one that seems to meet with resistance when we speak to companies in Malaysia.

We believe that the lack of visibility in treasury shares treatment by companies is a plausible reason why share buybacks have not had a greater positive impact on share prices, unlike more developed markets such as the US and Europe. For now, share buybacks appear to be a very long-term capital management potential story for Malaysian companies.

* NZ lowers its interest rate by 0.25% to 8% today to fight slowing down of its economy, its first in 5 years.

* Inflation in Malaysia rose to 7.7% in June, more than double May's 3.8%(a 27 year high) due to substantial increase in petrol and diesel prices wef June 5. The July's figure is expected to be higher as the increase in electricity tariff comes in early that month. According to Moody's economy, BNM will raise its overnight policy by 0.25% to 3.75% when the policy makers meet tomorrow.

* The US House of Senate passes bill to aid 400,000 house owners to avoid foreclosure and to prevent Fannie/Freddie from collapsing.

* TheStar: The US House of Senate voted 94-0 on Tuesday to move ahead a legislation to curb speculation in oil markets. This bill would require Commodity Futures Trading Commission to set limits on trading in oil markets by investors and speculators and to close a loophole that allow speculators to trade on the London oil market to escape the scrutiny by US regulators.

Share BuyBack to boost warrant exercise

StarBiz: Many listed companies buy back their own shares. There are many reasons why companies buy back their own shares. Some of the more common reasons include better cash utilisation, stabilising share price, more efficient way to reward shareholders than paying dividend etc.

There is also another reason why companies buy back their shares that is relevant for companies with outstanding company warrants. When a company buys up its own share to the effect that the share price rises above the warrant’s exercise price, it has a chance to recoup the cash spent buying back its own shares via proceeds from warrants exercise.

Last year, there was one listed company which appeared to been using shares buy back to encourage warrants holders to exercise. The company, Hil Industries Bhd, had 95.3 million warrants which was to expire on April 15 2007. Hil Industries only started the buy back program in Feb 28 2007 and has already accumulated about 8 million shares as at April 3 2007, the last day it bought back its shares before the warrant expired. That was quite aggressive as it represented a significant portion, about 21%, of shares traded during that period. The share price of Hil Industries rose from below 50 sen to as high as 65.5 sen a week before the warrant was to expire.

HIL-WA, which in early February 2007 was reduced to a few sen, also enjoy a late-stage pre-expiry rally which saw the warrant price rose to as high as 19.5 sen just days before the company started its aggressive share buyback exercise. It should be noted that the warrant then retreated to close at 0.5 sen when it ceased trading in late March last year when the mother share was still hovering at about the exercise price of 50 sen.

The subsequent surge in HIL share price after HIL-WA stopped trading managed to attract more than 17 million warrants to be exercised and in the process brought more than RM8.5mil cash to the company. For Hil Industries, the buy back made sense as it spent RM3.73mil cash to buy back the 8 million shares but got back RM8.5mil from warrant exercise. Hil Industries actually managed to sell all the 8 million shares that it bought back just days before the warrant expired and got back RM4.4mil. So, the entire exercise brought in about RM9.2mil cash to the company.

So, what can we learn from this case study? The answer is to look at another company which is in the same situation as Hil Industries last year. The company to watch is Ancom Bhd. This company has about 98 million warrants (Ancom-WA) that will expire on June 23 2008, which is about 2.5 months away. Ancom shares have been thinly traded over the last few months and the share price managed to hold at just below the warrant exercise price of RM1. This company has in the past been active in shares buyback and other treasury shares operations.

It would not be surprising to see some actions in the company’s share price prior to warrants expiry. After all, the major shareholder and managing director of Ancom had told the Exchange that he intends to deal in the securities of Ancom during the closed period ahead of the company’s financial result expected at the end of the month. He and another director of the company still hold a significant amount of Ancom-WA. Their intention on what they will do with their warrants is likely to create some volatility in the prices of Ancom securities before the warrant expires.


MyTake: Below is an analysis based on the warrants expiring this year with the aim to identify warrants that are in the money or out of money currently and weight them based on chances of share buy back or potential capital gain, if any. From the analysis, Ancom and the stocks highlighted in yellow are the shares that are almost or already in the money, in which not much money to be made by investor now unless it drops. The ones highlighted in blue are more interesting as they have a higher possibility amongst others that the share price may go up due to share buyback towards the expiring of the warrant, but it is really up to the companies and controlling shareholders. The stocks are PohHuat, Sunway and Harnlen. Time to monitor them? Why not?

* The 14th Dalai Lama of Tibet. The spiritual leader has asked nations not to boycott the Beijing Olympics and also said that he is not politically motivated for the separation of Tibet from China. He is pressing on the "human rights"treatment in China which he considers very poor. The list of dignitaries not attending the Beijing Olympics is growing and this has put China in an awkward position as this Summer Olympics is supposed to be a showcase of coming out party for China to the world. In short, we should never mixed politics with sports, just like we should never mixed politics with business.