Making Hay: Friday Edition

In The Ring - June 9th, 2023

“In the 1930s, we had a fixed exchange rate system based on gold. It was fixed and rigid. This time we have a fiat currency system. I think last time, they let the economy go and, and the currency (remained) stable. I think next time, they will try to save the economy and let the currency go down.”  -The great Felix Zulauf, at this year’s Mauldin Strategic Investment conference.

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Chart of the Week

As those who have been reading this newsletter for a year or more should be aware, one of my favorite stock-valuation metrics is the price-to-sales ratio. Over many decades, this has provided an excellent indication of when the stock market has been over-, under-, or fairly valued. Part of the reason for its accuracy is that it largely filters out the impact of profit margin swings. These can make stocks look unduly cheap or expensive depending on where we are in the economic cycle. During recessions, profits collapse, which can make stocks look misleadingly pricey. During times like now, when profit margins are unusually lofty, equities appear cheaper than they are on a normalized profitability basis.

Admittedly, the price-to-sales signal wasn’t as timely or helpful from 2009 through 2019 when the Fed was largely in binge-print mode, especially in the second half of the last decade. However, it did give a decent warning that stocks were dangerously inflated in 2018 and 2019 prior to sharp corrections. Now, after the rally of the last eight months, it is back to a level that should set off some alarm bells. In fact, this measure is essentially as high as it was at the top of the late-1990s tech mania. This was the greatest U.S. stock bubble of all-time — even exceeding 1929 — at least until the 2021’s “peak insanity”.

S&P 500 Price-to-Sales Ratio (Since 1992)

Evergreen via Bloomberg

Champions

There may be no market sector or sub-sector that has been as frustrating for investors as the gold miners. This is despite the reality that recent years finally produced the high inflation that goldbugs had been anticipating as far back as 2009. 

That was when the Fed first launched its massive money fabrication scheme known as Quantitative Easing. It kept at it, with brief interruptions, until 2019. That was kind of a long time for what was supposed to be a temporary program. However, as others, such as Milton Friedman and Ronald Reagan, long ago noted, there are few things as permanent as a temporary government program.

Ironically, it took the pandemic to finally create the inflation eruption long anticipated by gold’s ardent and long-suffering fans. It was the Fed and the U.S. Treasury’s combined multi-trillion-dollar lockdown offsets — essentially, the adoption of the fringe Modern Monetary Theory (MMT) — that blasted inflation out of the 2% range it had been in for most of the last 30 years.

Paradoxically, it was before inflation took off in 2021 that gold-focused investors received a partial payback for their years of enduring losses. It was when both the Fed and the federal government were in max spend-and-print mode back in 2020, that precious metals stocks, including silver miners, went postal. But then an odd thing happened: as inflation dramatically accelerated, gold and silver miners’ stocks hit the wall. Even today, the main gold miner ETF is 25% lower than it was in the late summer of 2020. For the junior miners, the pain has been more intense. The ETF comprised of these smaller — and riskier — names has taken a 38% thumping since its brief glory days during the pandemic.

Looking back further is yet a sorrier story. The main ETF has lost nearly half its value while the junior version is down a nauseating 71% since the 2010/2011 great gold bull market top. Both of these “return” numbers include dividends such as they were which, for most of that time, wasn’t much. Moreover, these results don’t incorporate inflation, which has further reduced the real returns, especially in recent years. Some inflation hedge, huh?

Gold, itself, on the other hand, has fared considerably better. It is actually somewhat higher than it was in 2010/2011 and about the same as its peak in 2020. Regardless, that’s not all that stellar considering the favorable inflation backdrop of the last three years.

The culprit is the Fed, which has been in the midst of the most severe monetary tightening since the early 1980s. This has exerted downward pressure on all commodities, not just precious metals and the miners thereof.

Despite the dirty dozen years for gold miners, there have been some outstanding profit-making — and, critically, profit-taking — opportunities along the way. The key has been to take advantage of the periodic, if fleeting, bouts of euphoria. As noted, 2020 was the best example of that when the leading gold miner ETF more than doubled from its pandemic-panic low while the junior version nearly tripled. Even when measured from their prices pre-Covid, the gains were impressive: 43% and 36%, respectively.

Despite my belief that the precious metals complex in general is in a long-term uptrend, this publication has frequently advised selling into strength. We did so this January, based on the early-year rally, and then again in April. This was after upgrading gold miners during the sell-off from mid-January to mid-March, which saw an 18% correction in their primary ETF. That tumble caused us to put out another buy on it, which was fortuitously followed by a 33% rally. As usual, we suggested some lightening up at that point, though we didn’t quite catch the peak of that snap-back.

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To learn more about Evergreen Gavekal, where the Haymaker himself serves as Co-CIO, click below.

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Here’s what we wrote in our Making Hay Monday edition:

As recently as early March, the main gold miner ETF was languishing close to the lows of the last few years. As a result, there was considerable disenchantment with the performance of the gold complex, in general, and this ETF, specifically. This caused me to highlight it as attractive. Despite easing back a bit lately, it’s popped 27%.

This newsletter certainly hasn’t called the gold market’s twists and turns perfectly. But it has done a decent job of suggesting accumulation and reduction points. On the former score, once again, gold and, particularly, the precious metals miners have experienced a retracement. That same ETF is now off 13% from its April peak, which was also the high for the year… so far. It’s not enough of a decline to create a table-pounding situation, but, in my mind, it’s worth a small amount of buying.

Looking for gold producers that have experienced a multi-year breakout and then have pulled back might be a superior approach for those preferring individual miners versus an ETF. There aren’t many that have broken above their 2020 highs but at least one has. For those who want to stick with the ETF approach, the junior version, down 38% from its 2020 apex, might be the most attractive presently. My expectation is that the larger producers will continue to acquire their small- and mid-sized competitors.

In my opinion, we’re getting closer to the point where the Fed will need to resume its Big Easy stance. While we’re not there yet, and it may not happen until the first or second quarter of 2024, precious metals producers are likely to see their stocks pop even when the Fed decides to pause.

Accordingly, I think it’s now prudent to add some gold exposure. However, it is my usual suggestion to buy, but buy slowly, stepping up the accumulation pace on any further weakness. It remains my conviction that precious metals miners will crush the S&P this decade, the exact opposite of what happened from 2010 to 2019.

Champions List:

Gold & gold mining stocks

Uranium

Farm machinery stocks

Select financial stocks

Oil and gas producer equities (both domestic and international)

U.S. Oil Field Services companies

S. Korean stock market

Physical Uranium

Copper-producing stocks

For income:

Certain fixed-to-floating rate preferred stocks

Select LNG shipping companies

Emerging Market debt closed-end funds

Mortgage REITs

ETFs of government guaranteed mortgage-backed securities

BB-rated energy producer bonds due in five to ten years

Select energy mineral rights trusts

BB-rated intermediate term bonds from companies on positive credit watch

Contenders

There are actually two to cover today. The first is Japan. Regular Haymaker readers are aware this has been a market we’ve favored this year. Actually, it’s been on our like list since late September of 2018. Frankly, it’s done OK, but by no means spectacularly since then; lately, though, it’s come alive. Moreover, the performance in its home currency, the yen, has been much better than when measured in U.S. dollars. This is because the yen has been clobbered, putting downward pressure on market prices for American investors.

In yen terms, the Japanese market had a major upside breakout in the fall of 2020. After a nice run in the wake of that “range expansion”, it then slumped by 20% last year during the global bear market, at least based on the U.S.-traded Japanese ETF. Again, much of this was a result of the yen’s plunge vs the U.S. dollar, as opposed to an actual decline in stock prices.

From the low in mid-October, this ETF is up 27%, outperforming even a vigorously rallying S&P 500. Last month, the Japanese stock market was one of the few asset classes to experience a continuing rally along with, of course, U.S. mega-cap tech. Most of the rest of the global investment universe actually had negative returns in May.

What concerns me about Japanese shares on a near-term basis is their sudden popularity. It’s hard to pick up a financial publication without reading a bullish article on Japan. This type of favorable attention is the stuff of corrections. However, I think this will be similar to the gold stocks in terms of a near-term, relatively shallow decline in the context of a long-term bull market. Consequently, my advice is to do a little trimming around the edges, but I definitely would not exit what I now believe to be the Land of the Rising Yen. (More to follow on that topic next week.)

Additionally, for those who may have picked up shares in one of Japan’s blue chip companies last year due to this newsletter, it, too, has suddenly vaulted in price. Again, some profit-realization strikes me as appropriate. Though it took a while for this one to move, the rally over the last few months has justified prior patience.

Another downgrade pertains to the midstream energy infrastructure sector. One of the worst-performing names within it was the victim of a persistent and, in my view, irrational attempt to block a 94% complete natural gas pipeline. However, the debt ceiling increase legislation included a provision mandating the removal of environmental obstacles to this vital energy project. The positive news has caused the share price of one of its co-owners to double since late April. While further appreciation is likely over time, this has been such a monster move that cashing in some profits might be the best course of action. It is fair to note, though, that it remains at less than half of its pre-pandemic price level.

Japanese stock market

Top-tier midstream companies (energy infrastructure such as pipelines)

European banks

U.S. GARP (Growth At A Reasonable Price) stocks

Telecommunications equipment stocks

Swiss francs

Singaporean stock market

Short-intermediate Treasurys (i.e., three-to-five year maturities)

Intermediate Treasury bonds

Small cap value

Mid cap value

Select large gap growth stocks

Utility stocks

Down For The Count

The poster pair of 2021’s meme mania, GameStop and AMC Entertainment, have been big disappointments to their legions of influencer-driven fans, ever since they hit their hysterical crescendo that year. They have long been objects of scorn in this newsletter, particularly when they’ve had their numerous inexplicable, though often meteoric, rallies. Like watching a meteor streak across the sky, these have been exhilarating but ultimately short-lived.

The legendary Jim Grant wrote up the recent goings-on at GameStop this week. Here’s an excerpt of what he had to say:

A meme denied… GameStop Corp. (ticker: GME) terminated CEO Matt Furlong yesterday (Wednesday) with immediate effect after posting $1.24 billion in revenue over the quarter ended April 29, short of the $1.34 billion consensus. Trailing 12-month sales slumped below $6 billion, compared to $9.36 billion over the fiscal year ended February 2016. 

Chairman and incoming chief executive Ryan Cohen stated in a filing that Furlong’s simultaneous resignation from GameStop’s board of directors “did not result from any disagreement with the company.”  Yet Cohen, GME’s largest shareholder with a 12% stake, then took to Twitter to direct an apparent phonetic jab towards his ousted predecessor: 

@ryancohen
Not for long

Mr. Market was in no mirthful mood, as GME shares sank 18% to extend the drawdown from their January 2021 blow-off peak to 74%. “It’s hard to have an opinion [on a stock] with no earnings call, little-to-no investor communication, and a lack of strategic vision,” analysts at Jefferies wrote. “One consistency remains: changes at the top. Over the last five years, GameStop has had five CEOs and three CFOs.” 

Though GME initially fell hard on the news Jim describes, it is back up sharply today. This strikes me as similar to the undying faith in the crypto complex its adherents constantly display — despite the vast wealth destruction it has inflicted on the multitude of latecomers.

Rarely, in the annals of financial market history, has so much been lost by so many to the benefit of so few, those rare souls who got in early and showed no remorse in pumping and dumping. The fact that a seemingly endless stream of rank speculators investors keep coming back for more punishment is a mystery that perhaps will never be satisfactorily explained.

Meme stocks

The semiconductor ETF

Junk Bonds (of the lower-rated variety)

Homebuilders stocks

Financial companies that have escalating bank run risks

Electric Vehicle (EV) stocks

The semiconductor ETF

Meme stocks (especially those that have soared lately on debatably bullish news)

Bonds where the relevant common stock has broken multi-year support.

Long-term Treasury bonds yielding sub-4%

Profitless tech companies (especially if they have risen significantly recently)

Small cap growth

Mid cap growth

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Special Follow-up From Team Haymaker

On Monday of this week, we were proud and enthusiastic about posting Dave’s interview with Richard McPherson and Doomberg on the exceedingly consequential topic of nuclear energy. We are re-posting a link to that interview here in order that those of you who haven’t yet seen it might do so right away. The other reason for our re-posting is that we’d like to ask that you all share this video with everyone you know. Our mission here is to spread the word on the extraordinary potential of SMR/MSR technology — the more attention we can drive to conversations like this one, the more reason for hope that MSR capabilities might gather momentum and set out on a path to providing worldwide energy abundance.

Please watch it, share it, and comment on it at your convenience.

Thank you greatly.

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IMPORTANT DISCLOSURES

This material has been distributed solely for informational and educational purposes only and is not a solicitation or an offer to buy any security or to participate in any trading strategy. All material presented is compiled from sources believed to be reliable, but accuracy, adequacy, or completeness cannot be guaranteed, and David Hay makes no representation as to its accuracy, adequacy, or completeness.

The information herein is based on David Hay’s beliefs, as well as certain assumptions regarding future events based on information available to David Hay on a formal and informal basis as of the date of this publication. The material may include projections or other forward-looking statements regarding future events, targets or expectations. Past performance is no guarantee of future results. There is no guarantee that any opinions, forecasts, projections, risk assumptions, or commentary discussed herein will be realized or that an investment strategy will be successful.  Actual experience may not reflect all of these opinions, forecasts, projections, risk assumptions, or commentary.

David Hay shall have no responsibility for: (i) determining that any opinion, forecast, projection, risk assumption, or commentary discussed herein is suitable for any particular reader; (ii) monitoring whether any opinion, forecast, projection, risk assumption, or commentary discussed herein continues to be suitable for any reader; or (iii) tailoring any opinion, forecast, projection, risk assumption, or commentary discussed herein to any particular reader’s investment objectives, guidelines, or restrictions.  Receipt of this material does not, by itself, imply that David Hay has an advisory agreement, oral or otherwise, with any reader.

David Hay serves on the Investment Committee in his capacity as Co-Chief Investment Officer of Evergreen Gavekal (“Evergreen”), registered with the Securities and Exchange Commission as an investment adviser under the Investment Advisers Act of 1940. The registration of Evergreen in no way implies a certain level of skill or expertise or that the SEC has endorsed the firm or David Hay. Investment decisions for Evergreen clients are made by the Evergreen Investment Committee. Please note that while David Hay co-manages the investment program on behalf of Evergreen clients, this publication is not affiliated with Evergreen and do not necessarily reflect the views of the Investment Committee. The information herein reflects the personal views of David Hay as a seasoned investor in the financial markets and any recommendations noted may be materially different than the investment strategies that Evergreen manages on behalf of, or recommends to, its clients.

Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product made reference to directly or indirectly in this material, will be profitable, equal any corresponding indicated performance level(s), or be suitable for your portfolio. Due to rapidly changing market conditions and the complexity of investment decisions, supplemental information and other sources may be required to make informed investment decisions based on your individual investment objectives and suitability specifications. All expressions of opinions are subject to change without notice. Investors should seek financial advice regarding the appropriateness of investing in any security or investment strategy discussed in this presentation.