Jeet kune do investing (III) vs. conventional investing

I revealed offline to Mich at Beating the Index how much my portfolio (87%) is weighted towards oil and gas stocks, and only C.J.’s (my wife’s) defined contribution plan is in a balance fund.  He wrote:  “Your portfolio is high risk indeed! I imagined you would have some bonds and more utilities, you surprised me really …”  So I even managed to surprise another junior oil investor with my portfolio.

But let’s consider that conventional styles of investing are too rigid.  They present stereotypical strategies for conventional times.   If Bruce Lee had been a financial advisor, he would have advised his clients to adapt fluidly to the market–to anticipate the market’s moves and to respond in a way suited to each individual.  There are no recommended trades, for each investor is unique, with a unique set of risk tolerances, liquidity and investment goals.

I am an inflationista.  There is no doubt in my mind that Bernanke is creating money faster than the credit bubble is deflating; nor do I have any doubt anymore that the Bernanke Put is for real: no matter how fast credit deflates, Bernanke promises to pump it back up with fiat money.  Now the Bank of Canada wants to create inflation, albeit only 2%, but that they also want desperately  to keep the loonie on par with the greenback; and with these two strategies, governor Mark J. Carney will not be able to control run away inflation in Canada.  Indeed, one could argue that the Canadian housing market has already run away from him.   So now I have been investing for the last two years believing that hyperinflation is our opponent, and my jeet kune do moves must adequately anticipate and respond to that reality.

Consider these conventional strategies and how they cannot possibly succeed in time of hyperinflation:

(1) Get out of debt; (2) maintain a balance portfolio; (3) diversify your portfolio; (4) Subtract your age from 100 and this is the percentage of stocks vs. fixed income; (5) Real estate is always a great investment.

(1) Get out of debt.

Debt is always very bad if it is high interest consumer debt (credit cards, lines of credit). But for many people their mortgage is their best protection against hyperinflation–the currency can lose value much faster than you pay off the debt or interest rates can go up.  Creditors lose in inflationary times, and so it stands to reason that debtors can win, provided that their debt is not spent on frivolous consumer goods.

(2) Maintain a balanced portfolio.

A balanced portfolio puts the emphasis on having stocks for growth and fixed income for safety.  But it is questionable whether stocks in general are a good hedge against inflation.   Warren Buffet wrote an article during the height of the last great inflationary period (1977, Fortune Magazine):  “How inflation swindles the equity investor“.  Fixed income investments are a disaster during hyperinflation, especially today, with the rate of return being so pathetic due to artificially low interest rates.

(3) Diversify your portfolio.

I am not sure that this strategy works in conventional times, supposing that such times ever exist.  Diversification is not the same as not putting all your eggs in one basket.  My portfolio includes debt, real estate, oil and gas, and gold mining companies.  But it doesn’t include anything in aviation because my C.J.’s business is in aviation maintenance.  So you won’t see me investing in Bombardier, Boeing, Air Canada or West Jet, because if one company goes down, it can have a domino effect on the entire industry.  That’s not putting all your eggs in one basket.  But those who advocate diversification suggest that the investor either own an index fund or diversified mutual fund, or a roughly equal number of stocks in each of the major sectors of the economy.  I am pretty sure this will only lead to pretty mediocre results.  I’ve noticed over the years that most investor billionaires are barely diversified, but have made their money in highly concentrated moves:  for example, Warren Buffet is mainly an insurance guy.  John Paulsen shorted sub-prime mortgages then bought gold.  Sometimes it is better to get to know one or two industries really well, and stick to what you know.

(4) Subtract your age from 100 and this is the percentage of stocks vs. fixed income.

This bit of conventional wisdom has cost people a lot of money.  The last two years has provided pathetic yield on fixed income and meanwhile we’ve been in a great bull market.  Hyperinflation is going to wipe out whatever seniors have left and they’ll be saying a final “good bye” to their wealth.  The reason why this strategy is wrong is it has an imaginary understanding of what is a high risk investment.  Stocks are considered high risk and fixed income, low risk.  But in hyperinflation, there is nothing more certain to destroy a portfolio than fixed income investments.

(5) Real estate is always a great investment.

The sub-prime mortgage crisis has done much to destroy this myth.  For me, real estate has been a wash in the last two years.  The rental house we bought is up $70,000; but the commercial building in Texas which I bought with my brother has zero equity, is not breaking even, and $70,000 of my initial investment is basically a write-off.  But many people think that real estate will maintain its value in a time of hyperinflation. Gonzalo Lira trounces that myth in an article demonstrating that during hyperinflation the high interest rates and the unwillingness of creditors to lend out a rapidly devalued currency, destroys real estate prices.

Meanwhile, as of this moment, my concentrated jeet kune do portfolio is 86% above book.  Commodities go up during hyperinflation; so my stocks are nearly all in Canadian commodity companies (oil and gas, gold, and sugar).

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Jeet kune do investing I: the case of Canadian junior oil and gas

I have great admiration for Beating the Index.  The website provides very valuable analysis of the Canadian junior oil and gas sector, the major plays (esp. Bakken and Cardium), and the macro issue of why the price of oil will likely rise in the long term investment horizon.  In addition, Mich, the website’s sole proprietor, reveals to us a part of his self-managed portfolio, what moves he makes as he beats the index.  His style is his own, adapted to suit his particular portfolio.  For example, because he is using leverage, he has to cash in on his winners–sometimes he also drops losers and holdings which remain  static.  In one post, his commentors on his blog praise him for being willing to take losses and move on, saying that this is the mark of great trader.

But then one has to wonder, if an analyst has done his due diligence and decided that a company is a good buy, and then the market decides to dump the stock, whether that stock just became a better deal.  So in my trading, I very rarely dump losers, though I have sometimes done so to realize a tax loss or to implement a change of strategy.  Rather, I’ve averaged down on losers, and most of the time it works, as I shared in a post critiquing Dennis Gartman’s first rule of trading, “Never, under any circumstance add to a losing position…. ever!”  Gartman says to add to winning positions rather than to losing positions.  Generally speaking, I ride the winners, but I don’t often add to my positions.  Gartman’s rigid style seems to be flawed, and his own HAG fund is still going nowhere.

Now Keith Schaeffer, one of the leading independent analysts of the Canadian junior and intermediate oil sector, provides a compelling argument why it is better to add to the companies with momentum:

When it comes to the junior and intermediate North American oil and gas plays, I want to buy expensive stocks. I rarely buy cheap stocks. That sounds counter-intuitive, but it makes sense.

When a company trades at a high valuation it can raise money with less dilution, and can use its stock as currency to take over other companies. They can grow more quickly and more efficiently than companies with low valuations.

“Dilution” is one of the terms that junior oil and gas investors seem to fear.  Indeed, share price usually seems to drop after a public offering.  Crocotta Energy’s recent share offering is a great example:

CTA share price fell on Feb 3 after announcing a $25 million bought deal

One day on an airplane on the way to Barbados, I met A. Zoic, an experienced entrepreneur, who explained “dilution” to me:  He said, “The number of shares are increased, but the size of the company also increases.  So you have smaller percentage of the whole, but the company is much larger.” Zoic’s words came back to me, the inexperienced investor, time and time again as I watched Midway Energy, my largest holding, take on more and more new shares; and Zoic’s advice helped me over the last couple of years to understand that when a junior oil raises money in a public offering that that is a really good thing because it increases the overall size of the company.  This has the added benefit of increasing the average volume of shares traded which in turn makes all shares more liquid.  A great CEO with an established reputation, like Midway Energy’s Scott Ratushny, has been able to raise the investment dollars to create the momentum that makes a good value into a great investment.

In the end, the best strategy for trading junior and intermediate oil and gas is neither the value nor the momentum strategy alone.  Rather, in my view, the two strategies should be implemented together in an artful Jeet Kune Do of  (1) Momentum–buy winners:  I keep adding to my position of CPG; (2) Averaging down seeking value:  I kept buying MEL (when it was still TFL) as it plummeted in price; (3) Buy and hold:  I watched MEL go from 0.39, my lowest price, to $5.19 (and am still holding).   Junior oils are too volatile to cut losses early, and I’ve found for the last four years as a junior oil investor, that my overall gains far outweigh my losses.

What works depends as much on the investor, his liquidity, credit limit, available margin, size of portfolio, as it does on the style of investing.  I rarely cut my losses.  I don’t see that ability as the mark of good investor.  The mark of good investor is perhaps better described as an even keel temperament to do the right thing without allowing the market to determine his next trade for him.  According to the legendary martial artist, Bruce Lee, the best style is no style–consider how these words fit investing:

Too much horsing around with unrealistic stances and classic forms and rituals is just too artificial and mechanical, and doesn’t really prepare the student for actual combat. A guy could get clobbered while getting into this classical mess. Classical methods like these, which I consider a form of paralysis, only solidify and constrain what was once fluid. Their practitioners are merely blindly rehearsing routines and stunts that will lead nowhere.

I believe that the only way to teach anyone proper self-defence is to approach each individual personally. Each one of us is different and each one of us should be taught the correct form. By correct form I mean the most useful techniques the person is inclined toward. Find his ability and then develop these techniques. I don’t think it is important whether a side kick is performed with the heel higher than the toes, as long as the fundamental principle is not violated. Most classical martial arts training is a mere imitative repetition – a product – and individuality is lost.

When one has reached maturity in the art, one will have a formless form. It is like ice dissolving in water. When one has no form, one can be all forms; when one has no style, he can fit in with any style.