Dennis Gartman

Is it time to buy US? I. Studying the fundamentals

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Blogging has been a great help to DIY investors.  They can formulate their own strategies in writing, see what works, and share their knowledge with others.  Bloggers often have skin in the game; it might not be very much skin, as many are not rich people, but they are real investors and not like young journalists who don’t really have much hands on experience with trading or owning anything more elaborate than index or mutual funds in their RRSP accounts.

One of the clear reasons for thinking that many financial journalists are not particularly knowledgable about investing is that they are always engaging the advice of “experts” who are wrong most of the time.  Blogger Devon Shire is hypercritical of Robert Prechter, whose predictions are often dead wrong.  Another famous talking head is Dennis Gartman, whose own fund, HAG.TO, has remained essentially static since the fund began in 2009 while the stock indexes have greatly improved.  So why is this guy on TV?  He’s doing worse than an ING Direct savings account, where at least your money gets 1.5% interest.  The original investors of his HAG’s IPO at $10.00 are still 35 cents below water.  In the meantime, the Dow Jones and the TSX are both up about 60%.  How can a fund lose money in these conditions?  Why does Dennis Gartman get on TV and why do so many financial advisers read his famous Gartman Letter?  I think it may be because the journalists and the advisors are themselves incompetent.  At least all the many sheep following Warren Buffet around can say he is the best investor of all time.  A proven track record is actually a sign of competence.  But what proves that Gartman or Prechter know what they are talking about?

Bloggers, who have skin in the game and gain experience as they go, thus contrast with financial journalists.  Consider the Financial Post’s John Shmuel has a column with the title, “Lofty loonie spells buy opportunity”; but just a few weeks ago, he’s done columns on why Canadian stocks will outperform.  So why would he change his mind?–Or does he even see the contradiction? Well, as a journalist, he’s not actually trying to present a coherent strategy but information as it comes to him.  So I find that journalists can be great sources of information but terrible sources for eking out an investment strategy.  Why does Shmuel think that the lofty loonie spells a buying opportunity for US equities?  It seems for no better reason than that loonie is at a three year high.

Well, I did a few blogs about how and why I short the US dollar by using leverage in my US margin account to buy Canadian gold mining or oil and gas companies (e.g., abx, gg, erf, pwe, pgh).  The dividends from the oil and gas companies cover the interest charges and some.  Later, I added the selling of put options on the same equities, and reduced my overall cost of carry, because the leverage is now pushed off to some time in the future and I don’t actually have to pay interest on it today.  Has this strategy worked?  Extremely well.  Now that the loonie is at a three year high, will I now go long on the greenback or US equities as Shmuel’s article advises?  I don’t think so.  Consider the following chart (source Yahoo! Finance, straight line is mine):

What we see is that the loonie hit a low of $1.61 in 2002 and has basically improved in a nine year trend against a dollar.  Once the extremes of 2008-2009 are removed, a secular trend emerges which would suggest that the greenback will continue to move down against the loonie unless the fundamentals that caused this trend are changed.  If we looked at gold or oil against the dollar, we will see the same trend.  What we are seeing in the chart is US dollar inflation.  Not that the loonie is much better, but what happens in periods of inflation is that the cost of commodities rise.  Since the Canadian dollar depends so much on commodities, then whither commodities so the loonie.  If the price of commodities is increased by the inflation of the US dollar, can we expect this trend to reverse?  I think so if any of the following events were to happen:

(1) If Bernanke gives up QE.

(2) If Stephen Harper announces a deficit budget in the order of 150 billion or more (its is currently projected at 45.4 billion).

(3) If the US Congress makes serious cuts or attempts to balance the US federal budget.

(4) If the Chinese and other foreign investors decide to abandon Canada.

Let’s discuss each of these issues:

(1) If Bernanke gives up QE. I fully expect him to announce QE 3 in the next few months.  If he doesn’t continue to implement QE then the US government will have to make serious cuts of a trillion or so dollars from its current spending.

(2) If Stephen Harper announced a deficit budget in the order of 150 billion or more.  The Canadian population is about 1/10th that of the USA.  Therefore, the Canadian deficit would have to reach 150 billion in order to match the magnitude of the US deficits of 1.5 trillion.  I don’t see this happening under Harper’s watch.  In fact the trend is that the deficit is dropping in Canada.

(3) If the US Congress makes serious cuts or attempts to balance the US federal budget. This won’t happen until a cost cutting president gets elected.  It may actually never happen.  But the new Republican House is arguing over small cuts which won’t make any difference in a 1.5 trillion or so deficit.  Cut a few hundred billion out of that, and you are still over $1 trillion.

(4) If the Chinese and other foreign investors decide to abandon Canada. Right now, China, Korea, Thailand, Japan are all pouring money into Canadian resources.  Heck, foreigners are even buying our sovereign debt.  I see this trend continuing, as Canada has what these economies need, commodities.

The economy in the US is bad.  I’ve lost money in the US in a bad real estate deal started in 2008.  You won’t see me fall into that trap again unless the secular trends change.  My feeling is that my reasons for shorting the US dollar haven’t changed because the loonie has improved to $1.03 US.  This is a sign of secular trend not a buying opportunity for US stocks.

And if you ask me why I expatriated from the US?  I’ll tell you now that it’s so that at least one of my dad’s four children will still be able to take care of him in his old age.

Update:  Why pick on the Financial Post and John Shmuel?  David Berman has a similar article at the Globe & Mail: “Bruised greenback an opportunity for Canadian investors.”  Like Shmuel, he makes it clear that the US dollar is at a low but doesn’t seem to deal with any of the secular trends that put it there and then irrationally states:

It seems likely that the worst of the freefalling is over, given that the factors that drove the dollar down – including massive deficits and stimulative monetary policies – will probably move in reverse as the economy improves.

But he provides no actual proof that the US economy is improving.  That’s just baseless optimism as far as I can see.  Personally, I doubt that the damage of the QE that Bernanke’s already done has run its course.  Some inflationistas believe that when the economy actually improves, that’s when we will see the full effect of monetary inflation, because then velocity and credit will also expand.

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

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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.

Dennis Gartman’s Third Rule of Trading: A commentary

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Dennis Gartman’s Third Rule of Trading:  “Learn to trade like a mercenary guerrilla.”

A guerilla is a warrior.  A mercenary is a warrior who fights not out of loyalty or patriotism but for money and profit.  So one would assume that Gartman is saying not to stand by a company that you like, nor a trading strategy, if its not working.  Be flexible, because you’re in it not to prove a point but simply to make money.  So he writes, “We must indeed learn to fight/invest on the winning side, and we must be willing to change sides immediately when one side has gained the upper hand.”

I’ve read other financial writers that say that people are often irrationally loyal to a company whose stock they invested in.  My mother-in-law told me once that she thought it was basically immoral to short a stock, like you were betting for the downfall of a company or something.  Regent College professor Paul Williams feels that one of the main problems of the market place today is the disconnection between the people–creditors, companies and clients alike; indeed, the stock market is one big anonymous place where traders can determine the ultimate fate of a company, sometimes in a matter of minutes, and that is all done outside of relationships with the other stakeholders, the workers and the management that may be ruined in the process.  And yet that is the system.  So I suggest that Gartman is correct.  The anonymity of the market means that I can make the decisions that support my own solvency as opposed to what is going to help the companies whose stock I decide to buy or sell.  I am indeed a mercenary ready to switch sides.  This anonymity leads to the greater efficiency–and yes, perhaps, the brutality–of the market; decisions can be made not out of emotion, personal relationships, tribal loyalties, politics, patriotism or idealism, but simply because they are financially viable.  This means that if Nortel, Enron, or BreX go down the tubes, I don’t have to go down with them, but I sell them and find something better to invest in–and hopefully, I do it before it is too late.  This efficiency ultimately is good, in my view, and leads to great prosperity because the winners are the best companies and the losers are not viable.  If you want a road to mediocrity and poverty, then create a system that rewards losers and punishes the successful (such as socialism or bailouts).

I made the decision in 2008 to sell my shares of Microsoft.  Yet my sister works for Microsoft.  I didn’t tell her about my decision to sell, and we are still talking to one another.  Isn’t the anonymity of the market wonderful?

Dennis Gartman’s Eighth Rule of Trading: a commentary

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Dennis Gartman’s eighth rule of trading:  “Markets can remain illogical far longer than you or I can remain solvent” (quote attributed to J. M. Keynes)

This depends on the definition of the term “solvency”.  As a function of the solvency ratio, one must be pulling a profit at all times.  However, I assume that Gartman probably means something like this:

The financial ability to pay debts when they become due. The solvency of a company tells an investor whether a company can pay its debts.

The way Dennis Gartman-type trader would become insolvent is through a margin call that could not be met.  But Gartman says never to meet a margin call but rather liquidate positions.  But what if selling assets is insufficient?  The margin account could end up in a negative position and the trader becomes insolvent.  Gartman’s advice is good as far is it goes.  If a trader bets on a position using margin and leverage, he has to know when to leave the position before becoming insolvent.  Say you’ve shorted Berkshire Hathaway because you know that “idiot” is running that company to the ground:  when the irrational market keeps bidding that stupid company to the sky, you better get the heck out of that position before it bankrupts you.  That’s excellent advice.

But wouldn’t it be better to use leverage in a way that leadeth not unto insolvency?  So here is my alternate rule:

Thou shalt not use leverage unto insolvency

Lehman Brothers and Bear Stearns are the negative parables of times–investment banks so highly leveraged that they couldn’t withstand a downturn in the economy.  They had established debt-to-equity ratios of 30 or more to one.  A company or individual that keeps the debt to equity ratio at a more manageable level will not likely go bankrupt except during an Armageddon of deflationary meltdown, if the country loses a war on its own soil, or if communists come to power and seize all wealth.  Warren Stephens, in a Forbes interview, said that his investment bank only leveraged at 2-1, because he learned that one of the most important goals of business is to be in business tomorrow.  I am personally only comfortable with a debt-to-equity ratio of 1 or less.  Moreover, it is not a good idea to depend on available margin alone, unless that margin is extremely ample.  When the stock market crashes, margin credit also plummets.  Therefore, it is good to have a line of credit (e.g., HELOC) to fall back on.  Indeed, for the selling of puts covered by the margin, I immediately subtract the cost of assignment from the available line of credit, while reserving at least half of the line of credit for averaging down.  So it is ok in my opinion to use leverage; it just must be managed in a conservative manner.

Dennis Gartman’s first rule of trading: A commentary

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Dennis Gartman’s first rule of trading:  “Never, under any circumstance add to a losing position…. ever! Nothing more need be said; to do otherwise will eventually and absolutely lead to ruin!”

Horizens AlphaPro Gartman Fund (source TD Waterhouse)

Dennis Gartman is a colorful media figure who apparently has a trading business on the side.  Fabrice Taylor, in an article in the Globe & Mail, “Dennis Gartman needs less talk, more action“, points out that for all of Gartman’s media presence, he doesn’t do all that well as a fund manager.  The Horizens AlphaPro Gartman Fund (HAG.to) closed at $9.00 yesterday.  Fabrice Taylor, critical that Gartman’s fund was still at only $9.12, wrote almost a year ago (Nov. 30, 2009):

But the market is up 30 per cent since the fund launched. What’s up with that? Mr. Gartman didn’t get back to me, but the people at Horizons AlphaPro tell me the fund is intended to be market neutral, meaning it won’t move with the market. Why? Because it’s long and short, and supposedly constructed in such a way that the market’s performance has no net effect on the returns. The only thing that does have an effect, in theory, is the manager’s skill. It may be early days, but Mr. Gartman’s performance has been found wanting.

He’s expected to return between 6 and 12 per cent regardless of the market. Eight months in, he’s nowhere near that. …

Nearly a year later, he’s still nowhere near that point.  I thus view Gartman with a great deal of skepticism, particularly because he shorted Berkshire Hathaway, calling Warren Buffet an “idiot” on account of his (Buffet’s) buy and hold strategy.  Gartman explains his first rule:

Averaging down into a losing trade is the only thing that will assuredly take you out of the investment business. This is what took LTCM out. This is what took Barings Brothers out; this is what took Sumitomo Copper out, and this is what takes most losing investors out. The only thing that can happen to you when you average down into a long position (or up into a short position) is that your net worth must decline. Oh, it may turn around eventually and your decision to average down may be proven fortuitous, but for every example of fortune shining we can give an example of fortune turning bleak and deadly.

By contrast, if you buy a stock or a commodity or a currency at progressively higher prices, the only thing that can happen to your net worth is that it shall rise. Eventually, all prices tumble. Eventually, the last position you buy, at progressively higher prices, shall prove to be a loser, and it is at that point that you will have to exit your position. However, as long as you buy at higher prices, the market is telling you that you are correct in your analysis and you should continue to trade accordingly.

With all due respect, I doubt that averaging down is what killed those companies.  Usually what destroys investment companies is unwise use of leverage.  In my view, the goal of business is to be in business tomorrow.  So I don’t tend to use leverage for momentum stocks but for income stocks.  That way, short of a dividend cut, I will always be able to pay the interest and I won’t have to go bankrupt.  In addition, it is probably unwise to depend on the margin in your account to cover the leverage.  More credit (such as a HELOC) has to be laying in wait to cover a margin call, if God forbid, the market drops to that point.

Averaging down vs. Gartman

So Gartman says never to average down.  Never buy more of stock when it goes down–the market is telling you that you are right when you buy stocks on the rise.  Yet my experience teaches me that this is wrong.  Consider the following positions that I averaged down on during the last two years since the beginning of the crisis:  Western Gold Fields (WGI.to, now NGD) up 252.33%; Crescent Point (CPG.to) up 37.28%, plus 7% dividend; NAL Oil and Gas (NAE.un.to) up 16% plus 8.6% dividend; Barrick Gold (ABX) up 45%; Midway Energy (MEL.to, formerly TFL) up 294%; Great Plain Exploration (GPX.to) up 30%.  Some of my picks are still weak, but nothing is losing me any substantial capital.  Overall, the current positions in the portfolio are up over 62.3% above my book value.  By Gartman’s rule, I should pick my own style of trading over his, since his fund is still in a net zero position over the same period.

Why does averaging down work for me?  Here are some rules for averaging down:

(1) It is not a good idea to average down on stock that is in trouble. I did not average down on BP.  Nor Nortel.  Nor would I have averaged down on BreX or Enron. I sold my Enbridge (ENB.to) after the first oil pipeline spill (though that turned out to be wrong); I dropped Centerra Gold (CG.to) after the coup in Kyrgyz Republic (also wrong).  And I am thankful that the dot.com stocks collapsed before I began trading, but I doubt seriously I would have been caught in that mania.

(2) Begin with an appreciation of the value of a company. Perhaps it is an income stock like CPG.to or NAE.un.to.  Perhaps a junior oil company with a good team of proven oil men (like MEL.to).  I like commodities because my hunch is that fiat money will diminish in value while commodities will retain their value.  So I like trading gold mining stocks.  I now begin by easing into a long position or selling a put option to reduce the cost of entry.

(3) Understand that the market is not only sometimes wrong but often wrong.  Gartman’s point that a trader should let the market tell him whether he is right must be refined.  The market may be right over the long haul but in the short run, it is usually over buying or over selling.  The dictum of Buffet is better, “Be fearful when others are greedy and greedy when others are fearful”.  This is clearly saying a contrary message to Gartman’s first rule of trading.  The reason Buffet’s advice works is that, as  he learned from Benjamin Graham the author of The Intelligent Investor, publicly traded companies have two values:  (i) the value that the market places on it; (ii) the value it has based upon an evaluation of its balance sheets and its potential earnings going forward.  This second value, which is the most overlooked during periods of market insanity, represents the worth of the company if it were to be bought in a private sale.

(4) Pay attention to book value. Book value (a.k.a., shareholder’s equity) is an very important consideration.  Graham recommends that a defensive investor never buy stocks that are selling at a price to book of more than 1 1/2 times. He also taught that buying a company at a  price to book ratio of 1.0 means that the buyer is getting the company for nothing, for the buyer pays only for the shareholders’ equity, at a one to one value, but pays nothing whatsoever for the company’s future profits.  During the 2008 market crash, many stocks were selling at below shareholders’ equity.  An averaging down strategy makes it possible to take advantage of such deals.  But paying attention to book value saves the investor from sinkholes like the dot.com companies which often had negative book values.

(5) Maintain sufficient cash or credit to be able to average down.  When I first started trading I would shoot my wad and then there would be nothing left with which to average down.

(6) It is permitted to “average back up”; i.e., to take profits from the stocks as they come back up, especially when it helps to reduce leverage.