Long - Term View On The U.S. Stock Market

Well, I was totally wrong in my last post on the U.S. stock market. Instead of going down it went strongly up. I am quite a good example of how difficult it is to predict a market move in the short - term.

Fortunately, January was a good month for those trying to profit on the descending stock market - for example, S&P 500 fell 5.1%.

In this post I want to look at the U.S. stock market in the longer time horizon.

Firstly, this market still looks like it is in its topping stage. While many other stock markets look to be in their bear market phases (or in a strong correction), the U.S. stock market stands firm:

Apart from Dow Jones Transportation, which looks like being in a strong correction or even in its bear market, other indices seem to be in their topping phases (which means that currently they are going nowhere).


However, in the long-term the markets do not paint a rosy picture.

1. Open interest in S&P 500 futures is going down:

The green arrow depicts the descending trend in open interest. When during the bull market phase the open interest goes down it means that less and less players are interested in participating in the game. And the basic stock market rule is that bull markets end with vanishing enthusiasm.

2. Less and less players are taking long positions in stocks (measured as a ratio of long positions / short positions held by big speculators):

3. More speculators are taking short positions in stocks:

As the chart shows, despite the ongoing bull market in stocks, since the middle of 2013 more and more speculators have been taking short positions.


4. The spread between junk bonds and U.S. treasuries is widening:

The chart shows the widening spread between junk bonds and 10-year treasuries. Please, note that before the last financial crisis (2007 - 2009) we encountered a similar pattern.
Since the second quarter of 2014 the spread has widened from 36 points to 50 points but the stock market seems not to be prone to that phenomenon. Not just yet...

Summing up, in the long-term the U.S. stock market does not look rosy for those believing in another year of price increases. However, in my opinion, there is no hurry to open short positions in stocks (unless you have very deep pockets). Topping processes are very tricky. What is more, the may last and last.

Precious Miners Portfolio - December and January Performance

Below you will find how my precious metals portfolio performed since inception:

Since December 16, 2015 the portfolio went up 14.4% while GDX (the big precious metals miners ETF) went up only 1.14%. In the same period the broad stock market, represented by S&P 500, lost 6.4%.

Another chart:

And the performance of each company:

As the chart shows, all picks reported positive returns. The best ones were Claude Resources (an increase of 30.2%) and Richmont Mines (21.1%). The worst stock was Fresnillo - an increase of 5,4%.

It Looks Like Harley Davidson Replicates The U.S. Economy

Most recently Harley Davidson (NYSE: HOG) published its 2015 results. Looking at the annual company's vehicle shipments I have spotted an interesting pattern:

The chart demonstrates changes in annual shipments. If there is an increase in shipments it is depicted in green. And vice versa - if there is a decrease, it is depicted in red.

It is interesting that in 2007, one year before the last financial crisis, Harley Davidson reported a decrease in shipments. A similar situation happened last year - for the first time since 2010 shipments went down 1.6%.

Well, it looks like Harley Davidson, a flagship U.S. company, behaves like the U.S. economy. Currently it is slowing down.

Strange Session In The U.S.

It was not a usual session in the U.S. Main indices went up, slightly but up.

However it seems that we saw an artificial increase. For example, NASDAQ 100 went up 1.4%. This increase was made at a very high volume - 910 million shares changed hands.
What is strange enough - today as many as 141 issues made new lows (yesterday it was only 70 issues) and 14 issues hit new highs (nearly the same amount as yesterday). It is not a normal situation when indices go up (in such cases the number of new lows should go down).

Similar things happened to S&P 500. What is more, the chart below shows that today the big investors were selling their shares (descending Accumulation/Distribution line):

Now we are close to the medium-term lows. Usually at such levels stocks used to start a bounce up.

However, since January 21 the market does not want to go up. Well, in my opinion, the market is trying to tell something important and it seems that the info may be negative for those looking for another leg up...

Facebook - Optimism Not Based On Fundamentals

Yesterday Facebook announced its 2015 preliminary results. It is not an easy task to analyze this company - simply put, it has a very short financial history. What is more, Facebook's strength is based on its popularity among its users - the company is something like a fashion company.

However, let me try to do it in a simple, as usual, way.

I assume that the company's valuation is driven by its ability to deliver positive cash flows. Facebook was definitely able to deliver higher and higher cash flows from operations:

Of course, in the case of Facebook, its ability to deliver cash flow from operations is strictly linked to the company's revenue. In other words, the higher revenue the higher cash flow from operations.

At this point I see the first scratch. Facebook is still able to increase its revenue from year to year but last year this growth was weaker:

Well, I guess that the company is going to face this phenomenon in the coming future - it is really hard to increase such a high revenue ($17.9 billion in 2015) through organic growth.

That is why Facebook should focus on improving its effectiveness, for example through increasing its cash flow margin. To remind my readers, cash flow margin says what amount of cash is generated by one dollar in a company's sales. In the case of Facebook, in 2015 each dollar in sales was delivering $0.44 in cash flow.

Here is another scratch. It seems that Facebook's efficiency is slowly going down:

As the chart shows, 2015 was the first year when the company's cash margin was lower than in the previous year. Putting it differently, Facebook is currently facing some limits. Its revenue is growing at a slower rate; what is more - this revenue is delivering less cash, measured on a percentage basis.

Now I can try to present a quick valuation of the company's shares. According to the company, in 2015 Facebook delivered free cash flow of $6,076 million. Let me assume that Facebook is going to grow its earnings at the rate of 3% per year, indefinitely.

Next, assuming that:

• the company's beta is 1.04
• risk free rate is 2.38%
• historical return of the stock market in the U.S. is 5.81%

then the cost of equity is 2.38% + 1.04 x (5.81% - 2.38%) = 5.95%

Facebook is a debt-free company therefore the cost of capital is equal to the cost of equity.

To find the company's business value I have to discount the annual free cash flow by the cost of capital diminished by the growth rate:

Facebook's business value = $6,076 million /  (5.95% - 3.0) = $205,966 million

To find value of equity I have to increase business' value by adding cash held by the company ($18,434 million at the end of 2015). As a result, the company's equity value is $224.4 billion.

Well, today the company's market cap (assuming that shares are trading at around $110 a piece) is around $312 billion so the company is actually overvalued by 28%.

Coca - Cola Shares Are Going Up On Fumes

Coca Cola is an example of yet another stagnant business. What is interesting, investors do not seem to spot it. Let me look at Coca - Cola's basic financial measures. The chart below depicts cash flow from operations, excluding working capital issues. In other words, the chart shows how much cash is delivered by Coca - Cola's core business:


Well, it looks like the company entered a stagnation period, starting from 2011.

What is more, looking at the chart below, it seems that cash flow from operations has been the main driver of Coca - Cola share prices:

The red arrow indicates where the problem is. Between 2001 and 2011 Coca - Cola was steadily increasing its cash flow from operations and share prices were closely following this pattern. However, since 2011 the company was not able to increase its operating cash flow any longer.

Despite this fact, investors were eagerly buying its shares. In other words, share prices were going up without fundamentals.

Historically, if something is not backed by fundamentals it should correct.

Fortuna Silver Mines Looks Really Good

Fortuna Silver Mines (NYSE: FSM) is included in my Precious Metals Portfolio. Most recently the company published its 2015 operating results. It was really a hard time for all miners, Fortuna included.

However the company was able to increase its production (apart from silver, it produces also gold, zinc and lead). The chart below shows silver and gold production, starting from 2009 (plus 2016 estimates):

As the chart shows, silver production increased nearly fourfold since 2009 and gold production nearly sixfold since 2011. Really impressive.

What is more, Fortuna is going to keep it up. The chart below shows the estimated production till 2020:

source: Fortuna Silver Mines presentation

Note that the chart shows production measured in silver equivalents (these equivalents comprise also gold, zinc and lead).

The chart also confirms that San Jose is going to be a flagship property. The commercial production at San Jose started in 2011. Initially this mine was responsible for a significant increase in production costs - please, look at the chart below (and note a rapid increase in costs between 2010 and 2011):

Note: accounting costs are calculated on a per ounce of silver basis

Fortunately, the company learned how to operate San Jose properly  - hence the rapid decrease in accounting costs. Most recently, in 3Q 2015, these costs were standing at around $10 per ounce of silver, which made Fortuna a profitable company, even at today's relatively low silver prices.

Well, I am confident that this company should continue delivering decent results in the coming future. What is more, if silver prices start going up it is going to be delivering really outstanding results, better than its peers.

This Time It Was Really Different But The End Should Be As Usual

Firstly, a chart:

The chart depicts two financial instruments:

• U.S. stock market (represented by an index S&P 500)
• BDI - Baltic Dry Index, which is a measure of shipping transportation activity
• Copper

Generally, when the world economy grows, each measure goes up - world trade grows (BDI), there is demand for commodities (Copper) and stocks go up (S&P 500). It is a healthy economic model depicted by the yellow area on the chart above.
In other words, the previous bull market in stocks (2003 - 2007) was supported by the two leading economic measures (BDI and Copper price).

However, the ongoing bull market in stocks, depicted by the pink area, has not been supported by these economic measures (both world trade and copper prices have been going down).
So, this time it was different. But was it, really? I don't think so. In the long run everything should reverse to the mean so there are two alternatives:

1. the stock market will go down (or, at least, it will stop going up)
2. suddenly the world economy will speed up lifting copper prices and the world trade

I choose the first alternative. In my opinion, the last bull market was supported by central banks and artificially low interest rates plus a lot of the so-called quantitative easing - hence the flourishing stock market and stagnating world economy.  I think that this stimulus is dissipating, which should have a negative impact on the world stock markets.

Intel Corp - A Slowing, Decent Business

Last Friday Intel announced its 4Q 2015 results. These results confirm the fact that the company is a stagnant business - please, look at the chart below:

As the chart shows, since 2010 the company has been reporting rather stagnant Nopat (defined as net operating profit after tax).

 What is more, the stagnation in Intel operations is best seen at the chart below:

The chart shows one of the best indicators of a company's financial strength - return on invested capital (ROIC). As the chart shows, since 2010 Intel has been delivering lower returns. In other words, the company was allocating its capital into the assets delivering smaller growth.

Well, in my opinion, it is nothing wrong - at some point any company meets some setbacks or simply put, it is not able to find interesting growth opportunities any longer. Intel is such a case.

However, the company's management is, in my opinion, an investor-friendly group of people. Encountering growth limits, they repurchase Intel shares and pay decent dividends. Since 2010 Intel:

• paid $25.4 billion in dividends
• spent $37.4 billion on share repurchases

Investors have been buying this strategy. Although the company was reporting lower ROIC and weaker Nopat, Intel share prices were going up:

What is more, the company's shares were stronger than Dow Jones Industrials:

I think we are close to another bear market in stocks but Intel should sustain its relatively better performance against the broad stock market.

In The Long-Term The US Stock Market Looks Bearish

The broad stock market is at its inflection point. In one of my last post I have noted that an S&P 500 index is drawing a huge technical pattern called "Head and Shoulders". Breaking down below 1,875 points level would mean that the pattern was filled. 

Today the index closed at 1,880 points so, basically, we are still in the upward trend. Who knows, maybe we will even see a bounce up.

However in the long-term the technical analysis says there is a very big chance the market is going to change its trend. Please, look at the chart below:

The chart shows the market price action (the upper chart) and the difference between the number of  new highs and new lows (lower, bigger chart).  

It is easily seen that in 2007, when the market was still going up, more shares were hitting new lows than new highs. Since the middle of 2015 the pattern seems to repeat - we see more shares recording new lows than those recording new highs.

In my opinion, it is a bearish pattern.

  

Gold Miners Portfolio - Update

I have changed the way I am reporting the value of my precious metals portfolio. Now my portfolio and GDX are starting from the same point (December 16, 2015). As a result, it is possible to visually compare the price action of both instruments. Please, have a look:

As the chart shows, since December 16, 2015 the portfolio has increased its value from 9,997.1 to 10,255.6 (2.6% up), while GDX has fallen 6.6%.

Is A Big Short Approaching? S&P 500 Is Drawing A Giant "Head and Shoulders" Pattern

A few days ago I presented the so-called "Head and Shoulders" pattern, drawn by Apple stocks.

Today let me show another "Head and Shoulders" pattern - this time this pattern is much more important because it is related to the broad stock market, represented by an index S&P 500.

Before the previous bear market in stocks (2008 - 2009) S&P 500 drew a similar pattern:

Today the market looks like:

The pattern has not been filled yet. To do it, the index has to fall below 1,875 points.
If such is the case, shorting the broad stock market should make sense.

Richmont Mines Announces 2015 Operating Results

2015 was a good year for Richmont Mines (it is included in my portfolio of top five miners). The company produced 98,031 ounces of gold (3% up, in comparison to 2014). The chart below demonstrates the company's results:

The biggest share in this high production belongs to the Island Gold Mine, a flagship property. In 2015 this mine delivered 56.1% of total gold production. The second biggest producer was the Beaufor Mine (26.9%). The chart below shows the production breakdown, starting from 2011:

It is easily noticeable that Island Gold is the leading property - each year this mine was delivering the majority of the company's gold production. This situation is not going to change.

Quite contrary - Island Gold is the property at which the company plans to build its strength.

According to the most recently published Preliminary Economic Assessment,  in 2016 the company will put in operation Island Gold Lower Zones, an extension of the Island Gold. The chart below shows the expected production, delivered from this new mine:

As the chart shows, at its peak, in 2019, the Island Gold Mine should deliver as many as 92.5 thousand ounces of gold (an increase of 68%, compared to 2015). Part of the construction has just been finished - in 2015 the company increased the mill capacity (from around 700 tonnes per day to 900 tonnes per day).  

Precious Metals Market Looks Better But There Are Still Bearish Signs

Most recently the precious metals market started to show signs of life:

As the chart demonstrates, since August 2015 big gold miners, represented by GDX, have been stronger than the broad stock market, represented by S&P 500. It even looks like a triple bottom - a pattern signaling a reversal in the downward trend (yellow areas).

Next positive - since March 2015 the junior miners, represented by GDXJ, have been stronger than big miners. It is also a sign of a bull market.

However, the overall trend in the precious metals market, represented by GDX, is still DOWN (the upper chart).

What is more, the price action demonstrated by silver, indicates that we are still in a bear market in precious metals. As a rule, during a bull market in PM market, silver is appreciating faster than gold. The chart below proves that today it is not the case - gold is still stronger than silver:

Apple Has Drawn The Long-Term Head&Shoulders Pattern

For those interested in the technical analysis - one of the most popular stocks, Apple, has just made a long-term "Head and shoulders" pattern. According to the technical analysis, it means a trend reversal. What is more, it took around fourteen months before the pattern was drawn:

source: www.stockcharts.com

Another thing - Apple is a leading stock. It sets the general trends. If this tech-giant breaks its long-term upward trend it is not a good sign for long positions in stocks...

Claude Resources Provides 2015 Production Results

Claude Resources accounts for 25% of my gold miners portfolio. It is also a leading company in this portfolio - I believe that in 2016 this miner should perform very well.

Yesterday Claude announced its 2015 production summary. The most important info is that Claude produced 75,748 ounces of gold in 2015. Both deposits, Santoy Gap and Seabee, performed very well:

The chart shows that 2015 was a milestone year for the company. Claude shifted the burden of its production to the Santoy Gap mine - as many as 42,399 ounces of gold were delivered by this deposit while the Seabee mine (a former leading mine) delivered 33,349 ounces. Somebody could ask why Claude increased production at the Santoy Gap and decreased at Seabee? The answer is simple - the mill. The Claude processing plant (mill) is able to mill around 800 tonnes of ore per day. In 2015 Claude was milling 463 tonnes of ore per day from Santoy Gap (on average) and 297 tonnes of ore per day from Seabee (760 tonnes totally). The charts below show basic operating measures related to both deposits:

As the charts show, despite the fact that head grades demonstrated by Seabee were higher than those reported at Santoy Gap, the company decided to increase mining operations at Santoy Gap. Simply put, Santoy Gap is currently the most prospective deposit for the company.

On the other hand Claude plans to increase the mill capacity by 20%. If such is the case, the company could easily increase its production. Let me present the slide from the company's last presentation:

As the slide shows, in 2016 Claude plans to extract around 14 thousand ounces of gold from the Santoy Gap deposit. Let me cite the company's announcement:

"At the Seabee Gold Operation in 2016, production is expected to be between 65,000 and 72,000 ounces of gold. The majority of tonnes and ounces in the 2016 business plan are expected to be sourced from the Santoy Gap deposit as it ramps up to an average of approximately 700 tonnes per day."

Well, there is a problem. Since in 2016 Claude plans to produce around 56 thousand ounces of gold at Santoy Gap (up 32%, comparing to 2015) only 9 - 16 thousand ounces are to be delivered by the Seabee Mine. Let me count - at the end of 2014 there were 85,200 ounces of gold at the Seabee Mine, classified as mineral reserves. In 2015 the company depleted this deposit by around 33.3 thousand ounces of gold so there should be around 52 thousand ounces of gold left. So the company has quite a lot of gold at Seabee to produce more than 9 - 16 thousand ounces per year. Hmmm...I guess that Claude is underestimating its planned 2016 gold production. With higher mill capacity it should deliver more gold in 2016 than the planned 72 thousand ounces (maximum).  

O.K. Let us wait until March 2016, when the company is going to publish its operating and financial update.

Anyway, Claude looks very good at the moment. I am confident that the company should perform well in 2016.

Oil Prices - Two Important Charts

Oil is going down, down, down. Yes, that's right. When any financial instrument goes down or up over an extended period the analysts start making predictions.

As my readers know, I am very far from making any predictions. However, why not to look at something and try to find some factors supporting an investment thesis. Today let  me look at oil prices.

Firstly, a long-term view:

The chart shows net positions in futures contracts on oil (crude oil light sweet NYMEX) held by big speculators. It is really a strange situation. Despite the fact that oil prices are currently at their multi-year lows, speculators still hold quite large net long positions (196.3 thousand contracts)- there is no pessimism at all! In the long-term, the downward trend in oil prices should continue because the relevant reversals occur only when there is remarkable pessimism.


Now, the short-term perspective:

The chart shows short positions held by the managed-money. Currently these speculators hold very large short positions in oil futures. Usually, such a pattern means that a short term bounce is coming - simply put, there is too much short-term pessimism.

Summarizing - the downward long-term trend in oil prices seems to be secure but in  the short term the market demonstrates a chance for a bounce.

Selling Pressure In Gold Is Dissipating

There are many signals indicating that selling pressure in the precious metals sector is dissipating. One of these signals is visible on the chart below:

The chart shows that between 2009 and 2011, despite the ongoing bull market in gold, investors were less and less interested in acquiring gold (the green arrow). In 2009 GLD, the biggest world's ETF investing in physical gold, increased its gold holdings by 353 tons. In 2010 these holdings increased by only 147 tons but in 2012 the investors withdrew 26 tons from the fund. Then, in 2012 we saw the beginning of the current bear market in gold.

In 2013 as many as 553 tons of gold were withdrawn from GLD. This year was also the worst time for gold bugs - gold lost 23.2% in its value against the US dollar.

However in 2014 and 2015 investors withdrew only 89 and 69 tons of gold, respectively (the blue arrow). Despite the fact that gold was still losing its value against the US dollar, the selling pressure was not that high as, for example, in 2013. In my opinion, it is the light at the end of the tunnel for gold bugs.

Another big gold ETF, IAU, demonstrates a similar pattern:

The dissipating selling pressure in these two big gold ETFs may be an indicator of the end of the bear market in gold. On the other hand - the dissipating selling pressure is not a signal that a new bull market in gold is starting.

Precious Metals Miners Portfolio - Update

The year 2015 ended so it is time to summarize the value of the Simple Digressions Precious Metals Miners Portfolio.

For those unfamiliar with stocks included in the portfolio - here is a useful link.

As the chart shows since the inception, the portfolio value increased by 1.5%. During that time, GDX, an ETF comprising many big miners' stocks, lost 2.3% in value.

Finally, the broad stock market (S&P 500) lost 1.4% in value.