Case Study: Nasdaq 2000 vs. Naspers 2015

One of the most profound moments I've seen trading financial markets is when a new high is made and the excitement all but seems to spill over onto the street with much elation and equally great debate.  So when the Nasdaq returned to it's former glory this month it was with much relief and I think somewhat thought reflection of what the last 15 years has borne for investors and traders alike.

In passing comments I made to some in my trading circle I noted that although I wasn't around in 2000 when the IT Bubble burst, there was a rather confident mood this time around with the index comfortably securing its spot at previous highs effectively breaking a negative return had you invested just before the bubble popped. 

If one thinks back to the Great Crash in 1929 you will recall the number of years it took to return to former levels and it's for this reason that I believe the Dot-com bubble will sketch the Nasdaq in trading and investing history as a reference point for future bubbles. The inclusion of it in  the list of widely documented financial crashes of severe proportions does serve as a warning of the consequences of complacency and the damaging potential of human's greedy ways. 

Dot-com bubble 2000

A brief history of the Dot-com bubble can be simply explained as this; new sector of an economy coupled with technological innovation and growth rates to lucrative to pass by. The late 90's were defined as an era where the introduction of the internet as a form of communication and mass information transfer were the name of the game. Much hype had been built up around these fledgling internet companies, although the earnings uncertainty were merely brushed aside in favour of earnings potential.    

The problem with this approach is that there is a substitute of authentic earnings for an increased awareness of aesthetic chart value to feed an obsession of seeing charts breaking numerous records. Participants were pushing the price of internet companies at phenomenal rates, ignoring the usual metrics which should have been used and thus created a sensation. 

Did anyone make money out of the Dot-com rally? 

Of course they did, especially the ones who were aware of what was going on. These type of occurrences happen frequently with the concept of financial market bubbles being studied more closely so as to have a greater understanding about what causes them and the after party hangover which hangs around...for years. 

It becomes a question of the style of which you either trade or invest. Usually with bubbles there are huge amounts of money flowing into one particular stock or sector. The valuations start exhibiting overpriced indicators for long periods of time with no loss of momentum. Investors begin to take on an active approach rather than passive to protect the exponential amount of money that's made in a short span of time.

 In the battle between technicals and fundamentals, technicals always come off best in these markets. The reason being is that there is no consideration to a fair value and where those in the fundamental camp might begin to offload at higher levels, the technical crowd will keep propping up the price level and helping it cross over higher and higher levels making the price look vertical in nature. As the price starts to take on this shape more fundamentalists question the validity of the valuation...again and then we see the whole process start again.

This is exactly how it happened in the Dot-com era where internet companies had not become profitable as of yet but there was still untapped opportunities. In hindsight looking at the tech companies that dominate the stock market today, they would prove profitable in the long run however at the time they were running at huge losses. We still see this today with social media companies being the new flavour of the day.

Crouching Tiger, Hidden Dragon: The Chinese Internet Boom 

Fast forward 15 years later and a similar pattern has been emerging for a number of years within the Chinese internet sector. Most notably we have see China's biggest, Alibaba, make it's US listing last year dominating the news headlines as the largest IPO in history.

In the local arena, Naspers has seen it's investment made a few years ago in Tencent flourish. However this hasn't been without scrutiny at the sizable movements it's made in a short span of time. The P/E ratio is well over 100; with it being at these levels fundamentalists are once again hot on the heels. Can it continue?

The fact of the matter is it can't and I think it's imperative to understand that. There will come a time when both companies , Naspers and Tencent , will have to prove that there earning prospects reach the bottom line and it's because of this we will see either consolidation which I feel is highly unlikely given the vertical nature of the chart or a pullback. The depth of the pullback will be determined by the quality of the decisions made by both past and present management as well as how well these prospects are executed to profitability.

It's important to note that I am not in any way calling a market top, for all we know Naspers might even go on to see R3000. However what I am doing is painting a possible scenario to events which may play out in the future. The key here is that we have no control of the market but we do have a degree of understanding to how it may pan out. The market, so much like history, has a way of repeating itself and it would be critical for us to know what might happen.

If there's one lesson we can take out the Dot-com bubble is that investors feel more comfortable with seeing the physical instead of intangible promises going to the moon and back. If you're the type of investor that prefers the slow and steady pathway this kind of stock certainly won't fall within your risk profile. When it comes to long term investing in these stocks the results often end up in disappointment which is why you need to have an active approach at all times.

Finally, there is money to be made but always remember risk management before profits always.
Stay Safe Stay Profitable

 If you would like to contact me you can through my email at cadetrader@gmail.com or if you wish to follow me on twitter and get the latest updates of news, interesting commentary and general trends in the market, my twitter handle is @CadeTradeR if you follow this link it’ll take you directly to my twitter timeline: https://twitter.com/CadeTradeR

The Iron Throne: Guest Post by Mercedarians

When one canvasses material relating to the current state of the iron ore market, one can't help but notice kindred attributes to the oil glut established by OPEC's insistence on maintaining current production levels in order to secure a more preponderant market share. A trend of voluminous producers constricting their more minuscule competitors seems to be playing out in multiple, otherwise non-cognate commodities. That said, it goes without saying that different sectors have varying degrees of efficacy when attempting to manipulate their own production variability. We can reasonably assume that oil, given its fluid nature, is the most facilely manageable, with industrial metals like copper and iron ore falling somewhere in the middle, and precious metals, like gold and platinum, the least easily manipulated commodities.

The proxy, in this case the iron ore price, serves almost exclusively as the variable determining the investment community's sentiment towards the sector. This is the rational approach of course, but what if, for a moment, we were to think not like shareholders, but like business people.

What if the Iron Ore price were to drop below the $50 level this year, and stay there for a protracted period of time? I'd imagine that most of you, given the phrenic constructs you have already put in place, would postulate that margin compression would render investment into the sector unfruitful for a number of years. Seems logical, but the thing is, the worlds biggest and baddest producers disagree. At the very least we should ask why.

View image | gettyimages.com

So lets start by analyzing the state of the current market:

The US Dollar: Headwind - A 23% appreciation against a basket of global currencies in the last year, placing considerable downward pressure on all commodity prices, not least of all, Iron Ore

The Aussie Dollar: Tailwind - Having depreciated by 19% in the past 12 months, the currency has gone a long way in cushioning the blow experienced by the self-imposed 56% drop in the Iron Ore prices.

Interest rates: Tailwind - Swaps currently suggest a 74% probability that the Reserve Bank of Australia will cut interest rates next month.

Steel Production: Tailwind -  Growth of just 1% per year in China would be required to reach 1 billion tonnes of crude steel production by 2030.

China Supply: At first glance, it would appear that the deliberate oversupply, and ensuing price decline brought about by the majors is bearing fruit. Almost 90 million tonnes of iron ore production cuts have already taken place in China, with the country now sourcing only 20% of total demand from its 4037 domestic suppliers, down from 50% last year. These Chinese producers would be in a worse state still, were it not for accommodative local governments fortifying local operations through tax breaks and other forms of palliation. In fact these synthetic competitive advantages have been efficacious enough to have already facilitated a production increase of 7% for the first half of the year, taking total production for the first six months of 2014 reaching 710 million tonnes. Chinese mines are however operating at an average of only 40% of total capacity, down from 75% last year, with 75% of existing Iron Ore production operating at a loss. Sustained price action below $80 would result in further substantial Chinese production cuts in the region of 125 million tonnes, according to Rio Tinto's Chief Executive Officer Sam Walsh.

View image | gettyimages.com

 China Demand: The "disappointing" economic data released recently diverts from the fact that for the first time, strong growth in the services sector means that services now account for more than half (51.6%) of GDP in the first quarter, indicating that the desired shift from a manufacturing led, to a consumption led economy is beginning to take shape. “The latest GDP report underscores offsets coming from China’s services-led transformation, a key underpinning of consumer demand,” said Stephen Roach, a senior fellow at Yale University and former non-executive chairman for Morgan Stanley in Asia. “I suspect the economy is close to bottoming and could well begin to pick up over the balance of this year.”

Australia: Production now tops 1.1 billion tonnes, and accounts for 83% of global production. Governments hands off approach has however seen the suspension of junior miner Atlas Irons 13 million tonnes of production, along with a 40% production cut at Odisha Iron Ore and Sinosteels closure of its Blue Hills operation. UBS estimates that all Australian miners would be operating at a loss under $34 a tonne. At present however, we find BHP Billiton announcing a 19% production increase, Rio Tinto an 18% increase, Vale a 13% increase, and Fortescue, Australia's fastest growing producer, a 54% increase. So all in all, it seems to me for one, that everything is going according to plan. Local government, along with a large number of smaller producers have however begun to weigh in on the matter, with Nev Power of Fortescue, seemingly on the verge of requesting government intervention. "I am not sure what they [BHP Billiton and Rio Tinto] are doing but all I can say is that the current state of the iron ore industry has been a disaster for everyone. It's has ripped the heart out of the industry, it's ripped the heart out of the suppliers and contractors to the industry, it's ripped out the heart out of the communities, and there are absolutely no winners out of any of this, only losers". It also seems that given a $1.3 billion Western Australian budget shortfall, and a second credit rating downgrade looming, Premier Barnett is well-incentivized to do so. They are socialists after all.

View image | gettyimages.com

The route cause of any deliberate market share consolidation is the conscious decision by major suppliers to substitute higher margins with higher volumes in the hope that the vector of price reduction will be more shallow than the vector of volume increase, thus increasing net profitability.

Which companies then, if any, will survive this transition from margin-focussed sales, to volume-focussed sales, and emerge with a considerably larger market share than before?

In the short term, the actions taken by the majors does have its downside. 46% of BHP Billiton's profits are paid out in the form of dividends, and with those yields over 5% in the case of both BHP Billiton and Rio Tinto, the maintenance of the progressive dividend policies common to the majors is now threatened. Given the fallout and management changes resulting from the financial crisis dividend cuts, it is unlikely that current dividends would be reduced before, at the very least, the Iron Ore price reaches the lower half of current range estimates. The gap will therefore need to be filled in the interim by a combination of borrowings and spending cuts, both of which increase cost of funding and the probability of a ratings downgrade.

Goldman estimates that at an Iron Ore price of $40 or below, Billiton, Rio, and Anglo American would have to reduce dividends, and Kumba Iron Ore would have to suspend its dividend completely. At that price, all Chinese production will have ceased, BC Iron and Fortescue, with costs of production at $39 will likely also have ceased production completely. The majors would remain operationally profitable at that stage, but with both government and shareholder related pressures weighing even more heavily on management by then, we can reasonably assume that cuts would be a very real probability.

In conclusion, with Citi having recently lowered its price forecasts to an average of $37 a tonne for the rest of the year, its survival of the fittest, and with production costs at Kumba's Sishen mine at $30.60 a ton in 2014, and $24.84 at Kolomela, representing its two largest operations, it is clear that Kumba's metrics far more proximately resemble those of the majors than the minors. With both operational and production costs in the lower percentile of global producers, accommodative Chinese and Australian policies pending, eventual production cuts, and a lower competition environment moving forward, Kumba in fact stands to benefit from the very market share consolidation designed by the majors to destroy its counterparts. A windfall that would not have been accessible were Kumba not the quality operation it REMAINS today.

You can follow our Guest Writer on Twitter @Mercedarians 

Naspers the Nemesis

Today I decided to do a follow up article to a write up I had posted in November in which I fessed up to not taking a trade because I had allowed emotions to play a role in the decision to execute the trade or not and how the missed opportunity really hurt my confidence when I saw the move coming.

Naspers has been one of the top momentum plays amongst traders in South Africa partly because of its exposure to tech giant TenCent. One only needs to look at it's competitor Alibaba to appreciate how fast the Chinese online presence is growing at rates which by some accounts surpass rational beliefs.  However I'm not here to give any fundamental validation to the price levels we've seen but rather talk about the trading lessons I've learnt thus far from my attempts to capture profits from the often volatile moves. 

Being involved in trading for almost 3 years now I look back and I find mistakes littered around my trading performances and yet if there's one share that stands out as one which sums them all up, mine would be Naspers by far. Let me give you a brief timeline:

One of the first trades I took was Naspers and surprisingly to the short side. At the time there was a lot of noise around by analysts about how expensive the stock had become and that there was an imminent pullback to come. The price at the time was over R400, so I trusted their judgement and not my own being fresh in the game and that turned out to be a mistake which cut me out after a day. So I was wrong, I could accept that but maybe that pullback was going to come and so the wait began...

Fast forward a year and a half later and now the price is staring closely at the R1000 and Kippy the Clown here is still waiting for the pullback. Again analyst begin to question whether these price levels are sustainable and if so the growth trajectory needed to keep it steady. Big scary numbers fly around and suddenly my mind goes into overdrive, perfect plan. Wait for the price to hit R1000 then short it, surely can't carry on growing at these rates...

That didn't work out too well so it was 2-0 to Naspers. Then to add insult to injury the price surges past the R1000 level stops me out goes even higher as if to rub my nose in it. Looking back now I'm grateful for being responsible and having a stop loss. By now I'm frustrated with this wretched stock and so badly want to trade it right like everyone else is doing. So I contemplate and settle for the notion that I'm no top calling hero and if I want to play this one right I'm going to have to ride with the trend not against it.

View image | gettyimages.com

So I wait my chance to climb on board the train and my chance comes as the price makes a new high of R1350 and pulls back sharply to R1050. I'm waiting like the wolf outside the piggies house and swoop in determined to make back my losses and more. When the unexpected happens, it falls even further and stops me out...again!!! Argh 

The logic or should I say illogical reason behind the trade is that although it was a good one my mind kept thinking about the losses I had made previously and started to think of ways to get them back with an overgeared exposure. But once again the market proves to be the supreme master and disciplines those who ignore the rules of engagement. 

Defeated, deflated and whatever else you want to call it, I just had enough of this particular stock and just put it down to working against me, so when the time came again last year October I refused to see what was going to go down which resulted in a missed opportunity. Fear had now crept its way through the front door and didn't want to leave. 

So what have I learnt from these experiences? 

1.  The noise created by analysts/traders is enough to make you do foolish things. Follow your own plan and trade the chart not the opinion of others. The trend is your friend until it ends and there's nothing more truthful than that. 
2. When trading any security, always identify the underlying trend and trade with it. There's no point trying to be a hero and calling the top of such a strong stock. When the time and trend is right there will come the a day when shorting is possible but not when it's experiencing such a massive shift in sentiment.
3. Revenge trading gets you nowhere, in fact it leaves you in a worse off position than you were in. Trade based on solid planning and not over past bad experiences in a trade. Every trade is a new trade no matter what happened in the past.   
4. Along the pathway of your journey you are going to find securities which make you and break you. Certain stocks stick out like in my case Naspers or Aspen, find your own and take notes of what works for you and what doesn't. There are trading basics within these securities and much of the knowledge you extract from them will be the foundation for taking things longer term. 

In saying this and watching the price of Nasper getting closer and closer to the R2000 mark I smile with glee at finally realising the error of my ways and capturing the elusive profitable Naspers trade which has escaped me for so long.

 If you would like to contact me you can through my email at cadetrader@gmail.com or if you wish to follow me on twitter and get the latest updates of news, interesting commentary and general trends in the market, my twitter handle is @CadeTradeR if you follow this link it’ll take you directly to my twitter timeline: https://twitter.com/CadeTradeR