Everyday You Aren't Selling You Are Buying

I am often asked if I still own a security that I've opined on. If the answer happens to be "yes", I often find myself issuing a disclaimer such as "but I'm not adding to my position at present". The implication is that it is no longer a bargain, therefore I'm not adding. But, by not selling, I am making the same decision as buying. So, I must continue to like the company at its current valuation. I found it more compelling when it was cheaper, but evidently I would buy it today if I still own it. I find myself going through this circuitous logic regularly.

Two Master Limited Partnerships, DEP and EPD, have prompted my introspection. These two mid-stream oil and gas service partnerships have been stellar performers. Now, selling at all time highs I wonder if they shouldn't be sold. They aren't selling at ridiculous valuations, but they are getting extended, especially the bigger of the two, EPD. DEP's multiples are more reasonable. At today's pricing they will still yield about 5.5%, not all dividend income as some is return of capital. Both are growing, adding assets, and well managed.

Dan Duncan, the founder and force behind both companies died near the end of 2010. He left the companies with a capable cadre of management and his heirs a nice bonus, zero estate tax on his 10-20B estate! I liked him when alive, admire his timing in death, and plan to keep his two companies for the foreseeable future. I'm not selling, so I guess I remain a buyer.

Aaron Rents [AAN] Is An Auld Lang Syne Holding

Yesterday I accomplished two things. That's big in retirement world! First, I bought more shares of Aaron Rents [AAN] as the market was marking them down by 7 percent and, second, the wife and I attended the annual Burns Supper.

Burns Suppers, held world-wide to commemorate the birth of Scottish poet Robert Burns are full of poetry, kilts, bagpipers, and scotch malt liquor. I appreciate all of the foregoing. There are also lots of Scots speaking with thick brogues. I missed a lot of the presentation because I couldn't catch the cadence of the brogue. Earlier in the day I believe the market was having a Scottish moment as well, because I couldn't understand why they were throwing out a solid company like Aarons.

I've written about Aaron's before, lastly in 2009, so I won't delve into any numbers today as they've continued to perform well. Last quarter was solid and future guidance acceptable. The company uses debt sparingly and sells for a modest 12 X forward earnings. In a past life I owned 25 furniture rental stores, understand the accounting, and feel confident that a growing number of customers like the rental experience. So, the sell off presented an opportunity to add to my position.

I didn't understand the market's behavior Friday anymore than I understood the Burns revelers last evening. But Robbie Burns, that cool dude in the sunglasses, would understand my toasting auld lang syne to my long-time, old friend Aaron Rents as the market presented me with a New Year's opportunity to buy some more shares at a discount.

The Cure For High Prices Is High Prices

A quick, cursory glance at almost any commodity chart will lead the viewer to only one conclusion: watch out! Agricultural products, precious metals, industrial metals, rare earth minerals, energy, etc. have all experienced a steep ramp up over the past 6 months.

That increase in price has been explained by a weak dollar, upcoming inflation, emerging market growth, a rebounding economy, permitting difficulties, and the growth of commodity influenced ETFs. Given the foregoing, demand has been significant and prices have risen. Investors have taken notice, but so have producers.

Timing anything is notoriously difficult. This cycle will be no different than trying to figure out when tech stocks would peak or the last deadbeat would receive his triple subprime home equity loan. You can sense it's coming, but when?

My guess is that we're about 2 years away from the cure kicking in. The process has already begun as high prices has encouraged large numbers of new mining projects in various stages of permitting/buildout and we are beginning to see a significant number of untilled acres being planted. The cure for high prices is high prices.

To avoid the impact of increased supply, world economies need to get going and keep going. Any stutter along my 2 year guestimate and investor/speculator confidence could weaken, causing prices to start a readjustment process. ETF money isn't the same as industrial demand and if that segment of demand starts to move elsewhere, the new supply will look overwhelming!

Like the greater fool that I often am, I'm sticking with my allocation of commodity related companies and ETFs. The likes of Bunge, Cloud Peak, and Devon are likely to remain in my portfolio even after my 2 year threshold. But, the ETFs, GLD, SLV , and EWZ, are likely to be sold as months elapse and we get nearer to increased supply and weaker demand.

The recent sell off in many commodities will likely be reversed and owners will be rewarded by further moves upward, but sometime over the next couple of years, high prices will drum up supply and prices will correct. It always happens.

Rare Earth Comments Signal Inexperienced Owners

My posts receive much more exposure on Seeking Alpha than they do on this site. Consequently that's where I get the most feedback; usually of little value.

The rare earth bubble article stirred the pot pretty good. My thesis was rare earths aren't rare, rising prices will attract big miners, REE companies are selling for insane valuations, and finally, if you want to be near the space, buy FCX or TC as they will benefit if the bubble doesn't explode and you'll not lose your nest egg if it does. Most commentors didn't want to get it.

I usually get this type of response when I advocate shorting a stock. All the supporters rally with inane logic and never dispute the central facts. Same thing here. The owners of REE stocks defended the price rise with all types of mineral trivia, mine location, and personal attack. Nobody bothered to re-think their investment and convince me that paying $5B for MCP, a development stage junior, that has committed most of its eventual production to W.R. Grace at a fixed price and therefore won't materially benefit by any huge run up in REE prices, is a prudent investment. That attitude and lack of discipline is how bubbles develop and one is developing, if not already present.

I did receive one comment worth reading. A person that could actually read and understand called me on my reference to Alfred Einstein, hoping it was Albert's brother. I have no idea as what I was thinking about when I typed that other than I probably had a scotch in my hand and wasn't concentrating deeply. It's better to make typing errors than investment errors.

A Tale Of Two Companies

If Charles Dickens was alive and well in Omaha, instead of writing A Tale Of Two Cities, he may have tackled A Tale Of Two Companies. Omaha is home to two agricultural manufacturing companies that are both well run and in some business lines, direct competitors. Valmont Industries [VMI] and Lindsay Corporation [LNN] control the center pivot irrigation industry and also have significant operations in utility poles [VMI] and highway crash cushions [LNN]. Both are consistently profitable and financially sound; indications of sound management.

Valmont is the larger of the two and has numbers that are generally superior to LNN. VMI has a 10% operating margin to Lindsay's 9%, while producing a ROE of 11% vs LNN's 10%. Sales grew 20% last quarter at Valmont with the aid of an acquisition and only 4% at Lindsay. But the stock market views things differently.

Lindsay has been the clear winner as far as the market is concerned. Consequently, you now pay 16 X cashflow, 3.4 X book value, and 24 X forward earnings. A buyer of Valmont only pays 10.7 X cashflow, 2.7 X book, and 18 X forward earnings. Valmont is not priced cheaply. Lindsay is just priced expensively.

I expect Lindsay will revert to Valmont's level of valuation and will continue to explore put option pricing and the availability of shares to borrow. In the long run i like both of these companies, but, at present, Lindsay is clearly over valued.

Rare Earth Minerals Are Not In a Secular Bull Market. It's A Bubble

Scarcity generally does lead to higher prices. But one still has to be careful. In the case of rare earth minerals, I'm afraid Alfred is going to be correct once more. Speculators are pushing any and all rare earth related stocks skyward with no regard for logic and financial analysis. All they heard was that China was no longer going to be an exporter of rare earths, leaving the rest of the world in a shortage. True to form, they've chosen the wrong companies to exploit any bull market in rare earths. As always, it is insanity and will not end well for the uninformed.

The major beneficiaries of the rare earth boom have been small, junior miners such as Molycorp [MCP] and General Moly [GMO]. However, they really don't have a business yet and are basically development stage companies. GMO has basically no revenue and a $450MM market capitalization, while MCP, also without any revenue, is valued at $5B! It's all on the come.

The problem is that rare earths are not rare! Until recently they were just by- products of other mining projects. Giants such as Freeport McMoran [FCX] are in the rare earth business and will be more so as pricing increases. So is large moly miner Thompson Creek Metals [TC].

The above chart shows where the insane money has been flowing. I own TC, for its molybdenum business and in process gold/copper project, not for any rare earth miracle. Thompson is a conservatively financed and well managed company. It has over $1B of sales, $500MM of cash, no debt, and a market cap of of only $2.5B. That's right, it has half the market capitalization of MCP!

Remain sane with proven operators, not story stocks.

Secular Bull Markets Don't Guarantee Short Term Success

It's Tuesday and the wife is positively giddy as she watches Glee on television. That same giddiness and glee is also present in the commodities space of the stock market. The trend is up, the trade has worked, and the story is intact. Investors/speculators continue to pile into any and all real asset plays as an inflation hedge, a dollar hedge, and a participation in emerging markets. I've done so myself. But I worry.

"What the commodity markets are telling us is that we're living in a finite world, in which the rapid growth of emerging economies is placing pressure on limited supplies of raw materials, pushing up their prices. In other words, commodities are in a real, secular bull market, not a bubble." The forgoing quote is a sentiment that I encounter daily in articles, newsletters, and analysis. I don't disagree, but that does not mean that a nasty correction cannot happen in spite of the commodity shortages.

An example. The aggregate industry in the U.S. is a wonderful, regionalized monopoly. Supply is limited by the inability of operators to easily obtain permits for new quarries, mines, and facilities. The scarcity is real. Until 2008 the share prices of all aggregate companies marched steadily upward based upon their ability to raise prices, even in the face of declining volumes, due to limited supplies. It was a secular bull market in rock. Then as the real estate recession moved from residential real estate development to commercial development to road building, the price increases no longer stuck well enough to offset the huge volume declines. Share prices declined. I was on the right side of that trade and did well.

The aggregate business is still a good one, if your balance sheet is conservatively financed, and the permitting of new projects hasn't become any easier, but the share price declines show that shortages can become oversupply rapidly. That oversupply can affect the conservatively financed and the aggressive companies alike [MLM and VMC, respectively]. Commodities, and commodity companies, face the the same dilemma as the rock suppliers.

Should China experience a "hard landing", commodity volumes will drop drastically, prices will be slashed, and share prices will no longer enjoy a positive trend. Inflation and a weak dollar won't be able to compensate for a stalled China. Emerging markets are going to emerge and use huge amounts of raw materials, but their progress doesn't have to be in a straight line. Raw materials are in a secular bull market, but they aren't immune to dislocations caused by retrenching markets.

If China were to stall, the secular bull market in commodities goes into neutral for several years. I don't have an opinion on China's ability to manage their economy, but I do have an opinion on how my raw material/commodity investments are structured. If China craters, I only want to own companies with pristine balance sheets that can easily survive until the emerging markets bounce back. I don't own "junior" miners, rare earth hopefuls, and leveraged operations that are taking on large, debt funded, expansions to supply China.

I don't have the conviction to sell materials stocks short, like I did the aggregate operators, but that could change! In the meantime I hope the China led recovery continues, and should it not, that my conservative materials positions perform well enough to get me to a prosperous resumption of the secular bull in commodities.

Glee's over so I can quit typing.