Students of Roger Montgomery's (Buffett's) intrinsic valuation method

[Macros]

Understand where you are coming from Trooper, but I guess my view is this: regardless of the fact that investors have area's of competence, one should be aware of the big issues.

Is it not better to invest in areas which have an economic tail-wind and also have sound qualities? If a business has sound qualities, it can still fail to adapt to difficult economic head-winds should they last longer than expected. So while these barriers can provide protection in the short-term, I don't think they last unless the business is able to adapt. It is also apparent to me that many do not succeed at adaptation when required (e.g. Colorado, Angus & Roberson etc etc) and are replaced with new companies that better understand the environment.

I think that sometimes people who have specific knowledge of a particular industry can fail to appreciate some of the risks that that industry faces. I think that this is due to familiarity resulting in a greater comfort level and lower appreciation of risk.

 

[The Trooper]

I tend to agree with you and you have raised some very good points. These are things the investor rather than the speculator should understand relative to their investment. If a good business fails to adapt it ceases to be a good business. Hopefully by understanding the financial indicators of this failure as well as keeping abreast of the global information available an investor would recognise this before the market. There is however no certainty in sharemarket investment and i think you have touched on this well.

 

[Tysonboss1]

If one can accept that the big trends are important, why is it that retailers = safe and profitable gold producers = speculation? Surely it depends on the environment and economic landscapes which can last for many years if not decades.

Thoughts?

Is buying and holding gold Investing?

In Security Analysis, Benjiman Graham proposed a clear definition of investment that was distinguished from what he deemed speculation. It read,

"An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative."

No doubt that Gold purchased outside of bubble conditions meets the first condition being safty of principle, But it fails the second test of generating an adequate return, you could say it actually creates a negative return due to storage costs.

So buying gold is not investing, it is speculating. Now there can be intelligent speculation just as there is intelligent investing, Whether buying gold at 100year highs is intelligent only time will tell. But it is not investing in the true sense of the word.

Is owning a gold producer Investing?

On the face of it, yes.

A gold producer is in the business of digging up a commodity and selling it, It's profit depends on the sale price being well above it's cost of production.

Now to truely be considered an investment there must exist a margin of safty. For a producer with exposure to a single commodity you would not only want to be able to by the producer at a price that low enough that it's current earnings will generate a sound return, but also that it will still generate a sound return based on a fall in commodity prices.

Gold is currently at a 100year high, it is selling for over 5 times it was just 10 years ago. Some might agree gold is in a speculative bubble and when working out whether a gold producer is profitable a much lower gold price should be used.

Not many gold producing companies have all the attributes that attract value investors based on a much lower gold price.

 

[notting]

I am glad Roger claims to be a crap economist. Better the churl who knows he's a churl than the scholar who's proud of his scholarship.
I'v never seen a good economist. Only those who think they are or those who are popular for a minute. Every one loved Greenspan, some even had expensive paintings of him on there corporate walls! Then came the GFC!!! The pictures were swiftly hidden away in cuboards etc.

Hmmmmmm the world is rather fullish. Seems food,water and resources are looking a little shortish.
The breadliners have stopped working because they can't afford food,the tucks have stopped transporting because the fuel is costing them more than their profits. One things for sure housing, land and comodities aintever going to be cheaper. What all the economists have to say. 'It's a sub prime credit squeeze'

All together now....
On the count of three 1,2,3.
'Well we can grow our way out of this crisis.'
Anyone got a better idea?............
Another Idea?
An idea? Lets have a drink, it's Friday.

PS if you want to forcast global growth or no growth look at oil now! if its above 75 tepid to zero growth shortly.

 

[Macros]

Tysonboss1,

This is a great post in that you have demonstrated the exact frustration that I have with investors that follow the traditional 'value' philosophy.

You quote: "An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative."

You conclude that gold fails the second test.

If you were to 'invest' in physical gold, you are not investing as it doesn't provide a return on capital. You are correct in your conclusion on this point, but for the wrong reason. Gold does not provide a return on capital because there is no liability and no counter-party.

Gold held in storage is exactly the same as a bunch of cash notes held in storage. The difference being that cash notes are fiat currency and are eroded in their purchasing power over time whilst gold protects against monetary debasement. Neither are a true investment until they are lent out and receive interest in return, which takes on the counter-party risk that you expect return of your capital. We perceive that lending cash to the bank is a risk free transaction, but it isn't.

So when looking at investing in companies, I find it curious that those who say 'why invest in gold companies?' and use the case of holding physical bullion to conclude that it is speculation. It should be clear that there is a delineation between investing in gold producers and physical bullion. One is an act of investment and the other is just money.

When investing in gold producers, I believe that you are investing in the profitability of these companies as opposed to the resources in the ground. On this basis, they are no different to any other business. I've written more about this issue here http://macrovalueinvestment.blogspot.com/2011/06/valuing-resource-companies-including.html which takes the concept of investing in the flow (profits) as opposed to stock (resources in the ground).

You say:
"Now to truely be considered an investment there must exist a margin of safty. For a producer with exposure to a single commodity you would not only want to be able to by the producer at a price that low enough that it's current earnings will generate a sound return, but also that it will still generate a sound return based on a fall in commodity prices."

First of all, as with investing in any business, I believe that you should be aware of the big issues and trends. There is no difference between a fall in commodity prices and a retailer in a deflationary environment where you have to sell your goods for lower prices.

Therefore you must have an idea of where the trend lies. If you don't, then you are speculating, regardless of it is a resource producer, retailer or technology business. It is clear that any business that has tight margins between cost of goods and sale prices is a higher risk business.

You say:
"Gold is currently at a 100year high, it is selling for over 5 times it was just 10 years ago. Some might agree gold is in a speculative bubble and when working out whether a gold producer is profitable a much lower gold price should be used."

I'm not having a go at you personally here, because I've heard this sort of view many times and I believe that it demonstrates a complete lack of understanding on this issue and the issues that the world faces. Gold is at a 100 year high because the fiat based currencies are at a 100 year low. Gold hasn't changed in price, it is only the paper currencies that are losing purchasing power that have decreased. If you think that gold is in a speculative bubble, then you have not truly considered the issues we face in world currency systems and where they are headed. On an inflation adjusted basis, based on the traditional measure of inflation, gold would be $5,000 per ounce today. This doesn't take in to account the level of global debt outstanding that needs to be defaulted via monetary debasement. You may disagree with me on this, but it isn't a matter of contention.

You say that "a much lower gold price should be used" when working out valuation. Well, no. You don't do this for other businesses, so why would you apply it here. The only reason that this should be the case is if you know which direction it is headed and why. You could apply this concept to an iron ore producer, but if you were to apply it to a gold producer it only means that you have not performed sufficient research. Yes, there can be short-term fluctuations, but this applies to all things.

What if the actions taken by world leaders were responsible and we were on a semi-gold standard like the great depression? Retail stocks would get CRUSHED in massive deflation as the price of their goods would suffer massive falls. The valuation is based on future earnings and the earnings you thought they had would disappear rapidly.

This is my point. You need to know what is going on and where things are headed. Otherwise you are in the dark and don't have the margin of safety that you thought you did.

There are quite a few gold Australian producers have total cost of production around $600 per ounce. Current AUS gold price is heading towards $1,500 per ounce. Is a 60% margin not enough for you? Gold is heading MUCH higher due to world currency issues. This is not speculation, it is fact. We either default on all debt and have a great depression or the debt is inflated away and purchasing power is eroded even further. Given actions to date, we are already on the inflation pathway and it snowballs from here.

I'm not a gold bug or have any particular affinity to gold, however I do read in to what is going on from a big picture point of view. As someone with this perspective and as a value investor, there is many attributes that attracts me to gold producers given the environment ithat we face.

 

[Tysonboss1]

Is it not better to invest in areas which have an economic tail-wind and also have sound qualities? If a business has sound qualities, it can still fail to adapt to difficult economic head-winds should they last longer than expected.

I think that sometimes people who have specific knowledge of a particular industry can fail to appreciate some of the risks that that industry faces. I think that this is due to familiarity resulting in a greater comfort level and lower appreciation of risk.

yes, that comes under the "Understanding the business" to be able to say that you truely understand the business, you have to have an understanding of the risks faced by that business and the likly outcomes economic factors will have on the operating performance.

Offcourse no matter how good your understanding, and how good a certain business is, it can still end badly so the margin of safty principle also calls for some diversfication, So even if part of you portfolio goes badly in aggregate you will still do welll

 

[Macros]

Notting,

My point is that we need to call a spade a spade. 'Economists' like Alan Greenspan are the sorts of people that assisted and responsible in the mess we find ourselves today. Most traditional economists don't look at the world as it is and instead look at it with the tinted glasses of their failed traditional Keynesian economic models.

My point is that as investors we need to be economists. Not economists as in the profession, but we need to watch the economy and figure out what is going on. I believe that the better that this is done, the more successful one can be.

Yes, oil is a massive issue and it seems that we could have a supply/demand shortfall in the second half of this year. Clearly this is negative for economic growth. We can still have growth in nominal terms but it will be a severe drag in real terms unless there are some solutions found quickly. Given shenanigans like the US and IEA selling 60 million barrels, which is around 2/3 of one day usage, in order to try to pull down the price, it seems that there are no near term solutions that are being supported by governments.

 

[Tyler]

Tysonboss1,

This is a great post in that you have demonstrated the exact frustration that I have with investors that follow the traditional 'value' philosophy.

You quote: "An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative."

You conclude that gold fails the second test.

If you were to 'invest' in physical gold, you are not investing as it doesn't provide a return on capital. You are correct in your conclusion on this point, but for the wrong reason. Gold does not provide a return on capital because there is no liability and no counter-party.

Gold held in storage is exactly the same as a bunch of cash notes held in storage. The difference being that cash notes are fiat currency and are eroded in their purchasing power over time whilst gold protects against monetary debasement. Neither are a true investment until they are lent out and receive interest in return, which takes on the counter-party risk that you expect return of your capital. We perceive that lending cash to the bank is a risk free transaction, but it isn't.

So when looking at investing in companies, I find it curious that those who say 'why invest in gold companies?' and use the case of holding physical bullion to conclude that it is speculation. It should be clear that there is a delineation between investing in gold producers and physical bullion. One is an act of investment and the other is just money.

When investing in gold producers, I believe that you are investing in the profitability of these companies as opposed to the resources in the ground. On this basis, they are no different to any other business. I've written more about this issue here http://macrovalueinvestment.blogspot.com/2011/06/valuing-resource-companies-including.html which takes the concept of investing in the flow (profits) as opposed to stock (resources in the ground).

You say:
"Now to truely be considered an investment there must exist a margin of safty. For a producer with exposure to a single commodity you would not only want to be able to by the producer at a price that low enough that it's current earnings will generate a sound return, but also that it will still generate a sound return based on a fall in commodity prices."

First of all, as with investing in any business, I believe that you should be aware of the big issues and trends. There is no difference between a fall in commodity prices and a retailer in a deflationary environment where you have to sell your goods for lower prices.

Therefore you must have an idea of where the trend lies. If you don't, then you are speculating, regardless of it is a resource producer, retailer or technology business. It is clear that any business that has tight margins between cost of goods and sale prices is a higher risk business.

You say:
"Gold is currently at a 100year high, it is selling for over 5 times it was just 10 years ago. Some might agree gold is in a speculative bubble and when working out whether a gold producer is profitable a much lower gold price should be used."

I'm not having a go at you personally here, because I've heard this sort of view many times and I believe that it demonstrates a complete lack of understanding on this issue and the issues that the world faces. Gold is at a 100 year high because the fiat based currencies are at a 100 year low. Gold hasn't changed in price, it is only the paper currencies that are losing purchasing power that have decreased. If you think that gold is in a speculative bubble, then you have not truly considered the issues we face in world currency systems and where they are headed. On an inflation adjusted basis, based on the traditional measure of inflation, gold would be $5,000 per ounce today. This doesn't take in to account the level of global debt outstanding that needs to be defaulted via monetary debasement. You may disagree with me on this, but it isn't a matter of contention.

You say that "a much lower gold price should be used" when working out valuation. Well, no. You don't do this for other businesses, so why would you apply it here. The only reason that this should be the case is if you know which direction it is headed and why. You could apply this concept to an iron ore producer, but if you were to apply it to a gold producer it only means that you have not performed sufficient research. Yes, there can be short-term fluctuations, but this applies to all things.

What if the actions taken by world leaders were responsible and we were on a semi-gold standard like the great depression? Retail stocks would get CRUSHED in massive deflation as the price of their goods would suffer massive falls. The valuation is based on future earnings and the earnings you thought they had would disappear rapidly.

This is my point. You need to know what is going on and where things are headed. Otherwise you are in the dark and don't have the margin of safety that you thought you did.

There are quite a few gold Australian producers have total cost of production around $600 per ounce. Current AUS gold price is heading towards $1,500 per ounce. Is a 60% margin not enough for you? Gold is heading MUCH higher due to world currency issues. This is not speculation, it is fact. We either default on all debt and have a great depression or the debt is inflated away and purchasing power is eroded even further. Given actions to date, we are already on the inflation pathway and it snowballs from here.

I'm not a gold bug or have any particular affinity to gold, however I do read in to what is going on from a big picture point of view. As someone with this perspective and as a value investor, there is many attributes that attracts me to gold producers given the environment ithat we face.

lol,
Resource prices revert the the marginal cost of production

 

[Macros]

Lol wrong. Marginal cost of production on marginal projects catch up to prices.

 

[Tysonboss1]

1, This is a great post in that you have demonstrated the exact frustration that I have with investors that follow the traditional 'value' philosophy.

2, If you were to 'invest' in physical gold, you are not investing as it doesn't provide a return on capital. You are correct in your conclusion on this point, but for the wrong reason. Gold does not provide a return on capital because there is no liability and no counter-party.

3, Gold held in storage is exactly the same as a bunch of cash notes held in storage. The difference being that cash notes are fiat currency and are eroded in their purchasing power over time whilst gold protects against monetary debasement.

4, So when looking at investing in companies, I find it curious that those who say 'why invest in gold companies?' and use the case of holding physical bullion to conclude that it is speculation. It should be clear that there is a delineation between investing in gold producers and physical bullion. One is an act of investment and the other is just money.

5, When investing in gold producers, I believe that you are investing in the profitability of these companies as opposed to the resources in the ground. On this basis, they are no different to any other business. I've written more about this issue here http://macrovalueinvestment.blogspot.com/2011/06/valuing-resource-companies-including.html which takes the concept of investing in the flow (profits) as opposed to stock (resources in the ground).

6, First of all, as with investing in any business, I believe that you should be aware of the big issues and trends. There is no difference between a fall in commodity prices and a retailer in a deflationary environment where you have to sell your goods for lower prices.

7, It is clear that any business that has tight margins between cost of goods and sale prices is a higher risk business.


8, Gold is at a 100 year high because the fiat based currencies are at a 100 year low. Gold hasn't changed in price, it is only the paper currencies that are losing purchasing power that have decreased.

9, If you think that gold is in a speculative bubble, then you have not truly considered the issues we face in world currency systems and where they are headed. On an inflation adjusted basis, based on the traditional measure of inflation, gold would be $5,000 per ounce today.

10, You say that "a much lower gold price should be used" when working out valuation. Well, no. You don't do this for other businesses, so why would you apply it here.

11, What if the actions taken by world leaders were responsible and we were on a semi-gold standard like the great depression? Retail stocks would get CRUSHED in massive deflation as the price of their goods would suffer massive falls. The valuation is based on future earnings and the earnings you thought they had would disappear rapidly.

12, This is my point. You need to know what is going on and where things are headed. Otherwise you are in the dark and don't have the margin of safety that you thought you did.

13, There are quite a few gold Australian producers have total cost of production around $600 per ounce. Current AUS gold price is heading towards $1,500 per ounce. Is a 60% margin not enough for you? Gold is heading MUCH higher due to world currency issues

14, I'm not a gold bug or have any particular affinity to gold, however I do read in to what is going on from a big picture point of view. As someone with this perspective and as a value investor, there is many attributes that attracts me to gold producers given the environment ithat we face.
.

1, Why be frustrated, Just run your own race. If you believe one thing just follow that and forget what others believe.

2, thats exactly what I said, physical gold can be held as a store of value and a hedge against inflation. But it will only work out well if you buy it outside of bubble conditions. Is gold in a bubble, who knows, But it has gone up at 19.8% pa in the last 10 years, when inflation has been very much less.

3, Yes again I aggree, Holding cash under the matteress is a terrible idea. Holding gold in this situation is better, because gold and most real assets with have their value increase inline with inflation.

However cash at bank earning 6% will still cover inflation and provide about 0.5% real growth after tax. offcourse if hyper inflation came this would change. but at present and in the recent past cash at bank with reinvested interest has been a good hedge against inflation.

4, yes, which is why in my post I distingished between the two.

5, yes, which is why I said that on the face of it buying a gold producer is investing, I then said you had to conduct calculation to work out cost of production vs sale price etc. etc.

6, I can see a big difference, if a producer is producing gold at $500 and selling for $1400 his profit will be under huge pressure should the sell price drop to $400. where as if a retailer simply buys at $X and sells at $X+ regardless whether inflation or deflation pushes his buy price up or down he will just sell at a higher or lower price.

7, Only where they can not raise or lower their sell price to match. Miners have some what fixed cost of production and have no control over the sale price.

8, In 10 years gold has gone from $250AUD to over $1400AUD 19.8%pa growth, The Australian dollar has not been devalued by 19.8% pa. So there has to be another factor causing this rise. I am not an expert though. If it is a rise caused by speculative enthusiasim or fear, it may eventually reverse and people that bought it as an inflation hedge may regret it.

9, Consider this, since 2000 property values have gone from $200 to $450 leading to wide spread claims of a speculative bubble. In the same time gold has gone from $250 to $1400. But I guess some believe gold is different, gold only goes up, gold never falls.

10, Yes, I would apply the same to other miners, when valuing a mining operation with a life of 20 years I would not use an all time high Iron ore, coal or oil price in my calculation. I would use some conservative. for example valuing an oil company based on the $140 per barrel we saw in 2008 would be a big mistake, a conservative person would apply a margin of safty and use per haps $75 per barrel.

11, only the stock they have on the floor would be devalued, once thats gone they would buy in replace ment stock at the cheaper price and sell at a cheaper price, this happens every time the aussie dollar goes up,

12, thats right, but just because a vaule investor using figures to value investments does not mean he is not also drawing on a body of experiance, education and sound economic logic, Ben graham says in the intelligent investor with out it (experiance, education and sound economic logic) you can't say a margin of safty exists.

13, there was also australian oil companies producing oil at $20 per barrel and oil was $140 per barrel, what happened to their share prices and earning when oil dropped to $50. Using a record high spot price is a mistake, But do what ever you like.

14, good, it does all opinions to make up a market, if over time your opinion proves right, you will do well. Still having a real margin of safty and diversification will protect you if you are wrong.

 

[Tysonboss1]

There are quite a few gold Australian producers have total cost of production around $600 per ounce. Current AUS gold price is heading towards $1,500 per ounce. Is a 60% margin not enough for you? Gold is heading MUCH higher due to world currency issues. This is not speculation, it is fact. We either default on all debt and have a great depression or the debt is inflated away and purchasing power is eroded even further. Given actions to date, we are already on the inflation pathway and it snowballs from here.

Sorry just one more thought,

Buffett visited some canadian tar sands projects will production costs for oil of about $40 / barrel. When question about whether he would invest it he said he wasn't sure that with such high production costs he could say he had a margin of safty.

Now, oil was about $90 a barrel at the time. and buffett is a believer in peak oil.

But he refused to enter because he doesn't know where the oil price will go over the next 5 years. and the investment even would not produce the returns he wanted if $50 oil came back.

 

[skc]

When investing in gold producers, I believe that you are investing in the profitability of these companies as opposed to the resources in the ground. On this basis, they are no different to any other business. I've written more about this issue here http://macrovalueinvestment.blogspot.com/2011/06/valuing-resource-companies-including.html which takes the concept of investing in the flow (profits) as opposed to stock (resources in the ground).

Read your blog... Looks like you put a fair bit of effort in that. Good stuff.

Not sure I agree with your "invest in the flow"... you may end up paying a much higher share price than someone else if you place too much faith in management to reproduce historical returns.

Take for instance a gold miner who has 2 years left in their mine, with forecast cashflow of $25m for each of the remaining 2 years. They also have $150m in cash, no other asset or debt, and their historical ROE is 25%.

Can you show us how much you are willing to pay for their share (say they have 100m shares)?

 

[Macros]

Tysonboss1

1, Why be frustrated, Just run your own race. If you believe one thing just follow that and forget what others believe.

- I run my own race and don't need others to see what I see in order to be able to know that I'm doing the right thing. I have no one else to blame but myself if I go astray. However, for some reason, I have some compulsion to share my views, which I think is helpful for myself in being able to express them more clearly.

2, thats exactly what I said, physical gold can be held as a store of value and a hedge against inflation. But it will only work out well if you buy it outside of bubble conditions. Is gold in a bubble, who knows, But it has gone up at 19.8% pa in the last 10 years, when inflation has been very much less.

- 10 year window is the problem. You need a 200+ year window to see clearly. The bubble does not lie currently in gold, but in other forms of currency, which makes for interesting times ahead.

3, Yes again I aggree, Holding cash under the matteress is a terrible idea. Holding gold in this situation is better, because gold and most real assets with have their value increase inline with inflation.

However cash at bank earning 6% will still cover inflation and provide about 0.5% real growth after tax. offcourse if hyper inflation came this would change. but at present and in the recent past cash at bank with reinvested interest has been a good hedge against inflation.

- Cash at bank currently just covers our headline inflation at 6%. After tax (depending on tax rate) it likely makes a negative real rate. This will not always hold true as there are pressures to keep the official CPI figures down and the bank rate probably not cover inflation in the years ahead (IMO). In the US for example, you are getting closer to 0% with 5% headline (from memory) and 10% based on traditional metrics (shadowstats.com - e.g. including food and energy prices). Technically you could also lend out your gold for a similar rate of return if you were in the ability to do so.

4, yes, which is why in my post I distingished between the two.

- I realise this, but needed to make a point here as there is often some confusion on this issue. Sorry if it didn't exactly match your case.

5, yes, which is why I said that on the face of it buying a gold producer is investing, I then said you had to conduct calculation to work out cost of production vs sale price etc. etc.

6, I can see a big difference, if a producer is producing gold at $500 and selling for $1400 his profit will be under huge pressure should the sell price drop to $400. where as if a retailer simply buys at $X and sells at $X+ regardless whether inflation or deflation pushes his buy price up or down he will just sell at a higher or lower price.

- I don't agree with you here. I think it works in the same way, but with varying outcomes depending on the circumstances. E.g. margin on a widget of 10% at sales price of $100 = $10 versus same margin at 10% on $50 = $5 (e.g. discounting or deflation). Earnings are impacted and depending on the scenario margins might change too.

7, Only where they can not raise or lower their sell price to match. Miners have some what fixed cost of production and have no control over the sale price.

- I'd argue that many industries only have marginal control over the sale price. In more favourable conditions they might have more control and in unfavourable conditions they might have no control (e.g. retailer desperately needing to sell inventory). There isn't a fixed cost of production as it depends on how management tackles the problems - the cost of production could vary a lot with different management and different strategies. The price trend, no matter what the business, should be judged by the investor in my opinion.

8, In 10 years gold has gone from $250AUD to over $1400AUD 19.8%pa growth, The Australian dollar has not been devalued by 19.8% pa. So there has to be another factor causing this rise. I am not an expert though. If it is a rise caused by speculative enthusiasim or fear, it may eventually reverse and people that bought it as an inflation hedge may regret it.

- 10 years ago gold was way too low due to sales from central banks (who now have to buy it back) and a loss of understanding of its value as a currency - it was out of favour (e.g. barbarous relic comments). This period is a time for it to catch up to where it should have been and it hasn't got there yet - let alone deal with the outstanding debt issues we face. It isn't a true inflation hedge as many see it - it is a true currency which holds as a store of value. We are going through a currency collapse and if the fiat currency is the denominator the theoretical price is infinite. I believe that gold will be used once a new currency system is found and will balance out in order to act as a long term store of value. For further information read fofoa.blogspot.com/ if you are interested in this concept.

9, Consider this, since 2000 property values have gone from $200 to $450 leading to wide spread claims of a speculative bubble. In the same time gold has gone from $250 to $1400. But I guess some believe gold is different, gold only goes up, gold never falls.

- the property values have been pushed by a exponential credit growth cycle globally, which is now finished its run. Gold is the inverse to this, so yes, gold is heading up at this point of time as it counteracts the incredible amount of debt in the global system that will never be paid. This is not a speculative bubble like the 70s. The 70s started the unstable credit cycle that is now ending.

10, Yes, I would apply the same to other miners, when valuing a mining operation with a life of 20 years I would not use an all time high Iron ore, coal or oil price in my calculation. I would use some conservative. for example valuing an oil company based on the $140 per barrel we saw in 2008 would be a big mistake, a conservative person would apply a margin of safty and use per haps $75 per barrel.

- I don't agree. I think it is more important to understand the fundamentals of the particular good, the same way you would analyse the direct of sales prices for any other item (e.g. TV, shoes, engineering service). The margin of safety should be applied by investing in companies at large discounts and with resources that are heading up and not down. The oil price crash in 2008 was based on futures contracts. In reality the spot price did not go down so low and was a temporary blip and has been held up by the significant supply/demand metrics that we face.

11, only the stock they have on the floor would be devalued, once thats gone they would buy in replace ment stock at the cheaper price and sell at a cheaper price, this happens every time the aussie dollar goes up,

- sales prices fall, the dollar value of the margins then fall. total demand can fall leading to greater discounting and further falls margins.

12, thats right, but just because a vaule investor using figures to value investments does not mean he is not also drawing on a body of experiance, education and sound economic logic, Ben graham says in the intelligent investor with out it (experiance, education and sound economic logic) you can't say a margin of safty exists.

13, there was also australian oil companies producing oil at $20 per barrel and oil was $140 per barrel, what happened to their share prices and earning when oil dropped to $50. Using a record high spot price is a mistake, But do what ever you like.

- again, temporary price falls can occur in all industries. high margins of safety and larger profitability margins mitigate the short term effects for strong companies.

14, good, it does all opinions to make up a market, if over time your opinion proves right, you will do well. Still having a real margin of safty and diversification will protect you if you are wrong.

- agreed.

 

[Macros]

Read your blog... Looks like you put a fair bit of effort in that. Good stuff.

Not sure I agree with your "invest in the flow"... you may end up paying a much higher share price than someone else if you place too much faith in management to reproduce historical returns.

Take for instance a gold miner who has 2 years left in their mine, with forecast cashflow of $25m for each of the remaining 2 years. They also have $150m in cash, no other asset or debt, and their historical ROE is 25%.

Can you show us how much you are willing to pay for their share (say they have 100m shares)?

Thanks for the feedback SKC.

I stand by the flow concept as it is the most logical view for me.

Regardless of a theoretical price, I wouldn't invest in a company such as the scenario you provide. It is clearly going out of business, perhaps due to mismanagement, and management may do anything they can to extend their time and destroy shareholder value.

It would only make sense to me as an opportunistic short-term investment if you had information that suggested that there could be a way for cash to be extracted from the business and that you could pay less for the sum of parts value.

 

[Macros]

Sorry just one more thought,

Buffett visited some canadian tar sands projects will production costs for oil of about $40 / barrel. When question about whether he would invest it he said he wasn't sure that with such high production costs he could say he had a margin of safty.

Now, oil was about $90 a barrel at the time. and buffett is a believer in peak oil.

But he refused to enter because he doesn't know where the oil price will go over the next 5 years. and the investment even would not produce the returns he wanted if $50 oil came back.

There is always another side to the coin. Buffet has not proven to be an expect in this area and it is something that I personally think he continues to struggle with (I'm not suggesting that the tar sands are necessarily a good investment). I'm guessing here, but I think that Buffet is struggling since the end of the credit cycle. His actions in taking advantage of tax payer funded government bail-outs and support of the big US banks shows that he isn't perfect. In the meantime, Jim Rogers has been successful in making calls on where the commodity trends are headed.

The spot prices fell only temporarily and the futures prices fell by more. There was speculative activity on the top and the price falls were out of line with supply/demand and were therefore short-lived. We are back to $100+ oil and could be looking at $200 oil over the next few years unless drastic changes occur.

 

[notting]

When oil heads for 200 China will have a billion starving people and Bob Brown be Pope. Ain't going to happen.

 

[Macros]

China, like many other nations, subsidises their oil local oil prices, which is part of the problem and makes it more likely to happen as it drives the shortages. Don't be so quick to discount possibilities.

 

[Julia]

China, like many other nations, subsidises their oil local oil prices, which is part of the problem and makes it more likely to happen as it drives the shortages. Don't be so quick to discount possibilities.

Agree. Appreciate your posts Macros. A lot of common sense there.
Have sent you a PM.

 

[notting]

China inc is the problem alright. However their pockets aren't that deep. They import food, for example! Oil makes everything go up.
With a manipulated low currency pegged to the US they are going to be dishing out more and more to keep the force over their slaves, I mean employees, DOH! people. That makes it more extreme, more expensive whilst US prints away. Tick Tock. Go Uncle Sam!
The other point was that not even the oil companies whant it that high because it generates demand and legitimizes alternatives. So if it gets too high they'll pump, release, what ever.

 

[skc]

Thanks for the feedback SKC.

I stand by the flow concept as it is the most logical view for me.

Regardless of a theoretical price, I wouldn't invest in a company such as the scenario you provide. It is clearly going out of business, perhaps due to mismanagement, and management may do anything they can to extend their time and destroy shareholder value.

It would only make sense to me as an opportunistic short-term investment if you had information that suggested that there could be a way for cash to be extracted from the business and that you could pay less for the sum of parts value.

When everyone of the gold stocks you are valuing on your blog are substantially higher than their current prices, I think a sense check of your methodology / assumptions is in order.

Your logic that the flow is more important than stock is true in some aspect of the valuation. But from what I can see you are extrapolating current flow into the future without discounting the uncertainty enough. Every now and then your valuation will prove correct when such uncertainty comes true, but that's just like a pokie machine paying out every so often.

Anyway, I have no time for 15-bullet-point reponses so will leave that to you and Tysonboss