SINLetter - December 2008

Welcome to edition 40 of Suria Investment Newsletter (SINLetter), a free monthly investment newsletter. The objective of this newsletter is to provide you with unbiased initial research and basic facts about individual stocks and other financial instruments so that you can research them further before deciding to add them to your portfolio or not. If you are reading this and are not a subscriber, you can subscribe by going to www.sinletter.com/subscribe.aspx and you will start receiving this newsletter from next month. I have provided relevant links throughout this newsletter, but if you have any questions or comments, feel free to write to me.


November Blog Entries:

If you do not subscribe to blog entries by email or in case you missed them, here are the blog entries for November.

If you do not receive blog entries by email, you can subscribe to receive them by email here.


Has the Bear Been Tamed?

There is little doubt in my mind that what we have witnessed over the last year is history in the making. Most people are drawing parallels between this bear and the one that kicked off the great depression in 1929. Volatility is indeed off the charts with the CBOE Volatility Index or Vix (VIX) hitting a high of 80.86 on November 20, a reading not seen since the launch of this index in 1993. Even during the euphoria of the dot com bubble, a sudden 20% correction in the Nasdaq in August 1998 pushed the Vix only up to 45.29. Despite the extremely volatility and the rapid drop in the market, comparing this recession with the Great Depression requires a vivid imagination.

Unemployment during the great depression hit 25%, the government tightened the money supply instead of loosening it and the FDIC did not exist back then. Hence when banks went under, they took all your cash with them. It is also important to remember that right before the crash of 1929, there was widespread speculation in stocks by retail investors, often utilizing leverage, a situation probably similar to the dot com mania but unlike what we experienced before the crash of 2008. While valuations were high in late 2007, they were nowhere near valuations experienced during stock market bubbles and much of what we are experiencing is collateral damage from the real estate bubble. What we have here is fear, flight to safety and indiscriminate selling of every asset class to raise cash.

The effects of the government throwing everything but the kitchen sink at the current problem are not yet fully understood and may be felt for years to come in the form of higher inflation. Value Line is predicting a recovery in the second half of 2009 but given Value Line's recent track record and loss of talent, I would take their forecast with a pinch of salt. On the other end of the spectrum is economist Nouriel Roubini who sees nothing but doom and gloom ahead and expects the economy to remain in a recession at least until the end of 2009.

Gas prices have come down significantly over the last four months and according to a radio program I was listening to, the United States consumes 390 million gallons of motor gasoline each day. With average gas prices down from a high to $4.09 in July 2008 to $1.89 last week, this $2.20 drop could be looked upon as a $858 million daily stimulus for consumers. On a related note, this post by the Bespoke Investment Group mentions how you can lock in these low gas prices by using the ETF United States Gasoline Fund (UGA).



Whether you read about how a Walmart worker was trampled to death in Long Island by early shoppers on black Friday or about lines that snaked around the block in New York city for the new touch screen Blackberry Storm, it looks like the consumer has sprouted new legs (pun intended). A friend of mine who went shopping on black Friday also mentioned how the parking lots were full and there were lines at the checkout counters in JC Penny. This is a far stretch from the bread lines during the Great Depression. Anecdotal evidence aside, it turns out that Black Friday sales were up 3% year-over-year. While Black Friday does not define the entire holiday shopping season and if anything points to higher sales at lower profits, there is a chance that the holiday season may not be as gloomy for retailers as analysts were predicting.

Given the impressive 16.9% surge in the Dow and the 19.11% surge in the S&P 500 in the last 5 trading sessions of November, it appears that the indiscriminate selling may have finally stopped. Gold shot up $69.2 or 9.26% to $816.3 per troy ounce and even the ETF IYR that is based on the Dow Jones U.S. Real Estate Index (^DJUSRET) shot up nearly 32% since November 20th. An apartment REIT called AvalonBay Communities (AVB) that I have been following for a couple of years, dropped from a high of $149 to $42.80 on November 20, 2008 before rebounding to close the month at $60.67. In the previous recession, the company lost only 32% of its value from peak to trough and this time around it dropped over 65% assuming we saw the bottom for AVB in the third week of November.

Stocks, gold and REITs all going up in unison is exactly the opposite of what we have been experiencing over the last two months. While I was fearful at the start of this year, I am greedy now and the model portfolio while enveloped in a sea of red is almost fully invested at this point. By no means does this mean that I think we are out of the woods or that the recession is likely to be short and shallow. I have been expecting this correction and recession since late 2006 and I think we have many quarters of pain ahead. However it is important to remember that even during the great depression, stocks bottomed out in 1932, a full 7 years before the end of the great depression in 1939.


Portfolio Performance:

Our recent purchases Sterlite Industries (SLT) and Towerstream (TWER) posted small gains in November but the overall portfolio lost 9.14% thanks to steep declines in former gainers like Chinese solar company Suntech Power (STP) , Irish medical research company ICON plc (ICLR) and drilling equipment provider Diamond Offshore Drilling (DO). As you can see from the table below the model portfolio outperformed the Nasdaq but lagged behind the Dow and the S&P 500 in November. Year-to-date we are still outperforming both the S&P 500 and Nasdaq but are lagging behind the Dow. We are still up 35% since we started this portfolio in August 2005 but this is a far cry from the triple digit gains we had at the start of 2008.

Performance Metric Dow S&P 500 Nasdaq SINLetter
November 2008 -5.32% -7.48% -10.77% -9.14%
Since Inception (Aug 2005) -16.89% -27.45% -30.05% 35.04%



Suntech Power is going through a difficult period due to a weaker Euro, low oil prices and a sector that has become very crowded. It is hard to believe that this $8.54 stock is the same one in which we took partial profits in late 2007 at $65.17 for a gain of 151.33%. The company recently lowered its guidance for the fourth quarter of 2008 as well as full year 2009 and was hit by six analyst downgrades. It is really hard to see the bright side of solar at this point if you expect oil to stay at or below these levels and the strength in the US dollar to continue. However declining polysilicon prices, increasing efficiency of solar panels and expected green initiatives by the Obama administration should bode well for solar long-term and I am going to retain our position in Suntech especially since I do not believe oil is going to stay around $50 per barrel for very long. The time to sell was back in late 2007 when I should have liquidated our entire position as discussed in the blog entry Scaling Back on Suntech Power and not now after the stock has lost 90% of its value since the start of 2008. In fact if you have a contrarian's bent and a stomach for the volatility in this sector, the solar ETF TAN would be a great way to play a bounce in the sector as it's holdings include most of the major solar players like First Solar (FSLR), Sunpower (SPWR) and Suntech Power (STP) as well as polysilicon provider MEMC Electronic Materials (WFR).

Another stock in our portfolio that has taken a hit but the business continues to do great is Activision Blizzard (ATVI). Even though Activision is in the recession proof gaming industry the stock has dropped significantly over the last three months along with industry leader Electronic Arts (ERTS). October video game retail sales increased 18% year-over-year and software sales jumped a whopping 35% to $696.8 million. Activision outperformed analyst expectations for earnings and revenue when it reported third quarter results earlier this month. The latest version of the Guitar Hero franchise was sold out upon launch and the highly anticipated World of Warcraft expansion pack Wrath of Lich King, set a sales record by selling 2.8 million copies within the first 24 hours after launch in mid-November.

Activision shed nearly 30% of its value since we added it to our portfolio in September, while Electronic Arts is down more than 60% over the same time period. A 42,500 share direct purchase for over a million dollars by Electronic Arts CEO John Riccitiello in early November failed to inspire any confidence in the stock. In light of Activision's plan to buy up to $1 billion of its own stock and the record breaking sales of its games, the stock is currently at the top of my conviction list.

Gold bounced back in November with a gain of $92.6 or 12.79% to close the month at $816.30 per troy ounce.

Portfolio Readjustment:

I am making no changes to the model portfolio at this time. As discussed below, I am adding the timber REITs Plum Creek Timber (PCL) and Rayonier (RYN) to our watch list.


Timber as an Asset Class

Investment objectives are as varied as investors themselves with some looking for short-term gains, while others are looking for long-term growth and yet another segment seeking a steady stream of income from their investments. Wouldn't it be great to have an investment that not only increased in value but also grew physically as you held it? Imagine purchasing a troy ounce of gold on January 3, 2008 for $288.50 and watching it value increase 183% to the recent $816.3 per ounce. Now imagine how thrilling it would be to have that one ounce of gold become two ounces while you were holding it. Timber is one such investment that can not only increase in value but can also physically grow as you are holding it. The kicker is that you also get a green investment as many timber companies harvest planted trees as opposed to harvesting old-growth trees, hence preserving timberland.

We discussed the importance of asset allocation in the October investment newsletter and I figured it would be a good idea to expand upon that theme and discuss timber as an asset class in this newsletter. Here are some of the reasons to consider timber as an asset class for your portfolio,

  1. Timber has had an outstanding record as an asset class returning 14.5% a year between 1972 and 2006, outperforming all other major asset classes like stocks and bonds.

  2. Real prices of timber have always risen over a 100 year period outperforming nearly all other commodities as supply is limited (unlike oil, there are no new discoveries of timber), while demand is robust for construction and in use for paper products.

  3. Timber prices are usually less volatile than stocks and timber as an asset class is not correlated with stocks.

  4. North American forests grow at 8% a year and as tress get larger their value increases as well. Hence timber not only grows as an asset class, the growth is value added.

  5. If prices fall, timber companies can defer harvesting until a later date.
 

Here are some reasons why timber may not be the right asset class at this time or for some investors,

  1. Investors in timber usually are patient and have a very long investment horizon ranging from a number of years to a few decades.

  2. Timber has been falling rapidly since early 2006 due to lower construction demand and hence the low volatility claim appears to be jeopardy for now.

  3. The construction industry appears to be in a long-term slump with October housing starts down 4.5% below September and a whopping 38% below October 2007. Confidence amongst U.S. homebuilders is currently at the lowest level it has ever been since the index of builder confidence was created in 1985.

  4. Given current market conditions there are several competing and undervalued investments that offer as good if not better yields that timber REITs.

Lumber consumption in the U.S fell 14% in 2007 and is expected to fall an additional 15% or more in 2008 based on consumption in the first six months of the year. One could argue that lumber prices already reflect soft demand with near month CME lumber futures having dropped from $300 at the start of this year to $193.50 currently, representing a drop of over 35%. The current price is also below a 12 year trading range of $200 to $450. For long-term patient investors it may be a good idea to scout out opportunities in this sector in case housing starts improve or home builder confidence turns positive (probably a lagging indicator). One could also dollar cost average into a position over a period of time to smooth out short-term volatility.

Individual stocks in this sector worth considering are Plum Creek Timber (PCL), which is often considered the blue chip stock of the timber industry, Rayonier (RYN), Potlatch (PCH) and Weyerhaeuser (WY). Plum Creek Timber is structured as a REIT and is more of a pure play than either Weyerhaeuser or Rayonier. Weyerhaeuser sold of its paper business and there is investor pressure on the company to convert to a REIT in 2009.

The Claymore/Clear Global Timber Index ETF with the symbol CUT that is sure to be disconcerting to environmentalists, contains both Rayonier (RYN) and Weyerhaeuser (WY) in its portfolio holdings and provides a diversified global opportunity to invest in timber. Another option is the iShares S&P Global Timber &Forestry Index Fund WOOD, which in addition to Rayonier and Weyerhaeuser also holds Plum Creek Timber and has a slightly lower expense ratio of 0.48% when compared to 0.65% for CUT. However the downside to these two ETFs is that they have significant exposure to paper, wood manufacturing and distribution companies instead of just timber REITs. This might explain why their returns are not exactly correlated to lumber returns. As discussed above CME random length lumber futures have dropped 35% so far this year while CUT is down almost 55% and WOOD, which started trading on June 25, 2008 is down more than 40% in just the last three months.

Instead of adding add these timber REITs to the portfolio at this time, I am going to add Plum Creek Timber (PCL) and Rayonier (RYN) to our watch list in case there are sudden drops in their prices or housing starts show improvement.

Check out the following links for additional research and reading about timber and related topics.

Acknowledgement: Matt of Steadfast Finances assisted me with research for the "Timber as an Asset Class" section of this newsletter.


Every month we add featured stocks into a model portfolio started with a cash position of $100,000 on August 2, 2005. To keep calculations simple, trading costs and regular dividends are not included.

Model Portfolio - November 30, 2008

Long Stocks

Stock Symbol Number of Shares* Cost Current Value Diff ($) Diff (%) Date Added
Sterlite Industries SLT 2000@$4.71 $9,430 $9,860 $215 2.76% 11/6/2008
Intel INTC 500@$15.60 $7,800 $6,900 $-900 -11.54% 8/29/2008
Activision ATVI 600@$16.41 $9,846 $7,020 $-2,826 -28.7% 8/29/2008
Towerstream TWER 13,000@$1.1361 $14,769 $9,880 $-4,889 -33.1% 6/0/2008
Textron TXT 150@62.55/share $9,382.5 $2,284 $-7,098 -75.65% 5/31/2008
Companhia Siderurgica Nacional SID 200@43.15/share $8,630 $2,304 -$6,326 -73.3% 4/30/2008
Lionsgate Entertainment LGF 1,000@9.41/share $9,410 $6,470 $-2,940 -31.24% 2/29/2008
Tata Motors TTM 500@17.52/share $8,760 $2,275 $-6,485 -74.03% 2/29/2008
Barclays PLC BCS 400@32.435/share $12,974 $4,500 $-8,474 -65.32% 11/20/2007
Powershares Water Resources PHO 400@22.10/share $8,840 $5,432 $-3,408 -38.55% 10/31/2007
Marcus MCS 500@19.94/share $9,970 $6,445 $-3,525 -35.36% 9/14/2007
Blockbuster BBI 3,000@3.925/share $11,775 $3,570 $-8,205 -69.68% 7/9/2007
Unilever Plc UL 200@32.53/share $6,506 $4,580 $-1,926 -29.6% 5/11/2007
EMC Corp EMC 600@13.85/share $8,310 $6,342 $-1,968 -23.68% 3/31/2007
ICON Plc ICLR 300@18.65/share $5,595 $6,357 $762 13.62% 1/31/2007
Diamond Offshore Drilling DO 80@76.65/share $6,132 $5,904 $-228 -3.72% 1/3/2007
Alvarion ALVR 1000@6.87/share $6,870 $3,200 $-3,670 -53.42% 1/3/2007
WisdomTree Investments WSDT.PK 1000@7.40/share $7,400 $900 $-6,500 -87.84% 11/30/2006
Teva Pharmaceutical TEVA 300@35.05/share $10,515 $12,945 $2,430 23.11% 9/1/2006
Suntech Power STP 250@25.93/share $6,483 $2,135 $-4,348 -67.07% 7/31/2006
Procter & Gamble PG 180@55.60/share $10,008 $11,583 $1,575 15.74% 6/30/2006
Johnson & Johnson JNJ 200@57.65/share $11,530 $11,716 $186 1.61% 2/28/2006


Options

Option Number of Units Cost Current Value Diff ($) Diff (%) Date Added
IBNAZ.X 5@2.6/contract $1,300 $375 $-925 -71.15% 10/9/2008
IBNMV.X 5@2.05/contract $1,025 $925 $-100 -9.76% 10/9/2008
Cash     $1,138      
Total     $135,040 $35,040 35.04%  

 

* Price and number of shares adjusted for Activision Blizzard (ATVI) and ICON plc (ICLR) to reflect splits on September 8, 2008 and August 13, 2008 respectively.

Voluntary Disclosure: From the stocks that are currently in the model portfolio, I own shares of Sterlite Industries (SLT), Intel (INTC), Activision Blizzard (ATVI), Towerstream (TWER), Lionsgate Entertainment (LGF), Tata Motors (TTM), PowerShares Water Resources (PHO), Barclays (BCS), Suntech Power (STP), Teva (TEVA), Alvarion (ALVR), WisdomTree (WSDT.PK), Unilever (UL), BlockBuster (BBI) and Marcus (MCS). I also own $20 Jan 2009 IBN calls (IBNAZ.X)

 


To unsubscribe, please click here.

DISCLAIMERS:

  • Suria Investment Newsletter (SINLetter) does not warrant the completeness or accuracy of the content or data provided in this newsletter.
  • Suria Investment Newsletter (SINLetter) does not comprise any solicitation to buy or sell securities.
  • Suria Investment Newsletter (SINLetter) will not be liable for any investment decision made or action taken based upon the information in this newsletter.
  • We suggest you check with a broker or financial advisor before making any investment decisions.