In This Episode
Dan opens up this week with an essential mental model all investors must master. It’s a simple way to figure out where you’re most likely to succeed, in the stock market and in life. Great financial minds like Warren Buffett, Andrew Carnegie and Ben Horowitz of Andreesen Horowitz have used this idea to achieve stunning success and enormous wealth.
In What’s New this week, you’ll see why the recently IPO’d Chinese company, Luckin Coffee, might not give Starbucks as much trouble as investors think. We’ll also contemplate the recently reported “deaths” of both inflation and value investing. We’ll finish up with a look at Whitney Tilson’s Tesla prediction… which is looking pretty good these days!
Our interview this week is with money manager/newsletter publisher Jesse Felder. Jesse has been managing money for over 20 years. He started his professional career at Bear Stearns & Co. and later co-founded a multi-billion-dollar hedge fund firm headquartered in Santa Monica, California. Since founding his newsletter, The Felder Report, in 2005, he’s been featured in many major finance publications like The Wall Street Journal, Barron’s, The Huffington Post, MarketWatch, Yahoo! Finance, Business Insider, Investing.com, Seeking Alpha and more. Jesse also hosts and produces the Superinvestors and the Art of Worldly Wisdom podcast. He lives just down the road from me in Bend, Oregon with his wife and two kids.
Jesse talks about how an old Apple IIe computer game sparked his interest in the stock market at a very young age, then discusses his career at Bear Stearns, and running his own hedge fund.
Dan and Jesse talk about their common beliefs about value investing and gold. Jesse describes the two different ways he invests in gold, and how he’s always looking for “the most hated asset class on the planet.”
Dan then asks his No. 1 question for Fed watchers, and Jesse gives some great insights about how the Fed has distorted financial markets and why you shouldn’t wait until a recession to prepare your portfolio for the worst, including two big risks investors don’t appreciate today.
Dan finishes up with this week’s mailbag, and tells why it’ll be difficult to get him to publish recommendations of option trades. He also tells listeners the difference between an established company rolling up competitors and a brand new business entering a huge market.
NOTES & LINKS
- To follow Dan’s most recent work at Extreme Value, click here.
- To check out Jesse Felder’s The Felder Report,” click here.
00:01:59 – The mental model that helps you succeed in the market and in life
00:03:30 - Warren Buffett and Andrew Carnegie on sticking to what you know
00:08:23 - The No. 1 principle for intelligent, businesslike investing
00:11:38 - Why real estate agents own rental properties
00:12:30 - Peter Lynch’s advice for generating new investment ideas
00:14:43 - “Embrace your weirdness…”
00:16:24 - Bill Ackman hedge fund analyst on Starbucks vs Luckin Coffee
00:19:53 - Fortune’s Shawn Tully on the “Fab Four” to the “Breakneck Burners”
00:21:44 - The Deaths of Inflation and Value Investing!
00:23:44 - Whitney Tilson’s Tesla prediction is looking pretty good
00:24:47 - This week’s interview with Jesse Felder begins
00:26:00 - How an Apple IIe computer helped Jesse get into finance
00:30:50 - “The most hated asset class on the planet”
00:31:36 - “What I’ve learned over the last 20 years is that…”
00:35:22 - Two ways to own gold
00:36:33 - A “Ben Graham-style” investment available today
00:37:17 - “We’re at a really big cyclical moment”
00:40:00 - Don’t worry about gold’s recent weakness
00:40:47 - Using technical analysis to avoid value traps
00:42:38 - “FANG” stocks vs “BANG” stocks
00:43:43 - Dan’s No. 1 question for Fed-watchers
00:46:00 - A must-see movie about the Fed’s role in the housing bubble
00:49:05 – Don’t wait for a recession before you “batten down the hatches”
00:51:00 - “The greatest reach for yield we’ve ever seen in history”
00:52:27 - Two risks investors don’t really appreciate today
00:53:15 - A final thought from Jesse
00:54:19 - What separates the greatest investors from everyone else
00:54:44 - This week’s mailbag…
00:56:05 - Why it’s difficult to get me to publish option recommendations
00:58:48 - How bitcoin gets “lost”
01:03:17 - “When you hear this pitch, grab your wallet, turn around and run”
Announcer: Broadcasting from Baltimore, Maryland and all around the world, you’re listening to the Stansberry Investor Hour. Tune in each Thursday on iTunes for the latest episodes of the Stansberry Investor Hour. Sign up for the free show archive at investorhour.com. Here is your host, Dan Ferris.
Dan Ferris: Hello, and welcome everyone to another episode of the Stansberry Investor Hour. I am your host, Dan Ferris. I’m also the editor of Extreme Value, a value investing service published by Stansberry Research. We have a really great show lined up. I’m very excited about our guest today. We’ve been trying to get him on for a long time and I can’t wait to talk to him. But right now let’s get to the weekly rant.
Now last week’s rant was all about my personal model of the dominant emotion at work in the stock market. I said fear is the dominant emotion in the stock market at all times. It doesn’t go from greed to fear to greed to fear. It’s just fear all the time. Investors are only human and all humans are afraid of doing something too different from what everyone else is doing. It’s the fear of not buying at the top when everyone else is buying and the fear of not selling at the bottom when everyone else is selling. And the fear of not owning when everyone else is owning in between. Right.
You may recall that I mentioned a book called The Great Mental Models, Volume I, General Thinking Concepts. By Shane Parrish and the folks at the Farnam Street website. It's a really good book. And we’re going to talk about one of those great mental models today. It's one of the most important ones for investors. It can keep you out of all kinds of trouble. And also, it just sort of naturally leads you into where you’re most likely to succeed in the stock market and in life.
The mental model I’m talking about may be familiar to you. It’s called circle of competence. This idea was created by Warren Buffett as a way to help investors say out of investments they don’t understand.
Now imagine a circle with a smaller circle inside of it. So the bigger outer circle, that’s what you think you know. The inner circle is what you really know. It’s a subset of that bigger thing. That’s your circle of competence. What you really know.
Investors ought to start out with this idea by asking a very simple question. Is buying and selling stocks and bonds and options and all this other stuff in the financial markets, is this within my circle of competence? It’s a good question. And circle of competence I think is just, for that reason, it’s one of the most important things an investor can know about himself.
Now in that Farnam Street book I mentioned, the very first thing you see on the first page about circle of competence is a question. What don’t I know? Right. That’s the via negativa. The negative way of looking at things that we’ve discussed in previous podcasts. And so that’s the negative component of assessing your own circle of competence. Hmm. What don’t I know about XYZ company, for example?
So the positive component is simply a constant reminder to stick to what you know best when it comes to allocating your hard earned capital.
In his 1996 letter to shareholders, Warren Buffett wrote, what an investor needs is the ability to correctly evaluate selected business. Not the word selected. You don’t have to be an expert on every company or even many. You only have to be able to evaluate companies within your circle of competence.
Obviously this basic idea has to be older than Warren Buffett, right? Nineteenth century steel magnate Andrew Carnegie wrote in his autobiography, The losses men encounter during a business life which seriously embarrass them are rarely in their own business but in enterprises of which the investor is not the master. My advice to young men would be not only to concentrate their whole time and attention on the one business in life in which they engage but to put every dollar of their capital into it."
Now it’s certainly possible for you to widen your circle of competence. You’re not stuck with your current circle of competence. But widening it usually takes a lot of work and it happens over a long period of time. So think if you play a musical instrument and you’re kind of okay and you want to get a lot better, well, that’s not going to happen instantly, right. It’s going to take a long time. And that’s the way widening circle of competence works.
Now the Farnam Street book actually reminded me of another story that Warren Buffett told which I used in Stansberry’s Extreme Value Newsletter, the monthly newsletter that I wrote with Mike Barrett. I used this many years ago. And the story goes like this.
A guy goes into a new town and he encounters an old man sitting in the town square. It’s a nice sunny day. There’s a little general store. A few people walking around. This guy’s from the big city. He thinks, oh, you know there’s not much going on here. And there’s a dog lying on the ground near the old man. People walking around. And the stranger who just walked into town says to the old man, he says, “Hi, there, I’m new in town. How you doing?” The guy says, “I’m doing great.” And he asks the old man, he says, “Does your dog bite?” and the old man says, “No.” The stranger walks over, leans down to pet the dog and the dog lunges at him chomping down on his clothes and almost takes a piece of his skin off. And the stranger said, “I thought you said your dog doesn’t bite.” The old man says, “That’s not my dog.”
See the old man, he’s a lifer. He’s been in that town all his life. He knows everything going on around him. And he knows all the people and he knows what they had for breakfast and he just knows everything going on. The stranger only knew the appearance of everything around him. He was operating in the bigger circle, not in the smaller circle. His circle of competence.
When it comes to investing, think about the places and the market where you are the old man, the lifer. The guy who’s been there all his life or who’s been in town for decades and decades and knows it inside out. Because if you’re not a lifer who knows it inside out you’re probably a stranger who only knows the appearance of the businesses you’re investing in. And you’re operating outside your circle of competence. You don’t want that. Be the old man. The lifer. Not the stranger.
Well, you obviously need to be brutally honest with yourself about things that you know and what you don’t know. And you – this requires some real hard looking in the mirror and figuring out what you really do know and what you don’t know. What’s within my circle of competence.
In fact, one of the hallmarks of operating within your circle of competence is that you have a good grasp of its limits, its boundaries. So the size of your circle of competence is far less important than your ability to stay within its boundaries when you’re allocating your precious capital. Right.
Do you go with a company that’s got a boring business that you know very well and you’re confident it’ll keep growing slowly over many years and paying dividends? Or do you buy something really exciting because a friend of yours is really excited about it and he think it’s going to triple next week. That’s an absurd example, I hope. I hope that’s an absurd example. But it illustrates the point.
Whatever kinds of businesses you know, those are the ones you should stick with in the stock market. You can learn about new businesses, and you should be learning about them all the time. But you have to decide when you've truly pushed that boundary out a little bit more and that there’s something else that’s within your circle.
Warren Buffett’s mentor, Ben Graham, said at the very end of his great classic book, The Intelligent Investor, that investing is most intelligent when it is most business-like. And then he said the first and most obvious principle of business-like investing is knowing what you are doing. Know your business. And this is a quote from the book. "Know what you are doing. Know your business. For the investor, this means do not try to make business profits out of securities, that is returns in excess of normal interest and dividend income, unless you know as much about security values as you would need to know about the value of merchandise that you propose to manufacture or deal in."
By this definition, let’s face it folks, most people just don’t belong in the stock market. They should be doing something else with their money. And I’ve spoken with literally hundreds of investors. I’ve been doing this for 21 years. And I’ve spoken with hundreds of investors over the years at conferences. And I’ve heard from hundreds, probably a couple thousand more, from feedback e-mails from various newsletters I’ve written and from this podcast too. And my overall impression is that most folks are all too often operating outside their circle of competence.
I’ll give you a quick example. Just a very small, quick example. A few episodes ago I interviewed Brian Dalton, the founder and CEO of Altius Minerals. Now Altius Minerals trades on the Toronto stock exchange under the ticker symbol ALS. And over the counter in the use under the ticker symbol ATUSF. I cannot tell you how many dozens and dozens of e-mails I’ve gotten asking me the difference between these two symbols. And I have to tell you, I only thought about this recently. I really stepped back and thought, you know if you don’t know something that basic and if you can’t find out for yourself in the age of Google where you can find out almost anything, you know if you just don’t have enough experience to know the difference between Toronto stock exchange, New York stock exchange, over the counter and figure out what those two symbols mean, maybe, maybe, maybe just maybe you’re operating outside your circle of competence in the stock market. Okay.
Now I don’t except everyone to know everything about every stock I write about or mention. But there’s some basic things that – and I could be wrong about this. These people asking about these ticker symbols. That could be just like the one thing that they didn’t learn in 20 years of investing or something. But, you know it could mean that they’re in over their heads. They’re outside their circle of competence and they’re operating in that bigger circle. Remember what that was called? That’s what you think you know. Not what you really know.
So, you know these same people wonder why I refused to, for example, write about options recommendations in detail. And I’ll talk more about that later in the podcast in the mailbag. But just think about like – I was thinking about all the real estate agents my wife and I have used to buy homes. A few of them. I guess three of them or so. Three or four of them. To buy homes and do various things over the years. They all own rental properties. Every single one of them.
Now that makes a lot of sense, don’t you think? They deal in value and location and all the other aspects of property every single day. Of course buying rental property is within their circle of competence. And I’ve talked to some of them they say, I don’t bother with the stock market. I don’t know anything about it. That’s exactly right. It’s just like Andrew Carnegie said, right? That you focus all your energy there and all your capital too.
Peter Lynch’s excellent book, One Up on Wall Street, I recommended this book dozens of times and will continue to do so. One Up on Wall Street by Peter Lynch. He says, you can – he basically says you can get investing ideas by looking at the companies whose products you use just in your daily life. That’s a great idea. Because you have concrete experience with these companies day after day.
Now, of course, the experience of buying and using a product or service is not in itself enough to tell you whether a stock is a buy or not. It’s the beginning. It’s just an idea generation. A starting point really. And then you start from there and you build up your knowledge and you begin researching the business and find out if it’s really good. I mean you know I use Uber and Lyft, but I would never buy those stocks. They’re just loss making behemoths that appear to be dramatically overvalued.
But it makes you want to look into them. And if you think you can buy and sell stocks without knowing all about the businesses you’re buying and selling, you are definitely operating well outside your circle of competence.
Now I realize there are people like quantitative investors, but again, people who know what they’re doing there, you know they’re like PhD physicists who have been at it for years and years and years. And they’re operating within their circle of competence because the algorithms and things that they’re using to trade stocks are just extremely complicated and took a long time to master.
So this rant, it comes with a little bit of homework. Look, I’m not recommending anyone buy or sell anything based on what I said in this rant, okay. What I’m recommending is that you adopt the circle of competence as one of your core boundaries when you’re assessing new investment recommendations from now on. If you come across a business and you just can’t figure it out, move on. Charlie Munger says he’s got a basket on his desk labeled "too hard." And that’s the biggest pile. Too hard. Just put it in there and move on to something you understand.
And look, as I said in a previous rant, think about who you are. Investing is personal. Your circle of competence is personal. It’s uniquely yours. So in that vein I’m going to leave you with one last quote from a book called The Hard Thing about Hard Things, which is a really good read by a guy named Ben Horowitz of Andreessen Horowitz, among other firms that he’s been a part of over the years. Andreessen Horowitz is one of them.
And near the end of the book Horowitz, you know after a really exciting tale about his journey through the tech business world, Horowitz writes the following. This – I have this in a little note on my phone. I reread it from time to time. And he says this. "There are no shortcuts to knowledge, especially knowledge gained from personal experience. Following conventional wisdom and relying on shortcuts can be worse than knowing nothing at all. Embrace your weirdness, your background, your instinct. If the keys are not in there, they do not exist."
I’ll tell ya, I love that quote. It helps me personally to find the boundaries of my circle of competence, which is something you need to keep doing. You need to do it every day. Every time it makes sense to do it. Right. Is this really in my circle of competence? You’re always asking that question. And it just helps me appreciate how much work it takes to truly make my circle wider.
Okay. That’s the rant. Write in. Let me know what you think. We’re at [email protected]. Now let’s talk about what’s new in the world.
I usually open a few tabs on my computer and just kind of mark some news items to talk about. I have like 20 tabs open. So I won’t get to all of them, but I think I’ll get to a few of them here. There’s a lot going on.
The first one I want to talk about is a transcript from the conference call by Pershing Square Capital Management. I think the company, their company is actually called Pershing Square Holdings. It’s a public company. I think it trades in Europe somewhere. This is Bill Ackman’s hedge fund. Pershing Square. Bill Ackman. Pretty famous investor.
One of his analysts is talking about the difference between Luckin Coffee and Starbucks. Luckin Coffee is a big Chinese coffee company that has coffee shops just like Starbucks kind of in China. And their thing is they’re going to grow really fast and they’re going to be bigger than Starbucks. Okay. And this is what one of his analysts said on the conference call. I’ll read it to you.
He says, so I think qualitatively they’re different experiences for the consumer. Quantitatively one misperception out there is that if Luckin’s growing their store count so quickly they’re going to be bigger than Starbucks next year. That’s just not the case. So while their store count may exceed Starbucks sort of in the near- to medium-term, it will take quite some time than that to actually be larger than Starbucks because the average unit volumes, average restaurant sales for a Luckin store are one-sixth the level of Starbucks. In other words, Starbucks is six times the level of a Luckin store.
So Starbucks plans to have 6,000 stores by fiscal 2022 in China. Luckin would need 36,000 stores to be the same size as Starbucks. That’s not going to happen. Starbucks has just over 30,000 stores globally. McDonald’s, which has been operating since the ‘50s, has 38,000 stores globally. So it’ll be the same size. You know quoting them as Luckin being bigger than Starbucks is just wrong. And he continues here.
And then part of the disconnect in the average unit volumes lends to the margins, which is USD 160,000 roughly per store. Now the at restaurant margins he says, at Luckin are negative 50%. Roughly as Starbucks in China they’re mid-30 percentage points positive.
I think he’s saying you know Luckin stores are negative percent margins in China. Starbucks stores are mid-30 percentage points positive in China.
And then he continues. We just don’t think that a model where each box loses money every year is sustainable.
And indeed, if you go and look up Luckin Coffee, their SEC filings, they went public I think Friday. So their SEC filings will show you that, for example last year they did about 126 million US dollars in sales. And the operating loss on that was $238 million. And if you look at the cash flow data last year in US dollars net cash used in operating activities was a negative $195 million.
So, you know this is a cash burner. It’s not nearly as good a business as Starbucks. And people who are – some people have written in to me and say, you know you like Starbucks, Dan, but what about Luckin? Aren’t they going to beat Starbucks at their own game? I don’t think so.
All right. Next. I found a neat article in Fortune by a really kind of famous financial writer named Shawn Tully. The article is dated May 20, 2019. A few days ago. And he’s basically comparing the cash burn rates of Amazon, Apple, Facebook and Google to Tesla, Uber, Lyft, and Snap. Because he says he hears this argument a lot that the big cash burn rates for that second group, well, they’re nothing new because, you know all these other companies experienced the same thing in the early years. And he says, it's just not true.
And he went and did the work. And for example, Amazon burned $859 million its first five years. Google burned zero. All their public documents indicate that they were never cash flow negative. Facebook burned $143 million over two years. Apple’s an interesting case because they didn’t burn anything in the formative early years according to Shawn here. And you know later on they burned some cash, but that was when they were a much bigger company, just having some trouble.
Okay. Then he moves on to the "breakneck burners" he calls them. Tesla. Tesla burned $10.9 billion over 12 years. Uber burned $8.8 billion over three years. Lyft burned $1.4 billion over three years. And what did Snap burn? $2.7 billion over three years.
So really not similar. And you can say there are things wrong with his analysis, you’re comparing the wrong companies. You should compare these cash burners to the dot-com companies that didn’t make it, for example or something. But it’s an interesting comparison I think.
Next, we got a couple of things that have died on us apparently. Okay. The April 22 cover of Bloomberg Newsweek said, "Is Inflation Dead?" And it’s got a picture of an inflatable tyrannosaurs rex toy that’s kind of deflated. And it says, is inflation dead? A new era has some frightening some downsides.
That is, you know if you wanted to entertain the idea that inflation is not dead, what better way than a business week cover that says that it is dead? Business Week famously in, I believe it was August 1979, published a cover that said, "The Death of Equities." Basically if you bought stocks then and held them for 10, 15, 20 years, whatever, it was an easy way to get rich.
Something else has died. We keep hearing that value investing has died. And a guy named Jim Osmond from Edge Consulting Group says, "Value investing has died because nowadays technology," and I’m quoting from an article in Hedge Magazine where he said, "nowadays technology and machines do so much work and they do it faster. The numbers game based on cheap valuation is a thing of the past. What we have been trying to do at the Edge is recognize value beyond the numbers."
And he actually has some okay views – if you read the whole article, this guy is not out to lunch. But any time I hear value investing is dead, I kind of agree that it’s not the simple numbers game that Ben Graham practiced 50 or 70 or 100 years ago or whatever it was. But, you know it’s not dead. Buying – look, when you buy stocks your future return is based on the price you pay. If you bought the – you could have bought the greatest business in the world at the peak of the dot-com. You could have bought Coca-Cola and it took you 13 or 14 years to break even if you paid too much for it. So I disagree that value investing is dead.
Moving on. We got to talk about Tesla real quick. Of course Stansberry now publishes the work of Whitney Tilson. Kind of a famous hedge-fund manager. And Whitney earlier this year he said that March 4 was – let me verify and make sure that’s right. Yeah. Friday March 4 he said was the beginning of the end for Tesla. And he predicted that Tesla would trade below $100 by the end of this year.
Well, earlier this week, I don’t know what – you know by the time we get the podcast published I’m not sure where – I can’t know where the stock price will be, but certainly Monday and Tuesday it did dip below $200 and hit one-year lows. So kind of, you know Whitney’s looking pretty good on Tesla. And of course, Tesla has a million problems and things just seem to be getting worse and worse.
Okay. Matter of fact, you know something? I have too much here. We need to get to our interview.
All right, folks, this week’s interview is one that I’ve been looking forward to for a while. His name is Jesse Felder. And Jesse has been managing money for over 20 years. He started his professional career at Bear Stearns, and he later cofounded a multibillion-dollar hedge fund firm headquartered in Santa Monica, California. Since founding his newsletter, The Felder Report in 2005, he’s been featured all over the place in all kinds of major finance publications. Wall Street Journal, Barron’s, Huffington Post, Market Watch, Yahoo Finance, Business Insider, Investing.com, Seeking Alpha, and I’m sure a lot more than that.
Jesse also hosts and produces a really good podcast called Super Investors and the Art of Worldly Wisdom. He actually lives not too far down the road from me. He lives in Bend, Oregon with his wife and two kids. Ladies and gentlemen, please welcome Jesse Felder. Jesse, welcome to the podcast. Thanks for being here.
Jesse Felder: Hey, thanks for having me on. My pleasure.
Dan Ferris: So, Jesse, I feel – I really have been looking forward to having you on the program. I feel kind of a kinship with you because, correct me if I’m wrong here, we’re a couple of value investors who like gold, right? I mean – and we’re not like the dogmatic sort of Warren Buffett mold that says you’re not allowed to buy gold.
I want to talk about how you came into all this, but we will get to the value investing and the gold too. But how did you become a finance guy? At what point in your life did you say, hey, this is it for me?
Jesse Felder: You know actually it was – I became interested in finance when I was a young kid. Actually I think I was like eight years old or something. My dad bought an Apple IIe computer and he got me a couple games just to kind of get me into it. One of them was a game called Millionaire, which was a stock market simulator. It’s funny, I found it on YouTube. They had a video of the game. And it’s the most boring, worst video game you could ever imagine. But I had a good time with it.
Shortly started – I guess you’d call it paper trading now where I basically started picking stocks and then looking at the prices on the weekends in Barron’s and just kind of seeing how stocks would do that. Companies that I liked. And when I graduated from college I just decided that’s what I wanted to do for a career. It was always a passion.
I interviewed at a few different places in LA. And the guys at Bear Stearns decided to give me a shot.
Dan Ferris: Nice. What was it like working at Bear Stearns?
Jesse Felder: You know I went to work originally for a couple of guys who were two – it was in the private client side. And these two guys were two of the most successful guys in the firm. I quickly realized they were really good at selling and generating commissions but really had very little idea of how to actually make money in the markets.
And so I went to find another gentlemen there, because that was really what I was interested in. I wasn’t too keen on learning how to sell. And so I found another guy in Bear who was essentially kind of running a hedge fund inside Bear Stearns. And he kind of took me under his wing and showed me the ropes. We ended up leaving a few years later to start our own hedge fund firm. And I did that for – for a few years, I was the head trader and kind of assistant portfolio manager. Through the late ‘90s and into early, mid-2000. And so right during, you know through the dot-com bubble I had a front row seat via the hedge fund.
Dan Ferris: Nice. So you’ve been really thinking in this way since you were a little kid. It doesn’t surprise me. So let’s talk about, I mean do I have you pegged right? To me you’re a value investor who also likes gold. Which is kind of un-Warren Buffett like. Is that fair?
Jesse Felder: Yeah. Absolutely. I mean one of the first things I started doing when I went to work at Bear I was reading through all the Berkshire letters. Value investing and the margin of safety concept is something that either like resonates you when you first read about it, resonates with you or it doesn’t. And for me that was like the Holy Grail. Like, oh, my god, I finally found some method to sort through this madness. So absolutely valued diehard investor.
Dan Ferris: Okay. So I just want to get to talking about gold with you because it’s such a dramatic dividing point among value investors. There’s the Warren Buffett group that says it’s a barbarous relic or it’s actually a useless rock, you know you dig it out of the ground, you sit it somewhere and it costs you money to store it and it doesn’t generate any income, etcetera, etcetera. And then there are other folks like you and me and I guess David Einhorn’s kind of a famous example, certainly Seth Klarman has invested in gold mining companies. And how do you come from value investing to gold? Tell us your thinking on this.
Jesse Felder: Well, you know I think as a value investor you have to kind of be a natural contrarian. One of my favorite quotes comes from Howard Marks which is you know in order to be successful in the markets you have to have a non-consensus view regarding value and you have to be right. So both of those are equally important. But looking for, when you’re a diehard value investor, I’m constantly asking myself what’s the most hated stock in the market? What’s the most hated asset class on the planet. And really it was mid-2015 when we saw gold written up in The Wall Street Journal as a pet rock. And people, the media writing about it as if it were absolutely worthless and not considered currency for 5,000 years.
So for me that’s my value mindset kind of really perked up was when gold became so hated from that 2011 to 2015 bear market that it became really interesting to me.
But also from the other standpoint, I think for value investors today I think anything, what I’ve learned over the last 20 years is that with the central banks doing what they’re doing around the world you really have to have, as much as value investors would like to just focus on micro and ignore macro, I think with what’s going on in terms of central banking around the world you have to have, pay attention to macro and have a macro framework. And so for me that was, you know looking at what’s – and this actually comes back to – I think a lot of people who use the Warren Buffett argument for not owning gold probably don’t realize that in the late 90s he bought up a ton of silver, and that was the second time buying silver. He had bought silver, a ton of silver back in the late 60s also.
And in his letters he explains why he was doing that. He had two reasons. One was the supply demand equation had just gotten very skewed in favor of higher prices for silver. And he also anticipated debasement of the dollar. And so I think when you’re looking at gold today it’s very easy to make those same arguments that the supply demand equation for precious metals and gold is very supportive of prices.
But also you look at what’s going on with the dollar and people are talking about – you have both sides of the aisle. Bipartisan support or, or at least bipartisan rejection of fiscal austerity and worrying about deficits and talking about modern monetary theory and we have a 5 %fiscal deficit to GDP that’s only widening right now. If we go into recession that’s going to blow it even further. To me I look at gold as protection against that type of dollar devaluation that necessarily has to happen when you have deficits like this.
So to me it’s coming from a macro framework, but I also think owning gold today fits very well with Warren Buffett’s thinking about the asset class too.
Dan Ferris: Yeah, that’s interesting that you note his comment about buying silver due to basically an expected weakness in the dollar. He says one thing. His official viewpoint. But then he kind of does another I think – he’s done that a couple times over the years.
Jesse Felder: Yeah, and I think he’s, you know it’s very much like you listening to Fed Heads now. They might be worried about the corporate bond market. Jay Powell for instance, you know this week was talking about corporate bond leverage or leverage across corporate America on balance sheets. And saying that it’s really nothing to worry about. But he almost has to say that because he can catalyze a sell-off in the corporate bond market by himself. So they – I think Buffett has that same kind of stature. That he’s probably – you know he can’t buy precious metals today. He has too much cash and the portfolio size is too big that – I mean this part of the supply demand problem with precious metals is that if institutions decide they have to start owning some there’s just not nearly enough for them to even buy in any size at all. If Buffett decided he wanted to put 5% of Berkshire Hathaway’s net asset value in gold or silver, the price would go to the moon. So I think he has to be careful with what he says because he can move markets so dramatically.
Dan Ferris: Right. How do you own gold, Jesse? Do you buy gold mining companies, bullion? What do you do?
Jesse Felder: I do a little bit of both. My favorite way of owning gold directly is through the – it used to be the Central Fund of Canada. It’s now the Sprott, I think Physical Gold and Silver Trust. And they basically buy – it's a closed end mutual fund. And they basically buy and warehouse gold and silver. It trades at like a 4, 5% discount to its net asset value. Which is a sentiment signal in itself that gold is – I mean I can go it at a 5% discount, I mean and that discount persists. So there’s just not that much interest in it.
But what I like is since Sprott took it over I believe they created a redemption clause where you can go to Sprott and say, I’d like to redeem my shares for physical. And they will redeem your shares for physical coins or what have you. So there’s really no risk in owning that as a paper gold thing. And you can also, you know it allows you to buy, like I said, physical at a discount.
But I also own gold miners. I think the mine, you know for me in late 2015 when I was looking at stocks like Gold Corp and New Gold and things were trading at 50%discount to their tangible book value, that was like a old Ben Graham style type of investment to me and I thought, you know in this market you can’t find anything that trades at a discount to tangible book value. And these things were so incredible cheap at the time. You can still find things, precious metal miners that traded at that kind of a discount, which is one of the only areas of real true value in the markets today I think.
Dan Ferris: Right. We’re at a really big cyclical moment. I'm pretty sure you agree with me. Stocks are exorbitantly expensive. And gold is still, it bounced off the bottom there early 2016, but it still it’s not very popular and it’s still well below the highs. It’s still a great bet. I agree. And also, I don’t know if you’ve noticed, since the 70s these gold mining companies have just not cared about free cash flow and returns on capital. And they’re getting a bit of discipline. I mean I don’t even want to say it out loud because I don’t want to jinx the whole thing because they’ve been so terrible. And mining is a terrible business, right? But we’ve seen this kind of getting discipline and generating good returns like in the railroad and then in the airlines. And I’m crossing my fingers for the gold miners too.
Jesse Felder: I mean it’s a very cyclical business. When gold prices were soaring through the 2001 to 2011, yeah, it allowed for a lot of bad decision making. But there’s nothing like a four, five year painful bear market to re-impose discipline on these managements because if they don’t they go out of business. I think that – and so this is the time to own them because they have been much more disciplined. They’re getting their costs under control. And they’re highly leveraged to gold prices. So I tell people, you know it all depends on your risk tolerance. I think everybody should have some gold and probably be overweight gold right now in the portfolio just as a diversification tool.
Because financial assets generally have done really, really well over the last 35, 40 years and now they’re more highly valued relative to real assets than almost any time in history. So I do think it's important to diversify away from financial assets in some respect. Gold’s a really good way to do that.
But the miners to me are a higher beta way of playing that trade. That you have to be bullish on the underlying I think to want to own them. And you know if gold does – and I do think this year gold’s going to break that $1,350 level and move significantly higher. And once it does, obviously the mining companies are going to – they’re not going to go up 10, 15%. They’re going to go up 100, 200, 300%. So.
Dan Ferris: So I know – I even hate to ask you this, but I know our listeners are thinking it. Just recently gold has been a little weak. It’s dipped back into the $1,280s, $1,270 region as we speak. Does that mean anything to you? Do you care?
Jesse Felder: You know to me it’s interesting that people are still so disappointed with the performance in gold. It’s up 20, 25%. Something like that. Since the 2015 low. And that’s not bad over a three year period. And it’s made a pattern of higher lows since then. So to me it looks really bullish. And this latest action so far over the last three, four months or so just looks to me like a bull flag pattern. Technical analysis is something I started studying 10, 15 years ago to try and add to my value repertoire because as any value investor knows you can easily fall into these value traps. And so I think technical analysis is something that I’ve tried to adopt to help me avoid value traps.
From that standpoint I do think, and from a momentum standpoint too. Michael Oliver’s a guy who I was introduced to a little over a year ago. And his momentum work is just fascinating. From a momentum standpoint too, gold looks like it’s turned the corner. Might have a little more short term weakness here with inverse to the dollar strength. But looks like this bull flag, once it breaks above $1,290-ish in the short term, it’s going to probably head back to $1,350 and higher.
Dan Ferris: From your lips to god’s ears, man. So do you ever buy – what do you think of like royalty companies? Do you ever buy those?
Jesse Felder: I don’t own any royalty companies. I mean obviously they’ve done well and people like them. They’ve always just to me from a valuation standpoint have been tough to justify. I prefer to find things, some of the monitors that, like I said, I mentioned Goldcorp and New Gold. Back in late 2015 it got really, really cheap. To me that was really interesting situation. Those are the kinds of things that I look for.
But I do think in terms of these gold stocks, and I wrote about this maybe a year or two ago when I was really looking at them closely, that over the last, I don’t know, five years or something it’s been the FANG stocks that have been leading the stock market and have become the most popular stocks on the planet. And I do think that we’re in the midst of a change in regime from financial assets to real assets. And part of that will be the BANG stocks, as I have called them, becoming just as popular as the FANG stocks eventually. And that would be Barrick, Agnico Eagle and it was Newmont and Goldcorp, which is now one company. So I guess those three that are really the majors that I think are going to become really popular in the years to come.
Dan Ferris: Okay. I think we’ve beat that horse roundly to death. Thank you for that. You mentioned the macro and not wanting to ignore the macro. And you talk about the Fed. I have a kind of a standard that I ask everybody who, you know has come out publically talking about the consequences of the Federal Reserve’s actions. So here goes.
Can you draw me some kind of a straight, fairly concrete connection from the Federal Reserve’s activity in the market to maintain a certain level of interest rates in that one particular rate, the Fed Funds rate, can you draw me some kind of a concrete connection from there to the stock market?
Jesse Felder: I think, you know the Fed has actually discussed this too. You know they know that lowering interest rates to zero or actually lowering it to one and holding it there, you know forced or really inspired people to borrow and buy real estate. And this latest cycle, taking rates to zero for the better part of a decade, is necessarily going to create a reach for yield. That people are going to say, I can get nothing from my savings account. I can get nothing from short term treasuries. And I can’t afford nothing. I have to get some type of income.
So you look at the inflows into like dividend focused stocks and read some things and there’s been massive inflows into those types of things. And it’s not just a U.S. phenomenon. It’s overseas investors trying to escape negative rates and coming to buy junk bonds here in the United States. Japanese and European investors.
So central banks know this when they talk about trying to create a wealth effect. And Ben Bernanke spent a lot of time talking about that in the context of quantitative easing. That they were consciously trying to push people out the risk curve into dividend stocks, corporate bonds and these types of things. The money that’s flowed into corporate bonds has been what’s largely enabled the massive stock buybacks that we’ve seen too, which has been the greatest source of demand for equities over the past 10 years.
So it’s been, you know the Fed has done it consciously. And what’s most interesting to me about that is that right after the financial crisis, my friend Bruce made a movie called Money for Nothing, about the Fed’s role in the financial crisis. And I think if you’ve only seen The Big Short you’ve only seen half the story, right? The other half of the story was the Federal Reserve’s role in creating the housing bubble.
But Janet Yellen shortly was interviewed after the financial crisis in the context of that movie before she became Fed chair. And she told Bruce in this interview, which wasn’t included in the final movie but he provided it as a separate cut later on, that she said we have to somehow find a way to go from an economy that’s reliant on bubbles to an economy that is reliant on its own fundamentals.
And so she was really well aware of the situation that Greenspan started, Bernanke, you know continued and to try and push up asset prices in order to boost the economy. And she perpetuated that game. This is just the situation we’re in right now. Which is the Fed, not just the Fed but Bank of Japan for a long time too targeting asset prices to try and boost the economy. It’s something investors need to be aware of.
Dan Ferris: Yeah. I feel like the, and this is something that I’ve seen on Twitter too a lot of folks. I follow you and a bunch of other good folks on Twitter. And they like to tweet every now and then, the Fed isn’t even trying to hide it anymore. It used to be about their dual mandate, you know about what is it? Unemployment, keeping inflation at 2%. But now they’re not even trying to had the fact that what they’re really doing is manipulating asset prices. And certainly when they caved on the raise because the stock market was down 19%, that was the moment wasn’t it? Wasn’t that like the most obvious moment when they caved in and said, we’re trying to get asset prices higher. We’re not trying to unwind our balance sheet.
Jesse Felder: Yeah. I mean but it’s been obvious, you know for years too. If you look at the timing of QE 1, 2, 3 and the performance of the stock market, you know they tried to set, you know in QE 1 stocks pulled back. Okay, well, now we need to start QE 2. They start QE 2, stocks do great. As soon as they start reining in QE 2 stock market starts pulling back again. And then the restarting of QE in every one of those instances was in obviously direct response to weakness in equity prices.
And so I think the Fed has kind of created this monster where they have, to whatever extent they’ve created a wealth effect and boosted consumer confidence through higher prices, they know that lower prices are going to reverse that effect. And so Jay Powell just became extremely worried about that in the fourth quarter when prices started doing down. And you look at the correlation between consumer confidence in the stock market. And it’s, you know it’s very, very high. And so prices, this is what a lot of people don’t appreciate either. They say, I’m going to wait for a recession to start battening down the hatches or put on hedges or whatever it is in terms of the risk in their portfolio. Well, the situation we have now with the relationship between asset prices and the Fed, asset prices could actually cause recession rather than be reacting to recession. It’s kind of going back to the George Soros reflexivity theory in that you don’t necessarily need the economy to slow down on its own to create a recession or have some kind of exogenous event like the trade war. You could just have a bear market for, because we’ve gone too far too fast and earnings are now, we’re probably facing an earnings recession. Prices going down could be the catalyst for consumer sentiment declining and being kind of a self-reinforcing thing.
Dan Ferris: Okay. So, Jesse, if I could just circle back to my initial question, because what I try to do with that question is make it really concrete for our listener. It sounds like your – the concreteness of it for an individual investor is simply interest rate suppression just kills so many alternatives that you wind up pushing into the riskier stuff. Period. You take more risk because alternatives have been suppressed out of all consideration. Is that fair?
Jesse Felder: Oh, absolutely. And from individual investors I talk to they have all gone from owning, you know they don’t have any more fixed income allocation. They’ve just put all their money into high dividend paying stocks. And they think that’s kind of – that’s their new focused income. And so that’s, yeah, exactly what has gone on is just is probably the greatest reach for yield we’ve ever seen in history because, you know you have 0% rates for the better part of a decade. People get desperate for yield.
Dan Ferris: Yeah. I keep hearing this phrase, bond like in regard to those big sort of dividend payers and the dividend raiser. The stocks that raise their dividends every year for 10, 20, 30, 40, 50 years. People talk about them as bond like. And equity, as you and I both know, is anything but bond like ever.
Jesse Felder: There’s two really big problems. Because to the extent that people have pushed equity prices up because they’re buying for yield, that makes equities that much more interest sensitive than they would be. And these dividend payers are obviously the most interest rate sensitive names in the equity universe. So as a bond investor you need to be worried about interest rate risk. But a lot of these equity investors are not even thinking about it in that way.
The other issue is that these dividend payout ratios are also entirely dependent on profits obviously. And profit margins are at their highest levels in history. So to the extent profit margins mean revert that puts those payout ratios at risk. And so you have the dual risk of not just interest rate risk, which I think you mentioned before you had me on, there’s a lot of reasons to believe that this disinflationary environment is turning into an inflationary environment once again. So that’s its own risk.
And then there’s also the risk of just profit margin reversion as a result of rising costs, rising wages and slowing topline growth. So I think that’s two risks that those investors don’t really appreciate.
Dan Ferris: Amen to that. So we’re actually getting near the end of our time already. And if I could ask you, Jesse, for our listeners, if I could ask you to leave them with one thought, what would it be?
Jesse Felder: One of my favorite quotes, actually one of my favorite books, is Market Wizards. And actually the whole Market Wizard series, you know all of them are excellent. But one thing, you know the margin of safety thing resonated with me when I first read Ben Graham via Warren Buffett. But for me the thing from Market Wizards that always stuck with me is the interview Jim Rogers where he says, when there’s nothing to do he doesn’t do anything. It really sounds simple, but he waits for opportunities that are so attractive that it’s like looking at $5 bill on the floor and all you have to do is pick it up. And I think for me, you know waiting for opportunities that are almost so attractive that you can’t pass them up has always been one of – that’s what’s led to my most successful investments. It’s always been the things where I’m like, ah, you know it looks pretty good, I’ll put some money there, that doesn’t work out for me.
So just being patient and waiting for, you know like Buffett calls it, a fat pitch. They maybe come around once or twice a year. But having that type of patience I think is really what separates the greatest investors from everybody else.
Dan Ferris: Thank you for that. I’m glad you said that. I want our listeners to really take that message to heart. So thanks a lot, Jesse, and, again, you know we’ll talk to you real soon. Thanks.
Jesse Felder: Great. Thanks for having me on. I really appreciate it. It was a pleasure.
Dan Ferris: Oh, you bet. Our pleasure. Bye-bye.
It’s time for the mailbag right now. The mailbag is really important to the show. It’s where you and I can have a frank, mutually informative, mutually beneficial conversation about investing and anything related to it. So write to us at [email protected] with whatever is on your mind. I personally read every single feedback email and I can’t respond to every single one, but I respond to as many as possible. So I’ve got three of them for you today.
Number one is from Jean S. And Jean S says, Dan, thanks for another interesting episode. I was kind of bummed at the end when you said that you couldn’t suggest any put ideas. Put options. I mentioned that a couple of episodes ago. And she says, although I understand why. It’s an important topic that I hope you continue to talk about and educate us on. As for Uber, which we discussed on the same episode, as a woman I would never get into one of those cars alone. Instincts tell me don’t even think about it. Jean S.
Thank you, Jean, for your question and your suggestion really and your insight on Uber. The thing is, Jean, I’m never going to do an option trading product. I’ve kind of decided that, you know maybe I never – I should never say never. Because you never know what you’re going to learn. I’m always trying to widen my circle of competence about this. So I’ll take the never back, but I’m just going to say to get me to do an option trading product is going to be really difficult because I believe that options are just, you know there’s too much potential for trouble. And they are too multidimensional. There’s just too many aspects to them. It's a derivative of the underlying equity. So it’s a different animal all together than the equity. And there are many, many aspects.
I mean, I wonder, you know people who trade options, I wonder if any of them know what Delta and Gama and Zeta and Vega and Ro and all the rest of it. I wonder if they really know what any of that stuff means or why it’s important or if they know what implied vol is and realized vol and the difference between the two.
So I wonder how many people buying and selling options know how they’re priced. Because that’s a complicated piece of business for most folks. How options are priced. It's really complicated math. So, you know you probably won’t hear me give concrete put option suggestions. I just – I stick with what I said which is when stocks are this expensive and we’re still even with a little bit of market weakness in the past several days or whatever, it doesn’t matter. Doesn’t matter, we’re still bumping up against all-time highest ever valuations. And that tells me that – highest ever valuations, lowest ever volatility and hedging is really cheap. And I’ll just leave it at that.
But good topic generally. But specifically you’re only going to get so much out of me.
Number two, question number two is from Ralph B. Ralph is an Alliance member. A Stansberry Alliance member. Thank you for that, Ralph. And Ralph says real simply, how would the bitcoin be maintained when all the bitcoin are mined? And how many bitcoin have been lost already? Ralph B.
So I talked to Eric Wade about this, who we had on the program a couple episodes ago talking about bitcoin. Eric has been there, done that. He mines different cryptocurrencies and he’s been doing the stuff for years. And basically bitcoin, what he told me by email here, he said bitcoin literally never go away. The technology of block chain means once they’re created they stay somewhere forever. And he says, what can be lost, which is what you’re talking about, Ralph, what can be lost, Eric says, is our access to them. If a person loses his or her key that gives them control over their bitcoin, their wallet, then they have lost their bitcoin effectively. There’s no password help with block chain.
So there’s an estimate that millions, a couple million, and there was an article in Fortune Magazine 2017, November 2017, suggested I think 2.7 million I think was the number, have been lost. Which means there’s fewer of them floating around than people think. So maybe, you know the demand relative to the supply is a little stronger than anyone realizes. But Eric says, the nature of crypto having no decentralized authority means that if I forget my password or key, there is no one to help me recover it. And if I save that key on a hard drive which dies, also no recovery. To true believers that’s a fair price to pay.
Okay. So it’s never really lost, but you can lose access. Good question.
One more. Larry B from Maryland. Larry wants us to know he’s from Maryland. As am I and Stansberry is headquartered in Maryland. Larry says, Dan, in the recent investor hour broadcast you said, paraphrasing, turnaround if someone talks about grabbing a small percentage of a large market in order to be successful. You prefer a large share of a small market. And then he ends the quote there. The paraphrase. And he continues, yet in this month’s Extreme Value pick you talk about own 5%of a fragmented market and expanding it for success. Could you elaborate on what appears to be opposite ideas? Thanks. I’ve enjoyed your uniformly interesting interviews. Would you consider having an interview with an options exert in the future? Good idea. I’ll put it off on the options expert. Larry B. Thank you, Larry B.
So I won’t tell you the name because people pay me a lot of money for Extreme Value and I can’t give away the advice that I provide for them. But yes, you’re right, a similar company, we’ll talk about a similar company that did a similar thing. Home Depot, right, the hardware store market was this extremely fragmented thing and they created these big box stores that, you know, frankly, kind of put a lot of mom and pops out of business. Walmart did the same thing with grocers, right? A lot of local mom and pop grocers went out of business because they couldn’t compete with Walmart prices.
But what I think the company I’m talking about in Extreme Value can do, I think it can acquire some competitors. And you see this in another highly successful company called Sysco. Sysco the food company, S-Y-S-C-O. That Sysco. You’ve probably seen the trucks around town where you live delivering food to restaurants and stores and things.
And Sysco is in a fragmented market and has bought up some competitors. And if you can do that, you know it’s a neat way to grow a business. If you can get away with it. Rolling up your competitors, rolling up a bunch of companies in a given industry has created success. Successful companies have done in this in the past.
So there’s a difference. I think if I wasn’t clear before, wheat I meant was – I was referring specifically to the company Beyond Meat whose ticker symbol is BYMD. Since its IPO recently a couple weeks ago it’s soured a few hundred percent. You know I think it’s a triple or a quadruple or something. It’s just crazy. Or quintuple. I mean it’s way up there. It was like – I know it was like 80 bucks at one point and I think it IPO’ed below 20 if I’m not mistaken. Anyway, you get the point.
And of course it’s making losses not profits like all these IPOs nowadays. And there was a line in there, a letter to shareholders that said something about the $1.4 dollar global meat market. And I said, when you hear this pitch, grab your wallet, turn around and run. Because it’s a bad idea. What you really want in a brand new business, if I didn’t make that clear enough, what you really want in a brand new business idea is to initially go after a small market and get a big chunk of it. So the difference is between an established business that’s been growing for decades in a fragmented market and may have an opportunity to roll up, to buy up some competitors on the one hand, which I think is a good plan. It can work. Versus on the other, like Beyond Meat, trying to get a tiny percentage of a gargantuan highly competitive market with a brand new product. You see? There’s a different. I hope that satisfies your inquiry. Very good question though. Thank you, Larry.
And that’s it. That’s it for another episode of the Stansberry Investor Hour podcast. Look, it's my privilege to come to you every week and I thank you for it and I hope you’ll come back and listen next week and the week after and the week after as long as we do this. You can find us online at www.investorhour.com. Go there to check out all the episodes, including transcripts, and you can enter your email on the homepage to make sure you get all the latest updates, including when each new episode comes out. That’s investorhour.com.
Thanks again, folks. Talk to you next week. Bye-bye.
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