Double or nothing: investments to swim against the tide

Australian Financial Review, December 2008

They say it’s contrarian investors who make the real money: those who see opportunity when others see crisis, the people who swim against the tide.

Unfortunately, those who have followed that approach in the last 12 months have not so much swum against the tide as sunk beneath the waves. Anyone who’s bought declining assets in the hope of a rebound has now lost half their money and is frantically trying to explain to their angry spouse where it has gone. (Disclosure: the author has lost half his money and is frantically trying to explain to his angry spouse where it has gone.)

Still, the accepted wisdom does hold true. Markets do bounce back, and the people who make the most money from a bounce are those who are in there at the bottom, not waiting for indisputable evidence that the worst has passed. Calling the bottom has been hopelessly difficult but it’s out there somewhere.

With that in mind, should you be thinking: double or nothing, and investing in the absolute dogs? The unloved detritus of world investment markets that have been so ruthlessly deserted there’s hardly anyone still in there? In this feature we look at 10 such markets and ask whether you should be piling in while all others are wedged in the exits.

• SMALL MINING STOCKS.

Examples: Paladin Resources has fallen from $10.70 to $1.89 since April 10 2007 – an 82.3% drop in 19 months. Mundo Mining was at 96 cents on February 28 and closed at 10 cents on November 21, down 89.6% in nine months.

All resource stocks have been hammered this year, but the smaller mining companies have suffered the most. Have they fallen so far they represent a bargain? We mention the two above because they are holdings of Fat Prophets, the investment commentators and mining specialists. FP started buying Mundo Minerals at 25 cents and is hanging in there despite a 60% fall from even that meagre level; they are taking a bet that the company can get past some start-up problems at its Engenho Gold Project in Brazil. “The company continues to make sound and sensible progress,” say the Prophets.

Paladin has been a Fat Prophets holding since 2006, since when it has watched the stock climb more than six times in value and then lose it all again on the back of plunging uranium prices and miserable attitudes to mining stocks generally. It’s still holding on: “Paladin provides good exposure to our view of longer term uranium price strength.”

Still, not everyone thinks the smaller companies are the way to go. We asked Evy Hambro, head of the renowned resources investment team at Blackrock in London (and also the manager for Global Mining Investments, the Australian-listed investment company), what he thought. “There are some huge opportunities out there,” he says. “But the risks outweigh the returns for many smaller mining companies. Many of them face financing challenges, often the assets they own are not leaders in terms of profit margins, and in today’s tough environment some of those margins are at risk. And for those looking to develop new projects – which is the majority – they will find it tough to raise the capital to do so.”

• BANKS

The Dow Jones US Financial Services Index is down 63.55% to November 25, the worst of all the Dow US sector indices – and that’s after a hefty bounce in the previous two days. In Australia, as of Monday night’s close, Macquarie was down 66.64% since December 11, National Australia Bank down 53.6% in exactly 12 months. Babcock & Brown, having lost more than 99% of its value in just over a year, is suspended.

Banks got us into this mess, but will they get us out again? “If it is any consolation,” says the author’s financial planner, who for sundry reasons shall remain nameless, “I do believe that it will be the financials that will pull us out of this recession.” And, indeed, that’s what usually happens: stock markets rally before economies do, and financials are usually the first sector to do so.

There have been signs of some significant investors believing the bottom has been reached, or is near. Two contrasting but highly important investors stand out: Warren Buffett’s purchase of $5 billion preferred stock in Goldman Sachs in September; and Saudi Arabia’s Prince Alwaleed’s announcement on November 20 that he was increasing his stake in Citigroup.