Saturday, December 5, 2009

Some Trading Thoughts (And Bit on "Personality" Brands)

Here are a couple of trading thoughts.

There was a big drop in gold on Friday. May be the yellow metal was taking a breather, may be it is starting to reverse, who knows? Certainly I do not. Knowledge of the future is highly valuable, as the Galleon case illustrates, and I do not have it with any certainty. At any rate, GLD was down 4.17%. The gold miners ETF, GDX, was down 5.31%, while the jr. miners ETF, GDXJ, was down 4.81%.

This might be a good ST conversion bet. Long GDX, short GDXJ in equal dollar amounts. GDXJ should move in any direction by more than GDX does, and GDX should move in any direction more than GLD does. Why is that? GLD is the physical metal, already mined and stored, less expenses. GDX is equity in miners, and miners, even if they are not financially leveraged, are operationally leveraged on the price of gold. Due to their high fixed operational costs, if the price of gold doubles, their earnings should more than double. GDXJ should be even more operationally leveraged: lower yielding mines, lower economies of scale, riskier governance, etc.

This is a risky trade for several reasons. One, precious metals got really volatile on Friday. A friend of mine who trades for a living, and who happens to be a big gold/silver bull, is out over the weekend just to see how it plays out. This means that the planned convergence may not happen. On top, even though the mean and median absolute daily performance of GDXJ is greater than that of GDX (which is consistent with the the operational leverage theory), GDXJ started trading relatively recently, so the number of observations is small.

Finally, of course, you can ask John William Meriwether how well big convergence bets work out.

Speaking of Meriwether, he is obviously a big believer that a third time is a charm, so he is launching a third fund doing, again, "relative value arbitrage" just like LTCM and JWM. A fool and his money are soon parted. But this is a nice lead in for the second thought. It shows that risk is back.

One place where you see this is the high yield market. The Distressed Debt Investing blog, a great blog BTW, reports: "In November of 2008, there was over $230B of corporate debt trading below 50% of par. Today there is less than $10B. As a percent of the market, 31.4% was distressed in November and now only approximately 1%." Emphasis mine.

In other words, someone (or a lot of someones) are throwing money in high yield. There is also anecdotal evidence of things getting too heated. Blockbuster did a deal in October. This is akin to a Trump-branded Dubai yacht harbor getting 3.50% fixed rate 30-year financing. Then last (?) week Pinnacle Foods, a Blackstone portfolio company, bought Birds Eye Foods, a Vestar portfolio company, with a $900 mm covenant-light ("covvie-lite") financing. Now, one, this is a huge deal relative to the recent HY deals, and it is cov light, and it is a sponsors flipping the company to another sponsor. Then there is the JohnsonDiversey deal, which has a PIK provision. These are all dear "relics" from the '05-'07 "boom."

How can one play this? Look at JNK, I think the most liquid high yield ETF. It has had a nice run along with equities since March, but it started leveling off. The run-up, as described in the quote from the debt blog, and the deteriorating quality of lender protections are signs that JNK might be going down. One can even short JNK and long LQD to bet that even if rates continue to go down, high grade will outperform on a relative basis.

Risks in this trade, again, are plenty. I am positive yields will be rising but as Howard Marks, the Oaktree Capital chairman writes, being too early is often indistinguishable from being wrong.

Now on to another recurring theme on this blog: brands. Again, as I have studied more marketing than the average consumer, I do not have "relationships" with any brands. But I do recognize and respect their power.

One of the big news this past week was the adversity that a certain golf brand experienced when it turned out that the person on whom the brand was based had been doing things that can be classified as "inappropriate." The brand protection machine went on full speed and it seems, at least to me, that the brand will be salvaged.

But the companies supporting this brand already have plenty of experience with risks like these and know how to manage publicity crises like that.

Michael Jordan has had well-publicized gambling problems and went through an ugly divorce, and yet the brand is doing fine.
Lance Armstrong also went through a divorce 2-3 kids later; moving on, he proposed to and then dumped Sheryl Crow; he has been through 2-3 high profile women since then, fathered another kid, etc. And, yet, the brand Livestrong is going on strong.
Kobe Bryant, another unfaithful husband who was also accused of rape, has rebounded quite nicely, even though he did change sponsors and does not have a product brand solely under his own name.
Martha Stewart went to jail, and came back nicely.

This highlights the risk of building a wholesome brand image based on a real person. It is almost easier if the brand is built based on being "real" (or even a "bad boy"). Someone like Charles Barkley is a good example. He does stupid things periodically (such as driving drunk or throwing someone through the window during a bar flight) but he "gets" it once sober, takes ownership of it, and moves on.

Sometimes overreliance on a personality brand can spell trouble for the entire enterprise. A recent example would be Steve and Barry's Chapter 11 and subsequent liquidation, and their reliance on Stephon Marbury//Starbury to drive sales. Turned out $9.99 shoes were not a great idea. Nether was relying on Marbury who showed all the caprices of a douche-star well-before achieving anything. Of course, taxpayer-backed GE Commercial Finance did the DIP loan after the Ch 11. I do not know what the recovery was.

So if there is a caveat related to investing here, look beyond the brands per se. As The Oracle of Omaha says, "I like Disney because the mouse does not have an agent. " Or something to this effect.

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