<August 16, 2019>
Most value investors I know consider themselves contrarians. Essentially, contrarians allocate capital in the opposite direction of the consensus in an attempt to buy low and sell high. It sounds so logical I often wonder why everyone isn’t a contrarian, but of course by definition that isn’t possible.
One of the things I like most about contrarians is their stories—they have the best. Just as contrarian investments have their cycles, so do the stories behind them. A good contrarian story typically starts with an exciting and opportunistic tone. The contrarian storyteller begins, “It was getting destroyed. I couldn’t believe how cheap it was becoming. And then I bought some and it fell more! The value was unreal! I couldn’t buy enough of it.”
During the middle of the story, hope is often replaced by agony and despair as the contrarian explains the experience of holding a position that consistently declines in value. “I’d come home from work and couldn’t stop thinking about it. I had trouble sleeping and was driving my spouse crazy by my endless ‘what if’ scenarios. It was excruciating.” A portfolio manager once told me he inadvertently plucked away one of his entire eyebrows while holding an out-of-favor position. He came home from work and his wife informed him of the bad news. “Honey, one of your eyebrows is missing!”
My favorite part of the story is when the contrarian is finally vindicated. The storyteller’s eyes light up and voice rises. “And then when I thought all hope was lost, the thing stopped going down. It just did. There was no specific reason—it just happened. I don’t know if it was relief or joy, but as I watched my losses turn into profits, I began to cry. It was the most painful and rewarding experience of my life.” Oh, how I love a good contrarian story!
In addition to enjoying a good contrarian story, I also like to tell them. Although I have many contrarian stories from the tech, housing, and everything bubbles, some of my favorites are related to the precious metal miner bear market of 2013-2015—one of the most violent and unforgiving bear markets I’ve ever encountered.
Discussing and defending the precious metal miners during that time was always challenging and, in some cases, entertaining. I’ll never forget when I had to explain the bull case for the miners in 2015 during an important meeting with a very large client.
The meeting was with a bright consultant that had a history of challenging portfolio managers.
I started the meeting by reviewing my valuation methodology and rationale for being bullish on the miners. I explained my belief that the miners were a classic contrarian investment and were selling at significant discounts to their net asset values. I felt value investors should be swarming over the miners, not avoiding them—it was the perfect time to be contrarian. However, I believed the position was too contrarian for most professional investors, as it carried unacceptable levels of career risk. I argued this was why miners were so inexpensive relative to their difficult-to-replace long-lived assets.
I should have stopped there. Instead of wrapping up my argument based on facts and sentiment, I did something I rarely do. I pulled out an old Warren Buffett quote and said, “As Warren Buffett likes to say, be fearful when others are greedy and greedy only when others are fearful.” Nice closing, I thought. But then came a quick and sharp response, “Well then, does Warren Buffett own the miners?” Oops. He did not and I knew he never would. I responded with the unfortunate truth, “Hell no, Warren Buffett would never own these things!” Instead of getting fired on the spot, I was fortunate—everyone in the room laughed and we kept the client.
Once an extremely contrarian idea, precious metal miners have emerged from their bear market and are one of the best performing sectors in 2019, up 39% year-to-date (NYSE Arca Gold Miners Index return as of 8/12/19). The justification for owning precious metals and the precious metal miners seems to be growing by the day. With the number of negative yielding bonds soaring globally and with central banks committed to their unconventional policies, it’s no wonder investors are clamoring for an asset or currency that cannot be easily replicated without sacrifice or effort.
Given our appreciation for the bullish case for precious metals, it’s fair to ask why there wasn’t a precious metal miner listed on our recent quarterly holding report. Unfortunately, given the rise in most precious metal miner stocks, we believe the miners on our possible buy list are no longer selling at discounts to the replacement costs of their reserves. This is not to say the miners are expensive using other valuation techniques, such as discounting cash flows (DCF). In fact, assuming gold and silver prices maintain their recent gains or increase further, we believe higher valuations based on a DCF model could be justified.
Generally, we’re more likely to invest in a commodity stock when the underlying commodity is trading below the cost of production and the business is losing money. During periods of depressed commodity prices and operating losses, we’ve found the reserves of a commodity business are more likely to sell at a discount to our calculated value. Given the recent rise in gold and silver prices, that is no longer the case for the precious metal miners on our buy list.
Although we are not actively pursuing the miners at this time, we remain attracted to asset-heavy businesses with strong balance sheets. In fact, of the ten equities listed on our June 30, 2019 holdings report, we consider seven to be asset-heavy and were mainly purchased on our belief that their businesses were selling at a discount to their net asset values. While these asset-heavy investments may not be “as good as gold,” we find them interesting and potentially rewarding nonetheless. Our ideas range from companies with valuable vineyard acreage, natural gas service assets, investment securities, and Manhattan real estate—all trading below our calculated net asset valuations.
The common theme of the Portfolio’s asset-heavy holdings is their extremely strong balance sheets. We believe the strength and liquidity of their balance sheets will help these companies survive the next recession and possible corporate credit crisis. Furthermore, most of their equities are trading at price to tangible book value ratios below 1x (see charts below). In effect, based on their depressed equity prices and valuations, we consider these investments to be out-of-favor and, yes, contrarian.
While nothing in investing is certain, we believe our holdings of companies with abundant assets and liquidity will help us achieve our goal of generating attractive full-cycle absolute returns. And while it’s not a stated objective, we’re also hopeful these investments will add to our list of entertaining and enjoyable contrarian stories.
Past performance does not guarantee future results. Current performance of the Fund can be obtained by calling 904-747-2345.
There is no guarantee that a particular investment strategy will be successful. Opinions expressed are subject to change at any time, are not guaranteed, and should not be considered investment advice.
Fund holdings are subject to change and are not recommendations to buy or sell any security. Current and future portfolio holdings are subject to risk. For a list of the Fund’s top 10 holdings, please click here.
Definitions:
Discounted Free Cash Flow (DCF): A valuation method used to estimate the value of an investment based on its future free cash flows. DCF determines the present value of expected future free cash flows using a discount rate, or required return.
NYSE Arca Gold Miners Index: A market capitalization weighted index comprised of publicly traded companies involved in the mining of gold and silver. It is not possible to invest directly in an index.
Price to tangible book value: The ratio of a company’s market capitalization divided by its shareholders equity less all intangible assets.