U.S. stocks were mixed today, holding onto most of this week’s gains ahead of tomorrow’s highly anticipated nonfarm payroll figures. Anticipation is running high because the vast majority of economic data points have been strong in recent weeks, and economists have been busily revising higher their expectations for job growth in December. Weekly jobless claims have been falling and yesterday we saw a surprisingly strong ADP employment estimate. As investors have come to grips with the perkier tone in the U.S. economy this year, stocks and the dollar have risen, while bonds and commodities have fallen. I have no idea what the employment figures will show or how the markets will react. I do think, however, that how our markets finish will be more instructive than how they open. Even if one possessed a time machine and could see tomorrow’s BLS figures tonight, it would still be tough to predict how our markets would behave in response. As we will later see, knowledge of important future events is not a guaranteed way to make money.
2010 may have ended in sleepy fashion, but most asset classes finished nicely in the black after some mid year scares (see attached piece from Credit Suisse). 2011 has begun with rising expectations for economic growth in North America, and our capital markets have once again started to gyrate as investors jockey with one another to place fresh bets. Today was a bit of an exception, though, as some market participants may have tried to square up some positions ahead of tomorrow’s employment numbers. After opening unchanged, equities retreated 0.5% or so before lunchtime. They drifted sideways with an upward bias as the day ended, with the NASDAQ’s 0.28% gain more than offset by similar sized declines in the other indexes. After a tough couple of months, bonds actually rose today, with yields falling between 3 and 8 basis points. Today’s economic data was a non event, but the rosier outlook for 2011 growth has been a tailwind for the dollar (up 0.65% today and 2%+ this week). Commodities have slumped, in part due to the greenback’s strength. The CRB index fell 1.25% today is already down almost 3% this year.
Next week I will look back at the predictions I made for 2010 and hazard some guesses about what 2011 might hold in store for investors, but for now let me just say that forecasting is a pretty tough business. There are myriad variables to consider, all of which change with time and can interact with one another to produce surprising outcomes. Even when one has access to the equivalent of a time machine (i.e. knowing — with certainty — how some variables will move over time), there can be no guarantee one will make money. Perhaps an example will make this concept more tangible.
It is January and you are a proud common stockholder of Newmont Mining (NEM, which closed just under $57/share today). As the name implies, the principal business of Newmont is mining, specifically gold mining. You are proud to be a shareholder because gold has more than doubled during the past 5 years and, like gold, NEM has run up nicely in the past year. Hovering near the $60 mark, the shares of this go-to name in the sector (NEM is the only gold miner in the S&P 500) seem poised to set a new, all time high if Q4 earnings reveal a new record for annual profits during next month’s conference call. You are confident because the company has been doing quite well and growing cash flows have enabled management to announce a hefty increase in the annual dividend in recent months.
But since this is mining and since Newmont shares are subject to the whims of Mr. Market, you also harbor a few doubts. What, for instance, would happen to the value of your shares if the price of gold starts to plummet? Then again, owing a miner should offer some upside leverage should gold continue to rise, so the price of NEM could do anything — depending on how unknowable variables play out in the future. Tough call, right?
Well, what if I gave you the ability to peer into the future, to know — with certainty — how some of these unknowable variables would change over the next 5 years? What if I guaranteed you that the following predictions about Newmont — its earnings, its share count, its dividend payout, and even the price of gold itself — all come true five years hence? Courtesy of my time machine, I can tell you exactly what will happen:
1. The price of gold rises almost 150%
2. Newmont’s earnings more than quadruple
3. Newmont’s dvidend payout rises 50%
4. Newmont’s share count rises less than 10%
Based upon the above information, you would probably be prouder than ever to be a Newmont shareholder. You would probably ask if these future events could be considered inside information, whether you could legally buy more, or perhaps even buy as much on margin as your broker would allow, right? After you’ve made your decision to buy, sell, hold, or lever NEM up to your eyeballs, I will ask you to guess the price of NEM shares five years into the future. Go ahead, take a guess. I, and many other long-time Newmont shareholders already know the answer: shares of Newmont Mining actually decline over the following five years..
Yes, NEM goes down. The time period to which I refer is January 2006 to January 2011, and my time machine is called history (i.e. a few charts and access to Newmont’s website). NEM traded at $60/share in January of 2006, and here are the actual changes to the variables mentioned above over the past five years:
Gold price in January 2006: $550/oz
Gold price in January 2011: $1370/oz (up 149%)
NEM earnings for calendar 2005: $0.84/share (announced in February 2006)
NEM earnings for calendar 2010: $3.80/share (Zacks consensus estimate – Q4 due in February — even a miss will produce a fourfold gain)
NEM annual dividend in January 2006: $0.40/share
NEM annual dividend in January 2011: $0.60/share (up 50%)
NEM share count in January 2006: 446 million
NEM share count in January 2011: 486 million (up 9%)
So why didn’t Newmont surge higher during the last five years? First, welcome to investing, especially in tough businesses like mining. Second, even accurate predictions don’t always translate into profits in the stock market. Conviction about certain outcomes for a company won’t prevent you from losing money, and conviction backed by leverage can be lethal (in 2008, NEM dropped into the low 20’s; a fully margined buyer at $60 in 2006 would have lost everything). Last, and most important, is that the price one pays for a security is paramount to forward returns. A margin of safety built into the purchase price of any investment is the best defense against an unknowable future.
In January of 2006, Newmont was trading at a nosebleed P/E and investors were hoping for production growth in addition to higher gold prices. Gold did its part by rising, but so did production costs. Newmont also suffered through production declines that today leave its gold output more than 20% below its 2004 peak. Priced for perfection at $60 in January of 2006, shares of Newmont Mining offered little margin for safety when the disappointments came. NEM’s experience has hardly been unique in the mining sector, either. The major African miners (AU, GFI, and HMY) are all down since 2006, while the major Canadian companies (ABX, GG, KGC, AUY, and AEM) are all below the best prices they fetched back in 2008. Most of these companies make a lot more money than they did three to five years ago, but P/E multiples have compressed as investors worry that the gold bull market will end at any moment. Bubble behavior this is not.
So what do the next five years hold in store for Newmont and the other miners? Who knows — and even if we did know it might not help. What we do know is that NEM now trades at less than 15 times last year’s earnings and less than 13 times this year’s estimates. NEM’s PEG ratio is 0.6 and it yields as much as a 3 year Treasury note (1.05%). Today’s shareholders of Newmont and the other big miners could still lose money during the next five years, but investor wariness about what might go wrong is at least somewhat reflected in the price of these names. Investors now have a decent margin of safety, and good things tend to happen to cheap stocks.
No one has yet invented a time machine that can let us travel into the future and back. If they had, the news would be spreading like wildfire across the servers of the $50+ billion company called Facebook. If they have forgotten what happened in the aftermath of the dot.com mania, investors in today’s high-fliers who are absolutely certain their companies will succeed should take note of NEM’s “success” over the past five years.. Not so good things tend to happen to expensive stocks.
— Jack McHugh