Why would anyone Buy Bonds right now?

Last week, bond manager Bill Gross (a man who should know better) made the curious statement that the stock market is sure to provide bleak returns for years to come.  This is despite the fact that stocks have historically outperformed every major asset class, particularly after prolonged downturns.

Of course, it's not completely unexpected for Bill Gross to be dismissing stocks. As the manager of one of the world’s largest bond funds, he’s expected to be a bond pimp (though to be fair, he now says that bonds won't perform well either).  So, how are bonds as an asset class?

When bonds are popular, long-term yields drop (there is no reason to offer a high interest rate if people will buy them with a lower one).   And just how popular are bonds at the moment?

As of August 1st 2012, the US 30-year treasury yield was 2.614%. For the first 6 months of 2012, the rate of inflation was 2.37%.  Therefore, 30-year treasurys yield a Real Return of exactly 0.244%.  At this rate of return, you will double your money every 298 years.

Canadian bond yields are excellent in comparison, though still dismal.  The Canadian 30-year treasury yield on Aug 1^st was 2.297%, with inflation during the first 6 months of 2012 at 1.95%, for a Real Return of 0.347%.  Far better than US treasuries, Canadian bonds allow you to double your money in slightly less than 200 years (198 years and 3 months).

The other problem with bonds is that when interest rates rise (as they are sure to do, well before 20 years from now), prices drop.   If interest rates rise at all, there is an excellent chance that your .244% USD bond return will disappear completely.

If you have billions of dollars that absolutely needs to be in a guaranteed investment (for international real estate escrow, for example), there may not be anywhere else to put your money.  I’m quite certain that most readers won’t fit into this category.

If your reason for buying Government bonds is, “I've heard that Government bonds are safe and I don’t want to lose my money,” then you should buy my book, The Intelligent Investors Mind, which clearly explains why this way of thinking is dangerous.

Normally, bonds -- especially Government bonds -- are one of the best and safest investments around; but in the world of investing, the exception proves the rule.  At present, bonds are bad news.

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"The cult of equity is dying. Like a once bright green aspen turning to subtle shades of yellow then red in the Colorado fall, investors' impressions of 'stocks for the long run' or any run have mellowed as well."

Bill Gross

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The World has Changed

There was an unprecedented delay since the last post in The Frost Report, as you may have noticed.

I could write volumes about the reasons for this, but simple explanations are always best: a new position at a global financial institution, followed by several high intensity 60-hour workweeks. For the moment, life is back to normal.

So, what has changed since the last post?

For one, the subject of the last post - the lawsuits expected against Baja Mining - have now begun. 

On July 27th, a large shareholder initiated a class action lawsuit for over $250 million, claiming "misrepresentation" by Baja.  Although the shares are now sure to be worth almost nothing (creating a loss for me) I am nevertheless satisfied by this development.  As a speculative buy, I own just enough BAJ shares to be annoyed at their drop in value, but not enough to affect me in any material way whatsoever.  In this case, justice is more interesting than profits.

In anticipation of the inevitable slowdown of the Chinese economy (something The Frost Report has been writing about since early 2011), the XME Metals and Mining Index has dropped more than 50%, exactly as expected.  Interestingly, established mining companies were hit just as much as companies that own nothing more than a piece of land.  And, those that produce gold were hit just as much as those that produce iron.  One of these days I will remember that when a sector drops, even the best companies drop right along with it.

With many commodity-producing companies running at P/E Ratios of around 2.0, opportunities certainly abound.  Long-term investors would be wise to consider making regular purchases of commodity index funds, such as XME.  I say "regular purchases" because December of this year may mark the low point.  In December, many investors will be doing year-end tax loss selling of the most battered stocks.

The global housing market slowdown (also something that The Frost Report has been anticipating since 2011) is now well underway.

In Israel prices have notably softened and they are preparing for a hard landing (i.e. a drop that they will not be able to control).  In Canada, regional bank branches that were doing 6-10 mortgages a week in the spring of 2011 are now lucky if they do 2.  And in China, home prices are officially stable and robust, signifying that the government is lying its pants off.

And finally, the thing that hasn't changed at all since the last post...

Retail Investors remain deathly afraid of stocks.

A Financial Planner a few days ago mentioned that in 2006 their company's best-selling mutual fund was composed of 80% stocks.  Now, their best-selling mutual fund is composed of 80% bonds.

It seems that stocks are still, and for some time will continue to be, shunned by regular investors as a dangerous game.  And so it is, if you don't know what you are doing.

If you are a long-term investor with a eye for value, the 2008-2012 (+) period will likely be the single greatest stock purchasing opportunity of your lifetime.

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"The day I went to work in 1932, steel mills were running at eight percent of capacity.  I remember days when the trading was so slow people played ball on the floor of the exchange."

David Babson, as told to Adam Smith in Supermoney

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Baja Mining - Lies and Lawsuits?

In an earlier article on The Frost Report, I wrote about a great mining company - Baja Mining.

What makes it great?  Well, they have a huge, mostly finished mine with great expected cash flow in a known mining district with a low stock price!

Without taking sides, I wrote alot about one problem that was contributing to the low stock price: Mt. Kellett Capital Management, a hedge fund and major shareholder, said that Baja was not being governed properly, and so were attempting to place some new members on the board of directors.  Mt. Kellett lost this battle on April 3rd.

It now seems that Mt. Kellett was right all along- Baja's management is indeed incompetent, or at the very least hopelessly confused.

Baja stock sank 40% (!!!) today, after Baja issued a press release saying that, contrary to everything they have ever said before, the project is NOT funded through to completion, and will require substantial new funding ($246 million) - from somewhere.

The issue of funding is especially interesting to me, since in my interview with Baja representative Alex Macdougall in February, I specifically asked him if there was any chance whatsoever of Baja needing to raise capital.  Macdougall's answer was: "There is no chance of them [Baja] raising monies before they complete construction."  About two months later, Baja issued a subtle press release saying that they were feeling "inflationary pressure," but that they were implementing cost-cutting measures to help offset these.   Looking back, I feel like I was sucker-punched.

Today's latest press releases also included a short "by-the-way" statement, which was that three more directors quit because (their words), "In light of recent developments...we are no longer confident that we can ensure the level of good governance and oversight that the Shareholders of Baja have a right to expect from us."  Tellingly, this quote only made the follow-up press release.  The first release had no mention of this quote, despite the fact that the exiting directors had specifically asked that it be included.  Shady.

The big question is...is Baja still a good investment?  The answer is that at $0.57 per share, now more than ever, it is a fantastic investment - for someone.  Just maybe not for you, the shareholder.

Whoever provides the funding to completion will find Baja an excellent investment.  Mt. Kellett, I'm sure, is wetting their pants with excitement at taking over this flopping fish of a company and its incredible mining assets (either that, or today's drop was because they finally said "**ck it" and sold out!)

For the average shareholder, it is far too early to load up on shares of a company that has proven so opaque and -- as of today -- almost ungoverned.  I bought a few hundred more shares just to be crazy, fully recognizing that Baja has turned from an investment into what is essentially an asset-backed gamble.

Bad governance is almost as bad as "unexpected accounting irregularities."  When the rules keep changing, you can't play the game.

I have no high expectations.

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The Earlier Article (including interviews): Stocks I Like - Baja Mining

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