When my children were younger, I used to take them on packing trips on horseback through wilderness areas. In Northern California there is a lake called Deep Lake. It is a very small, but very deep, secluded lake in a remote area, and in it are some of the largest and most stubborn trout I have ever seen. These huge beasts would lay in the shallows in the sun, and for hours on end we would try to tempt them with a wide variety of bait. We tried it all, and believe me, nothing worked. I could almost swear I saw them laughing too. All we could do was watch them in dismay until eventually we lost patience, went back to camp, ate our dehydrated beef stew, and talked about the fish that got away.
In last week’s article I talked about Royal Gold (RGLD:Nasdaq), another fish that got away.
We shorted the stock in late January as it made a double top, and were then stopped out early February as it continued higher. I felt it was a good entry and a good stop, but what bothers me about the trade was that I took it off my screen after the stop, and failed to follow-through on the idea. I lost patience. So when last week’s Barrons article came out, dragging it down from 19.45 to 12.70, yes, it was aggravating, but it was also a good reminder about patience. And lord knows we need patience in this market lately.
I also mentioned however, that I was looking for opportunity in the counter-reaction off the bottom. Dramatic sudden price changes attract attention. They are compelling, and often invite counter-reaction. So I felt that a new opportunity was presenting itself.
Some of you emailed however, horrified that I would contemplate a long position in a stock with such dismal fundamentals. Martha (who is short RGLD) wrote, “ …you didn't seem to grasp the real reason that the stock was down so much - the fundamentals! That Barron's article just alerted the whole world to the fact that RGLD is massively overvalued. Technical support means nothing when the whole world thinks the thing is worth $9.00 at best. I predict it will see single digits in the next two weeks… The one thing I believe in most is that in the long-run fundamentals matter - so unless gold goes to $800 - I believe RGLD will come back to single digits - I just have to be prepared to wait!”
There are things that I agree with you on Martha, and then there is a part of that type of thinking that I find dangerous, especially in today’s market.
The first thing I believe we have to always ask ourselves is, “What is it that actually moves a stock?”. Valuations do not move stocks. Fundamentals do not move stocks. Technicals do not move stocks. Tea leaves do not move stocks. What moves stocks are people’s perceptions and beliefs, and their actions based on those perceptions. People buying and selling, and the intensity of those actions, is moving those stocks. So what we really need to know is, what are people basing their perceptions on most of the time?
In a logical world, people would base their perceptions on valuations and fundamentals. It makes sense. If everyone used common sense, we would only be buying companies with lots of cash, solid earnings, focused honest management, real products, dividends, etc. Only the “good companies” would climb in price, and all the over-valued companies would fall. Investing would be easy. I would like to think that all I had to do was chose a stock with “real value”, wait patiently for the market to see it my way, and watch the price gravitate towards that value. Unfortunately, its not always that easy – not anymore.
As Keynes once said, “There is nothing so disastrous as a rational investment policy in an irrational world”. If there is anything that the tech bubble taught us, it is that greed and fear are quite often stronger than logic. In today’s market, we have a lot of reasons why people are buying and selling, and everyone have a different time-frame in mind. Some people are watching valuations. Some people are watching technicals. Some people are even throwing darts. And they are all acting within the greater context of the general market mood. The gravity of emotions is pulling as well, affecting perceptions.
Even when the price does eventually gravitate towards “real value”, we have often left a lot of potential on the table in the mean time. Many bears in 1999 were stomping their feet and screaming about fundamentals and the insanity of the prices of techs. And they were right. Now that we are down 75% from the March 10, 2000 top, they can gloat. But by golly, in their refusal to see that the market does not always act logically, they sure missed out on one heck of a ride on the way up.
RGLD last week was a similar case. I agree with you Mary, if the world thinks that the thing is worth 9, then it will move to 9. But not everyone in the world is basing their trade on fundamentals alone. Fundamentals contributed to our original decision to short it. It kept climbing however, because its really perception that moves a stock. If the whole world thinks its worth more, it will climb higher despite the fundamentals.
We have to take into account more variables. Psychology tells us that for every large sudden action, there is usually a counter-reaction, quite often one that completely disregards fundamentals. Based on that, RGLD had a pretty good bounce from 12.70 to 16.89 last week. It may very well continue down to single digits based on valuation, but in the mean time I don’t want to miss out on the 4 pts potential in this stingy market.
To find that potential, I believe that we have to expand our thinking. We can’t afford to be tunnel-visioned. If we can find a balance between technicals, fundamentals and psychology, covering all the bases, we are going to have a much better chance of maneuvering this challenging market. Because we can wait all we want, but sometimes the fish just don’t see it our way.