Buffett’s Berkshire Hathaway, Victim Of Its Own Success?

Berkshire Hathaway is the well-known holding company run by its famed CEO Warren Buffett, regarded by many as the most successful investor of all time. Buffett is also famous for holding court with his many aphorisms about money and investing, such as ‘investing is easy but not simple’ or ‘Wall Street is the only place where people ride to in a Rolls Royce to get advice from those who take the subway’.

A philanthropist and a pragmatist, despite his enormous wealth accumulated over the past 50 years, Buffett is also humble enough to admit that he’s been lucky to be born at the right place and the right time in history.

Testament to his lucky star, here stands Berkshire Hathaway, a humongous financial behemoth, whose market capitalization is north of $270 billion, surpassed only by three public companies in the USA such as Exxon-Mobil, Apple and Microsoft.

Buffett and his somewhat under-appreciated partner Charlie Munger have managed to turn a small flailing textile business acquired in 1965 into a large diversified financial conglomerate. Berkshire operates in a wide array of businesses (confectionery, food, retail, railroad, banks, electric and gas utilities, home furnishings, manufacturing, jewellery, publishing…) around his core insurance operations.

Buffett built his empire using the ‘float’ provided by his insurance business (that is paid premiums which are not held in reserves for reported claims and that may be invested) to finance his investments, a practice that he referred to as ‘having one’s cake and eating it too’.

In the early stage of his career Buffett mainly focused on long term investments in listed public companies. Recently, given the size of his company, he has shifted his focus to buying whole companies.

Since 1965, Berkshire Hathaway has never paid out a dividend to shareholders, but has reportedly grown its book value by about 19,7% compounded annually, versus 9,4% for the S&P500 index (calculated accounting for reinvested dividends).

This outstanding performance looks a little less impressive, if we look at the most recent years.  In fact, Buffett himself in the last annual letter to shareholders admitted that unfortunately his holding company has underperformed the S&P 500 Index in 3 of the last 4 years, with a negative absolute return in 2008 and 2011.

Moreover, this could actually mark the first year during which Berkshire has underperformed the broad market over a 5-year stretch, raising doubts from Buffett’s critics on his legendary magic touch at making money.

I would note that Berkshire’s difficulty to beat the market consistently has actually already been noticeable for quite some time. If we calculate a simple moving average of the 10-year relative performance versus the S&P 500 index, it is easy to plot a chart, which clearly shows a declining trend, from about 18% in the 1985 down to about only 2% last year.

This would suggest that Doug Kass’s criticism at investing nowadays in Buffett’s Berkshire could bear some validity.

Doug Kass, head of hedge fund Seabreeze Partners, has been a long time Buffett admirer and always revered his common sense investing approach.

However, about 5 years ago Kass started calling into question a number of issues related to Buffett and his company. Eventually he put his money where his mouth was… by short-selling Berkshire Hathaway stock (that is betting Berkshire’s stock price would fall or would return below market average)!

Since then, Buffett has been questioned on several other issues, starting from the intensity of his work at Berkshire and the role of his succession at the helm of Berkshire Hathaway.

Buffett’s son’s role as non-executive Chairman, to preserve the values that distinguish Berkshire, left many investors at odds with his decision. Likewise, the fact that the role of executive CEO has been selected by Buffett in total agreement with Berkshire’s board but has not yet been revealed to the public.

In the meantime, fund managers Todd Coombs and Ted Weschler are gradually assuming a bigger role in terms of actively managing his portfolio of stock holdings, while Buffett and Munger still maintain their role of key decision makers when it comes to new acquisitions or large capital investments at its subsidiaries.

Some detractors of the Sage of Omaha point out that his unfortunate response to the Sokol’s affair in 2009 was far from optimal. In that instance, reports highlighted that David Sokol, than Berkshire’s CFO and apparent heir to the throne, had front-run a major Berkshire’s investment in Lubrizol, raking up millions on his personal account. Buffett initially said he saw nothing wrong with Sokol’s dealings, only to change his mind later on acknowledging the impropriety of those trades when pressed by criticism from the investment community.

That certainly took some shine off his clean image that Buffett has cultivated over decades, trying to stay away from Wall Street shenanigans.

On the other hand, I believe it would be wrong to criticize Buffett on the grounds of his opportunistic investment in Goldman Sachs during the financial crisis in 2008 or because of its stake in Moody’s (both institutions had questionable roles in the collapse of the financial markets as contributors to the housing bubble were involved in unethical practices).

Warren Buffett pragmatist as he is, always stuck to his golden rule that all investors should keep in mind: do your homework when it comes to money.

Buffett has also always avoided common practices in Wall Street, such as short-selling (another popular criticism often remarked upon during bear markets), or at times following the crowd (still memorable the tech bubble he missed by not investing in technology in the mid 1990s).

As far as short-selling is concerned, I believe that his optimistic view of America and life in general would not be suitable to such an investment strategy and I would promptly dismiss this criticism altogether. Buffett is at his best when he identifies an investment and pursues it aggressively, with the view to hold it over the long term, not speculating in order to make a quick buck.

As per not following the crowd during the tech bubble, he followed his tenet of not investing in any business you do not understand (he partly backtracked by investing in IBM only a few years later). Frankly, I don’t see anything wrong with that either, looking at the outcome he produced.

Despite his (or his successors’) talent at spotting sound investment opportunities, the law of big numbers is probably working against Berkshire, though. Declining returns in the future (especially when compared to Geico, his insurance crown jewel) are a distinct possibility. The recently announced 1st quarter results at Berkshire seem to prove this point.

In spite of a 50% jump in profits, well ahead of market expectations due to a very favourable performance of its insurance operations, Berkshire book value increase still lagged the broad market performance in the same period.

Given all the above arguments, what’s the investment case in Berkshire Hathaway?

I would contend that at this stage it is unlikely that Berkshire will generate significant above average market returns.

Berkshire insurance operations require a lot of capital, as rating agency S&P highlighted with Berkshire’s recent downgrade by one notch. The agency noted that Berkshire’s holdings make the company risky and its practice of maintaining less capital to hedge against losses than its competitors could be an issue, should the economy fare worse or take a hit in the reinsurance business.

Some financial analysts believe that Berkshire Hathaway’s intrinsic value is still higher than its current market capitalization. Regardless, in light of Berkshire’s recent price appreciation and the many issues the company will have to face going forward, I would be more inclined to participate in the market with low cost efficient ETFs rather than owning Berkshire’s high priced stock (one share of class A stock is worth almost 170k dollars).

The Sage of Omaha may well be with us for many more years to come, but the odds he will be able to outsmart the market going forward are probably less than his adoring fans would have us believe. On the other hand, there is great scope in following Berkshire’s management choices in terms of portfolio selection, with new additions or sales. This is an insightful exercise, very helpful to identify interesting investment themes and to provide valuable clues on the US economy from some of the most brilliant investment minds in the world.

Bend It Like... Corning?

The idea of making a type of flexible glass that does not break easily is centuries old and already in the Ancient Roman age the idea of creating such glass was mentioned in several accounts. According to historian Petronius, a glassmaker was granted an audience with Emperor Tiberius to showcase his invention. Unfortunately, the emperor had him beheaded for fear that such an amazing material could undermine the value of gold and silver.

We have no evidence that such material ever existed, of course, but the dream of creating a flexible glass is soon to become part of our life thanks to Corning Inc.

Last June, Corning presented his most recent creation called Willow, a type of glass that is as thin and as flexible as a sheet of paper. It can be drawn to form sheet with high quality surface area and bent enough to be spooled.

The capability to make very thin glass is not unique to Corning or new to the glass industry. What is new is that glass can be made to very thin levels, while preserving all the excellent chemical physical attributes required of the modern substrate.

Willow is made with Corning’s core manufacturing technology called fusion forming. This process involves heating glass in a trough at very high temperatures, in such a way that molten glass evenly pours over the sides and solidifies at the bottom. The difficulty for Corning was finding the rate at which to draw the glass after it fused, in order to achieve high-grade surface quality and getting it onto rollers.

What really sets Corning apart from competitors is that they figured how to make glass sheets in large quantities, so that customers will be enabled to use their own production lines (i.e. TV manufacturers).

This process shows the extent to which technological innovation in the glass industry will rely more and more on a close link between R&D and manufacturing at the OEM level.

Such close cooperation was already evident in the case of Apple, when in 2006 Steve Jobs asked Corning to develop a new type of high performance glass (later named Gorilla glass) that could meet the requirements (durability, thinness, clarity and resistance to scratches) needed for a new generation of mobile devices like the iPhone.

Flexible thin glass roll-to-roll processing meets the growing need toward managing the mass production of high performance displays, such as those used in electronic mobile devices.

High performance displays are employed where there has been a significant change to the backplane technology. The backplane is the part of the device that actually drives the pixels, turning them on and off.

With high-resolution displays consumer electronics manufacturers are trying to create more vivid colours, smaller pixels to achieve superior image resolution by packing more of them and at the same time to have a faster device for more compelling video performance.

To enable high performance displays it is required that a substrate glass has intrinsic thermostabilty to benefit of smaller and faster transistors.

Plastic is not the right answer for the challenges posed by the manufacturing process of such devices as it cannot provide the same clarity or withstand high temperatures.

Mobile devices require the layering of several panels performing functions such as TFT substrate, colour filters cover, 

touch-sensor feature and mobile cover. All these functions could in the future be performed by Willow, bringing the overall thickness of a display down by about a third, with great advantages in terms of weight, flexibility and production cost.

It is widely believed that the adoption of Willow, tentatively scheduled in the next three years, as recently announced by Corning, should accelerate the pace of product innovation in many industries.

In consumer electronics the trend towards thinner, lighter and larger screens is gathering pace as people become accustomed to rapidly evolving personal devices as thin and light as possible. Now customers expect the same in devices such as notebooks and tablets, with the consequence that glass becomes even more important than ever before, while moving up the value chain.

Television could experience a renaissance after the introduction of OLED and 3D viewing, pushing the envelope on features like image clarity and size, while integrating touch-screen functionality.

With this process in place, it is possible to imagine a whole new range of applications, including all those who benefit from touch-screen features (not only in consumer electronics mobile devices, but also digital wallpaper or windows) as designers get accustomed to think about glass not in terms of one limiting factor, but as a vital component of the entire product design.

Flexible glass will go a long way to help creating products such as wearable electronic devices, such as the often talked Apple iWatch, smart eye-glasses, bendable mobile phones and tablets for the mass market or even new interactive game consoles.

Other fields like architecture or the photovoltaic industry, where photosensitive materials needing protection from oxygen and moisture to avoid calcium degradation, will benefit greatly from such type of glass. OLED lighting (organic light emitting diodes) could be printed on flexible glass and used in a curved shape (think about lamp shades that generates lights instead of a bulb). How quickly the transition to roll-to-roll processing will happen could also significantly make a difference in terms of an investment in Corning shares.

Corning is in my opinion not only a remarkable company from the point of view of constant innovation and forward thinking; it is also an interesting investment proposition for investors who wish to diversify their portfolio into equities with a long term perspective.

Few companies in the USA have managed to stand the test of time by staying in business for more than 150 years like Corning Inc. Founded in 1851 by Amory Houghton, Corning established almost from the onset its glass making operations in the small town that carries its name.

Over the course of its last 100 years, Corning has diversified its operations achieving great success in numerous areas, such as consumer products (Pyrex), telecommunications (fibre optics), clinical lab services and diagnostics (Quest and 

Covance were spun off in the 1990s), specialty materials, solar panels and environmental technologies.

Corning survived a disruptive crisis in the aftermath of the tech bubble, when its core high tech fibre optic business collapsed and the share price fell from a peak of $60 down to a little over $1. The company managed to stay in business thanks to a solid balance sheet and to its long-standing commitment to innovation and R&D. In fact, even nowadays the company keeps its expenditure in R&D close to about 10% of total revenues, in good or bad times.

Investors have been shunning Corning for quite some time during the recent market rally, underperforming this year the main indexes at some point by almost 15%.

Nonetheless, a week ago when the company announced its quarterly results above expectations, the market promptly started to re-evaluate Corning’s  prospects. Corning announced not only better profits, but gave clear indications that several business lines are having good traction with customers, with sales of Gorilla glass on a strong growth trajectory.

Management is convinced that the share price has been so undervalued that the board has committed to a $2bn share buyback (roughly 9% of its total market capitalisation).

Corning currently still trades below its book value, sporting a 2,8% quarterly dividend yield which the company just upped to 10c/share. It is my opinion that on the current valuation metrics, Corning is a very compelling investment proposition for those seeking exposure to the next up-cycle in glass, specialty materials and environmental technologies.

Bank of Japan, New Policy Implications - The Reverb

The decision of the Bank of Japan last week to up the ante on asset purchases and to extend the maturity of purchases was a truly remarkable surprise to the financial markets. From many perspectives it could be considered an unprecedented monetary policy decision with deep repercussions to being felt around the world.

Market expectations before last week's announcement were set somewhere at about 2-4 trillion Yen additional asset purchases, as opposed to 7 trillion Yen as indicated by the BoJ Governor Haruhiko Kuroda, not to mention the surprisingly wider array of asset classes and maturities eligible under his new plan.

The goal of this plan, to defeat deflationary pressure in the Japanese economy, is unequivocally positive from a risk-taking investment point of view, at least in the near term. I am inclined to think that this plan is almost certainly a game-changer as far as a decline in the Yen, relative to other currencies, is concerned.

In fact, the scale of monetary easing involved is estimated to reach around 30% of Japan's GDP by the end of 2014 (incidentally, the FED balance sheet expansion is about 15% over a period of 5 years) and the pace of Yen depreciation should pick up steam fairly quickly towards the 100 Yen/$ mark.

Kuroda's program is aimed at turning around Japan's deflationary environment and raising expected inflation to 2%. Nonetheless, past experience tells us that a story of countless and arguably unsuccessful Quantitative Easing policies from the BoJ have done little to eradicate deflation. Hence I would argue that to successfully fight deflation, the Government needs to put forward, as per its intentions, a comprehensive set of supply side reforms aimed at improving its competitiveness, together with stronger long term fiscal control over its public finances.

On these two counts of course, it will be Prime Minister's Shinzo Abe's job to deliver, particularly on highly contentious matters, such as an increase in the sales tax, a greater resolve on to cut unproductive government expenditures and last but not least to push for more competition in an overregulated economy.

In the aftermath of this announcement from the Bank of Japan will this three-pronged approach bring to a Yen avalanche, as has been suggested by prominent investors such Bill Gross and George Soros? The implication would be that in their opinion what the BoJ started might actually slip out of control, considering that the BoJ seems the most aggressive central bank pushing the envelope on the adoption of experimental monetary measures using somewhat imperfect tools.

Although this is a legitimate concern, in my opinion the likelihood of that to happen is probably not very high for at least two main reasons:

1. The BoJ has not given any indication that there will be any purchase of foreign currencies against sale of Yen.
2. The fact that differently from the recent FED Quantitative Easing 3, this plan has no open-ended expiration date.

One might also argue that the most industrialized countries could try to put the brakes on Yen depreciation before the 2% inflation goal has been achieved. Regardless, from an investment perspective history tells us the Y/$ exchange rate has been hovering in a broad range around the 110-115 level for the most part of the decade before 2009.

Therefore I do not see a strong reason to believe that such an exchange level could be reached without much resistance, gradually offsetting what the US monetary policies of the last five years have achieved in terms of dollar appreciation versus the Yen. 

As a corollary to a continuing of a weak yen environment, I would also be inclined to maintain or start an overweight allocation to Japanese equities with particular emphasis on exporting companies.

Bitcoin, New Virtual Currency, Or Digital ‘Tulip’ Bubble?

The Bitcoin frenzy has officially taken off in grand style this month, on the back of the Euro debacle in Cyprus and the stark realization that blind trust in the monetary authorities that regulate fiat currencies (including the Eurozone) can be rather costly to savers.

It is no coincidence that Bitcoin was created in 2008, in the midst of a massive world financial crisis and implemented the following year. In fact, the nature of Bitcoin is quite the opposite of putting your trust in the financial authorities: it is broadly speaking… everyone for himself. In the words of Satoshi Nakamoto, the pseudonym behind the project, Bitcoin is a virtual currency completely decentralized, without any trusted parties.

The Bitcoin project started with a strong ideological push against governments and public authorities, as a peer-to-peer service in the shape of an electronic payment system centred around a virtual currency outside the circuit of traditional central banks.

It is unknown who is behind its creation, maybe one or more IT geeks or hackers, as portrayed in an episodeof the populat American TV series ‘The Good Wife”. What we do know is that Bitcoin has achieved remarkable success, in terms of media coverage and record Google searches, when compared to other virtual currencies invented so far.

What sets Bitcoin apart from other popular virtual currencies, such as Facebook credits, QQ coins in China, or Linden dollars, in the game Second Life, is that it is not controlled by the companies that invented them and most importantly has a value outside its eco-system.

Bitcoin units are set with a fixed upper limit of 21 million units, which can be split in several decimals. There are about 11,8 million available to be purchased on the marketplace, with the rest being ‘mined’.
The ‘mining’ process takes place with the solution of complex algorithms, with a Bitcoin protocol controlling the process.

The protocol works in such a way that the more computing power around the world  is trying to ‘dig’ new bitcoins (imagine an army of computer geeks competing to solve complex equations), the more difficult the solution of those algorithms becomes. The opposite would happen if the number of Bitcoin diggers and their relative firepower were to decrease. Searching for new prime numbers is possibly a fair comparison to this process, in the sense that just like them, now only supercomputers or pool of IT and mathematics experts can manage to solve the problems that lead to the ‘discovery’ of new bitcoins.

Bitcoins are stored in an electronic wallet on your computer and this is when, in my opinion, arises the most important limitation in terms of its widespread usage. Bitcoins owners have already been targeted by hackers and their virtual wallet emptied. There is little or no chance of finding the culprits due to the anonymity, which is the distinctive feature of the whole system.

Truth to be told, some experts believe Bitcoin transfers are still more traceable than actual cash, but that is a rather difficult and complex task. Bitcoin has been used on a few websites for illegal activities such as money laundering, purchase of drugs, weapons and even hacking software, drawing an investigation from the FBI.

As things stand, there is no jurisdiction in the USA having a comprehensive policy on Bitcoin, partly because it is difficult to assess whether Bitcoin is a currency or a commodity. If there is no exchange of Bitcoin into US dollars, this activity should remain unregulated. Its dual nature currency/commodity explains why it has rapidly become a speculative phenomenon.

Venture capitalists and other investors (such as the Winklevoss brothers who have disclosed ownership of 1% of all Bitcoins)  are starting to become involved in Bitcoin and interest from the financial community is definitely growing.

In fact, the wild price gyrations and extreme price volatility have attracted many professional traders.

In my view, this indicates that, at least for the time being, the notion of Bitcoin as a currency is secondary.
Bitcoins can be traded at any time of the day any day of the week on a few exchanges, the most prominent being the Japanese-based Mt.Gox, originally a card collection exchange. Mt.Gox claims it is managing about 80% of all Bitcoin trades taking place around the world.

Last week, Mt.Gox trading systems suffered several hacking attacks and transactions were suspended, due to an inordinate rise in the number of users and volume of shares traded. Nonetheless,the  meteoric rise and fall in value for Bitcoin has happened before, like in 2011 going from $1 to about $30 and then back to low single digits. A year ago, Bitcoin was traded at about $13 and went as high as $260 a week ago, only to fall by some 70% and then to quickly rebound by 50%.

Any financial expert would tell you that these type of price swings are not typical of a currency, but are more indicative of a commodity (like the 16th century tulip-like) speculative bubble. Bitcoin representatives are telling everyone this unstable pricing is a natural consequence of its growth and that things will tend to adjust over the long run.

I believe that the concept of an independent electronic payment system is a valid proposition, so long as a sufficient number of merchants adopt it, under the assumption that it a cheaper and more efficient system to trade around the world. In the meantime, there are many questions that remain unanswered.

First of all, the security issues need to be addressed. The electronic wallet on your computer is not an efficient and sensible way to store value, at least no better than stashing cash under the mattress.

Secondly, I am quite confident that the authorities will get eventually a grip and attack this virtual currency ecosystem (the ECB itself has already made an official statement indicating that Bitcoin represents a challenge with negative effects on their authority in the markets). I think this is likely to happen, either because it threatens the official currency system or because of its use for illecit activities.

This intervention from the authorities could damage the users’ trust in Bitcoin and their confidence that it could also be a store of value. New forms of electronic payments are likely to appear in the future, but at this stage, I would not necessarily bet on Bitcoin becoming the new Amazon… and if you really like gambling, old fashioned betting is probably more fun than trading a virtual currency!

Real-i-ty Check - USA & UK Investment Outlook for Online Real Estate Stocks

Online real estate websites such Zillow, Trulia and Move in the USA, just like Rightmove PLC in the UK, have been on a tear for almost the entire first quarter of 2013. To say that share price appreciation for these stocks has been remarkable would be an understatement, as these stocks have respectively climbed by an average 65% year-to-date.  Best performer Zillow rose by 97%, well ahead of its US counterparts Trulia (92%) and Move Inc. (39%) but also Rightmove PLC (35%).

UK investors would be wrong to feel disappointed with Rightmove’s performance vis-a’-vis its US counterparts, because, to be fair, Rightmove PLC has actually risen in the previous years, well ahead of all US real estate websites, with an extraordinary tenfold increase from the low of 2009!

Despite the wide range of share price performance within this small group, it is worth noting that this specific segment of the real estate sector has outperformed the broader indexes by a mile.

In fact, year-to-date, the main US equities indexes are up by about 13,5%-16% and the UK is similarly up by 14%. Furthermore, online websites outperformed US REITs and Homebuilders indexes, respectively up by about 10% and 15%.

What are the drivers for this truly astonishing performance from online real estate service providers and what should investors expect going forward?

Before delving into this question, it is worth remembering that the broad equity markets are currently enjoying a very favourable environment, on the back of unprecedented expansive monetary policies in developed economies across the globe. 

Ultra-low interest rates and Quantitative Easing policies provide an extraordinary fuel for real estate investments and the general outlook for housing markets in the USA and the UK seems quite favourable over the next few years.

In the USA, the housing market peaked around April 2007 and troughed in October 2011, after recording an estimated 30% drop (excluding foreclosed homes, the fall is less steep at about -23%) and since then, the market has entered a mild recovery of roughly 7%, albeit with wide differences on a regional basis.

Nonetheless, several issues seem to be hampering a recovery and keeping the housing market from firing on all cylinders.

First and foremost, credit availability remains tough. The majority of transactions taking place involve high quality borrowers or are all cash deals.

Secondly, the regulatory environment is still awaiting final clarifications on several aspects impacting the lending industry and mortgage issuance. Some industry experts also point out that a reform of Government sponsored agencies Fannie Mae and Freddie Mac should be taken into consideration.

With regards to affordability, low interest rates provide a boon for prospective buyers, as mortgage payment/total income ratio remains well below historical averages. Some real estate analysts estimate that it would probably take a 7% mortgage rate to bring average payments back to the long term of 20%, from the current level of 12% (assuming no appreciation of house prices).

Clearly, with mortgage rates below 4%, we are probably still far away from worrying about affordability for most areas of the country, which in return should also bring back a 60-65% home ownership level in the USA.

Meanwhile, several other negative factors such as housing inventory constraints, difficult financing and a relatively high level of negative equity nationwide (about 27% of all mortgage are underwater) seem to indicate that in the next couple of years house prices could be more volatile than in the past, showing great price swings between different geographies and within local areas.

On the other hand in the UK, housing transactions are still at about 50% below the 2007 peak. The downward house price adjustment has led to increasing affordability, despite the sluggish economic recovery. Similar to the USA, market conditions remain supportive for the broad housing markets. Despite the still sluggish domestic economy, low interest rates and the recently announced government Help to Buy initiative should underpin a more robust housing market recovery going forward.

Industry sources seem to indicate tentative signs of recovery and recent RICS surveys seem to suggest that several data points bode well for a more positive outlook for the broader housing market.

Leaving aside for a moment the positive outlook for housing in USA and UK over the medium term, how can we explain such a stellar performance for real estate website stocks?

I am inclined to believe that fundamental drivers such as revenues and website traffic growth have been the catalysts during the first quarter upswing. But these two factors alone would not be enough to justify this upswing. In fact, I also believe that a sanguine investors’ sentiment, high betas and relatively small market capitalizations for these stocks have played their part in the rally.

These internet stocks are still perceived to be high growth names deserving lofty valuation multiples, given that these companies are committed to increasing traffic, improving their brand recognition and adding services, both for desktop and mobile solutions.

Notwithstanding the generally bright outlook for housing and top-line growth for these companies, Zillow’s quarterly results last week have poured cold water on investors’ unbridled enthusiasm. A sense of urgency for a reality check to those who own stocks in this sector or wish to build a position now seems due.

The disappointment in terms of earnings has been shocking to those who were oblivious of valuation metrics and Zillow got hammered 10% in a day on the back of slowing revenue growth and increased advertising expenditures that have had a negative impact on the P&L.

Revenue growth alone is not enough for US website stocks to justify paltry earnings and high double-digit EV (Enterprise Value)/Ebitda (Earning before interest tax depreciation and amortization costs) ratios. Move Inc. is cheaper than market leaders Zillow and Trulia, but its tiny market capitalization (about $430 million) and smaller online market share in my opinion make it a less compelling investment proposition.

On the other hand, Rightmove PLC share price, despite its huge run up to 1900p, seems to have a bit more room to go higher.

Rightmove’s management has been able to expand its Ebitda in the past 5 years at a 25% CAGR. If we look at the relatively basic features in terms of services offered, when compared to its more sophisticated US counterparties, I would be inclined to believe that a broader range of services could support its revenue trajectory in the years to come.

Rightmove PLC is enjoying enviable market dominance, boasting nearly 80% market share of UK property websites (as measured by pages viewed) and often ranks in the top 10 most visited websites in the country.

On the margin, I would also not rule out the possibility that this company could be a take-over candidate for a major real estate company or a global Internet service provider, given the synergies an acquisition could generate.

Although Rightmove PLC is remarkably cheaper than Zillow or Trulia, based on EV/Ebitda estimates at about 10x for 2015, I would still point out that this stock is not recommend for faint-hearted.

Online real estate websites provide a very valuable tool to retail customers and brokers alike, providing powerful databases to all users and making typically fragmented markets more efficient in the context of volatile house prices.

I have few doubts that Zillow and other companies in this industry are likely to benefit from several growth drivers going forward, such as increased web traffic advertising and more value-added services (consulting, relocation services, mortgages, renovation etc…), but their current valuation multiples are demanding.

Typically online real estate stocks also correlate with house-hunting seasonality, when more traffic is generally observed in the first half. As a consequence, near term these stocks may have already peaked.

Housing may provide great opportunities in the medium term, but at this point unless you have a strong risk-taking predisposition, I would stick to the bricks and mortar, rather than punting high growth Internet real estate stocks.

Gold Price Tumbles From Multi-Year High. End Of The Line For The Secular Bull Market?

Over the last few centuries, gold has earned its status as the King of precious metals.  Although its relevance as a currency has disappeared in our modern age, its reputation as a store of value and as a hedge against the risk of loss in purchasing power is hard to shake.

This is despite the fact that gold has little intrinsic value and differently from financial or real estate assets, does not generate any income, interest or dividends.  Ask anyone if they would rather own $100,000 in cash over the next 30 years or the equivalent value in small ingots (provided they could be safely stored), I am confident that gold would win hands down.

Rightly so, I might add... but probably only if you held it for a very long time. In the last 100 years, gold has come a long way from a government-imposed value of $20,67 per ounce, to reach an all time high of $1,920 in September 2011.  By comparison, yearly inflation in the USA has averaged at about 3,4% over the last century.  Based on that, the buying power of an ounce of gold in 1913 would be equivalent to $486 in today’s money, making an investment in gold back then really look bright and shiny!

Between 1913 and 2013, there have been times when the gold price was set at predetermined levels.  In the USA, it has been free to fluctuate, only since 1971 when the Bretton Woods system (that is the convertibility of gold against the US dollar) was unilaterally called off.

Since 1913, the gold price increase has often more than surpassed the official rate of inflation, but there have also been decades when its price has been falling both in nominal value and relative value.  Gold bulls would note that the ratio between the gold price and the CPI (Consumer Price Index) generally averaged between 2 and 3 times.

Remarkably, in 1980 when we witnessed the stratospheric rise over $850 per ounce (in today’s adjusted price, that would be equivalent to over $2,500, versus the all time high of $1,920 in 2011), the gold/CPI ratio was very close to the same level of 8 that we saw recently, after having risen 6 fold for over 12 years.

Hence, it is no surprise that the gold price’s sudden fall by about 15% in the last week has drawn enormous attention from investors and the media alike, in an almost tumultuous effort to understand what is going on and why this is happening now.

Conventional wisdom in equity markets dictates that when an asset falls by over 20%, it enters bear-market territory.  With gold over the last 12 years, we have hardly ever really heard any talk of a bear market, although an accurate analysis of its price over the same period shows there have already been 7 corrections in several calendar years, one of which actually went as far as almost 30%.  

That did not stop the gold price from soaring, primarily on the back of the perceived protection it offers against the expansionary monetary policies undertaken by monetary authorities around the world and the growing notion of gold as an alternative asset class, uncorrelated to other markets.

Gold ownership is nowadays more broad-based, if compared to the previous gold ‘bubble’ of 1980.  This is because institutional investors and individuals have been able to pile up on gold, partly thanks to the adoption of new financial instruments such as ETFs or ETNs investing in physical gold.  These instruments made gold ownership far more accessible and cheaper than trading physical gold or futures, the domain of institutional investors. Gold as an asset class is believed to comprise no more than 3% of investors’ total assets worldwide, which could be seen as a possible supporting factor in the long run.  

Regardless, in the near term investors’ sentiment and central banks behaviour are the primary forces behind gold price formation.

This is important, because in order to understand how gold price moves, we need to differentiate it from other commodities used for industrial purposes or consumption, such as copper or grains. Gold for industrial usage has a limited scope in the context of its marketplace, as probably only about 400-500 tons out of roughly 2,500 officially mined yearly worldwide are being consumed for commercial purposes.

If we compare this amount to an estimated 152,000 tons held by central banks, we can safely say that the large mining conglomerates will only be marginally able to affect the gold price by winding down new or existing mining developments.

Even if top producers can be somewhat profitable with a gold price of $1,000/1,100 per ounce, it is my opinion that the financial community and emerging markets’ central banks willingness to increase their reserves with a long term strategic goal will likely determine the price of gold in the future.

Given these premises, it should not be surprising that the rumoured large institutional sell order (a hedge fund?) that hit the markets on Friday April 10th triggering the start of this sharp downfall could have been in the range of 500 tons, wreaking havoc on a marketplace that offers no circuit breakers in case of panic selling.

Alternative theories behind last week’s rapid decline seem to indicate other factors at play.  Among them, timely reports from influential investment banks, such as Goldman Sachs and Citigroup, are calling the end of the secular bull market for gold.  

It has also been mentioned the likelihood of Cyprus selling its reserves (speculating that other Eurozone large gold-holding countries could follow suit) in order to raise liquidity for their bailouts.  Finally, even a farfetched story, such as a plot by the US authorities to weaken the gold price in order to support the value of the US dollar (generally tends to rise during periods of weaker gold prices) has received wide audience.

Maybe the concatenation of all the abovementioned events formed the perfect storm for gold. But in all likelihood, the real determinant factor was that after long years of almost unabated rising, the market has come to realise that inflation is not yet materializing significantly in the world economy and actually there are signs of deflation manifesting in several countries.

Given the historical evidence of the gold price/CPI ratio, it is my view that the market has come to realise, especially since the start of 2013 (during which time gold underperformed massively, versus other asset classes) that gold had gone a long way in terms of more than discounting the prospects of inflation created by expansionary monetary policies.

Maybe the return of inflation is only a couple of years away and gold will come roaring back again, but in the meantime, short of a likely near-term bounce, I would suggest caution at jumping on the ‘gold bugs’ bandwagon. Gold has time and time again shown that it can undershoot any attempt to determine its fair or intrinsic value and it remains a great asset to hold during times of great fear.

On the other hand, given the still lofty levels that gold is trading at, I have doubts that gold can be an effective hedge against inflation... Unless you are prepared to keep it and leave it to your grandchildren!