Gold and Silver in a Consolidation Phase

I talked about gold and silver previously being on the way up when the spread between inflation and nominal interest rates rise. Today, inflation is benign, and nominal rates either holding steady in the west because they are already at rock bottom, or rates are falling in Asia and Australia. The lower the real interest rates, the more likely gold and silver will rise.

From technical analysis, we can see that since Oct 2011, gold has been on a corrective mode. It peaked at around USD1900 oz. If you followed the monthly MACD chart, it would have signalled a buy from Oct 2009 at around USD1000 oz and triggered a sell signal in Oct 2011 at around USD1680 oz, a rise of around 68% in 2 years. It is now on a consolidative phase of between USD1560 to USD1800 oz and may remain so for a while.

The silver chart is similar to the gold chart, only more volatile. XAGUSD triggered a buy around July 2009 at USD15 oz, riding all the way to around USD35 oz around Sep 2011. In fact if you compare both charts, Silver seems to lead Gold by one to three months. Could silver be a leading indicator for gold?

Published December 28, 2012

Going for gold, but not at record- breaking pace

Investors already own huge amounts of it via bullion in vaults and ETPs

By

Neil Behrmann

In London

Less glittery: The global jewellery industry is under pressure because of high gold prices, and the market is now very dependent on more investors accepting much higher prices than earlier in the decade. - PHOTO: REUTERS

 

GOLD has been an extraordinary investment since it bottomed around US$250 an ounce in the autumn of 2001. Since then, it has risen 662 per cent to around US$1,880, fallen back to around US$1,525 and is currently US$1,700. As opposed to the bearish views around 9/11, the vast majority of advisers now maintain that investors should have a 5-10 per cent holding in gold. With the exception of Goldman Sachs - which recommended profit-taking recently - predictions for next year range from US$1,750 to US$2,100 an ounce with the consensus at US$1,850. In today's money, the 1980 peak of US$850 would be around US$2,300, so bullish advisers say the metal is at fair value.

The most popular bullish argument is that the US, Europe and now Japan are intent on quantitative easing - that is, boosting money supply. With interest rates close to zero and government bond yields pitiful, US Federal Reserve Board chairman Ben Bernanke has effectively launched a currency war.

"By printing all this money, Bernanke is debasing the dollar, as the rest of the world is not printing money as fast as the US," says John R Taylor, chief investment officer at FX Concepts, a large foreign exchange fund. "As a result, in the long run, foreign currencies will go up in value, and commodities like gold and oil will rise in dollar terms."

 

With these bullish factors in play, gold holders are wondering why the price isn't taking off.

A simple reason is that global investors already own a massive quantity of gold via bullion in vaults and exchange-traded products (ETPs) such as GLD. According to the World Gold Council (a research and promotion organisation that promotes the interests of goldmines), investment in gold has been accelerating at a fast pace.

 

In 2002, total investment was 352 tonnes and exchange-traded gold products had as yet not come on stream. By 2011, total bar, coin and exchange-traded products reached 1,704 tonnes and, in the first three quarters this year, amounted to 1,130 tonnes. This indicates that the market is very long in gold (that is, it already holds a lot), so in some respects asset managers are talking their book.

Meanwhile, jewellery demand - which was 2,662 tonnes in 2002 and accounted for more than 90 per cent of total demand then - declined to 1,972 tonnes in 2011 because of the steep rise in price. In the first nine months of this year, jewellery demand came to 1,353 tonnes - only 42 per cent of total demand.

 

In other words, the jewellery industry is under pressure because of high prices and the market is now very dependent on more investors accepting much higher prices than earlier in the decade.

JPMorgan also has some explanations: "Gold is up 10 per cent year-to-date, but has effectively been in a range since September 2011. This has caused some to question whether the bull run in gold that started in 2000 has come to an end. What has been driving this lacklustre performance? We think an important explanation is the weakness in emerging market growth, equities and currencies against the dollar."

 

JPMorgan estimates that around 75 per cent of physical gold demand comes from emerging markets. The past decade's rally in gold coincided with the rise of emerging market economies and the rapid appreciation of their currencies against the dollar. This meant that the price of gold imports for emerging market importers such as India and Asian nations was cheaper than the international US dollar price.

 

JPMorgan predicts a rally in emerging market currencies which should raise imports, and thus predicts a price of US$1,800 an ounce next year. Moreover, further central bank balance sheet expansion coupled with increased tolerance of higher inflation should support gold, the investment bank maintains.

 

Central banks are also continuing to diversify their reserves into gold, and that should underpin the price. In 2011, they bought 411 tonnes and in the first nine months of this year, 374 tonnes.

Best Cities To Live In My Opinion Part 1: New York City

In the last 5 years of travelling, mostly around the region, to Europe and lately to the US, I'm starting to consider the places my family would live in if one day my love for Singapore dies. Singapore is a vulnerable state. However, this article is not about why Singapore may not survive past two decades, or how the 2 to 3% population growth that we've seen in the last three decades will slow down to 1 to 2% per year after we reach 6 million.

The list considered are mainly cities that we've visited in the last 5 years, so cities like Shanghai, Melbourne, Perth, Sydney, Guangzhou etc I've left out because although I love them, I haven't been there recently enough to make a judgement. Also, the cities I'm considering must primarily be English speaking and their populations must be over a million. Too small a population limits the number of things I can do for leisure and unless I want a drastically slow pace of life (like watching cows roam the fields) I would still want a relatively varied lifestyle, with investment opportunities, entrepreneural ventures, potentially doing work such as lecturing on a part time basis etc.

Of the entire list, New York, London, Singapore, Hong Kong and Beijing ranked in the top tier. Let's run through the list of top tiered cities:

1. New York:

a. Job opportunities in Wall Street used to be plentiful, but not anymore as banking is on a decline there in the near term. Nevertheless, the US is a hot bed of innovation and entrepreneurship. It has a market of over 300 million so most young innovators turn into billionaires, within a few years, like Google, Facebook, Microsoft, Apple.

b. In terms of the arts and entertainment, the number of things you could do in New York is far more than in Singapore. There's the Broadway for musicals, there are scenic walks in Central Park, by FDR Drive or Lincoln Drive. You could visit Brooklyn bridge if you're an artcghitecture lover. The list goes on. The buildings in New York are probably among the most artistic, surpassing Singapore's (which made leaps and bounds in architectural annovations).

c. Food is amazingly good, except for the Chinese food that we've tried (we should bring Crystal Jade franchise to New York). Pizza is one of the best we've tried, and so are burgers and fries. Good food is at a fraction of London's and surprisingly, sometimes cheaper than in Singapore. A meal in Keen's Steakhouse cost around USD 155 for two. In Morten's Singapore, it would cost around SGD 200 so it would be same to slightly more. What raises the cost of food in New York is the tipping culture, which ranges from 15 - 25% of the food bill! But in Singapore, 10% tax is added regardless of the level of service.

d. Climate wise, New York is colder than London or Tokyo during winter. If you like four seasons, NYC is by far the best.

e. Amazing architectures. I'm a big fan of architure and city planning. When cities have wide, straight streets with ample pavement, I can have a clear line of sight of the buildings far along the street. The trees along the streets add variety into the scenary. The skyline of NYC is mixed with buildings from every decade. You can see buildings of various heights, with different styles, built in different periods. The most impressive buildings are along the Highline, http://www.thehighline.org/ which was previously a rail way track suspended above ground, converted into a garden. Central Park is another brilliant stroke of town planning. It rivals Hyde Park of London and is as amazing as Singapore's green belt (Gardens by the Bay). See pictures below on the Highline.

 A residential building along High Line, which is between 14th to 28th Street in the West Side of Manhattan

 View of Hudson River from a section of High Line

 

A magnificant hotel over the High Line, which is called the Standard I believe. 

Buildings along Rector Street, lower Manhattan, near Battery Park

e. Now for the negative parts of New York. The city has been ravaged with increasing frequency by hurricanes, the latest being Hurricane Sandy, where over 120 people died. When we went across to Jersey city, we were told by Starbucks staff along Hudson Street that the water reached 1.6m high! I think the intensity of hurricanes will grow over time and if NYC doesn't build a flood defence system like London, large parts of Lower Manhattan, Brooklyn, Statten Island, Jersey City, Hoboken will be damaged and flooded constantly. Eventually, offices will move up the city. NYC also suffered a mild earth quake of Richter Scale 3 recently. No one knows if the tectonic plates have formed new cracks, but it is a concern.

f. The subway system is archaic and in some parts unsafe. http://online.wsj.com/article/SB10001424127887324669104578206330147606730.html?mod=googlenews_wsj The stations are very old and not maintained very well. There are cracks on the walls and one feels that they have not been painted for years. The MTA staff are not very helpful when tourists ask for directions, to the extent that some are extremely rude if you don't speak with an American accent. but a good thing is they are air conditioned so in the summer commuters don't suffocate in the stifling heat.

g. As with most European countries, taxes in the US are extremely high. If you are working in NYC, be prepared for up to 40% of your income taxed. On top of that, what bugs me the most is that even if I am financially free and decide to live in the US around 3 months in a year, add a few US stocks and houses in my portfolio, I will be taxed heavily on my capital gains and dividends. It reduces my Internal Rate of Return heavily and the only time I would buy houses in the US is after a mega crash like the one seen between 2006 to 2011. High taxes reduce the incentive to work hard. For entrepreneurs, it disincentivizes them to expand their businesses and increase hiring. For investors, it reduces the potential returns via dividends and capital gains, make US a less attractive place to invest and push capital out of the country. This is my only fault I have with Obama's administration. All other policies, such as standing up against the power gun lobby NRA, foreign policies I support.

h. National Rifle Association or the NRA in the US is a very powerful lobby. http://www.bloomberg.com/video/flag-waving-protester-interrupts-nra-presser-EH4STklnSD6qdXtpAdZzBQ.html I never understood why the US allows ordinary people to carry guns. It might be appropriate in the 1800s or 1700s, when society was less orderly and citizens were turned into freedom fighters against British colonialists. But in modern society, the only ones licensed to carry guns should be the police and no one else. All it takes is one mad person like in the New Town incident to vent his frustrations against the innocents. The carnage will be unimaginable. I was stunned when the spokesperson for NRA advocated that armed guards be stationed in every school to prevent future shooting incidents! Can you believe Wayne LaPierre's suggestion? An armed guard may be a deterrent for some gun man, but when faced with a derranged mad man who intends to kills himself at the end of a shooting spree, an armed guard will not save every life. The US needs to stand up against the NRA and ban guns totally so as to make the country a much safer place. I checked that homicide by firearms is 4 times more likely in the US than in the UK, a country that does not allow its citizens to own firearms.

i. Extremely rude New Yorkers. We've come across many gracious Americans, but we have our equal share of extremely rude people. From the immigration people at the US airports to the sales girls at shopping centres, half of them readily give us a tongue lashing or make sarcastic remarks when we ask too many questions or make requests that are reasonable but not usual. Perhaps it's their preoccupation with the freedom of speech, or the right to say what they want or feel. What about the right of others'? With freedom comes responsibility right? Even in the smaller cities in Europe have I not experienced such poor levels of service at such a high frequency.

Conclusion:

NYC is definitely rich in culture, has fabulous architecture (especially along the High Line), and fantastic food. It's climate is also nice if you like four seasons. The negatives are rude people, high taxes, natural disasters and lack of safety in some areas (thanks to NRA). It is definitely a place to return and explore in more detail. The condos are great to live in and I will explain in a later article. Facilities are comparable to Singapore's condos, even better because they have children's playroom, 24-hour concierge. But as investments they are too costly. Happy Holidays, till we meet again!

The Cheapest Real Estate Market in the World: Foreclosure Single-Family Homes in the US

http://musingsonwallstreet.blogspot.com/2012/03/which-is-most-attractive-singapore.html

In March 2012, I wrote an article comparing real estate markets in Malaysia, Singapore, the UK and the US. I concluded that the US was by far the cheapest in the world. If I had to choose, due to proximity, the state of Johor comes second and third London. The worst place to invest was Singapore.

Today, it is widely believed that the US real estate has seen the turning points. I've repeatedly mentioned that investors who can spot major, multi-year turning points tend to achieve super normal returns. Below is an article from Business Times that discusses private equity firms coming to mop up single-family homes in the US.


Published December 20, 2012

US investors rush to buy failed mortgages

Some pay average of 36 cents on US$1 in auction of 9,500 nonperforming loans

       

Mr Hill: Says Blackstone likes nonperforming loans now in terms of the housing sector. Blackstone, the world's largest private-equity firm, has stepped up investing in nonperforming loans as part of a broader strategy to capitalise on the housing-market turnaround. - PHOTO: BLOOMBERG

 

[LOS ANGELES] Hedge funds and private-equity firms are betting on delinquent home loans being sold by the US Federal Housing Administration (FHA) as the government agency accelerates debt sales to avert a bailout and stem foreclosures.

Investors including Lewis Ranieri's Selene Investment Partners and One William Street Capital Management LP paid an average of 36 cents on the dollar in an FHA auction of 9,500 nonperforming loans, the Washington-based agency said this month. Bayview Financial LP, a firm backed by Blackstone Group LP, paid as little as 26 cents.

The FHA, which faces a projected US$16.3 billion shortfall because of failing loans made during the housing crash, is preparing to sell more than 40,000 delinquent mortgages next year to fortify its insurance fund after disclosing it may need a Treasury Department subsidy for the first time in its 78-year history.

The FHA doesn't have the legal authority to use some workout tactics investors employ, such as principal forgiveness. "We're seeing between a 15 and 20 per cent better recovery than we would if those same loans went all the way through to foreclosure, and that's a pretty big change," Carol Galante, acting commissioner of the FHA, said. Private buyers "have more flexibility in how they can resolve this situation to be positive for the borrowers and for them financially".

The FHA, a division of the US Housing and Urban Development Department, had 734,290 seriously delinquent loans in its portfolio at the end of November, a default rate of 9.6 per cent on the agency's 7.62 million loans. That's higher than the 7 per cent serious-delinquency rate - those mortgages more than 90 days late or in foreclosure - for the 50 million US home loans tracked by the Mortgage Bankers Association. "The FHA could easily be the largest seller, if they sell 40,000" mortgages, said Louis Amaya, chief investment officer for National Asset Direct Inc, a nonperforming loan investment firm with offices in San Diego and Stamford, Connecticut.

The FHA's recent auction had 13 loan pools that sold for 24.8 cents to 59.3 cents per dollar of unpaid principal balance. The sales prevented US$1 billion in fiscal 2013 losses for the agency's insurance fund, Ms Galante said.

Blackstone, the world's largest private-equity firm, is acquiring nonperforming loans through Coral Gables, Florida-based Bayview, which has purchased more than US$22 billion in mortgages, said Peter Rose, a spokesman for New York-based Blackstone. Bayview won bids on two of the FHA's portfolios, paying 26 cents on the dollar for a pool of 1,430 Illinois loans with an unpaid balance of US$269.1 million, and 34.9 cents on the dollar for mortgages on 908 properties in 34 US states with an unpaid balance of US$172.9 million.

"We like nonperforming loans now in terms of the housing sector," Tomilson Hill, vice-chairman of Blackstone, said in a Dec 5 interview with Bloomberg Television. Blackstone, which has spent US$1.8 billion this year buying single-family rental homes, stepped up investing in nonperforming loans as part of a broader strategy to capitalise on the housing-market turnaround, according to chairman Stephen Schwarzman.

"We are loading the boat," he said on an Oct 18 earnings conference call. A trust created by Selene Investment Partners, a Uniondale, New York-based firm where Ranieri is a principal, paid 37 cents on the dollar for a portfolio of 1,385 loans with an unpaid balance of US$238 million.


The nonperforming loan market may grow to as much as US$30 billion next year if Fannie Mae and Freddie Mac, the government-sponsored mortgage enterprises, carry out plans to sell delinquent loans, said Mr Amaya of National Asset Direct. (this is a second wave of foreclosure homes to hit the market, which could bring supply imbalance in 2013. I do not therefore think the US real estate will recover in a straight line. It may dip a little in 2013 but not drop lower than 2012 June's low. Also, many major cities like New York has already reached new high and due to a lack of supply will probably not dip in 2013).

The two taxpayer-owned companies are under a mandate from their federal regulator to dispose of nonperforming assets. Fannie Mae, which has nonperforming loans with a total unpaid principal balance of about US$233 billion, is planning to begin qualifying potential bidders for some of those mortgages as early as the first quarter of next year.

Castle Peak Capital Advisors LLC, founded by a group of former GMAC managers, paid 39.5 cents on the dollar for 1,392 loans with an unpaid balance of US$239.4 million in the FHA auction.
Most of the US$1.5 billion in nonperforming loans Castle Peak has acquired since 2008 came from private sources, such as banks, said John Lynch, a managing partner at the Minneapolis- based firm.
"A lot of the pools we buy are kind of stagnating on some balance sheets," he said. "The sooner you can get to the borrower and work with the situation, the less you're going to lose. So what HUD and the FHA are doing with these pools, and if other agencies follow it, I think is a good thing for the overall housing market."

Investors have multiple options for making money on the loans they purchase. For eligible mortgages, they can be reimbursed as much as 63 cents per dollar of principal forgiveness under a US Treasury programme. Should modifications fail, investors can resell the homes or keep them as rentals.

The FHA divided its mortgage sales into two parts: Purchasers of so-called national pools of delinquent loans must agree not to foreclose for at least six months. Buyers of "neighbourhood stabilisation" pools - geographically concentrated in areas hard hit by foreclosures, such as Chicago; Newark, New Jersey; Tampa, Florida; and Phoenix - additionally agree to keep at least half of the properties and rent rather than sell them. The FHA isn't allowed to rent homes back to their former owners after a foreclosure. The FHA was founded during the Great Depression to spur loans to low- and middle-income borrowers. The agency provides liquidity to the housing market by insuring lenders against losses on mortgages with down payments of as little as 3.5 per cent. Lenders are made whole if the borrowers default.

The FHA usually takes ownership of a property after it has gone into foreclosure and the mortgage servicer has received its insurance payout. The loan-sale programme allows servicers to transfer delinquent loans to the agency before foreclosure - though only after they've attempted to work with borrowers to bring mortgage payments current.

The FHA is selling loans in areas where the costs of foreclosing are highest, Ms Galante said. More than 2,300 of the auctioned loans were on properties in Florida, where borrowers were an average of 1,114 days delinquent - the most of any state - by the time of foreclosure, according to Lender Processing Services Inc. The US average was 728 days.

It costs the FHA an average of US$28.78 per day to maintain and market a property acquired after an insurance payout. The agency is now losing about 71 cents on the dollar on its repossessed properties nationwide - and more in areas where most of the loans are being auctioned off, Ms Galante said. Ed Pinto, a senior fellow at the Washington-based American Enterprise Institute who has criticised the FHA's accounting practices, said his calculations show the agency's typical loss on a foreclosure is 63 cents on the dollar - close to the loss from the average winning auction bid. "I'm having a hard time figuring out where they're making up much financial benefit," he said. - Bloomberg

 

Dividend Growers for Equities

Below are excerpts of an article on dividends and equities. The best type of companies are those that consistently grow dividends. The article came from Business Times on 19 Dec 2012.

 

Are dividends the way to go in equities?

Firms that grow their dividends can yield a 'double compounding' effect. By ANDREW HENDRY

 

Winning stock: Nestle has raised its dividend every year for 16 consecutive years with an average annual growth rate of 13%. - PHOTO: AFP

WHILE many investors focus on capital gain as the main source of return from equities, history shows that long- term returns are enhanced a lot by the inclusion of dividends. Just take the outcome of a US$1,000 investment in a portfolio of US equities since the beginning of 1970. The capital alone has increased to US$13,474, but the total return - which includes dividends and the reinvestment of those dividends - has risen to US$51,377. The difference is accounted for by the benefits of compounding - that is to say, the amplifying effect of reinvestment.

However, this compounding effect can be further enhanced if an investor were not to focus just on any dividend-paying stock, but on companies that can grow their dividends, resulting in a "double compounding" effect. For example, had you invested US$1,000 in the US stock market 10 years ago, your stake today would be worth US$1,980, including the reinvestment of dividends. Now if you were fortunate enough to have put this money not in the broad market, but instead into an elite group of companies in the US called the "dividend achievers" - companies which have rewarded shareholders with a rising dividend every year for 25 years or more - your investment, on the same terms as above, would have increased to US$2,750. That is a vastly superior return to simply investing in the index. As a consequence, for this to work to greatest effect, you need to concentrate your money on companies that increase their dividends year in, year out - and stick with them for long periods of time. Consistency and patience are what's required. But what about high-dividend yields, so often targeted by equity income strategies? A high yield is not an automatic signal of value. In fact, it can often be a sign of trouble or limited growth potential. Without growth in the business, a company cannot sustain long-term dividend growth. Consequently, the return profile of a telecom or utility sector - industries which currently yield the most - is typically predictable but unexciting; very much like a bond, in fact. A 6 per cent yield today is likely to be 6 per cent in three or five years' time and the dividend stream will be exposed to the eroding effects of inflation. Investing in companies that can increase their dividends over time is much more compelling because dividends and share price performance go hand in hand. It is better to begin with a lower starting yield compared to the highest yields in the market if you insist upon growth in the dividend stream because rising dividends will lead to higher yields in the future. Yield tomorrow is more interesting than yield today. More importantly, a rising dividend stream will create pressure for the share price to perform. The combination of a higher dividend and a higher share price can be a powerful one for investors.
Take, for example, Nestle - the world's leading food- and-beverage company with household brands such as Kit Kat and Milo. The Swiss company has a long history of profitable growth and it is no coincidence that the dividend track record is equally impressive: Nestle has raised its dividend every year for 16 consecutive years with an average annual growth rate of 13 per cent. Back in 1996 at the beginning of this sequence, the shares were yielding a paltry 2.4 per cent - too low to be considered by many dividend investors. However, the dividend has increased more than six-fold since then. So the yield at the outset, with the benefit of perfect hindsight, was actually more than 15 per cent. Not surprisingly, the strong growth in the dividend stream has led to significant capital appreciation and the share price has quadrupled during that time. Looking at the total return, the investor has been rewarded with a six-fold increase in his investment.

Global remit offers the widest choice

Unfortunately, many Asian companies are all too ready to cut the payout during difficult times as they often base their dividend on a payout ratio, leading to decrease in the payout when profits fall. As a consequence, regional companies with a consistent history of dividend growth are few and far between. DBS and Link Reit are two stand-out examples. So, in order to employ a dividend growth investment strategy in a diversified way, investing globally provides greater choice of consistent dividend growers.

The outstanding region for dividends continues to be the US: over 90 American companies have raised their payouts to shareholders every year for at least 25 years. Some, such as Johnson & Johnson, manufacturer of baby shampoo and mouthwash, have done so for almost 50 years. Other examples include household names such as Coca Cola and Wal-Mart. The prize for the most consistent dividend track record goes to Procter & Gamble, which has raised its payout every year for 58 years.

But it's not just US companies which have the capital discipline to be long-term dividend growers. Australia has an established dividend culture spanning several decades, while laws in Brazil require companies there to distribute at least 25 per cent of annual earnings to shareholders. The focus on dividend growth can also increasingly be found in Europe, with food producer Nestle boasting a 16-year dividend growth history or pharmaceutical company Roche, a European dividend achiever with 25 years of consistent dividend growth.

Income investing and growth investing have often been seen as two distinct strategies, but there is a sweet spot where the investor can benefit from both. Dividend investing should not be just about the yield. The dynamic of a growing dividend leading to good share price performance is extremely powerful, and is an excellent way to create wealth for the investor over the long run.
The writer is MD for Asia at M&G Investments

Olam and Apple Case Studies: Why Sell-Side Reports Are 75% BUYS and Downgrade to SELL Only After Share Prices Tanked

Over the course of the Olam saga, I called several sell-side analysts to ask about their opinions. Almost all of them initially were very supportive of Olam. When I quizzed them over the negative Free Cashflow over the last 5 years, most echoed what Olam's management told the press, "you don't understand the business model". After the announcement of the 8% YTM 5 year USD bond, stapled with at-the-money warrants, some analysts started to issue "SELL" calls or "HOLD". Their reasoning was the dilution of equities destroys shareholder value. Many of the analysts could not cross the bridge between bonds and equities, that the issuer's bonds actually foretells where the equity prices will head to. If bond prices of Olam rose for short term debt, e.g. 2013 maturities, but continue to fall for the longer tenor ones, e.g. 2017 and beyond, it is a signal by the institutional investors that they are more comfortable with the short term solvency of the company but uncomfortable with the longer term prospects. Also, equity analysts fail to understand that when yields of an issuer rise beyond 7 - 8%, they signal heightened bankruptcy risk. If yields start to fall, that's when you should be issuing strong BUY calls immediately and start buying the equities.

It is very difficult for sell-side analysts to issue SELL recommendations on listed companies. No management of listed company likes to have a SELL recommendation slapped upon them for it often means higher cost of issuing capital. It may also mean a margin call on significant shareholders' stake if their shares are pledged. Also, brokerages often need to maintain good relations with listed companies as there may be potential placement shares and M&A businesses.

Below is an article in Seeking Alpha on why analysts downgrade Apple shares only AFTER the share price has fallen. Ring a bell?

Apple (AAPL) share price has tanked 20% over the last 6 weeks. First Call rating consensus shows a peak in optimism to 1.76 over September on a scale of 1.00 to 5.00, where 1.00 is 100% Strong Buy. Despite the 20% correction, the rating has declined to 1.83. The analyst consensus is a lagging indicator of the share price. Analysts get more bearish at lower prices: buy high, sell low. While the Apple share upswing lasted, target prices had good prediction power on a 1 month horizon, but were still poor on a 12 month horizon. Apple had missed estimates in its June quarter and negative articles were popping up. Until December, most analysts kept the mantra of raising target prices. I give some reasons why I believe analysts missed the reversal completely. My specialist sales experience at the Credit Suisse First Boston Technology Group puts me in a privileged position. This observation is a generalization that explains the average error of judgment. This does not exclude the possibility that some brokers actually deliver good homework and hire competent specialists.

Regulation has backfired

The rules on analysts' recommendations tightened after the 2001 crash. The regulation wanted to improve the transparency for all players on the market. Company financial updates and rating changes should be visible simultaneously to all classes of investors alike. Information now travels at the speed of light. Trading programs pick up these mood changes and act in nanoseconds. The Investment bank has no time to inform its fee-paying clients about changes in recommendation. Changing a recommendation has also become more cumbersome as internal committees have to approve the change. A good specialist in sales will feel when the wind is about to change and will have called his client base before the news hits the wire. The impact of the regulation has had an adverse effect. Although recommendation changes are now visible to all parties at the same time, large blocks will have been dumped in the market beforehand. In November, some large Apple blocks hit the market, without any material news or rating changes. Analyst recommendations now lag trend reversals with a larger delay than before.

Analyst price target competition

The level playing field on stock information makes it harder for brokers to differentiate their ideas from others. With a hot stock like Apple, analysts often compete with each other on setting the highest price target. In the internet broking era, the price target is like an advertising banner that determines the bullishness of the research material. Analysts push their valuation methods to ever bolder targets in an attempt to get attention. The valuation case is limited to a P/E only, as it looks good on the Apple past growth record.

Research remuneration limits objectivity (This is a Big Problem)

Historically, the investment bank charges a commission to its institutional clients for the execution of an order. As the commission rates declined from 0.25% to 0.05%, a conflict arose between execution compensation and research compensation. The investment bank needs to make a return on its research efforts and analyst salaries. At the same time, it also has to make a competitive price for the orders. The decline of trading commissions make it hard to charge an additional research cost to clients. New trading platforms have also channeled flows away from the traditional commission generating flow. Investment banks need a minimum of flow in order to generate more flow and make trading profits. Trading spreads have become a larger profit generator than research compensation. Research envelopes are sometimes negotiated with large institutions, but most institutions prefer to build their cheaper buy-side analyst team. As a stand-alone department, the investment bank research division has become a pure cost center. Still, public companies demand a recommendation on their quoted stock by the large investment banks. Investment banks abide as they can make big tickets on the corporate advice activity. Although there should be a strict separation of both banking sides, there is a subsidy from the corporate finance department to keep the research division afloat. This can be done by transferring internal costs. Without any traceable evidence, this will automatically put some pressure on the analyst.

Insiders are really outsiders (Another Big Problem)

Although analysts are top business school graduates, they often lack the technical skill to understand the real drivers behind certain products. Those analysts rely too much on the management and investor relations for technical information on the products and the manufacturing. In fact, they have selective access to information. Every analyst is branded by the management as a potential beneficiary or threat to their wealth. Any personnel contact between the company, its employees and an analyst can create inside information and could be liable to prosecution. The analyst has the power to materially influence the share price. If the same person would leak some information to your neighbor, then that is not considered material to the market. Hence, the analyst is often the last person to pick up certain trends that the investor relations department has strategically omitted or denied. The IR job is a massive conflict of interest as the IR is often remunerated on share price appreciation.

Reality check

Wall Street is not Main Street. Only a couple of years ago, Apple was a nimble company that made great publishing desktops. With the iPhone, Apple changed the mobile space forever. The iPhone thrived in the fast wheeling/dealing biotope of the investment banking world. Long before Joe six-pack bought an iPhone or iPad, they dominated every investment conference or business hotel lobby. However, the universe of analysts and opinion makers on Apple is by no means a reflection of the real world. The steep hockey-stick adoption in the investment community might not get replicated in the rest of the economy. Bakers and butchers have different preferences. On a larger scale, the Apple love-story is automatically transferred to the rest of the world. Apple is a typical U.S. success story of a come-back kid and the enigmatic figure of Steve Jobs. 

Hic et nunc dominates for hedge funds

What we see here and now determines our view of the future and the past. This reminds me of medieval painters that picture Jesus in clothing of the year 1500. There is no worry in the market that Apple's current extreme margins of 35% can normalize back to 20% or lower. The rise of hedge funds in the trading mix, forces the analyst to think on a horizon that is too short. Short-term trends are then extrapolated on a steep curve. The short iteration of 2 success stories, iPhone and iPad, have pushed the bearish analysts into capitulation. Apple profit expectation now demands that they come up with a game-changing product every 1.5 years. Although technically that is still possible, the likelihood is very small.

Being bearish costs jobs

Stock price corrections usually happen faster and take less trading days to realize the same percentage move. This asymmetry means that bullish analysts get it wrong on less trading days. Because the market tends to move higher, it is safer to have a positive bias and jack up target prices as the share price catches up. Investment banks have to publish their percentage of buys, sells and holds. These statistics still skew around 75% to buys. That is only possible if the few sells are on the largest stocks. In the end, it should all add up to a zero sum game as the sum of all stocks should perform equal to the market. I once heard a head of research reply to this criticism that they only rate the good companies. Apple brought so much wealth and optimism to the tech segment that it is hard to put a knife in it.

Quant funds don't reason

Quant funds are usually low volume traders as trading costs eat away the small commission revenue. However, they will act quickly as they measure small changes in the analyst sentiment. They will try to anticipate the rating changes. They must have picked up a significant number of analysts that nudged down their numbers after the summer. Some analysts actually increased their targets as it was considered a timing effect and sales slipped into the next quarter and other excuses. Quant programs, however, don't reason or have any emotional link with Apple. They never heard of Steve Jobs and what his innovations have done for our daily lives. Quant funds just pulled the trigger and pushed the share down. This selling hit a very important other factor in quant program: momentum. With momentum down, more selling emerged. The price correction made some analysts cut their numbers and the quant program ran a new iteration and so on. Throw in a margin hike, a dead cross, and before you know it, Apple becomes a falling knife.

Conclusion: make your own homework

As an analyst, I regret the current dangerous market environment for fundamental long term research. Trends are extrapolated into ridiculous territory as the interests of investment banks, hedge funds, quants and also ETFs are not aligned with the individual investor. However, with good discipline and patience, you can make more profit from these anomalies than before. I wrote a piece on the Nokia mispricing on 17/10 and stand 40% in the money. I believe that independent analysts are the future. With information access now leveled, you can piece together your own data sources and build a good financial model with realistic assumptions. You have to leave a safety margin of at least 30% as the market will exaggerate more than before. Amazon (AMZN) looked expensive at $200, but that might not prevent it from rising to $300 before going to $50. Watch out for the short squeeze, and pick either very large companies that can't be taken out or that have a small short interest. Watch insider sales, as you don't want to bet against the CFO.

My Apple DCF target is still $500. I will become a buyer at $380, and a seller again at $650.