July 7, 2010
Greetings!
THE UGLY, THE BAD…. The S&P 500 has tumbled 15+ percent from this year’s high in April due to concerns that a sovereign-debt crisis in Europe and China’s moves to slow the world’s largest emerging economy will dent global growth. At the end of April we were in great shape, then the euro faltered, resulting in May/June being one of the worst 2-month periods in the past 50 years. I’m concerned; however, this correction doesn’t change any of the fundamentals behind why we’re investing. It may take another 6-9 months for the European crisis to calm down and the markets to normalize. The root of the current European financial crisis lies in the enormous public social welfare system throughout the continent. In most European governments, workers receive enormous benefits such as early retirement and generous pensions, and European nations generally suffer from aging demographics as well as chronic high unemployment.
One issue that put a huge damper on our portfolios within the past two months was AspenBio Pharma – APPY. APPY is developing a blood test to determine the absence of appendicitis in patients. This has the potential to reduce the need for CT scans (high dose of radiation), save valuable dollars and save time. Goldberg Capital Management (GCM) been on the story since 2006, and a few weeks ago, APPY issued a press release that its latest 800- person study was inconclusive. No one following this company’s progress expected this as a possibility. A year ago they did a smaller study and stated that only one hospital site out of many had mixed results. Further, it was stated that all the other hospital test sites had very favorable results. The company believed these results were sufficient to receive FDA approval, but the better strategy was to perform another larger study to alleviate any confusion and expedite FDA approval This blind study was performed at some of the best medical facilities in the country. So, what happened? For now, the company is being tight-lipped, so we are waiting for a statement. But nothing about this makes sense if the company has been forthright with us all along. Could we have been misled for the past four years? Anything is possible, but unfortunately, it’s still a wait and see.
The other body blow occurred with Telecommunication Systems (TSYS). TSYS has had the best four quarters in the company’s history but Mr. Market has cut the stock in half. Many of you have asked why, and the truth is there is no rational explanation. Some large holders believe that Google may eat its lunch on the location base services (LBS) front. Others believe that their latest acquisitions may not work out. And others believe that hedge funds, mutual funds, and ETFs are manipulating the stock. Who knows? But I can tell you this, if we loved it at $7+ last year during really bad times, you got to love it at $-4 with more cash, revenue, etc…
AND THE FUTURE… To paraphrase Warren Buffet and his teacher Benjamin Graham — It is important to remember that the stock market — Mr. Market — is a manic depressive. Right now, the market is depressed and pricing everything irrationally based on fear and panic. In a few months, Mr. Market will likely become exuberant again because things are generally picking up. Everywhere I look, whether it be in Europe or the U.S., things are simply not that bad. And in China, things are actually going well. It is important to focus on the upcoming opportunities and participate in the next wave up for our stocks. How do we position our portfolios for the third quarter and further?
GCM is focused on three themes going forward: natural resources, technology & China. We’ve owned Applied Minerals – AMNL (formerly Atlas Mining) for many years now. AMNL owns a mine in Utah that produces halloysite clay. We’ve never given up on it due to the belief that the clay’s properties are unique and might one day be valuable to a willing buyer. GCM first purchased shares in 2003 (way ahead of the curve) and we believe that they are doing many of the right things today. I don’t think it’s IF anymore but WHEN. Stay tuned.
We also own a titanium mine in Chile – White Mountain Titanium. If the resource proves to be as large as we believe, then once again it’s not a matter of if, but when. There is currently a tremendous demand and backlog for reliable titanium sources. Hopefully, both of these companies will be of financial assistance to us in the next couple of years.
To many investors, China is a wild frontier; its public companies are still learning the ropes of reporting and corporate governance standards. Without visiting some of the smaller companies, seeing their products and facilities and talking with their employees, it’s difficult to even know if they actually exist! One way we protect ourselves from this risk is through diversification, but it’s also about increasing our due diligence.
GCM currently owns several small Chinese companies that trade on our domestic stock exchanges. I have not placed publicly traded Chinese firms in all client accounts as of this date because I am taking a slow and cautious approach. I have yet to visit China, but I’ve personally met with each company’s CEO & CFO on several occasions (often in NYC). I also have a trusted source, Hayden Communications International (HCI), an Investor Relations firm, that represents these small Chinese companies in the United States. HCI has feet on the ground and intelligence in China and know its client stories intimately. I’ve worked successfully with HCI for fifteen years and have access to their constantly updated research. Having intelligent eyes and ears in China makes the investing decision easier for me.
We expect our investments in China to be both volatile and, at times, dramatic. That’s because the Chinese government still has a significant — though transitioning — role in the economy. Over the next 20 years, China is expected to become the world’s largest and most influential economy, and that’s why we want to be invested there. But Chinese companies can also be difficult for U.S. investors to understand. I will eventually get to China, but for the time being (including this week) I will meet with them on U.S. soil. Due to the perceived risks, Chinese companies currently trade at a significant discount to their American counterparts. A trend currently underway is an improvement of the Chinese accounting standards that will eventually be more stringent than U.S. standards. Every time we’ve met management teams, they demonstrate an understanding of the balance sheet, concepts of cost of capital, and return on invested capital. As long as I continue to see examples of companies grasping crucial concepts, I think there is a chance for trust to improve.
China’s economy will be the largest in the world in 20 years. That said, the risks in China are real, so we look for companies with reputable auditors and a broadly diversified basket, with no company representing more than 1% or 2% of your overall portfolio. Why take the risk? If someone offers you a coin flip in which heads means you lose $0.50, and tails means you win $5.00, you will take that bet any day, every day (as long as you don’t risk so much that you can’t stay to play again). China is one of the few places in the world today where that bet exists.
Honest disagreement is often a good sign of progress.
-Gandhi
OUR GOVERNMENT AT WORK… On Jan. 6, 2009, Ukragro Corp. of Zhitomir, Ukraine, made an initial filing with the Securities and Exchange Commission to sell stock to the public. Its sole employee and owner was a 79-year-old massage therapist. The company had no revenue, $100 in assets and planned to open a string of health spas. Public records on file at the SEC show that the agency asked no questions and the application cleared through the commission eight days later.
Over the past two years, eight other start-ups reviewed by the SEC have been similarly headed by people in Ukraine or Russia, with no revenue or operations and minimal assets. Business plans ranged from renting bicycles in Kiev to selling cars in Siberia. All used the same small Seattle law firm, Dean Law Corp., to help with their initial SEC filings. The SEC cleared them to sell stock, in most cases without asking a single question, according to the public records at the agency. The company’s name was changed to Amarok Resources Inc., relocated it to California and refocused its business to prospecting for gold in Nevada and elsewhere. Its stock has gone from pennies a share to as high as $2.75 a share, giving the company a market value of nearly $200 million. It still hasn’t reported revenue and has yet to strike gold but has announced raising $2 million in private stock placements. The stock symbol is AMOK – just like the SEC!
Have an enjoyable summer and try not to worry about the market – that’s MY job!
Len
Goldberg Capital Management is an investment adviser registered with the State of CT Department of Banking. This Newsletter and its contents are for informational and educational purposes only. You alone will need to evaluate the merits and risks associated with the use of the information provided herein. Although this Newsletter may provide information relating to approaches to investing or types of securities and other investments you might wish to buy or sell, no information provided in this Newsletter is intended or should be construed as an investment recommendation or endorsement from Goldberg Capital Management. Please remember that past performance is no guarantee of future results. Please compare the financial statement that I prepared for you to your Charles Schwab statement to make certain that the numbers align properly.