Why I Don’t Use Guidelines When Investing

As your potential Fund Manager, it is my job to provide you with the best investment decisions that are the most responsible. With that being said, the way I operate at Rockvue Capital is very different than most funds in the sense that I do not cater my investment style to a specific sort of clientele. The way I invest is the way I invest, and if a potential partner understands and agrees with the method and philosophy in which I use on financial markets, that makes a great partnership. I deem this as a much more comfortable way of interacting between Fund Manager, partner, and potential partner. In this way, I will not pressure or corner anyone into joining the Fund. In order to achieve the best results, the Fund and its partners must share the same goals and same mindset. Throughout these weeks, you’ve gotten a glimpse into my investment philosophy with my three part series on the matter, and I would like to take the time now to discuss a much broader, almost personal level to my investment technique and philosophy: Guidelines in Investing.

I don’t like guidelines when it comes to investing. Give me a coloring book and I will more than likely start coloring outside the lines. This is a personality trait that has always been with me, and one that will never leave. I am not one that likes to be told that I have to do something. In elementary school, I never read the books that were assigned, instead I read the books that I chose and wanted to read. In my English classes in high school I would read printed out 10 – K reports from various companies instead of MacBeth or Romeo and Juliet.

There is a tangible struggle between me and authority, which is a predominant reason why I love the idea of having my own fund in which I can make the decisions I think are best. Note, I am not saying that my decisions are the best decisions to be made, rather in having my own Fund I am able to be more confident and free to make the decisions  I think are the right ones. Please understand this difference as it will free you from notions of thinking of me as hubris.

When I found the game of financial speculation at age 13, those same traits and qualities about me translated into this discipline that I love. Although I read everything I could get my hands on on topics such as Warren Buffett, dividend investing, and value investing, a part of me realized that I would never be one to don a cookie cutter ‘style’ about them. I knew I would be a hybrid investor of sorts: One that would take nuggets of information from various investing strategies and trading ideas and boil them down into a personal ethos of investing philosophy. Nine years later, that is exactly what I have done. An investor is always evolving, always learning, and always seeking to become better than they were the day before. Because of this, I never chose to place rules on how I would invest, or how I would trade. My philosophy and mechanisms of investment are built on the years of tinkering and not accepting standard guidelines. But what does this look like ?

For example, I use classical charting principles (think Peter L. Brandt or Edward McGee) mixed in with my deep value Benjamin Graham style of fundamental analysis. Purists of the value investing cult would herald me as a lunatic for using such voodoo work as technical analysis. Likewise, pure chartists would call me crazy for “wasting time” worrying about fundamental data when, according to that crowd, “price is the only thing that matters.” To some, this could be a red flag when it comes to deciding to invest with me. There will be some that think I am dabbling too much into too many fields, and there are certainly people whom might think, “he should stick to one thing and be really good at that.” I hear all of those concerns, but at the end of the day, I have found what works for me. There are many ways to make money in financial markets and there are many ways to lose money in financial markets. By not following guidelines, forging my own path of reason and judgement, I have found a way that a) provides me with the best risk management system, and b) capitalizes on market imperfections and mispricings.

This brings me to the psychology side of my investment decision making process. I have well documented the psychological benefits of my particular way of trading the financial markets, so I will not regurgitate it here. However, I want to stress that it is paramount that a potential partner, whomever they be, have the same psychological logic about the markets as I do. You might be asking yourself, “Why is that? Aren’t I giving you my money so that I don’t have to think about things psychologically about the markets?” To a certain extent yes. But to a much larger extent, it’s more complicated. I will use two theoretical examples to illustrate the importance of psychological symmetry between Manager and Partner.

This first example will deal with an individual security selection that goes wrong. In this example we will also assume the Fund Manager sends out alerts to Partners after each trade made. We will assume I pick a stock in the US market and after going long the stock immediately begins to head towards the stop loss price. Let’s say John Doe receives the alert from me that I have added a long position in the Voyager Fund at $5.00 entry with a stop loss at $2.00. Throughout the week, John is watching my pick go from $5.00 to $4.00 to $3.50. At $3.50 he’s had enough and decides to call me to voice his displeasure seeing the NAV of the Fund and his money decline. After telling John I understand why he is upset, I refer him to the many resources available to read about my investment style, and remind him that my style is set up to lose no more than 1% of capital on each trade. So at worst case, the NAV of the portfolio would decline 1% if the stop loss gets hit. If John still doesn’t understand after explanation, it will only create further strife down the road with each incorrect trade (and remember, I will have more losers than winners).

The second example deals with the amount of cash being held by the Fund Manager at any given point in time. Let’s say the market is reaching all time highs each and every day (sound familiar right?), and the Fund Manager has advised his clients that he is happy with how the portfolio has performed, pleased with the return percentage, and decides to hold a bit more in cash for the foreseeable future, citing lack of pristine investment bargains to be bought. After receiving this email about the plan to hold more cash, one partner, Jane, gets frustrated at the Manager, thinking to herself, “I gave him my money so that he could invest it, not to sit on it and basically bury it in a coffee can.” Jane is right to voice her displeasure only if her Fund Manager wasn’t forward with his views on cash percentages. Jane calls the Manager and proceeds to express her frustrations with him. The Fund Manager lets Jane know he understands, but also lets Jane know that part of his philosophy in the markets is to hold cash when the opportunity cost of a perceived investment is less than the opportunity cost of holding onto cash. If Jane does not understand the logic or if she doesn’t agree with that, Jane might not be the best Partner in the Fund.

The point is to let you, a potential partner, know that I place a tremendous amount of importance on compatibility of ideas and understandings on the markets. I am not one for guidelines, specifics, and certain tinkered portfolio percentages based on what every other institutional investor is doing. If you want to get average results, do what everyone else does. That’s not what I’m about. I believe I can perform better than the averages, so average and ordinary is not what you will get if you invest in Rockvue Capital. It is paramount that you are comfortable with this. As always, I am free to discuss the various aspects of this article, and if you have any personal concerns or questions. I want the Fund to perform to its capabilities. The only way that can happen is to have partners that understand what Rockvue Capital is all about. The Fund is only as good as its Partners, and I truly believe that. I will always strive to be better and to perform better, because like yourself, I am one that loves coloring outside the lines and finding ways to make the standard extraordinary.

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A Word on Bitcoin & Cryptocurrency

A couple of potential investors into the Fund expressed interest to me in Bitcoin, its mechanism as an investment, and my general thoughts on the cryptocurrency space. While I answered those individuals on a one-on-one basis, I wanted to take the time to write out my thoughts on the matter in order to give you insight into the thought processes I have when it comes to this complicated space of Bitcoin and cryptocurrency. I will do my best to separate my thoughts into two categories: Practical​ ​Application​ ​&​ ​Investment​ ​Speculation.​ By keeping these two domains separate, you will gain a more complete understanding on what I think of the topic. Let’s start by diving into Practical​ ​Application.

Practical​ ​Application

I will do my best not to make this part of the piece a political one, but in order to gain a more complete understanding of my thoughts, a small garnish of political theory must be applied. You see, when it comes to a practical application, I am hugely in favor of the power of Bitcoin and cryptocurrency. As a personal belief, I am always intrigued when society can figure out a way to manage and work with one another without the need of government intervention. Do not mistake that last sentence as a small cry for anarchism, but rather my belief that a smaller government, with less frequent interventions in private markets and transactions, eventually leads to exponential breakthroughs in all aspects of industry and technology.

With that being said, I am not naive to the fact that the US Government will absolutely try its hardest to find a way and shackle on regulations in the cryptocurrency space. Although some (albeit small numbers) regulations are good for business and anti-trust beliefs, the government (‘the government’ = US government) tends to be extremely liberal with such regulation applications. The reason behind this is simple: government revenue. The more the government can regulate, the more power it has to enforce various taxes and stipulations regarding production, consumption, and investment. As of right now though, the government hasn’t found a reliable way to regulate this seemingly ‘un-regulatable’ endeavor.

The practical draw of cryptocurrency is the elimination of a middle man or third party when it comes to private transactions. This has huge implications both domestically and globally. If you are familiar with the Silk Road scandal, then you already know the tremendous implications this no-middle-man structure has on private transactions and business. For those not familiar with the Silk Road endeavors, a brief synopsis will do (if you are interested in learning more about it, a quick Google Search will provide you ample resources): The Silk Road was an online marketplace (think of eBay, but for the dark webs) where individuals could buy and sell anything. When I say anything, I mean it. From drugs to prostitutes, to bootlegged DVDs, even hitmen.

The main source of payment for such transactions? Bitcoin. This is an obvious choice for a service like Silk Road because each transaction in Bitcoin in encrypted, which means it cannot be tracked like cash, credit, or debit cards. The only people that see the transaction taking place are the two engaging in the deal, but even then, the two parties do not know the names, usernames, or anything about the opposing party. That’s the practical use. Now obviously I am not saying that I love the application because of what took place on Silk Road, but my views on personal private property and the right to privacy do influence my positive skewed opinion of such matters. This isn’t without its downsides, but I believe the upside to such currency ideas are revolutionary and no doubt tremendously powerful. I will put it this way: The government would not be trying as hard as they are to regulate the cryptocurrency space if they did not see the inherent power it had, and the incredible ability to rid the importance of needless middle-men.

To conclude, practically, I love the idea of cryptocurrency. I like the idea of putting transaction power back into the hands of the individuals, and keeping it out of unnecessary hands (a la the government).

Investment​ ​Speculation

This is where things get interesting for me as your Fund manager. On the topic of investment speculation in cryptocurrency, Bitcoin specifically, I am of the opinion that my opinion is split. That is something I am not scared or worried about, because I am always happy to admit when I do not have a forthright opinion on any matter. When that occurs, I do the following: I research, read, digest, and interpret various opinions from various sources of news and influence. On the one hand, I have my personal opinion on the practical application of cryptocurrency, which one would assume would influence my opinion on investment speculation. This is not the truth, and it will never be the truth for your Fund manager.

My opinion on the practical use of Snapchat versus the investment speculation idea of Snapchat should lead you to that same conclusion. I want to be consistent in my thinking, which is one of the main purposes of these newsletters. One part of my investigation into Bitcoin as an investment lead me to a brief period in time known as the Tulip Mania (or Tulip Fever) in 1637. Unfortunately for some readers, your Fund manager is a history nerd (amongst other nerdy aspects), so digging into this research proved quite fun. For those not familiar with Tulip Mania of 1637, let us take a brief dive into it.

It started in the late 1590s when the tulip was introduced from Turkey to Holland. This tulipomania introduction of a new commodity made it a highly demanded object, but price wasn’t outrageous. Note that the tulip bulbs were considered rare, and they were, being a foreign entity they were not locally grown or produced, and quantity was limited. Shortly after being introduced to Holland, the tulips contracted a strange mutation in their genetic code which led to the pedals of the flowers displaying different colors all across the color spectrum. This only further spurred the rise in demand for tulips. The tulips were already starting to trade at a premium to its underlying value, but this further propelled the demand, causing the first strikes of speculation on the tulip market.

The biggest consequence from this speculation due to genetic mutations was that people began to believe that there was no downside to the tulip market. They believed that people would always want these tulips. They extrapolated their demand in the current situation indefinitely. Now in full bloom (pun intended), the Tulip bubble took the entire nation of Holland by storm. Garden shop owners captured most of the supply, which in turn further drove demand and perceived scarcity higher and higher. The bubble came to a head when people began buying tulips through the credit of their homes, their land, their cattle, anything they thought had value they exchanged for a chance to speculate in the tulip market. You can begin to see where I am going with this.

Like every single bubble throughout history you had people saying, “the market for (insert good) can only go up”, “this time it’s different”, “this time the valuations make sense given the perceived value”. All of these sayings have happened since 1637. When prices soared into supernova territory, buyers at optimal prices did what any diligent speculator would do, he sold his lot and secured his profits in the market. Of course this is a domino effect. When the first wave of sellers locked in their prices, it increased the supply of the tulips, which in turn decreased the price of the tulips. Others in the market saw this decline, panicked, and sold their lots, still for profits. However, as the selling continued, those who bought in late on the fumes of the bubble run began to panic, but, as many speculators tend to do, said to themselves, “I bought because this thing is going straight up, this market cannot go down.” So they held. Yet as they held they saw the price of tulips collapse as supply increased and the perceived value of these flowers became rational.

This eventually led to a complete collapse in the price of tulips as the chart to the right depicts. What can be garnered from this market speculation that took place nearly 400 years ago? For one, many of the assumptions made about the Bitcoin market are echoed in the sentiment of those speculators in the tulip markets from 1637. I have personally heard people tell me, “Brandon, the price of Bitcoin is only going to go up.” The explanation behind such accusations are simple: There is only a fixed amount. So in theory these people should be correct and Bitcoin should be a no-brainer investment? That is not entirely the case.

Take the gold market. There is only a fixed supply of gold in the world, in other words, there is only so much gold that can be mined from the Earth. Using the logic of many Bitcoin speculators, shouldn’t the price of gold be in the millions of dollars by now? Since gold has long been a tradable commodity, one would assume, using the logic set forth earlier, that the price per ounce of gold would be astronomical at this point due to scarcity of the commodity. This is where the logic falls apart for the Bitcoin speculator as well. You see, scarcity only means something if perceived value is realized into actual value. The reason gold isn’t sitting at $1MM per ounce is because there a large enough group of people that believe gold has no actual value besides a perceived safe haven for inflationary periods.

If prices were purely dictated by supply constraints, all commodities would eventually hit astronomical numbers. We know that there will only be 27 million Bitcoins made, and after that, no more will be created for circulation. On this knowledge I have been told that the price of bitcoin will hit $40 million dollars on a conservative estimate. This is naive to me. There are too many unknowns. What if they decide to change the amount of bitcoins created? We don’t know. What if governments can’t find a way to adopt Bitcoin as a nationwide currency that is accepted as frequently as US Dollars or paper currency? What if people just stop buying Bitcoins? The problem I am getting as is this: Currently the value of bitcoin is dictated on the basis that others think its going to be extremely valuable.

There is no backing behind its valuation or its current price, nothing. Now, this could eventually turn into a self-fulfilling prophecy, much like I discuss when it comes to Classical Charting patterns, where if everyone believes the price will go to $40 million, well by damn it certainly might. But all it takes is enough people to start selling, enough people to start realizing their profits. The Bitcoin bubble reminds me too much of the Tulip bubble, and as your Fund manager, I wish not to be named as a speculator that bought in at the height of a bubble.

bubble-phasesI know full well that I could be wrong, and I always accept that notion. I want to direct your attention to the chart on the left. This chart depicts the stages of a bubble. As you can see, the smart money entered on the stealth phase. This is where I as your Fund Manager prefers to enter any position for the Fund. The second phase of buying happens by the institutional investors, who see the smart money moves and are looking to piggyback on them. They also invest here because they want their clients to see that they are doing “what the smart money” is doing. Thirdly, the public gets wind of these investments, and once that happens, it sends prices to the moon.

This​ ​is​ ​the​ ​phase​ ​we​ ​are​ ​in​ ​now​ ​in​ ​Bitcoin.​ ​I will not enter when the public enters. This phase is where I as your Fund Manager would be looking to sell once stop losses are hit. As you can see, the main drivers for price advancement in the public phase of a bubble are enthusiasm, media engagement, greed, and most importantly delusion. The next part of the phase is the Blow – off Phase, which is culminated in the feeling of “This time its different!”, Denial, fear, and capitulation. The bubble takes a brief dip into Despair territory before returning to the mean. Above is a daily chart stretched out from close to the beginning of Bitcoin publicity as a tradable currency. You can use this chart to perfectly superimpose the Bubble Mania explanations. You can see the smart money buyers at those prices, you can see the institutional investors gain wind of it propelling it further, and finally you can see the public hitch on to the idea, sending the price to upwards of $5,500.

I am not against investing in Bitcoin.

I am against entering at levels I deem inappropriate and a substantial risk to your capital as a partner. If you choose to personally speculate in the Bitcoin market, do so cautiously. I sent out a video earlier in the week to a friend in which I told him that once price broke the symmetrical triangle it was forming, that it would be a good time to enter, but be cautious. Since that recommendation, price advanced nearly $1,000. Although classical charting principles remain the same, we are at a point where I am late to the party of investment. As your Fund manager, I do not see an applicable reason to invest in Bitcoin at these prices, and at these technical set-ups. If you have any further questions or concerns, feel free to email me, text, or call. Most of you receiving this newsletter do not read the entire thing, which is okay, but I hope you read enough to gain an understanding of how I think, which in turn leads you to increased confidence in my abilities as your potential Fund manager.

The Big Post About Water

Let’s talk about water, good ol’ H2O. Water isn’t a commodity you can physically invest in like gold, silver, or wheat. Because of this, we have to look at ways to invest in water indirectly. What are some of the options? Right off the bat there’s public utility companies such as American WaterWorks; followed by agricultural businesses that produce food; finally you have potash companies that use their recycled water byproduct as a means to sell to other companies that are in need of it.

One of these companies that could expose a portfolio to water is Intrepid Potash Inc (IPI). Intrepid Potash produces and sells potash and potash byproducts in two main product segments: Potash and Trio. The Potash segment produces and sells potash to the agricultural industry as a fertilizer input, the industrial market as a component of oil and gas drilling fluid, and the animal feed market as a nutrient supplement.

The Trio segment produces and sells specialty fertilizer that consists of potassium, sulfate, and magnesium, and is mined from langbeinite ore. The vast majority of revenue is generated in the United States, which is also the location of the firm’s production facilities. Here’s the other cool thing about IPI, it sells water. Taking a look at the third page of their last 10-K it reads, “We also have water rights in New Mexico and Utah under which we sell water primarily for industrial uses such as in the oil and gas services industry”. But it isn’t enough to know that IPI sells water. It isn’t enough to know where they record their water sales on their balance sheets. It’s important to know why water matters, and what could drive its demand.

Why Water Matters

Water is used for almost everything we humans do in the world. Its one of the essential building blocks of life for crying out loud! Now before I get scientists shouting, “the world is 70% water you idiot, how could we run out?!” You’re right. The odds of us running out of water are almost zero. However, the water that humans need is fresh water. Freshwater accounts for around 2.5% of the overall water population. This means we have 8 billion people fighting over 2.5% of a resource.

According to the World Resource Institute, water use is expected to rise by 50% by 2025 in developing countries, and 18% in the developed world. A really cool website I found for those that are nerds like myself, is http://www.worldometers.info/water/. Worldometers.info records in live time the amount of water consumed per year (in millions of liters) along with some statistics. According to Worldometers, “population is rising about 80 million per year, and energy demand is also increasing around the world, with corresponding implications for water demand” (Worldometers.info).

Now that we know how much water humans are working with, it’s important to understand just how we use that water in our society. Going back to our worldometers.info statistics, “agriculture accounts for 70% of all water consumption, compared to 20% for industry and 10% for domestic use” (Worldometers.info). Another cool site to check out if you’re interested in water usage / risk is http://www.wri.org/applications/maps/aqueduct-country-river-basin-rankings/#x=147.30&y=8.70&l=2&v=home&d=bws&f=0&o=171. This website displays what the WRI calls an “Aqueduct Water Risk Map”. This map rates country from 1 – 5 (1 being less at risk, 5 being severely at risk) for water shortages. Along with providing the average score for the country, the map breaks it down into the three major industries: domestic, agricultural, and industrial.

Take a look at the Baseline Water Stress Score, which is the ratio of total annual water withdrawals to total available annual renewable supply. Examining the developed nations we find the following scores (remember, its 1 – 5, with 5 being the worst scenario and 1 being no worries):

North America

  • United States – 2.9 Average (3.5 Agriculture, 2.8 Domestic, and 2.5 Industrial)
  • Canada – 1.2 Average (2.4 Agriculture, 0.9 Domestic, and 1.2 Industrial)

South America

  • Mexico – 3.5 Average (3.7 Agriculture, 2.9 Domestic, and 2.9 Industrial)
  • Brazil – 0.9 Average (0.9 Agriculture, 1.1 Domestic, and 0.9 Industrial)
  • Argentina – 2.5 Average (2.9 Agriculture, 2.2 Domestic, and 1.8 Industrial)

Africa

  • South Africa – 3.2 Average (3.2 Agriculture, 2.7 Domestic, and 3.3 Industrial)

Middle East

  • Every Country Average > 4.0

So now that we have a clearer understanding of the world in terms of water usage, supply, and shortage worries, let’s get more granular and find out just how water is used in the industrial industry, which is where Intrepid Potash is located. The Canadian Society for Unconventional Resources has a great PDF describing the uses of water for the oil and gas industry, an industry IPI sells their water rights and water too. I learned a ton about how water is used in the drilling process, so I’ve pasted a few quotes from the article below.

“During the drilling process water-based fluid (drilling mud) is used in a number of different ways including lubricating the drill bit, circulating the drill cuttings out of the hole, containing formation fluids and facilitating the operation of sophisticated formation evaluation tools.”

“Hydraulic fracturing operations which use water as the primary fracturing fluid can require thousands of cubic metres of water. These large volumes of water are required to stimulate each section of the length of the lateral and to carry the proppant material into the newly created fractures.”

Where Intrepid Potash Fits In

Now we can finally move on to the vehicle for our water investment, IPI. Intrepid Potash is committed to expanding their water sales resources for the year 2017 and beyond. According to their latest 10-K, IPI mentions water in their speciality product sales, saying, “Through our existing operations and assets, we also have the potential to grow our offerings of salt, water, and brine with low capital investments”, and, “In addition to our reserves, we have water rights and access to additional mineralized areas of potash for potential future exploitation” (IPI 2016 10-K). Reading into the balance sheet, I realized that IPI doesn’t explicitly record their water revenue under any particular name, rather they place it under “Other Income” on their books. But before we go into their water sales, it’s important to take a look at the company as a whole.

The Fundamentals

IPI is currently trading at a 22% discount to book value and only 1.1 times sales. Their financial strength isn’t great, which makes it an area of concern for investment. IPI has a Cash to Debt ratio of 0.24, ranking it lower than 62% of the companies in its industry. However, it has an Equity to Asset ratio of 0.76, which is better than 88% of companies in its industry. Looking towards profitability, IPI currently doesn’t make money, but their trends are headed in the right direction. After reporting a Net Income loss of -$524M in 2015, IPI reported their most recent 10-K Net Income at -$61.88M, a tremendous recovery and tilt in the right direction. Free cash flow is slowly but surely making the turn towards positive. After a dismal 2013 FCF reporting of -$185.9M, IPI has grown their FCF to -$29.69M in 2017.

What I like most about IPI’s prospects is their dedication to reducing debt and raising cash levels. In 2014, IPI had $151M in debt compared to $78.02M in cash. Since then, IPI has reduced its debt to $88.02M and grown its cash to $20.7M (compared to the prior year of $4.46M).

So what is the biggest driver of growth for the company? Their ability to sell water. Taking a look at the balance sheets we can find how much of an impact the water sales have had on their bottom-line. Remember IPI reports their water sales as ‘Other Income’. Looking at the 2016 10-K, we see that IPI’s Other Income grew from $575M in 2015 to $1,106M in 2016, close to a 50% growth in income. That’s impressive. My thesis, backed by the research on water, suggests that the demand for IPI’s water rights and water usage will continue to bolster the bottom-line of the company, propelling the company into positive FCF and a greater Cash to Debt Ratio, and it should be then reflected in the price action. Speaking of price action, let’s take a look at the charts to round out this analysis.

Price Action / Chart Analysis

Right now the charts are depicting what could be a bottom in the bearish trend of IPI. If you look closer you can see a wedge forming at the end of this long saucer formation

Price action has already crossed 50 MA in a bullish manner, and I like the increased volume I’m seeing on the charts as well. Anything close to the 3.00 strike range would be a good entry in my books, and I would set the stop below the 50 MA, which if hit, would rebuttal my bullish thesis and get me out safely. Not too sure on how much to risk, but I would be sure to keep it between 0.50% and 1% of capital.

Conclusion

In pure supply and demand terms, the world will eventually need more usable water than it currently has. Whenever an imbalance like that occurs, there is always a time and place to make a profit from it. If water has the likes of Michael Burry digging into it, it should be worth your time to do some digging as well. Below this piece are the websites used to research this piece. I hope this thesis is a good starting point for those that want to dig in further. If you find anything of substance, shoot us an email. Also, if you see anything wrong with this, shoot holes into the thesis so I can see where I could’ve been wrong in my thought process.

Sources For Research

http://www.csur.com/sites/default/files/Water_Consumption_v3_wBleed.pdf

http://www.wri.org/applications/maps/aqueduct-country-river-basin-rankings/#x=-12.30&y=6.85&l=2&v=home&d=bws&f=0&o=86

http://www.worldometers.info/water/

https://www.wri.org/our-work/topics/water

Investment Philosophy Part 2 – Diversification & It’s Shortcomings

I want to discuss part two of my Investment Philosophy series, Portfolio Concentration and Diversification. Although this is not the most important part of my philosophy (that was discussed in part 1), it is still very important for you as a potential investor in the Fund to understand how I think about such matters like diversification and the concentration of my portfolio.

Continue reading “Investment Philosophy Part 2 – Diversification & It’s Shortcomings”

Investment Philosophy Part 1 – A Word on Losses

I want to take the time to discuss my investment philosophy in a bit more detail as I believe it will provide you, a potential partner, more clarity into the mindset of your potential money manager. I will break these investment philosophy pieces up into three different parts, with this first part being about losses.

You might be wondering why I am starting with losses, given the main goal of firms is to maximize profit. That is not the main goal of Rockvue Capital. The main goal is to minimize losses and restrict drawdowns as much as possible. By doing this, I am able to let the profits take care of themselves, while preserving my capital, and your capital. Let’s breakdown how I do this in Rockvue Capital. (The investment philosophy discussed herein these three parts have solely to do with the Voyager Fund. The SteadFast fund is algorithmic and independent of discretionary action from myself).

Using Stop – Losses To Mitigate Risk

The most important factor in mitigating risk and drawdowns in the Fund is through the power of stop – losses. Stop – losses for those that aren’t familiar, are used in trading to set a predetermined price at which one exits a trade. Using an example, let’s say I want to buy stock XYZ on a breakout at $5 on a symmetrical triangle pattern. Now, on this trade, I will place my stop – loss order on a price at which my bet would be wrong. In other words, I would place my stop – loss at a technical point that would signal me to get out. If this still doesn’t make sense, feel free to email me with any personal questions.

Here is the most important part about using stop – losses: I have yet to sustain an individual loss of greater than 1% per trade. This is very important to me, and it should have the utmost meaning to you as a potential partner. Through the power of stop – losses and moving those stop – losses up as soon as I can, I am able to lock in profits as soon as possible, and try to get to breakeven as soon as I can. This is what I am referring to when I talk about minimizing as much risk as possible. Now that you understand a little bit more about how I manage risk technically from stop – loss orders, I would like to take the remaining time of this memo to discuss my views on losing in the markets.

How I (And You) Should Handle Losses

My view on losses may come as surprising to those who haven’t read my work before, or frankly who are reading this memo and haven’t read previous memos. I will make a lot of losses. Statistically my losses will outnumber my wins, the scale of which I do not know specifically. So far, the ratio is close to 45% winning percentage. I am not worried about this. In fact, I would be completely comfortable with a 1% win rate if at the end of the year I am net profitable. I don’t believe this will ever happen, but the point I am making is that I am a firm believer in Pareto’s Principle.

Pareto’s Principle states that 80% of outcomes come from 20% of the inputs. If I can focus on the 20% profitable trades, I can sustain 80% of my success from 20% of those trades. The reason that I am comfortable with this principle is that the losses I sustain are very small compared to the size of the gains I receive on my profitable trades. I hope that you understand this principle as a potential partner in the Fund. If the idea of suffering lots of small losses is something that you are not comfortable with, I completely understand, but I would love to discuss it with you personally before making a decision to either invest or pull capital.

Positive Asymmetry in The Fund

As a caveat for my talk on losses, I want to end the memo with a word on positive asymmetry. The Fund will at all times have a positive asymmetric skew to the profile of its returns. This goes back to the Pareto Principle I discussed earlier. If you look at a Normal Distribution, you will see a symmetrical bell shaped curve along the various probability distributions. This is what the return distribution will probably look like at Rockvue Capital: 

Image result for asymmetric investment return

As you can see, the amount of small losses (as the x axis shifts towards the left) will outnumber my wins, which is what we should expect going forward. however,  the power in asymmetry is that the smaller number of profitable trades will cover for the losses and (hopefully) return a net profit after commissions and expenses.

A Final Word

This first memo got a bit mathematical and technical, so I apologize if some of this material went over some heads, that was not the intention. When dealing with losses, it is important to get granular to understand the reasoning behind my philosophy on losses and the purpose of my stance to the firm.

Once again, all of what I do directly impacts your potential capital investment. For this reason, I want to be as transparent as possible with my philosophy. Stay tuned for Part 2 of the Philosophy Memos where I discuss the criteria on which I invest in equity positions.

Surfing and Trading

So this past week I’ve been relaxing (as best as I can) in Tybee Island, GA. This is supposed to be my last vacation before the school year starts, but I’ve spent most of it getting destroyed by waves, early morning workouts, and studying the markets. I’ve come to the realization that I cannot get away from the markets, mainly because I love them so much. It’s my passion, so I don’t think of it as distracting or “working” while on vacation.

This brings me to the point of this article. I won’t go into any details on specific companies, but rather provide an insight into the methodology and process of my trading. I tried surfing this week and I struggled, a lot. To my defense, the waves were very large and challenging in general. More or less, I’m trying to make excuses for myself. But while I was out in the ocean letting the waves decide where to take me, I thought about markets, investment opportunities, and the waves. It hit me. Along with a wave, a thought hit me that garnered a writing piece. My strategy to the markets is exactly like surfing in 4 major ways. Let’s break it down.

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Going Long Russia: Part 2

If you’ve stuck around for Part 2 of my Russian Bull Thesis, congrats! If you haven’t read Part 1, check it out here. I won’t bore you with Part 1 review, so I will give a brief overview. Part 1 dealt with the Russian economy as a whole, which returned a bullish hypothesis after my research. Secondly, it investigated different ways to play this Russian bull thesis. Part 2 is going to deal with the third option in which to invest in Russia: Direct investment in Russian Companies.

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Going Long Russia: Part 1

Jim Rogers is one of my favorite investors to listen to. Truth be told, every Sunday I search YouTube to see if there are any newly released videos of Jim Rogers’ views on economies and markets. Rogers is one of the greatest investors of all time, joining forces with George Soros to create the Quantum Fund. Since around 2015 – 2016, Jim Rogers has expressed bullish interest in Russia, and it was my first semester Sophomore year of college that I listened to his bullish hypothesis. Two years later, Russia is still high on Rogers’ bull list. Internally recognizing my contrarian investing habits, I became enamored with the idea of a Russian turnaround. Yet, it doesn’t matter what I think or what I hope, what matters is the reality and scope of the situation, and the likelihood that my thesis will play out. This piece will go into my bullish hypothesis on Russia, while at the same time providing two companies that I am looking to invest in within Russia, as well as a couple different ways to play the undervaluation in the Russian Economy.

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My Positions in My (Paper) Account

I want to start making monthly posts about the state of my portfolio, why I have positions the way I do, and what I am planning going forward. This will be more of a bulleted style list of things, whereas my companies analyses are droves of paragraphs. Without further hesitation, let’s roll.

Long Positions

British Pound (GBPUSD – Forex): 10.80 : 1 Risk Reward Set – Up

When Theresa May announced the Snap Election that would take place on June 8th, it got me really thinking about the state of the British Pound, and the state of the British Economy as a whole. Technically the charts set up beautifully. Looking at the weekly charts I noticed an extended triangle / wedge pattern forming, and I was waiting for the price action to shoot through the resistance line of around 1.252. I put my Buy Limit order in right above the resistance line, it got filled, and I’ve been moving my stop up ever since. I trade started out as a 3:1 risk reward ratio (my ideal setup), but when the trade quickly went my way, I moved my stop loss up proportionally, while keeping in mind my long term thesis on it. As it sits, I’m risking only 0.11% of my capital from the previous 1% entry risk, and any movement upwards over the course of next week could put me in the breakeven / small profit category WORST CASE scenario.

From a Macro Perspective, I am taking the bet that the British economy is going to be better than most people think. Yes they will have some difficulties, and if the Scots decide to leave the EU, they will take their oil with them, which is a huge factor in the success of the British economy. However, I remain long term bullish on the Brexit situation, and I believe capitalism will help bolster the nation’s currency higher. I don’t necessarily have an initial profit target, however, if the trend goes against me, I hope I am smart enough to have my stop in place.

Ocean Rig UDW INC (ORIG) – US Equity: 26.6 : 1 Risk Reward Ratio

Betting only 0.82% of my capital on this little trade here. ORIG is about as distressed a company as one can find. With mounting debt and pressure from distressed debt collectors, ORIGs life line as a company is hanging in the balance. So why would I want to invest in something like this? I am looking for a restructuring deal to take place. ORIG has a lot of assets that it can liquidate, making it a cash play for a potential buyout or restructuring process. It received over 75% support from shareholders for its new restructuring deal, and given the value of the company ($0.25 / share), the risk reward is very asymmetrical. I put my stop in at $0.21, so anything below that would stop me out of the trade.

This might be one of my most confusing bets in terms of the company itself, however I believe that in order to achieve abnormal returns, one must be willing to look in the depths and the cobwebs of the market.

Short Positions

US Dollar (DXY – Forex): -4.61 : 1 Risk Reward Ratio

On April 10th I entered a short position in the US Dollar. After looking at the price action, I noticed that on the daily charts, DXY had crossed its 50 MA in a bearish manner. So, towards the end of the trading day, I shorted the currency risking 1% of my capital, with an initial profit target for a 3:1 risk reward. As luck would have it, the trade has gone in my favor, so much so that I am able to move my stop loss to the point where if my stop does get triggered, I walk away with 1.04% profit. That’s not bad, worst case scenario is a 1.04:1 risk reward, I like the positivity about that.

Obviously I hope the trend continues to fall in my direction, as I think it might. The last three days look like a patented pullback, and hopefully the dollar moves lower into next week. Once again, no profit targets on this trade, just hoping to move my stop loss further and further down the trade.

Netflix Inc. (NFLX – US Equity): 4.01 : 1 Risk Reward Ratio

Risking only 0.50% of my capital on this bet, I decided to short Netflix from a technical and fundamental perspective. Looking at the fundamentals, Netflix has tremendous amounts of debt, and to me, a good deal of the optimism around Netflix is already discounted in the price. Netflix also failed on international subscriber numbers, which is the metric that I care about the most with the company. What I realized about companies like Netflix and Tesla is that its not the earnings numbers themselves that move the stock, its what makes up those earnings numbers. For Tesla its the amount of cars they sell, for Netflix its the amount of subscribers. In other words, Netflix could lose tremendous amounts of money each year, but if their subscriber base kept growing, investors wouldn’t care.

Looking at the weekly charts, NFLX appears to be trading in the midst of a channel, with most recently crossing below its 50 MA. I have my stop loss set at $149, which technically would indicate the reversal of my bearish hypothesis, and I would lose 0.50% of my capital. Its a trade that is completely emotionless to me.

Apple, Inc (AAPL – US Equity): 17 : 1 Risk Reward Ratio

I know I know. Go ahead. Comment and rant about how I used to be IN LOVE with Apple from a fundamental perspective and how much I LOVE their cash position and their PE Ratios. I’ll wait, don’t worry … In all seriousness, I do love the company. Last summer when it fell below $90, I remember having the conversation with my investment partner Jacob about how we should buy AAPL at these levels, because below $90, the Margin of Safety was freaking nuts. As luck would have it, that would’ve been a nice position to get into. However, at these levels, I would like to see a pullback from the all time highs.

Don’t get me wrong, I am still long term bullish on AAPL, I just don’t think current price valuations are warranted even though the company is trading less than 20 times earnings. To me, I smell a lot of animal spirits driving up this price, and I believe that a perfect release of the latest iPhone is already discounted into the price. I am only risking 1.03% of my capital on this trade, and if AAPL ticks higher than $143, I will get stopped out for a loss.

It will be interesting to see where these positions play out. I am happy having a concentrated portfolio, and I think that I will continue to lean that way as I grow as an investor. As Stan Drunkenmiller once said, “put all your eggs in one basket, then watch that basket very carefully.”

Is Silver About to Breakout?

Moving away from individual securities and US equities on the whole, along the quest for value, I love venturing into my bigger passion, Global Macro Investing. Don’t get me wrong, I’m a sucker for a great undervalued company trading well below book value. But at the same time, my friends will usually find me analyzing TradingEconomics.com and studying futures charts in my free time. If you were wondering, yes, I am writing an article about the price movement of silver during the Final Four, sue me. I tend to find this stuff more interesting than a basketball game (hockey however, is a different question). Nevertheless, let’s get to the hypothesis. In my early learning quest for all things Global Macro, I stumbled upon Macro-Ops.com, and it is now one of my bookmarked investing sites. One of the great things I learned from Alex and the boys over at Macro-Ops was their criteria for investment hypothesis. Let’s break it down: 1) What are the macro economic factors at play? (Tightening or Loosening), 2) What is the hypothesized reaction in the underlying security / commodity depending on the macro situation? (Long or Short), and 3) What do the charts say about the price action? (Where is the trend, and what are my resistance and support levels).

Continue reading “Is Silver About to Breakout?”