Avoid the Falling Knife
Monday August 5th wasn’t an enjoyable day in northeastern Florida.
Hurricane Debbie lashed our offices. Power and internet cut in and out.
The forecast called for historically high rainfall totals – up to thirty inches in some areas. And Tokyo’s Nikkei stock index fell 12.4% – the most since 1987’s infamous Black Monday stock market crash.
According to Bloomberg, global stock markets saw a decline of $6.4 trillion in just three weeks that ended with that collapse.
Social media assigned all sorts of blame for the decline – U.S. job market, disappointing tech earnings, and big fund profit taking were all up there.
Jeremy Siegel, from University of Pennsylvania’s prestigious Wharton School argued that the Federal Reserve needed to make an emergency rate cut.
We believe that this was pure panic.
The stock market is not the economy. The most recent labor market survey showed that the U.S. added 114,000 jobs in July. That’s below the 179,000 added in June. The unemployment rate hit 4.3%, up slightly.
However, as you can see here, it’s well below average:
Remember, higher interest rates fight inflation. And inflation remains high.
Here’s some data from the U.S. Bureau of Labor Statistics on the 12-month percent change, as of June 2024:
- All Items: +3.0%
- Electricity: +4.0%
- Restaurants: +4.1%
- Rent: +5.1%
- Hospital Services: +6.9%
- Car Insurance: +19.5%
What’s important to remember here is that inflation hits fixed income and poor the hardest. And that matters. And this understates the price inflation of staples like milk, bread, eggs, ground beef, chicken, electricity, and gasoline.
The things that all of us buy every week.
Those things are up significantly more. Since January 2020:
- Eggs are up 86%.
- Bread is up 46%.
- Gasoline is up 40%.
- Chicken is up 35%.
- Ground Beef is up 31%.
- Electricity is up 27%.
- Milk is up 22%.
That means the standard grocery bill is up 40%. And with inflation still at 3.0% overall, those prices are still going up. And while wages are going up, no one got a 40% raise in the last four years. So, we still feel inflation all across the U.S.
That’s why the Federal Reserve can’t cut rates to bail out Wall Street. And frankly, the government shouldn’t be involved in the market. The stock market is NOT the economy.
The real reason the stock market declined on Monday, was due to an unwinding of billions of dollars of something called the “Yen Carry Trade.”
We wrote a bit about it in the August 7th Grove Essay titled, “What the Heck is a Carry Trade?”:
This [stock market decline] happened, in part, because Japan had the world’s lowest interest rates for decades. Imagine that you could borrow money for almost nothing and invest it in U.S. stocks. For example, let’s say you borrowed $1 million in and put it into the S&P 500 a year ago. You made about $250,000 in profit, in one year.
That’s the index. Now think about individual stocks. Over the past year, Nvidia shares peaked at 200% gains. For every million dollars you borrowed, you made $2 million.
The wheels came off that trade when the Bank of Japan (BOJ) raised interest rates from zero to 0.25%. Yes, a quarter of a percentage point increase sent the Nikkei stock index down 16% over two days! That’s how important the carry trade was.
However, as analysts at Bloomberg put it:
One thing is clear, though: the pillars that had underpinned financial-market gains for years — a series of key assumptions that investors across the world were banking on — have been shaken. They look, in hindsight, a bit naïve: the US economy is unstoppable; artificial intelligence will quickly revolutionize business everywhere; Japan will never hike interest rates — or not enough to really matter.
Evidence to the contrary began to stack up over the last few months. And the smart money began to exit. As we wrote in the July 27th Weekly Update, selling started well before the BOJ cut rates. Hedge funds sold about $45 billion in stock, before the beginning of August.
Berkshire Hathaway, run by investing legend Warren Buffett, held $174 billion in Apple stock at the start of 2024. By the end of June, the position was down to $84.2 billion. So, Berkshire sold about $90 billion just in Apple stock in the first half of the year. Despite that selling, Apple Inc. stock rose from $186 per share to $210 per share over that period.
Buffett and Berkshire (the smart money) got out early. Now the rest of the hedge funds are getting out. And we don’t see that trend changing for the next couple of weeks.
In periods like this, there are two schools of thought. The bullish “Buy the Dip!” crowd and the bearish “Avoid the Falling Knife” crowd. In this market, we are in the latter camp. We believe this market could go lower. Particularly the stocks that we like.
So, in that vein, we are going to introduce a stock that we really like. They just acquired one of our portfolio companies. And it’s not one we need to buy right away. Also, we need to do some portfolio management.
Let’s start with the portfolio.
Portfolio Update: Buys, Sells, and a Victory Lap
With the current correction, we’d like to update our portfolio.
The last time we did this was back in December 2023. At that time, we didn’t issue sells. Instead, we put hard stops on three companies:
- Nel ASA (OTC: NLLSF) – Hard Stop at $0.58 per share
- Nickel 28 Capital Corp. (TSXV: NKL) – Hard Stop at C$0.80 per share
- Alaska Energy Metals (TSXV: AEMC) – Hard Stop at C$0.30 per share
That was our last gasp at letting these stocks recover.
They did not, so we hope you sold. Nickel 28 was the first to hit the stop. On January 15, 2024, it closed at C$0.79 per share. The next day, Nel ASA closed at $0.53 per share. Triggering our stop. On April 10, 2024, Alaska Energy Metals finally succumbed as well.
We will remove these positions from our portfolio now.
Hawaiian Electric Update
Hawaiian Electric (NYSE: HE) the provider of 95% of the electric power for the state of Hawaii, just settled a lawsuit over the 2023 Maui fires. In the suit, the company and its subsidiary will pay $4 billion.
That’s a billion dollars less than Capstone, an investment research firm, believed it would pay.
We added Hawaiian Electric to the portfolio in January 2024 around $14 per share. The company’s shares fell 75% in September 2023, after its equipment played a role in the catastrophic fires in Maui. The company’s liability for that disaster was about $5 billion, according to some analysts.
And at the time, the company’s dividend, uninterrupted from 1901 to 2023, looked like it would stop. It did, but we knew that was already priced in.
In our estimation, the company’s business outside of Maui looked strong. And it had an aggressive plan to replace oil power plants with solar, wind, and combustion turbines.
It was the uncertainty of the final liability that kept a lid on the stock price.
The recent settlement removed that uncertainty and the shares responded:
The shares fell below our 30% trailing stop guidance on June 4. If you sold, that’s okay. It saved you from a deeper loss (shares fell all the way to $7.74 before the settlement announcement).
However, if you held, it worked out.
The next step will be to see how the company pays that fine. And then if they will reinstate the dividend.
We are currently up 21.4% on our initial recommendation.
We believe Hawaiian Electric Industries remains a buy at its current price. The catalyst will be the reinstatement of the dividend. If you sold on the trailing stop, this is a good level to buy back into the stock.
Two Major Mining Companies Acquired One of Our Copper Miners
Our Canadian copper miner Filo Corp. (TSX: FIL) was just acquired.
Two giant miners, Lundin Mining and BHP acquired the company for C$4.5 billion. We recommended Filo on February 5, 2024, after a popular junior mining exchange traded fund (ETF) sold it in a big washout.
At the time, there was little interest in mining.
However, we liked the way management ran Filo. It was one of the “new mining” companies that follow the United Nations Sustainable Development priorities. As we outlined in the issue. They prioritize climate, workplace, governance, and community while they explore and develop new mines. That’s the direction mining must go in today’s world.
On the date of the issue, the stock closed at $20.58 per share. The current price is $31.39 per share. That means we currently have a 52% gain on our position.
At this point, we need to sell our shares and take our profit.
However, we are not letting this asset get away. Instead, we are going to buy one of the new owners (and former parent company of Filo Mining – Lundin Mining.
Let’s Buy the Buyer – Lundin Mining
Lundin Mining (TSX: LUN) was the parent company of Filo and a major mining company.
The company has a fantastic record of accomplishments. The most important of them is their ability to work within communities to build and operate mines.
They are one of the largest companies of the “new mining” era. Their mission statement is:
“We responsibly mine base metals vital to society, creating meaningful value for our shareholders.”
They are one of the few companies that means what they say. Here’s what we said about the Lundin Group in the Filo write up:
The Lundin Group has a multi-decade presence in this part of the world. The Lundin Foundation supports Filo’s ESG commitment in the region. A Managing Director of the Lundin Foundation sits on Filo’s board. Filo set out the following goals:
- Climate – Engage in climate and environmental stewardship that avoids, minimizes, or offsets impacts.
- Workplace – Provide a zero-harm workplace that is diverse and inclusive.
- Governance – Demonstrate accountability, integrity, and transparency in alignment with international standards.
- Community – Build trust through openness, respect, and contributing to the community resilience and prosperity.
These goals show that Filo understands how to operate as a new-style mining company. And they have to do this because the Lundin group of companies operates multiple projects in this area.
The Lundin Group is one of the best international exploration companies in the world. The patriarch, Adolf Lundin, founded the group more than fifty years ago in 1971. I had the pleasure of interviewing his son Lukas Lundin before he passed away in 2022. While his father founded the company, Lukas was the driving spirit for the last thirty years. Today, Lukas’ sons William, Adam, Jack, and Harry run the various companies. Adam Lundin is the Chairman and William is a board member of Filo.
And they are serially successful. The Lundin Group companies generated $15.8 billion. Here are some incredible returns:
- Red Back Mining: 1,041%
- Argentina Gold: 1,091%
- International Musto: 1,757%
- Lundin Energy: 15,566%
Those are some impressive results. And it contributes to our confidence in Filo.
Lundin Mining doesn’t take the industry standard “we are professionals who know best, and you locals are just rubes” approach. Rather, they work within the communities where the mines are located.
Today, they work in seven countries and produce more than six different commodities.
In the second quarter of 2024, they produced 74% copper. The plan to produce between 366,000 and 400,000 metric tons of copper this year.
Here are the company’s results for 2023:
- 315,000 metric tons of copper production
- 185,000 metric tons of zinc production
- 149,000 oz. of gold
- 16,000 metric tons of nickel
- $3.4 billion in revenue
- $345 million in free cash flow
- $206 million in shareholder dividends
Those are impressive numbers. And as the price of copper, zinc, and gold rise, so will its profitability. However, shares fell on the global stock decline, as you can see here:
The recent fall erased nearly all the gains from 2024. We believe that is an opportunity. We like this stock here. We love it at $11 per share. If the current weakness continues, that’s a bottom, based on the chart above.
At the current price, this stock pays us a 3% dividend.
Our risk with Lundin Mining, as with our entire portfolio is that this recent meltdown was the first step in a larger contagion. If that happens, everything will fall. Another risk here is that China’s economy weakens. That would make them buy less metal and impact metal prices. Lower metal prices will hurt Lundin’s profitability and dividend payments.
However, we see those as extremes. And the current decline in shares reflects the mass sell off in the market. It has nothing to do with the quality of Lundin Mining as a company.
Action to Take: Slowly build a position in Lundin Mining (TSX: LUN). We won’t put a stop on this one. Instead, accumulate shares over the next month. We’ll revisit this position at that time.
The current market pull back is concerning. However, companies like Lundin Mining should be resilient. They aren’t sitting on thousands of percent gains like the tech stocks. And if the company falls during a mass panic, they will be among the first companies to recover.
The offer us another blue-chip copper stock at a fair price, with a robust growth profile.
For the Good,
The Mangrove Investor Team
