We contemplate multiple strategies to “control risk.”  First, taking a “quicker trigger” perhaps to sell down seasonally on March 31^st or after especially brisk rallies even after nothing is amiss hoping to re-enter at lower levels.  Second, “pairing” longs and shorts to be a little more balanced.  In 2009-2010 we have had Overweight or “buy” ratings on most nonferrous base metals, for example, creating volatility.  Third, deliberately upgrading ratings after severe declines like April-May 2010 or downgrading after big runups like March or July 2010, although some consideration of unique circumstances will be made.  Fourth, employing derivative to cut risk such as owning a copper price put in a portfolio long copper stocks, or vice versa or a stock market put if “too long.”  Fifth, we are reluctant to any “sell down 10% or down 20%” loser rule to control risks, as sometimes the sectors or emerging shares are too thin to get out in time or we fear either selling at the bottom or selling low without getting back in to make matters worse.  A practical problem inherent to bland mutual funds or aggressive hedge managers is that clients may enforce a down 20+% rule in firing the manager.  We invite your opinions on such matters.

It is a legitimate criticism that the returns of our recommendations are particularly volatile.  First Coverage ranked JTVIR, LLC #1 of roughly 250 sell-side research contributors globally in the 2009 first-half, and did not tabulate us as a firm for the second-half as such performance continued.  First Coverage ranked us #12 among 500 to 1,000 individual contributors in 2009.  A leading hedge fund that monitors meticulously the performance of the recommendations of particular analysts ranked us #3 of 222 in March 2010, #222 of 222 in May 2010 and #3 of 216 in July 2010, calling attention to our volatility.

It would be easy for us to dismiss the 2008 second-half or April-May 2010 as abnormal periods that may not repeat themselves often.  However, we cannot ignore recent experience, and structural changes continuously increasing the interdependencies of world economies suggest to us that coincident and volatile boom/bust cycles remain possible.  Further, entirely separate factors caused metals sector downturns in 1975-1978, 1982-1986 and 1997-2002 that were more severe, worse multiyear downturns.

NARROWNESS OF “DEFLATION DEBATE” UNDERMINES ITS RELEVANCE

The popular of “deflation debate” framed in terms of the U.S. economy, federal inflation data and the U.S. bond market is too narrow, in our opinion.  The U.S. represents under 10% of metals or most commodities consumption, the Bureau of Labor Statistics changes inflation measurement at its whim and the global bond and financial markets should be considered.

Global auto markets appear to headed very close to a 70 mm light vehicle record level in 2010 similar to the 2008 record with gains in Asia and the Third World offsetting U.S. or EU declines.  World aluminum output made a record in June 2010, global steel output made a record in April 2010 and global stainless steel output probably will make records in 2010 too.  Further, 2010 Chinese nonferrous metals apparent demand is understated owing to overbuys from April to September of 2009 nearer to price lows.  We do not believe global markets contract, and the demographics of global population, per capita income and the “catchup” of many emerging markets to distribute income more evenly all serve to benefit consumption over time.

We would frame inflation/deflation considerations in terms of a combination of demand growth, supply growth and inventories of particular commodities.  Deflation in iron ore, nickel or other commodities with much capacity addition appears more plausible to us than copper, met coal, uranium, PGMs or other markets with fewer supply additions.  We would make no inference about global inflation or deflation if future electricity shortages force up aluminum prices or pit wall failures at Chuquicamata, water shortages at Collahuasi or Escondida  or a tough transition to underground mining at Grasberg force up copper prices.  The relative prices of some metals could rise even in a deflationary  climate if supplies dwindle.

Our concern is that predictions of 2% thirty year treasury yields could prove disappointed, and ever-rising U.S. treasury bond prices simply “transfer the bubble” from real estate, commodities or equities to the treasury markets.  A future crash in U.S. treasury bond markets could throw the U.S. back into recession or slow world growth, which might be terms “real world deflation after bond prices crash in a self-fulfillment.”  We believe the thirty year bonds of Vale issued at 6.99% in 2009 or Teck at 6.00% issued this past week are safer than U.S. treasuries yielding 4%. 

The deflation theme is very bullish to most sectors of the stock market in terms of higher P/E or lower WACC discount rates in DCF models.  Teck having a 6.00% thirty year bond issue last week expresses how much borrowing rates have fallen.  It is possible that the thirty year “risk free” rate has fallen to 3.00% already, and that bond investors assign a 1% or so risk premium to the U.S. treasury.