Samuel Brannan became the richest man in California during the state’s Gold Rush of 1849; although he never found a lump of bullion. He made his fortune selling shovels and picks to the gold-seekers.

Fast forward 150 years and the modern version of Mr Brannan – the mining services companies – are ready to profit as miners boost their investment above the record set in 2008 at the peak of the commodities boom.

The article, by Javier Blas and William MacNamara, goes on to note that mining equipment manufacturers such as Caterpillar, Joy Global, etc. are poised to profit from the spend spree. It would be nice to see Alloy Steel International cash in on this too, if it can work out its apparent capacity issues.

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Incidentally, this brings to mind a classic post by Mark Cuban, about the roadshow he and his co-founder participated in in the run-up to the Broadcast.com IPO. Key excerpt:

Prior to the road show, we put together an amazing presentation. We hired consultants to help us. We practiced and practiced. We argued about what we should and shouldn’t say. We had Morgan Stanley and others ask us every possible question they could think of so we wouldn’t look stupid when we sat in front of these savvy investors.

Savvy investors? I was shocked. Of the 63 companies and 400-plus participants we visited, I would be exaggerating if I said we got 10 good questions about our business and how it worked. The vast majority of people in the meetings had no clue who we were or what we did. They just knew that there were a lot of people talking about the company and they should be there.

The lack of knowledge at the meetings got to be such a joke between Todd and I that we used to purposely mess up to see if anyone noticed. Or we would have pet lines that we would make up to crack each other up. Did we ruin our chance for the IPO? Was our product so complicated that no one got it and as a result no one bought the stock? Hell no. They might not have had a clue, but that didn’t stop them from buying the stock. We batted 1.000. Every single investor we talked to placed the maximum order allowable for the stock.

On July 18, 1998, Broadcast.com went public as BCST, priced at 18 dollars a share. It closed at $62.75, a gain of almost 250 percent, which at the time was the largest one day rise of a new offering in the history of the stock market. The same mutual fund managers who were completely clueless about our company placed multimillion orders for our stock. Multimillion dollar orders using YOUR MONEY.

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With the exception of commissions-based brokers, it’s hard to believe there’s anyone out there who has really enjoyed the stock market over the past few months. I mean, just look at the ES [S&P e-mini futures] below.

Tim Knight still thinks the S&P’s going to decline to 925 or 930 within the next couple of months, informed by his 1937-1942 historical analogue, so he’s positioning himself accordingly.

Tim’s racked up some spectacular returns in the last few years, which lends weight to his analysis. Another point in favor of further market declines in the near future is the reversion inherent in a secular bear market. But, ultimately, even if you are confident we are in a secular bear market (as I am), timing the cyclical market trends is difficult. Which reinforces a thought I’ve had that a good default position during a secular bear market is to be market neutral (perhaps leaning a more to the short side as a cyclical bull rally starts to look long in the tooth, and leaning more to the long side after a cyclical bear rally looks like it’s running out of steam). So I plan to put more money to work in pairs trades going forward.

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I suspect that HF traders overstate the extent to which their algorithmic trading provides any liquidity or price discovery benefits to the broader market. On the whole, it seems like an enterprise which throws a lot of brain and computing power into a rat hole as far as everyone else is concerned.

On the other hand, to run with your metaphor a little, the traditional, buy-side value dinosaurs are already choking on the comet dust of a secular bear market, and they’re lashing out at the proto-rats as if they were the cause of it.

Value investing, at its heart, was a calm contrarianism — Graham buying broken-down net-nets when no one wanted to touch stocks during the Great Depression. Today it seems like every value investor thinks of himself as a contrarian, without realizing the extent to which value investors have become the market. If they’re all contrarians, none of them are. And if we’ve got another decade of secular bear market ahead of us, there are going to be a lot fewer value guys left standing at the end of it.

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Conventional wisdom says that long-term investors should generally eschew hedging, since the costs of hedging can lower long-term returns. This may be true during secular bull markets (such as the one that started in 1982 and ended at the beginning of 2000), but I don’t think it’s true during secular bear markets (such as the current one that began in 2000). Below is a chart comparing the performance of John Hussman’s equity fund, which employs hedging, and the S&P 500 tracking ETF SPY. These returns are net of management expenses, which are a full percentage point higher for Hussman’s fund than for the index ETF.

Hussman Strategic Growth (HSGFX) versus SPY

I suspect that if Dr. Hussman had started his equity fund ten years earlier, and hedged it the same way, his fund might have underperformed the market over the 1990-2000 time period. But his hedging helped him outperform during the first ten years of this secular bear market.

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The Big Picture:

– John Hussman, Vitaliy Katsenelson*, Jim Rogers, and Tim Knight all believe that we are in a secular bear market that started in 2000. I think they’re right. I also find it compelling that four investors with such varied backgrounds — a Ph.D. economist/mutual fund manager/former options mathematician, a traditional value manager, a great macro investor, and a great technician/trader — are essentially on the same page when it comes to the big picture.

– Secular bear markets can last about as long as the secular bull markets that preceded them. The previous secular bull market (1982-2000) lasted 18 years. So it’s possible the current secular bear market will last for most of the rest of the decade. Maybe longer, who knows. But when it ends, the major indexes will probably be about where they were when it started.

– Secular bear markets generally end, and secular bull markets start, when valuations on stocks are extremely low (because so many investors have given up on stocks by then). For example, at the end of the secular bear market that followed the Great Depression, trailing P/E multiples on stocks averaged about 7x, if memory serves, and stocks had higher yields than bonds, on average.

– Secular bear markets include shorter cyclical bull and bear markets. The current secular bear market has included, so far, a cyclical bear market from 2000-2002, a cyclical bull from 2002-2007, a cyclical bear from 2007-2009, and a cyclical bull market from March, 2009 to (it appears) April 2010.

How I’ve been trying to act on this:

During the cyclical bull market rally phase:

– Bought OTM puts (e.g., trying to buy umbrellas when it was sunny out).

– Didn’t add a lot of net short exposure. Entered some market-neutral pairs trades (e.g., Revisiting an Altman Z”-score pairs trade).

– Sold some long positions into the rally and raised cash (e.g., portfolio pruning). These are my current long equity positions and the reasons why I currently own them:

Biggest position:

AYSI.OB: because I think it has multi-bagger potential from here. My average cost is about 96 cents per share on this, and I haven’t bought any above $2.29 (I also have attempted to quasi-hedge the risk of a drop in Chinese iron ore demand here by buying puts on AYSI’s largest customer, BHP).

Second biggest position:

USEG: because I think it has multi-bagger potential from here. My average cost is about $2.80 on this and I haven’t bought any above $2.85.

Small positions:

TIRTZ.OB: because it has a nice yield
HBM.TO: inertia
PNDMF.OB: inertia
TINY: inertia
BRK/B: One share to keep my Geico discount.

During the last few weeks (what I think has been the beginning of a cyclical bear market.¹):

– Shorting stocks (e.g., New short position: AKS).

– Buying contra ETFs in IRAs, in lieu of shorting (e.g., EDZ and FXP).

– (one off) Buying a lottery ticket to bet against gold (“Everybody is bullish on gold”).

– Getting stopped out of shorts (I’m using trailing stops), sometimes for a loss (e.g., CENX) and sometimes for a gain (e.g., HGSI, round one).

– Getting stopped out of contra ETFs (trailing stops, again) sometimes for a loss (e.g., SRS) and sometimes for a gain (e.g., EDZ).

What I would like to do later this year:

– Buy shares of a small stock or two with multibagger potential at attractive prices.

– Buy more of AYSI and USEG iff I continue to believe the respective investment theses are intact and they drop in price.

*Katsenelson calls it a “secular range-bound market”.

¹What I think is happening and what the market does are, of course, two different things. I’m not going to argue with it. If we get a spike to the upside in the near-term, I may cover my shorts early and wait it out.

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