Fleck's Contrarian Chronicles : Why silver is shining brighter
A new ETF could spur silver to even bigger gains. Plus: Why Google's a gamble and 3Com is worth waiting for.
By Bill Fleckenstein
I'll begin this week's Contrarian with a quote from my daily "Market Rap" column (at Fleckenstein Capital) on March 28, the day the Fed raised interest rates 0.25%: "If the Fed doesn't pause and continues to appear tough, I would expect a sell-off, though I'm not sure how far that would carry."
So much for long-lived market angst. Although tough-Fed fears sent stocks tumbling that Tuesday (after the Federal Open Market Committee's communiqué struck folks as "hawkish"), fear was a no-show the next day. Stocks rallied strongly across the board.
Perhaps folks decided that the communique wasn't hawkish after all. Certainly, that is my interpretation. To quote from the document: The fact that further policy firming "may be needed," and the fact that the committee "will respond to changes in economic prospects as needed," does not sound particularly hawkish to me, especially when the Fed said that economic growth "appears likely to moderate" and that rising energy and commodity prices "have only a modest effect on core inflation." By my reckoning, that sounds quite flexible and data-dependent.
Meanwhile, I think that everyone with a bullish bone in his body wants to have as much money as possible committed before the Fed decides to pause. But I also think that some folks will withhold the last of their money until after the Fed has indeed announced it's done, a juncture that should bring about real opportunity on the short side.
A saunter down silver lane
Shifting to opportunity on the silver side, I have been laying out the bullish case for many years, saying that silver would ultimately trade in the teens. Last week, it climbed past $11 an ounce and closed Friday at $11.52.
Given the supply-demand deficit and the reliance on above-ground stocks, it's been my belief that whenever silver finally sprang into motion, it would really go wild. In the past, I used the analogy of copper trading at three times its cost of production as a framework to "justify" silver trading somewhere in the high teens. I believe the silver ETF, the new exchange-traded fund that was recently OK'd by the SEC and has yet to launch, will be the catalyst to help make that a reality.
Of course, in an environment where the dollar is finally destroyed (in a next-time-down scenario), both gold and silver could easily trade at some preposterous price -- as once-precious metals get sponsored by the momentum crowd, literally anything is possible.
What's value got to do with it?
Regarding momentum, recent corporate news makes for an interesting contrast. On the trading day following Google (GOOG, news, msgs)'s induction into the S&P 500 ($INX) "Hall of Fame," Google exploded for 25 points -- vividly demonstrating how little the idea of valuation sometimes matters in the investment business. (Having a position in Google is not really an investment. Rather, it's essentially speculation and an exercise in chasing rising prices.)
On the other hand, consider how the market responded that day to mildly disappointing news from a genuine value proposition/turnaround situation, 3Com (COMS, news, msgs). This maker of networking gear failed to win at "beat the number," as its revenues were a bit light and its loss was a tiny bit bigger than expected. For folks who'd set their expectations too high in the short run, 3Com's results were not good enough, which sent the stock down about 4% at one point on the day after 3Com's report (though it did manage to close up 0.5%).
Beijing bling?
In fact, there's really nothing in the short run to get excited about. But to that I say, who cares? If one holds a longer-term horizon, the results of 3Com's joint venture with Chinese telecom powerhouse Huawei were great: Revenues rose $145 million (up 66% on the year), with profits of $18 million. For me, this is the main reason to be interested in 3Com. Were it not for the chance of a play on China, via an American company, I wouldn't even care about 3Com right now. Its GDP-sensitivity is something that I find a negative in this environment.
As for how cheap 3Com is, there are various ways to approach the issue of valuation. Here's one: First of all, there's $2 a share in net cash. So, with the stock at roughly $5, that means 3Com's entire enterprise is being valued at $3 a share (assuming some way to return the cash back to investors, which is often a theoretical exercise). Nonetheless, if you just annualize the revenue and profits from the Huawei venture, you get revenue of $600 million and profit of $72 million.
If you say that 3Com's price-earnings multiple should be half the company's growth rate, i.e., about 30 times earnings, then the Huawei venture works out to be roughly $3 per 3Com share. At that multiple, you're getting the other parts of the 3Com business for free.
Calculated COMeliness
Now, I'm not saying that 30 times is the right multiple. Mr. Market might pick a higher or lower one, though I bet he'd probably opt for the former. (On the other hand, I would probably not purchase COMS at the valuation the market might set.) In any case, we could approach the valuation process in other ways and convince ourselves that 3Com, as presently constructed, is worth a lot more.
Of course, one problem with value propositions like this: The stocks often trade at a discount to the "sum of the parts" until a meaningful catalyst comes along. However, my concern has been in making sure that I have a margin of safety. After all, this is the networking business. As one could see from the company's recent conference call (ditto the results of other companies in this and related areas), business overall just isn't that great, Wall Street IT-spending hype notwithstanding.
On the other hand, as 3Com's new CEO said repeatedly on the call, his focus is profitability, not just growth. That's good news, as is the fact that he refused to give "guidance" until he has a better handle on the business. Guidance, by my reckoning, too often smacks of financial engineering.
Fetching, in the fullness of time
For folks with some patience, 3Com is unfolding about as expected, to potentially slightly better than expected. Of course, fast-money types obviously have no interest in ideas such as this. They'll be far more interested in the stock after it's doubled or tripled somewhere down the road, when 3Com could become a momentum stock like Google. Meanwhile, I am content to sit back and wait.
Bill Fleckenstein is president of Fleckenstein Capital, which manages a hedge fund based in Seattle. He also writes a daily "Market Rap" column on his Fleckenstein Capital site. His investment positions can change at any time. Under no circumstances does the information in this column represent a recommendation to buy, sell or hold any security. The views and opinions expressed in Bill Fleckenstein's columns are his own and not necessarily those of CNBC or MSN Money. At the time of publication, Bill Fleckenstein was long Newmont Mining, Pan American Silver and 3Com.
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