Trader's Diary

June 15, 2012 7:14 pm

Shares react to EU’s sticking plaster policies

Small investors’ obsession with natural resources
David Schwartz

Many investors assume UK shares are in a downtrend due to euroland’s financial crisis and the US economic slowdown.

Our graph provides another perspective. The trend has been rising since last October’s low point. Two major rallies in the last nine months ended at increasingly higher levels. Both subsequent sell-offs ended at higher levels as well.

The new trend is probably linked to a change in investor sentiment. Investors have learnt that EU leaders typically fail to deal with a problem until it reaches crisis proportions. They then apply a temporary fix and buy time until the next crisis.

Assuming that European leaders keep reacting in the same tardy manner, there is a good chance that the recent trend – wild swings disguising a gradually rising price trend – will continue.

There are no guarantees of course. The mother of all downturns might occur if events spin out of control. But I suspect this doomsday scenario will not occur due to the financial markets. Political leaders have become quite responsive to it. Rising nervousness by fixed-income investors appears to trigger each fresh fix.

FTSE 100

Two aspects of this crisis amuse me. One is the role of the financial industry. It caused the crisis but has now become the white knight that forces political leaders to take positive action. Voter concerns about sovereignty also catch my eye. European voters demand safeguards to their sovereignty without realising that it has already been lost to the bond market.

My theory about stock market prospects is about to be put to the test. Greek elections this weekend will probably trigger screaming headlines and big price swings next week. But I anticipate that any knee-jerk rally or decline will soon end for one simple reason – the ups and downs of the euro crisis will continue for many more months with or without co-operation from Greece.

Another trend that fascinates me is the attention that small investors continue to pay to the natural resource sector. It may have been a rational choice 10 years ago when some analysts claimed a 25-year-long sector super cycle had just begun. But mining shares are down 40 per cent since mid-2007. For perspective, the rest of the FTSE 100 is down about 18 per cent.

Yet many small private investors take no notice of the facts. They obviously hope that a fresh discovery will massively boost the value of their investment. These so-called “ten-baggers” occasionally do occur. But the indices clearly prove that occasional winners are not frequent enough to counter the broad negative trend.

Small oil and gas producers have a similar profile with a few big winners outnumbered by a number of losers. The old joke about building a small fortune by starting with a large one is particularly well suited to this sector.

The problem is that expert knowledge is required to profit in this sector. But many private investors rely on gossip, not solid information. My own experience illustrates the problems that they face.

I belong to an investment club. Good food, fine wine and pleasant company help to make our meetings enjoyable. And, in case you are wondering, we occasionally make a penny or two.

Several club members are experts in the natural resource sector. One is a retired oil analyst who remains very switched-on to sector developments. Another is a mining specialist who regularly interviews chief executives and makes actual site visits. I’ll wager that few private investors have this level of expertise available to them.

We purchased shares in oil driller Amerisur Resources in December 2011. Its shares had behaved erratically before our purchase, peaking at 29p in May and bottoming at 9p a few months later. Some investors profited on the rally but others lost their shirts when the trend reversed.

Our decision to buy was well-timed. The company had just announced an oil strike. Prices rocketed by 30 per cent.

Despite these optimistic developments, I have no idea how to evaluate Amerisur’s future prospects or decide when it is time to sell. I’ll wager that most private investors are in the same boat. But I can rely on expert advice. I wonder how they will fare without this kind of specialist knowledge?

Stock market historian David Schwartz is an active short-term trader writing about his own trades

tradersdiary@ft.com

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