Zachariah, Zweig & Cyclical Commodity Investing

Tuesday, Dec 25 2012 by

I came across this curious article on Gurufocus where Josh Zachariah rips into Jason Zweig, which piqued my curiousity. The article was written on Sep 19, 2011, so we now have the benefit of hindsight to tell us who was right, and who was wrong.

Zweig came up with the headline “Is Gold Cheap? Who Knows? But Gold Mining Stocks Are”. Zachariah talks a lot of sense:

While denying any ability in valuing gold he argues gold companies are cheap at a P/E of 14.

Coming from the editor of the most recent edition of “The Intelligent Investor” I found this logic abominable. In today’s market a P/E of 14 is not even that impressive. Walmart sells for 11 and Wells Fargo at just over 9, so by his same logic those companies must be steals.

One of the companies Zweig mentioned was Barrick Gold (ABX), and it is currently trading at a price to earnings of around 14 or right around the average of the S&P 500 index. On further inspection of the company you will see some particular trends which don’t seem favorable. The first being operating and net margins in 2010 were the highest in 12 years and likely farther yet as I only went back to 1999 figures.

Emphasis is mine.

Zachariah certainly has a point. Historically high operating margins in a sector that is notoriously cyclical where the underlying commodity is at record highs does not seem to be a good opportunity for investment, especially when the company does not appear to be on a cheap valuation. I may not be the best investor in the world, but even I’ve worked out that the price at which a company can sell its wares is kinda relevant to the profit it is going to make. Zachariah discloses that he was long WFC (Well Fargo).

So, what does 20/20 hindsight tell us? Well, if you had put money into an S&P 500 index fund a year ago, you’d be up 13.0%. If you had followed Zachariah into WFC, you’d be up even more, at 24.1%. No points for guessing what comes next … if you’d invested in ABX a year ago, you’d be down 27.5%.

I think it’s fairly safe to safe that Zachariah makes Zweig look a bit of an idiot.

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About Mark Carter

Mark Carter

I am a private investor living in Scotland. I am a computer programmer by trade.


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