Cyclical Dilemma!

Not many people can claim to have solved what I call the cyclical stocks’ dilemma. If market is a mystery, these stocks are right up at the top for exhibiting wild gyrations most investors find impossible to unravel.

Let’s look at the current market rally in metals. This began sometime late last year when after hitting decadal lows, metal prices, both ferrous and non-ferrous began to appreciate sharply in anticipation of the global unlocking. Add to that regular China stories, and some environmental concerns related to pollution and global warming and you have the birth of a new commodity bull run. This later leads itself into what we are hearing as the Metal Super Cycle. Copper lead the rally, duly supported by Steel and Iron ore while Aluminium has only recently joined the party. Price of related stocks began to climb up at a rapid pace and you have Hindalco, JSW and TataSteel hitting life highs while literally junk stocks like HindCopper shooting through the roof.

So far so good. What happened last week is critical to our discussion today. Out of nowhere, stocks went down 10-15% in two days and associated paper wealth shrunk considerably. They have made a comeback today but you never know if the party is over or if it was just a minor blip. This reminds us of the folly of extrapolating recent rally over the next two-three years when every expert sounds bullish and brokerages run over each other to raise price targets and experts line up on TV to sing paean to metal counters as the land of honey and milk. We, at this point can only speculate of future. This is the nature of the beast. When they fall, there is no bottom.

A well run company like NALCO, which is a rarity in metal pack to be debt free, was trading at .5 times book and nobody cared. It was available for 30rs not until too long ago and made significant profits year in and out. Suddenly, the stock shoots to 75 and it’s the prodigal son. I’m lucky to have been contrarion enough to buy last year that I have made some money in it. However, there is no sure profits here. You can’t hold it for five years assuming it will go up steadily. It may go up to 140 and fall back to 30 in a matter of a year or two.

So this is what I have learnt from this trade. Buy cyclicals when they are hated, booed and ignored. Like last year ONGC was available at 60rs which was hardly 3x earnings and .4x book. It is still much below the fair value but is up 70% in a year. And remember, you are in this game to make good 15-18% a year on capital because if you can do that for 15-20 years, you will be a very rich person. So if you get an opportunity to make almost double the money in one-two years, don’t let go of it.

However, please don’t be greedy and less, smart. Don’t fool yourself that you can sell right at the top or just on the day when market turns. When the price turns, it goes down so quickly that you can’t sell at any price. NALCO went from 82 to 69 in two days and you just couldn’t blink an eyelid.

Going forward, I will be less greedy and try to steer clear of them. The urge to make a quick, sure double or triple is a big temptation to resist. It’s the perfect Biryani you have to eat. However, you miss a beat and the profits evaporate quickly. You didn’t want to sell it at 80 because you were sure it will go to 90. Now you want to sell it at 80 but the price is 75 so you hold it out. Two weeks later, you are dying to sell it at 70 but it has gone below 60. And you finally end up selling it at 55 in despair, even after making good 30% on your investment because you could have made much more. This, my friends, is the dilemma.

Nobody wants to make 15% in a rising bull market because you’ll look like a fool. You want to own the latest fad, most rising stocks feted on Twitter and amongst your friends, the ones you read in newspapers and in which your neighbours have made money. You know doing the same might be risky, but who cares, Risk hai to Ishq hai, right?

Some of you do it out of ignorance, some of impunity. The poor retail guy will only burn his hand once in a while and be twice shy. The smarter chap living off the edge, on leverage is the one who will double the money on 10x leverage, and then lose everything on 20x leverage. This can be extremely hazardous to your financial health. Anyone who has been in this market for twenty years, without burning his capital much, even at a very low rate of average return is a rich man. This is the magic of compounding. If you can double the money every five years, over 25 years it goes 32 times. And assuming you also reinvent dividends and add money on the way , you can end up north of 100x in a lifetime of 30 years in this market. This is the boring way to get rich. You won’t be feted amongst your friends, or on TV or on Twitter.

The biggest hurdle to financial wellbeing is the hurry to get rich quick. Nobody wants to get rich in twenty years, but in twenty months or even weeks. That doesn’t happen anywhere. People selling virtues of cryptocurrency aren’t true believers, but true gamblers. They don’t believe that this has any value or can replace fiat currency or anything. All they care is that it goes up 10x in a month and want to partake some of the spoils. And since I don’t participate in the frenzy, I am labelled as too risk-averse. Maybe I am, perhaps.

I have realised the underlying volatility of cyclical stocks is too much to handle and now that I have made some money, it’s best take profits home and reinvest into the themes I truly believe can work out in future. Like I said, whether this is the top or not will only be known in the time to come. Till then, take care of your capital. You don’t know if it indeed, was the top. PS: Bitcoin is also down 30% from its top. Whether or not if it has peaked, we don’t know. But I am sure most of those investing don’t care, anyways.