Iron Clad Profits

Back on January 11th we penned a piece called ‘Fundamentals of a Market Correction’, in which we recommended shares of Genworth Financial (NYSE:GNW), then trading at $13.10, along with the corresponding sale of her February 14 call options.  We expected the total take on the trade to be 11.37% in thirty days were the stock to be assigned.

And so it was upon expiry last Friday.  GNW shares traded higher than even we expected, closing at $15.35.

Because we spoke again two weeks ago regarding re-establishing a position in Genworth, we received a number of emails inquiring to that end over the weekend.  We responded in the negative at this juncture, for two reasons: 1) the calls aren’t nearly as rich as they were when the original trade was set, and 2) the stock has already seen a significant boost, hitting new highs as late as last Thursday.  To our eyes, it appears as if the risk/reward for the trade is decidedly not as favourable as it was back after New Year’s.

Take a quick look at Genworth here:

Genworth looks bullish but a little tired here.  We suspect it may take a few weeks to consolidate.  Volumes have fallen, and there’s a pronounced divergence between the last month’s price action and RSI.  We’ll consider re-entering should the shares fall back toward $14.00.

Not a call to sell your financials by any stretch.

Our reasons behind the no-go for Genworth have nothing to do with our sense that the current bull move is over.  On the contrary, we’re fairly secure that there’s plenty more upside to come.  And we’re not alone.

Here’s a chart showing analysts’ expectations for earnings heading in to Q4:

As you can see, prior to earnings season there was tremendous confidence on the part of analysts, 73% of whom raised expectations on the stocks they cover.

That would normally be a tad too optimistic for us, particularly as we’re just exiting a recession.  But the proof is in the pudding.  Check this one out:

Nearly 70% of all stocks beat those same analysts upgraded EPS estimates.  Moreover, the outperformance ranks among the best in the last decade.

Look Here:

Top line growth also came in stronger than analysts expected.  As the chart shows, sales for better than 70% of reporting companies beat expectations.

Which is all well and good, but can it continue?

The Fed Raises Interest Rates!?

Much of the investing public is under the impression that the Federal Reserve raised interest rates last week and that this may put a damper on prospects for the stock market and, potentially, the current economic expansion.

Nothing could be less true.  What the Fed did last Thursday, in fact, was to raise the discount rate by a quarter point to 0.75%.  This is the rate it charges for overnight loans to banks in emergency situations.  It does not affect the rate consumers pay for loans or the interest rate on government issued securities.  By our reckoning, those changes stand to take place in another six to eight months – if they happen at all – and will likely entail a nominal rise of roughly the same magnitude as this one.

To sum: our take on last Thursday’s move is – meaningless.

And it looks like the bond market agrees with us.

As far as we can tell, the news of a hike in the discount rate and everything it signals for the future was met by the largest capital market on the planet with a great big yawn.  The benchmark ten year note was up by a half percent and the thirty year note by more than one full percentage point!

The much anticipated inflationary spiral and concomitant selloff in the bond market ain’t gonna happen so quick, friends.

Moreover, we see very immature signs of a rally in bond prices now in the making.  The above chart of the TNX ten year note interest rate index (which moves inversely to bond prices) shows signs of a MACD crossover that looks ready to dive below the waterline – a move that calls imminently for lower interest rates and higher prices for bonds.  We’ll be tracking this one closely.

The Broad Market is a Buy, Even if the Pullback is Incomplete

Our summary on the foregoing is that we’re still in a bull market, though there may be some broad market weakness ahead.  In forthcoming issues, we’ll be discussing how to capitalize on that prognosis with opportunities in the consumer discretionaries and the inverse precious metals ETFs.  But right now we’re going to veer into a special situation that requires just a brief introduction.

The topic is iron ore, which is considered a ‘non-tradeable’ in some quarters, because prices aren’t set in the traditional ‘open outcry’ method used by most industrial metals.  Rather, big iron ore buyers and sellers regularly meet to haggle over what prices will look like for a specified time period to come.

Currently, China is in talks with three global iron mining giants, Rio Tinto, BHP Billiton and Vale, over ore pricing for 2010.  Those three companies control roughly one third of the oceangoing trade in iron ore.  And after the better than 35% price cuts we saw in 2009, when the global economic recovery was still in question and China held the upper hand in talks, it looks like this year suppliers are going to come away the winners.

So long as there are no lasting, external shocks to the Chinese or American economies, look for iron ore to rise by as much as 20-25% this year.  Spot iron ore has already been on the rise for some ten months.

That means producers the world over should see a strong rebound in prices going forward.

The Trade

Our pick among the iron producers is Great Northern Iron Ore Properties (NYSE:GNI), a royalty trust that pays on production from the Mesabi Iron Range in northeastern Minnesota.  The yield on the shares is 11.20%, and the P/E is 9.09.  As long as the global economy is expanding, iron is a lock.  Here’s the GNI chart for the last two years:

Any break above $96 will likely lead to massive investor participation.

Charts of the Week recommends immediate purchase of GNI shares at $92.85 with a protective stop at $84.
Ore else.

With kind regards,

Hugh L. O’Haynew