Correction brings opportunities in resource sector

The resource sector is getting slammed today on account of a marginally higher dollar, and one dissenting Fed member (Bullard) jawboning an April rate hike (conceivably to test the market’s reaction).

In all likelihood, given that the Fed has all but lost its credibility and certainly doesn’t want to be credited with causing deflation, a rate hike will not happen in April.  In fact, if anything I expect more dovish language on account of a deteriorating domestic housing market, more global economic uncertainty and the fact that we are right in the midst of election season (and the Fed seems to have more of a democratic bias — perhaps because many republicans are openly hostile toward the Fed).

My thought is that Bullard’s bluff will be called. That means the lower prices I am seeing now across the resource sector could be a wonderful opportunity to allocate capital at a discount.

Stay nimble.

Negative interest rates, positive investment returns?

I wrote in January that it was time to look at the resource sector. Since then energy, materials and precious metals producers have provided double digit returns. And this is likely only the beginning.

Negative rates are the new normal.

Major changes are occurring in the global picture. Changes that may appear to be disorienting.  Such as today’s ECB rate cut and QE extension causing a massive near 2% rally in the Euro, defying all expectations.

Or the Bank of Japan’s negative interest rate program boosting the Yen.

This may be a sign of something much more critical to resource sector stocks: a beginning of the end for the US dollar rally.

I wrote last year that the US dollar rally was stalling. Since then the dollar has stalled, moving up and down, but having a very hard time making a decisive continuation of its short term uptrend — or its long term downtrend.  Instead it has been consolidating with a more downward bias as of late.

This to me is suggestive that the US dollar rally is in a phase where the next trend is being decided by the conviction of buyers and sellers and the global economic picture as it changes.  And it is changing — rapidly.

There is no doubt that the US economy has made some progress since the depths of the crisis in 2008-2009, but it is not the level of progress that the stock market would suggest or that the unemployment rate seems to portend.

Instead we’ve enjoyed a very slow, very weak recovery that has mostly created part time, low paying jobs. And this is not as much of a political issue as it is a monetary policy issue.

QE, low interest rates and bail outs have transferred wealth from the working class, and shrinking middle class to the wealthy.

This actually hurts the economy. Slowing consumption, reducing confidence and shrinking the job market. Reality is setting in. Federal Reserve policy makers seem to be realizing that their hawkish hopes of hiking interest rates may be just that. We may even see negative interest rates before we see a 1% Federal Reserve interest rate again.

Such a development is very positive for those traditional inflation hedges.  Which is why I will continue to circle various components of the resource sector in pursuit of misunderstood or undervalued companies which could be valuable investments for the long term.

Now is the time to look at the resource sector

The streets are red with the blood of disemboweled investors. Just the sort of situation that is ripe with opportunity. When emotions run high logic is a distant second.

What’s wrong with this picture?

Enormous allocations of capital have gone in to a variety of companies, including social media, discretionary technology and biotechnology that are speculative at best. Yet they have achieved lofty valuations as money rushes anywhere it may find a return.

Meanwhile, companies in the real world that have viable businesses  are languishing in the current commodity bear market.  Many trading at attractive valuations. What’s the deal?

Now is the time to look at the resource sector.

The backwards logic of QE’s supposed wealth effect

The Federal Reserve has recently admitted, through various policy speeches and interviews, that quantitative easing’s primary goal was to foster a wealth effect by raising asset prices across the board.

If that’s true, then why did the middle class largely evaporate over the same period?  Because the middle class does not own large amounts of financial assets.

Numbers don’t lie

Income inequality and wealth inequality are significant issues. The problem is growing and will continue to do so because the monetary policies enacted thus far have exacerbated the underlying imbalances in the economy.  Growing the wealth of the wealthy at the expense of the rest of the population is not only counterproductive, it’s actually dangerous.

The primary driver of US economic activity is consumption.  That means that a prosperous middle class is critical to a flourishing US economy.  Spenders that have an increased sense of wealth and rising incomes will buy larger homes, make more discretionary purchases, be better equipped to support larger families and ultimately that adds to our GDP.

Economic sanity must be restored

Favoring the wealthy and large corporations has created the problems that our economy will face in the future.  Adding to that, the enormous student debt owed by today’s generation of new entrants to a workforce with less high paying jobs will significantly hinder their ability to buy a home, car or make large discretionary purchases.  Thus robbing future demand from the economy.

This is a significant headwind for the US economy as we move forward in to a future that has been defined by the actions of today.  The only means of reaching an escape velocity whereby the middle class can thrive again is to re-examine the current economic paradigm with a focus on the future.  And I don’t mean in terms of 4 years or the next election cycle.

We can decide our destiny

The future of our country can be a wonderful one should we so choose to exert the effort necessary to make it so.  But that will mean difficult choices about spending priorities, it will mean forgiving large amounts of student debt and favoring the individual over the interests of the corporation (as a change).  It will mean bringing back regulation that strengthens oversight of Wall Street and banks (Glass-Steagall would be a good start).

Most importantly, though, we need to focus on our country.  Minimizing participation in global conflict and putting forward programs to rebuild our nation’s infrastructure.  Our roads, trains, power lines, water pipes and broadband delivery systems can all use a massive investment to bring the US back to being a global leader. A position we have earned, but have failed to maintain.

Seesaw market creates opportunities in volatility

There is a lot of emotion charging the market, creating exaggerated moves both up and down.  One day everything is fixed, the next everything is broken.  Manic depression wouldn’t even begin to describe the back and fourth being witnessed.

But with chaos comes opportunity.  And the opportunity here is finding beaten up, misunderstood and frankly cheap assets.  Right now the areas that seem to be most attractive are commodities, commodities companies, energy and energy companies.

The global markets are pricing in worldwide depressed demand.  Oil producers are pumping at frantic rates, more concerned about the flow of cash than the margin on each sale.  This has created a glut of energy supply — and with little demand oil prices have crashed below $30.00 to about $28.00 a barrel for West Texas Intermediate Crude (WTIC).

Consider the following opportunity: The US dollar has had a rally which induced a de facto tightening even before the US Federal Reserve raised interest rates.  As such, one can reasonably expect that the actual pace of interest rate tightening, with the backdrop of a softening US economy, will likely be subdued.

Markets have priced in a more aggressive interest rate hiking cycle, which is putting pressure on everything that’s priced in dollars.  Even stocks.

I think that we’re getting ahead of ourselves here.  The Federal Reserve is unlikely to let this situation turn in to a full blown 2008 panic again, unless there is a desire to bring back all the calls to audit the Fed and the political upheaval that protests and social unrest would bring.  Instead, especially given that it’s a critical election year, I believe the Fed will tap the breaks and ease off the gas, leaving interest rates at 0.25% and possibly cutting them to negative levels if the global slowdown increases in momentum.

Energy falls, stocks mauled

There’s a deflationary wind that’s been blowing this way since late 2014. It’s been strengthening since the August 24th intraday market crash in the US. And now I think it is really picking up.

What comes of this brewing storm has yet to be realized in equity markets, but energy prices (and the companies vulnerable to lower profits) have tumbled. As have the prices of mining companies and the materials they extract.

The weakness in China coupled with a slowing US and EU consumer portends to a long-term deflationary headwind.

And don’t look now, but the Japanese Nikkei market seems to be crashing…

Gold’s 2015 performance in various currencies (chart)

The Brazilian Real was walloped and the dollar was clearly a standout winner. Gold’s relative underperformance shows against US dollars that the US dollar is still seen as a safe haven currency.

Until that changes gold will underperform as measured by US dollars. I think we’re closer a that point in time when we see positive price action then we were a year ago, but I can’t say for certain if the markets will agree until stocks move in to a bear market.

As seen in the start of 2016, when stocks were out of favor, gold caught a bid and moved higher each day stocks were sold off. Now that stocks are catching a bid, gold is selling off.

Whether or not 2016 is the year that stocks enter a bear market remains in question. I am inclined to think that we have only seen a prelude for the downside in stocks that could occur this year.

An open letter to Barracuda Networks (CUDA) management

I am a recent investor in Barracuda Networks (CUDA).  Needless to say the earnings miss and subsequent market reaction between Thursday evening and market close on Friday was quite disconcerting.

During the conference call on Thursday, January 7th, Barracuda Networks CEO BJ Jenkins stated that a ‘faster than expected‘ migration to hybrid and cloud-based solutions was a catalyst for weaker than expected billings.

The problems, from my standpoint as an IT veteran and tech investor, seem to be in planning and execution.  There are a number of shortcomings which I can see that may give pause to Barracuda’s long term growth prospects:

1: Employee retention, compensation and work environment morale complaints are considerably higher than the industry average.  This leads one to believe that productivity would also be impacted:

2: Product prices that may scare away small businesses.  Thus pushing them in to subscription-based cloud offerings as an alternative.  I have dealt with this problem first hand with many of my clients who are inclined to move from on-site equipment in to cloud-based solutions.

Something has to give, whether it’s the core product price or the energize update price.  A discount would incentivize higher sales.

3: Slow, inexperienced front line support.  From an IT consultant who works with Barracuda Networks products and support regularly, I think that there is room for improvement.  I recently called in Barracuda Networks for support on a VPN product.  The first person I spoke to clearly had no technical knowledge whatsoever.  This, combined with the long hold time to reach an actual technician was a less than optimal customer experience.  Fortunately the technician who eventually came on the line was helpful.

4: Lack of trust.  I cannot emphasize this enough.  In the wake of all of the data breaches, espionage and with Barracuda Networks trying to gain a larger foothold in cybersecurity, trust has to be a number one priority.  Some years ago a remote backdoor was discovered in Barracuda Networks products and the management effectively stated it was not a big deal.

From an IT consultant’s perspective that’s a very, very big deal because we have a moral obligation to warn our customers against using such backdoored products.  After all, backdoors rarely stay secret for long.  My advice is to get ahead of the trust issue.  Ensure the public knows that Barracuda Networks would never install any backdoors, remote management or other sorts of potential security vulnerabilities.

Believe it or not in my network of IT contacts, there are many that still to this day refuse to buy or endorse anything Barracuda-related because of the issue not being publicly addressed to satisfy their quandaries.

5: We need true, industry disrupting innovation.  Not incremental improvement.  A renewed focus on virtualization, cybersecurity, threat detection and mitigation is path forward that will be greeted by the highest revenues.  IT spending has plateaued and in all likelihood so has the US equity market.

What will make Barracuda Networks stand apart from its peers is innovative, unique and cost effective solutions to the growing data breach epidemic, keeping virtualized environments secured from attack, working on automated threat mitigation strategies and showing these technologies as Barracuda Networks’ core focus for 2016.

In closing, I hope that this information is found to be constructive. I am cautiously optimistic that Barracuda Networks can turn itself around and rebuild value lost to investors.  It will take a lot of hard work, ambition and some calculated risk taking to reach that point.  And once there, even more to maintain it.

This message was sent to Adam Carson, VP of Finance and Investor Relations at Barracuda on January 9th, 2016.

China halts, dollar faults, buyers bolt

Storms are brewing. The wind will carry them from the east to the west. Be careful out there.

Thursday will be another difficult day in stocks and risky credit markets. The dollar is no longer being seen as much of a safe haven. Gold is catching a bid, but for how long?