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Gold Stock and Economic Headlines

And now one brief recommendation. It’s a gold stock, Freeport McMoRan (FCX). Freeport owns the Grasberg open pit mine in Indonesia, which is not only the world’s richest gold mine but also the world’s third-largest copper mine. And it acquired Phelps Dodge earlier this year, making it the largest publicly traded copper company in the world.

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Also, see my gold stock recommendation later in this issue.


The lead story in Wednesday’s Boston Globe (owned by the New York Times), warned, “Economists Predict Slow Growth Through 2011 for Massachusetts and New England.” The story that followed explained that according to Moody’s, New England’s growth is expected to average just 2.2% over the next five years, compared to 2.7% in the rest of the country. In 2004, according to the group, our growth was 4.0%. Back in May, the group projected growth of 2.6%. And now they’re projecting 2.2%, in effect saying that just six months ago they were wrong.

Details from the article include the expectation that home prices will bottom next summer, the fact that our wages are 22% above the national average, and the glaringly obvious statement that the price of oil remains an unpredictable wild card. In short, it was a fairly gloomy and fairly useless report.

But right next to it, in slightly smaller type, was the headline, “In turnaround, Dow gains 319,” followed by the “explanation” that upbeat reports from Goldman-Sachs and Wal-Mart had “brightened the economic outlook.”

Now, I used to believe that if it was in print, it was true. But in recent years I’ve wised up a bit; now I believe that if it’s in print, the writer at least believes it’s true ... unless he doesn’t know and he’s just trying to meet a deadline ... or unless he’s actually lying to achieve an ulterior motive.

Does this headline-writer really think that reports from a couple of companies were the main reason for the market strength? Does she not recognize that a higher-probability explanation for the strength is that the Dow had plummeted 7% over the previous eight trading days, making it oversold in the short-term and thus ripe for a bounce?

Does she appreciate the infinite complexity of the factors that actually go into the market’s movements every day? Finally, did anyone in layout at the Globe note the conflicting messages sent by these two economic headlines?

I don’t know. What I do know is that as hard as it is to predict the future of the economy, it’s fruitless to use those predictions to advantage in the stock market.

Our decades of experience has proven convincingly that the best guide to the market’s future is the behavior of the market itself. Economic headlines can be misleading. Trends, once in effect, tend to stay in effect longer than most investors anticipate. Stocks that are overbought tend to fall back to their trendlines. And stocks that are oversold tend to bounce back to their trendlines, just as the market did Tuesday with its 319-point advance.

Finally, diverging markets tend to bring trouble. We’ve been watching the divergence build in this year’s market since the first day of June, when the Advance-Decline Line of the NYSE peaked. Since then, the generals (Apple, Google, Research in Motion, Intuitive Surgical) have been marching farther and farther ahead of their supporting troops, and more and more stragglers have fallen out of formation.

First we saw the mortgage companies get taken out, then the homebuilders, then the banks, and then a wide swath of stocks. But still the generals kept marching. And it wasn’t until last week that their line finally crumbled. Now the troops are in tatters. There is no leadership. There is no support.

I look at the list of stocks on the NYSE hitting new highs and what do I see? A lot of low-risk income-oriented investments warrants and preferred stocks. I see Berkshire Hathaway, which is perennially attractive to value investors. And I see a couple of names that interest me just a little.

One is Owens Illinois (OI), which earned a spot in Cabot Top Ten earlier this year and is still chugging along. Its business, manufacturing glass and other containers, is prosaic, but its chart and numbers are impressive thanks to a great turnaround implemented by management.

The other is Dolby Labs (DLB), which beat analysts’ estimates when it released earnings last week. Dolby, of course, is on the technology side of the entertainment business. For over four decades it’s been making our music sound better, at home, in the car and in the theater. It recently announced the acquisition of Coding Technologies, a Swedish company with expertise in audio compression technologies that will prove valuable in delivering high-quality audio over low-bandwidth networks. And it’s now in the video business, too; the movie Beowulf, being released in theatres tomorrow, will feature Dolby 3D technology. In short, the company has a good long-term growth story.

Both companies clearly have managements that are making smart moves to improve their businesses, and I would take a keener interest in them (especially Dolby) in a strong bull market. But it’s a rare stock that can keep on marching ahead when the generals and their supporting forces lie scattered about the battlefield, so I don’t recommend pursuing them at present.

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I do, however, want to talk about Lululemon Athletica (LULU), which was the subject of a revealing story on the front page of Wednesday’s business section of the New York Times. In short, it appears the company, which exudes an aura of purity, is guilty of misrepresentation.

But first a little background.

Lululemon is a hot young clothing company that’s growing by leaps and bounds by targeting the market for comfortable yoga-inspired clothing.

Now, I’ve seen a lot of clothing companies come and go over the years; fashion is a fickle mistress. But after studying Lululemon for a while I came to like it. I concluded that it’s got great growth potential, if management can continue to make the right decisions. And this week they have an opportunity to prove what they’re made of.

The company, based in Vancouver, British Columbia, was founded in 1998. In 2003 annual revenues topped $5 million, and in the years that followed they grew to $18 million, $41 million, $84 million and $149 million. That’s impressive growth.

The most recent quarter saw revenues grow 80% to $58.7 million, while earnings jumped 133% to $0.07 per share ... great numbers by any standard. Profit margins were a plump 8.7%, great for an apparel company.

The firm owns over 80 stores and franchises a couple dozen more. The majority of revenues are from Canada, but the U.S. market is being tapped fast; the company has 40 stores in 17 states already and is opening new stores rapidly. There’s a store opening in the Dallas Galleria on November 21 and one in Union Square, Manhattan on November 23.

But Lululemon is more than clothes, just as Whole Foods is more than food. When you buy Lululemon, you get to feel like part of a healthy community. At the core is the company Manifesto, which includes statements like “Dance, sing, floss and travel.” “Friends are more important than money.” and “Your outlook on life is a direct reflection of how much you like yourself.”

And behind that Manifesto is the spirit of founder Dennis “Chip” Wilson, who’s now Chairman of the Board and Chief Product Designer. Of course, he’s also a skilled reader of trends and an excellent marketer.

Consider the company name; what does it mean? Nothing. It was invented to appeal to the Japanese market, which had been a major market for his former clothing business. Because the letter “L” does not exist in Japanese phonetics, the presence of three L’s” in the name makes it “innately North American and authentic.”

And what of the clothes?

First, they’re comfortable, appropriate for yoga, jogging, or sitting in Starbucks with a mocha latte. They have flat seams, panels, and gussets, so they fit well. And they’re pre-shrunk.

Most of the company’s clothes are made from Luon, a combination of nylon and Lycra that has a matte appearance and is comfortable and quick-drying.

Some are made of Silverescent, which integrates silver yarn into polyester fabric, making it anti-static, anti-bacterial and anti-odor.

And then there’s Vitasea, a blend of cotton, Lycra and a seaweed- compound. Lululemon claims Vitasea is softer than cotton, functions more “sustainably,” and also prevents irritation.

But Wednesday’s story (likely triggered by a tip from a short-seller) reveals that Vitasea has no seaweed in it! Instead of 24%, as its tag claimed, a shirt tested by the Times had zero percent seaweed! A test on a second garment similarly labeled revealed the same total absence of seaweed.

When questioned, the company said it had not tested the fabric itself, but trusted the claims of its supplier, a German company named Seacell that uses seaweed harvested from the coast of Ireland.

Manufacturing of Lululemon’s clothes, by the way, takes place in Canada, the United States, China, Israel, Taiwan, India, Thailand and Indonesia.

My first thought upon reading the story was that it echoed the scandal that found Chinese toys to be covered with lead paint ... except that lack of seaweed on your clothes won’t kill you ... and that the clothes are undoubtedly soft, regardless of what’s in them ... and that for some consumers, seaweed may actually be a turn-off.

But what I’m really looking for from the company is more of a reaction; a commitment from Chip himself to get to the bottom of the issue and to prevent future occurrences would be a good start. Lacking that, but still hoping it’s forthcoming, I look to the stock for guidance.

How badly did the stock react to this high-profile bombshell? Let’s check the chart.

LULU came public July 30 at 18 and finished its first day of trading at 30. Seven trading days later it topped out at 39, and then spent six weeks working up the strength to break through that level. And once it did, it ran all the way to 61, peaking on October 23 along with the Dow.

That was followed by a decline to a low of 37 last Thursday. On Friday and Monday it closed at 40. Monday’s market bounce bumped it up to 44. And Wednesday, the “scandal” pushed it all the way back down to ... 40.

To me, this is quite impressive behavior. It tells me all the sellers had already sold. It tells me it’ll take a bigger scandal than a lack of seaweed to sink this stock. And it tells me that any remaining shorts should think about covering now. I’d rather be on the long side of a company that’s growing this fast than the short side.

Of course, I’d also prefer the return of a strong, cohesive bull market ... but I know I’ll have to wait for it. The big question for investors in LULU now, though, is how management will handle this issue.


And now one brief recommendation.

It’s a gold stock, Freeport McMoRan (FCX).

Freeport owns the Grasberg open pit mine in Indonesia, which is not only the world’s richest gold mine but also the world’s third-largest copper mine. And it acquired Phelps Dodge earlier this year, making it the largest publicly traded copper company in the world.

We like gold stock because gold companies today are in uptrends after breaking free from long, tedious consolidations earlier this year; a number have appeared in Cabot Top Ten Report in recent weeks. And I like Freeport in particular because it passes a screen I call “Robot Value.” I copied the parameters for this screen from the American Association of Individual Investors some years ago, and I run it whenever times get tough in the market, in a search for low- risk investments.

Robot Value basically finds big companies that have low debt and are cheap. On this count, the standout statistic for FCX today is its PE ratio of 10, rather impressive considering that earnings growth in the past three quarters, influenced by both the acquisition and the increased price of gold, has been 82%, 104% and 46%.

And then there’s the chart, which has just pulled back from 120 to 100, where it’s found decent support. I think this gold stock looks rather attractive right here.


Editor’s Note:

Freeport will not be followed up here, but other gold companies have been recommended in Cabot Top Ten Report in recent weeks and those are always followed up until we recommend selling. Edited by Mike Cintolo, Top Ten is a great source of new stock ideas for both investors and traders.

Recent successes include:

Baidu, up 178% in five months DryShips, up 96% in three months First Solar, up 246% in eight months

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Yours in pursuit of wisdom and wealth,

Timothy Lutts
Cabot Wealth Advisory

Timothy Lutts is Chairman Emeritus of Cabot Wealth Network, leading a dedicated team of professionals who serve individual investors with high-quality investment advice based on time-tested Cabot systems.