This Week’s Commentary – December 29, 2007 – JDH’s Stupid Mistakes of 2007

Welcome to the year end edition of my weekly commentary, titled “JDH’s Stupid Mistakes of 2007”.

(I know, I know. I should never admit to my mistakes. I should give myself some fancy name, like “The Original Uranium Bug”, and I should print charts of stocks on the front page saying UP 16,470% to lead readers to believe that the stock is up 16,470% since I recommended it, even though, according to my own summary on the last page of my newsletter the stock is only up 402% since I recommended it three and a half years ago, but I digress……).

I have no problem admitting my mistakes. First, the point of this site is to allow me to put my thoughts out there, in real time each week, so that I can look back at what I was feeling and thinking at the time. By analyzing my thoughts, I can learn from my mistakes.

Second, I don’t have to worry about selling newsletter subscriptions. Every week anyone can read this commentary for free (yes, I know, you get what you pay for), and anyone can post their thoughts on the Buy High Sell Higher Forum. I don’t have to worry that you will stop paying for your subscription because I’m not tooting my own horn. The only revenue generated from this site is from readers clicking on the ads on the blog and the forum, which amounts to virtually nothing every month; the revenue almost pays for the hosting fees for the site. That’s fine, I’m not here to make money from this site. I’m here to learn from my mistakes, and pick up ideas and perspectives from each of you along the way.

So, here’s our most prolific poster on the Forum, David S. Lane’s perspective on 2007 (you can read his full post from December 23 here):

The usual uranium timing was taken over my the overall stock market timing in 2007.

First we had the big correction in early March.
The overall market tanked and took uranium with it.
Uranium wasn’t supposed to be down in March, one of its best months of the year.
The market snapped back and so did our stocks. But if the market didn’t snap back, our stocks wouldn’t have either in my belief based on what happened in the rest of 2007.
[This year was different.]

Yes, uranium pulled back in May as usual.

But then when the market swooned in July and August, it took the uraniums with them again. But August is normally one of the three or four best months of the year for uraniums.
[This year was different.]

And then uraniums recovered in October really, really well with the overall market.
October is usually next to May, the second worst month of the year for uraniums.
[This year was different.]

And now we get November.
Arguably the best month of the year for uranium stocks. Maybe a close second to March.
This November (along with December) was my worst month for uraniums in 4 years. December is also normally a strong month and was awful coming into Wednesday morning.
[This year was different.]

People only invest wildly in speculative stocks when money is easy to come by and the markets are roaring. When money is hard to come by, and credit is tight, people sell their most speculative stocks and move to “safer” ones and use the extra cash from the sales to cover margin calls. Deflation and credit tightening is the kryptonite of our micro-cap strategy.

So, until the overall markets get back on their feet, and the credit crisis is over, and the markets are no longer concerned with a recession, then, and only then will uranium stocks start acting in their normal seasonal patterns.

So, to summarize, 2007 was different. The “normal” patterns from previous years did not apply in 2007. I think there were two reasons for that.

First, the uranium market, finally, was “on the radar” of many investors and speculators. They started buying, and drove the market up. Way up. Too far up. If a rocket goes up fast, it will fall back faster, and that’s what happened in 2007.

Second, the sub-prime credit mess had a series negative impact on the market. In a rush to liquidity, you sell whatever you can get your hands on, and that includes resource stocks, even when they appear to be in a multi-year bull market.

Here’s another way 2007 was different: I lost money!

My last losing year was 2001, when the internet bubble burst and I lost 37.9%; it took me until September 2004 to get back to where I was at the peak in 2000.

I earned a respectable 17% in 2002, 12% in 2003, 18% in 2004, and then had two great years: 52% in 2005, and 94% in 2006. As for 2007, with one day left to go in the year, I am down 33.7%, so 2007 probably won’t be my worst year ever, but it’s not great either. (It could have been even worse; two weeks ago I was down 36.7% for the year; one week ago I was down 35.2% for the year, so I’ve picked up a few points in the last two weeks).

I have updated my Portfolio Performance page, so you can see the full chart of my portfolio performance; here’s a shorter version:

Since the title of this commentary is “JDH’s Stupid Mistakes of 2007”, what stupid mistakes can we see in this chart?

The biggest stupid mistake is not realizing that history can repeat itself.

My portfolio reached a peak in August, 2000, at the height of the dot.com boom. Rather then gradually taking money off the table as the portfolio grew, I got greedy, and paid the price. The portfolio fell, registering a loss of almost 38% in 2001.

In hindsight, there is no excuse for a portfolio falling by 38% in one year. Stocks begin to break-down, and once they do, it’s time to start selling. As the chart shows, it took me until September 2004 to get back to where I was in August 2000; that’s four wasted years. But did I learn from my mistakes in the dot.com boom? Obviously not.

The chart looks like a repeat of 2000 and 2001, doesn’t it? So much for learning from my mistakes. The all time high was reached in March, 2007, and by the end of December, 2007 the portfolio has fallen by 40% from those peaks. Obviously cash should have been taken off the table a lot sooner than it was. Obviously I didn’t learn from my previous mistakes.

However, in my own defense, while this chart proves I should have taken profits much sooner, a longer term view shows a slightly different picture. I have drawn a blue uptrend line starting at the end of 2004, and extending through the lows of 2005. The line extends right to the lows of December, 2007. If you average it out, the annual return of those three years (2005, 2006, and 2007) is around 38%. On that basis, the rates of return look pretty good.

I guess the question is this: do I want a nice steady rate of return, year after year, or am I willing to accept a great degree of volatility so that some years I can earn 94%, but other years I will lose 34%?

The answer, of course, is that I want to earn 94% every year, but that would appear to be an unrealistic goal. It would appear that a more realistic goal would be to continue to invest during bull markets, but to also take money off the table once profits exist. That is, however, easier said than done.

Take this chart, for example, of CHX.V – Cash Minerals Ltd., for the last two years:

If you had bought this stock in the summer of 2006 at 80 cents (which I didn’t), when should you sell? Obviously the correct answer was to sell at $2 on September 1, 2006, but you would need a huge amount of luck to do that.

Should you sell half when it doubles? That would be a good strategy, but of course selling at $1.60 means you left some profits on the table. And, every stock doesn’t double, so perhaps a better trigger point is some lower number? Perhaps sell 25% when you are up 50%, sell another 25% when you are up 75%?

Or perhaps you don’t sell on gains; perhaps you sell when it starts to fall. For example, sell half when the stock falls by 20%. Under that scenario you would have sold Cash Minerals at $1.60, which is 20% off the peak of $2. (Which is the same as selling on a double).

Perhaps the sell point is when the stock falls below it’s 50 day moving average, which in this case would also be around $1.60. The more conservative play would be to sell if the 200 Day Moving Average is breached, which would be at the $1.30 level in this case.

Here’s another example, DML.TO – Denison Mines Corp.:

The peak occurred on May 11, 2007 at $15.86, subsequently falling to $8.30 on August 17, 2007, a drop of almost half it’s value.

Selling at 20% off the peak would be selling at $12.69. Selling at the first breach of the 50 DMA would be selling at around $14 in April, but you would have also missed the top. Waiting for the 200 DMA to be breached would be a selling price of around $12 in July, 2007.

I’ve drawn green lines to show other indicators; there could be triggers based on the MACD, the RSI, or the Money Flow Index, but they tend to be much more volatile, and therefore less reliable.

One final example: PNP.TO – Pinetree Capital Corp., which I haven’t owned for some time now:

The peak occurred on April 13, 2007 at $14.98; the stock subsequently collapsed to $3.94 on December 14, 2007, a drop of 74%. (I wonder when Mr. Dines will tell us to sell?) 😉

Selling after it had fallen 20% from the highs would be a sale at $11.98; selling at the 50 DMA would be around $13, and waiting for the 200 DMA to be breached would be around the $9.50 area.

(For the record, the $4 level looks like a good support area, so if you wanted to buy Pinetree, now would be as good a time as any).

So, for those brave souls who have stuck with me this far, what does this mean?

It means that to avoid the stupid mistakes I made in 2007, I need some rules. Here are the rules that I propose for 2008:

First, I will keep track of the highs for each stock I own since I bought it. If it falls by more than 20% from that level, I will sell it. That way my maximum loss will be around 20%, which should help me avoid a 34% loss next year. Obviously if I was investing in less volatile blue chips I would probably set the stop loss at around 3% or 5%.

Also, this is not an actual stop loss; this is a mental stop loss. I don’t want to sell all of my stocks if some external event crashes the market for a day or two.

Second, when I have profits, I will sell using the following formula:

Stock increases 50% – sell 25% of holdings.

Stock increases 75% – sell 25% of remaining holdings.

Stock increases 100% – sell 25% of remaining holdings.

This means that if I buy 1,000 shares of a stock and it has increased by 100%, I will still own about 422 shares, and those shares will be basically free, since I have taken my original investment off the table.

So, what do you think? Is this too simplistic? I have started a discussion about this on the Buy High Sell Higher Forum, so please post your thoughts.

I will now spend the next few days with my crystal ball to figure out the plan for 2008. (Actually I’ll be spending the next few days taking my boys skating, or skiing if the weather co-operates, and my wife and I will probably sample one or two or three nice reds from the wine cellar, but for the sake of this blog, let’s pretend I will be deep in thought for the next few days).

Then, on Wednesday January 2, I’ll post my “here’s my best guess for 2008” thoughts, complete with updated performance charts and my updated portfolio.

In the meantime, help me write these posts by posting your own predictions in the 2008 Predictions section of the Buy High Sell Higher Forum, as well as helping me with the when to sell question.

Until Wednesday, thanks for reading, and Happy New Year!