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May 14, 2009

Where the Big Money is Betting Big

Andrew Mickey, Q1 Publishing

For years investors have debated whether the big money is the smart money.

The basic premise is the big money (the mutual, pension, and hedge funds) will buy into a “hot” sector. And continue buying into it as long as it keeps going up. The ongoing buying pushes prices up. As a result, the big money looks like the smart money most of the time.

Just take a look at the market swings over the past decade. The big money was buying large-cap growth and technology stocks in the 90’s. For nearly a decade, the big money was the smart money. The stock market consistently rose year after year. Even the average mutual fund was returning 20% a year.

Of course, the big money isn’t always the smart money. After the tech bubble burst, the big money was decimated. The average mutual fund was getting crushed. Most were losing money between 2001 and 2003. During this time, the big money was not smart money.

Then in 2003 and 2004 the markets started to show some life again. The big money, after just taking a beating, wasn’t about to get too aggressive. The smart money, however, was spotting contrarian opportunities in oil, metals, real estate investment trusts (REITs), and emerging markets.

Over the next five years or so these sectors did exceptionally well. Year in and year out these sectors delivered staggering returns. The big money moved into these sectors. China funds and commodity funds were being opened up by the big investment management companies to meet demand from investors demanding exposure to these sectors. As a result, the big money continuing to pile in making itself and the smart money look pretty smart.  

That’s why I don’t think the big money is always the smart money. The big money is smart money most of the time, but not always. And it’s recognizing those times when the big money is the smart money and when the big money is not the smart money is the key to being a successful investor.

Right now, in two sectors at least, it appears the big money is on its way to becoming the smart money. And any investor putting money into these sectors now will look pretty smart.

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Big Money is Still Big

First though, we have to look at how big the big money really is to get an idea of how much a wave of big money buying could really do to a sector.

Right now the big money isn’t nearly as big as it was a year or two ago. The credit crunch has wiped away nearly $50 trillion of nominal wealth around the world. That’s a big loss. On the positive side though, there’s still $100 trillion in nominal wealth floating.

A lot of that is still in the hands of big money managers too. The recently released report, Worldwide Mutual Fund Asset and Flows, from Investment Company Institute’s shows it. At the end of last year there were $18.97 trillion in assets held in mutual funds around the world. That’s trillion with a “t”. About $6.5 trillion of that is in equity funds, about $3.4 trillion is in bond funds, and about $1.8 trillion is in balanced funds (which invest in both equities and bonds).

The key here is where is it going and how much is left to invest. That’s why I’m very interested in the $5.79 trillion sitting in money market funds around the world.

That’s a lot of money of money on the sidelines. And with money market funds yielding next to nothing, it will be put to “work” eventually.

There is still a lot of money sloshing around outside of mutual funds too. Hedge funds, for instance, have just under $1 trillion of capital available. And we know most of them are just looking for a new trend, idea, or thesis to jump on. Then there are exchange traded funds, private equity funds, privately managed trusts, and more.

There’s a lot of money out there and it will seek outsized returns. So far, it looks like a little bit of that money is seeing opportunity. There have been billions of dollars pumped into new issues in all sectors. Investor interest has picked up in bonds too. But a lot of the new money interest has been focused on two sectors lately: gold and biotech.

Biotech Blast-off

It’s no secret the Big Pharma is facing some big problems. For years the companies have relied on steady revenue and income streams from their blockbuster drugs. These drugs have limited, patent-protected lifespan though. Once the drugs go “off patent” the generic drug makers become overnight competitors and Big Pharma’s big margins get pinched.

This is something we’ve been covering for a while. We only witnessed the initial corrective actions though.

In “The Only Way to Make a Fortune in Healthcare” we looked at the recent surge in mergers and acquisitions among the Big Pharma companies:

We’re seeing everything thing from multi-billion dollar mega –mergers to development deals with small biotech outfits. Merck is merging with Schering-Plough. Pfizer is taking over Wyeth. Roche has signed a merger deal with Genentech. Those are just three of the largest deals. There are dozens of other deals being cut with small biotech companies. And there will be many, many more in the months ahead. It’s the only way they can survive.

In order to get this boom really going the big money has to start moving into the small biotech companies too. Lately, it looks like the big money managers are starting to take action.

In just the past few weeks, quite a few biotech companies have been able to raise more cash (see table below). They need this cash to pay for clinical trials, more research, and everything else needed to develop new drugs.


Given the situation, this is just the start of a trend. Big Pharma companies are loaded with cash and they’ll be cutting development deals. The big money sees the opportunity in biotech as well. Everything is there for a big run in biotech stocks.

The best part about biotech is the sky is the limit. This is one of the few sectors where a stock can go from pennies to $10 or $20 per share on a single announcement.  Then, as it advances a key drug through different stages, they can run higher for a long time. Once a few discoveries are made and a few people strike it big, you can bet a lot more money will follow.

Biotech is not the only sector attracting big money though. There is one other and it could have even more potential.

A Golden Opportunity

Recently gold stocks have been attracting a lot of attention. There are many reasons to like gold right now. And all the fundamentals are there to look really smart in the next three to five years.

As we looked at the other day, the sheer impact of massive government budget deficits financed by newly printed dollars has always led to inflation throughout history. Given the situation in the United States, the budget deficits looming over the horizon are even bigger. Medicare and Social Security shortfalls will only make the current record-setting budget deficits. Combine that with sharply lower economic growth resulting from increased regulation, tax hikes, and an aging population the only way for the deficits to go is up.

As a result, the value of the U.S. dollar will inevitably decline. The stark reality of the situation has led a renewed interest in gold. The interest in shares of companies which mine gold and silver has only continued to grow.

This has been going on for a few years, but now it’s really ramping up. Back in February we noted how “The Final Hurdle for Gold May Have Been Passed”:

Unprecedented sums of money have been pouring into gold in the past few months…

Just take a look at the recent money which has been put into gold companies across the board. They’re all getting new cash. Major miners looking for extra cash to fund takeovers, exploration, and mine development are getting it. Small gold companies looking for one more financing to put themselves into production are getting it too. There’s money out there for gold.

Newmont Mining (NYSE:NEM) is expecting at least $1.7 billion (or more depending on the final terms of agreement) in new cash in its coffers.

Leading the charge in putting this financing together was Citigroup, J.P. Morgan, and BMO. They’re the big money. And they (except for BMO) wouldn’t have given gold the time of day when private equity players were chasing after real estate, Chinese companies, and other “hot” sectors over the past few years.

Of course, it’s not just one big deal though…In the past few months there have been a slew of financings of gold companies. Together Yamana (NYSE:AUY), Agnico-Eagle (NYSE:AEM), and Kinross Gold (NYSE:KGC)have attracted more than $800 million in new money.

Since then, a lot more big money investors have jumped on board. Leading hedge fund managers David Einhorn and John Paulson have put hundreds of millions of dollars into gold. Other fund managers have moved in too.

For instance, Pequot Capital Management, a hedge fund with more than $4 billion in assets, recently ramped up its gold exposure by 997%. Pequot plowed more than $250 million into gold in the past few months.

Highfields Capital did too. The fund management firm, with as much as $10 billion under management, has taken a strong liking to gold. In the last few months it has bet big on gold. It has increased its gold exposure by 302% when it threw more than $150 million into gold.

There are plenty more money managers who have spotted opportunity in gold. They appear to be wading in too. Gold stocks have been doing just as well as most other sectors during this rally. With the big money buying gold, there is a lot more potential upside in gold and gold stocks.

Big Money vs. Smart Money

In the end, there are times when the big money is the smart money. There are times when the big money is terribly dumb.

The deciding factor of whether to follow the big money or start looking for contrarian opportunities comes down to your time horizon.

For the short and medium-term, it’s best to ride along with the big money. Think of the old adages like “the trend is your friend.” Right now the trend is toward healthcare (biotech specifically) and assets which offer inflation protection (gold stocks have been exceptionally possible). We’re sure to find success in the long growing trends like inflation protection and healthcare in the months and years ahead.

For really long-term money though, you look for the big contrarian calls for assets which are completely out of favor. You know, buying stuff that nobody wants.

Michigan real estate, anyone? Remember, it takes a lot of water to manufacture anything. And the Midwest is one of the only regions in the country with a lot of fresh water. Or Vietnam, which has the demographics for decades of growth ahead and yet, has one of the hardest hit economies during this downturn.

Those are topics for another day though. For now, just remember there is a time to be running with the herd and a time to go completely against it. The quickest and safest way to a true fortune is figuring out on which side to be at what time. For the short and medium term, it’s best to stick with the big money.

Good investing,

 

Andrew Mickey
Chief Investment Strategist, Q1 Publishing

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