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Sunday, November 11, 2012

Portfolio allocations

Time to put money where the mouth is.

Today it is November 11, 2012 and here are some indicators on the economic health of the world, how they will be affected the next 2-3 years by the ongoing QE 3 and why. 

Apple stock: USD 547 per share. Short, 50% of capital at risk.
Google stock: USD 663 per share. Long, 50% of capital at risk (balancing Apple short position).

Bank of America stock: USD 9.43 per share. Long, 50% of capital at risk.
Physical gold: USD 1735/ ounce. Long, 50% of capital at risk.

Note that the total sum of the portfolio weights are 100%.


Apple: Inflation will increase production cost faster than Apple can raise prices, putting pressure on margins. Also, Apple's applications are becoming commoditized by competition and iOS will never (ever) evolve to become the industry standard (such as Windows has been for PC) as Apple is making the mistake of limiting it to own devices only.

Google: The company is service based (excluding Motorola) and can thus easily adjust prices to match its cost base in a high inflation scenario. From a fundamental point of view, the company is well positioned to gain exposure to fast growing service segments such as iCloud services and is in the position to cannibalize the business models of Facebook, Linked-in, PayPal, Skype and Amazon, through interaction/cross sell to its Gmail user base (the largest/ most popular web-based e-mail application in the world). Further spread of the Android operating system (penetrating increasingly cheaper devices and alternative applications, such as TVs, MP3 players, car stereos, digital watches etc) will provide additional channels for its advertising business and boost income from the Google Play store. It also has proven to have the ability to compete in the hardware segment through clever partnering - Nexus 7 and Nexus 4 are currently the best value for money buys within 7' tablets and 4' smartphones, respectively.

Bank of America: A bank is a service intermediary. It can easily mitigate higher costs (e.g. borrowing interest rates) by raising prices (lending interest rates). It is sensitive to opex increases due to high cost/income ratio, but in a high inflation scenario, salaries will grow slower than income as most of the inflationary pressure is created outside the domestic economy through commodity price increases. The banks balance sheet will increase faster than the money supply, as the velocity of money picks up when consumers start borrowing again, expecting further prices increases in real assets. Furthermore, BoA is one of the largest banks in America, and size matters in banking, due to huge synergies in the utilization of IT systems, diversification of risk and corresponding lower funding cost. Bank of America is trading at a Price to Book ratio of around 0.45. A fairly valued large bank should be trading around 1.2-1.5.

Physical gold: QE 3 is primarily creating inflation in countries that have pegged their currencies to the USD, and only secondary in the US, due to continued surplus supply in the labor market (8% unemployment is still above the 5-7% equilibrium unemployment rate). Some of these countries (India and China in particular, together with more than 40% of global gold demand) have long traditions for saving in gold. As incomes continue to increase in China, India, Brazil, SE Asia, etc, so will the long-term demand for gold in these countries.