Arjun Rudra's  Instablog

Biography:

Mr. Hui was employed by Merrill Lynch in New York City as a Relative Value and Technical Research Analyst. Before joining Merrill Lynch, Cam Hui held portfolio manager positions with Graham Capital Management LLC and Batterymarch Financial Management, Inc. Mr. Hui also held positions with Wood Gundy Inc. (now CIBC World Markets).

Mr. Hui obtained his Bachelor of Science degree (Honours) in Computer Science in 1980 at the University of British Columbia, and passed the Canadian Securities Course in 1985 and the CFA Charter in 1989.

Mr. Hui is currently semi-retired and living in Vancouver, Canada with his family. He maintains his interests in the markets and advises hedge funds and other clients as a consultant and serves on the Board of Advisors to Qwest Investment Management. Mr. Hui has presented numerous papers to quantitative discussion groups. Sample topics include: How Global are Resource Sectors; Hidden Biases in Quantitative Models; and Hedge Fund Replication.

Mr. Hui is a regular blogger and you can find him at Humble Student of the Markets

Q: Mr. Hui, you recently commented on the lack of follow through with some of the gold stock indices in relation to gold's most recent run-up to new highs. Can you please elaborate a little more on that and if possible, you’re view of gold moving forward? Also, how do you suggest investors play gold?

A: I believe that gold stocks are tactical trading vehicles and not investment vehicles, in the same way that leveraged ETFs are trading vehicles but could disappoint in the longer term. Investors seeking a leveraged play on gold should buy long dated call options on gold or GLD, the gold ETF. Investors seeking to hedge their inflation risk could just hold gold or gold like vehicles, such as Central Fund of Canada or GLD.

To read more on Mr. Hui’s thoughts on gold, I would direct you to a post his blog entitled, “Why You Shouldn’t Buy Gold Stocks”.

Q: On a broader basis, Mr. Hui, what is your call on valuations on the S&P 500 going into next year - is there room for further multiple expansion as quantitative easing continues and interest rates appear to not be going anywhere soon? How are you playing this view?

A: Let me preface my remarks by saying that no model works all the time, including valuation. Recall that as early as 1997 there were all sorts of stories flying around about how overvalued AOL or Amazon.com were (e.g.  at one point if Amazon’s sales were to be as big as Walmart they would still be overvalued) – but their stock price kept going up. I use valuation models to gain a perspective on the market and to understand context and risk.

The S&P 500 appear to be overvalued on a number of dimensions. Consider, for example, Tobin Q (Editor’s note: The Tobin’s Q ratio was devised by James Tobin of Yale University, Nobel laureate in economics, who suggested that the combined market value of all the companies in the stock market should be about equal to their replacement costs. The Q ratio is calculated as the market value of a company divided by the replacement value of the firm's assets. A low Q, between 0 and 1, implies undervalue while a high Q, over 1, implies overvalue)

(chart courtesy: Smithers and Co. )

I also see a number of other fair value estimates that are way below the current value of 1100. John Hussman believes fair value is between 672 and 810. Jeremy Grantham of GMO (AUM $US 86 billion) has a fair value estimate of 860 on the S&P 500 (click here to read more)

When I see these sorts of numbers, I see that there is a lot of downside risk in the market. History shows that when markets correct they overshoot past fair value.

In the short term, however, it doesn’t mean that the stock market necessarily goes down. My inner trader tells me that valuations and fundamentals have a way of not mattering to the market, until they do and the Tech Bubble of the late 1990’s is an example of that. We need to watch how the market reacts to news and how market internals behave.

While I have my own opinions, I have found in the past that my opinions tend to be extremely early in its calls and can’t time the market well. For market timing, I prefer to build more systematic models, such as the Inflation-Deflation Timer that I outline in my blog and in my research reports for Qwest Investment Management.

Q:  Mr. Hui, I know you closely monitor inflationary and deflationary trends in the economy, so are we currently facing inflationary or deflationary pressures, why or why not?

A: The investment conundrum for many wealth management specialists is to get the macro-economic environment right, as the inflation vs. deflation call could very well be the Call of the Decade. There is a lot of risk in that call. The two scenarios are diametrically opposed to each other. Inflation hedges (e.g. commodities) get creamed during deflationary episodes and deflation hedges (e.g. long dated default-free U.S. Treasuries) wither horribly during periods of runaway inflation.

Making that call is especially difficult because there are many well-respected people on both sides of the debate and I have never seen opinions so split in my career. On the inflation side, you have the likes of Warren Buffett and Simon Johnson, the former chief economist at the IMF. On the deflation side, you have Nobel laureates such as Paul Krugman and Joseph Stiglitz.

Given the huge differences in opinion, I am agnostic on the topic. Instead, I built an inflation-deflation timer model that uses trend following principles as applied to inflationary expectations. This class of model is useful for understanding macro-economic trends, which are persistent.

Currently, the model is calling for inflation, although the trend is weakening. For now, I am staying with the discipline of the model and giving the inflation trade the benefit of the doubt.

I am also producing an inflation and deflation headline watch in association with Qwest Investment Management.

I continue to perform research, as well as product development, with Qwest Investment Management on this issue of timing the inflation and deflation trade. I believe that it is of utmost importance for anyone looking to formulate investment and asset allocation policy with a 5-10 year time horizon. For people in wealth management and on investment committees, there is also a lot of career and reputational risk at stake. Get it right and you’ll be a hero. Get it wrong and you may never recover.

Q: Are you a believer in Peak Oil, Mr. Hui? What are your thoughts and predictions regarding the energy sector going forward?

A: People like Robert Hirsch, who co-authored the Peaking of World Oil Production: Impacts, Mitigation and Risk Management in 2005 for the US Department of Energy, and Matt Simmons, author of Twilight in the Desert, are compelling in their analysis.

What’s more, standard micro-economic theory holds that higher prices means high supply. Blogger Gregor Macdonald shows that non-OPEC production has been flat to down for the last several years.

 (chart courtesy Gregor Macdonald)

Oil prices have been rising, so where’s the new supply? This chart signals to me that we may be supply constrained on oil production in some way.

I won’t go into all the reasons why I am a Peak Oil believer but to download Mr. Hui's report on peak oil click here

Looking at this from a big picture point of view, Hirsch is right in that the challenge for over the next several decades is to transition from an economy that is powered by petroleum based energy source to other technologies. It isn’t about how high oil prices go, but whether economic growth can continue if we don’t have another energy source or use energy more efficiently.

Q: Sir, can you please highlight 1 trade idea that you think offers the best value moving forward and your reasons for liking it?

A: I am unable to make such short term calls. I prefer to rely on the discipline of models such as the Inflation-Deflation Timer, which is still bullish on the inflation and risk trade, but those readings could change anytime.

Thank You Mr. Hui!