Sam Subramanian's  Instablog

The third quarter was a favorable one for the longs. Except for a few short-lived, minor pullbacks stock prices moved higher through the quarter. Stock price volatility declined, takeover activity rose, and risk appetite improved to help the S&P gain 15%.

Recently I commented on the seemingly unfathomable transactions of large financial services firms divesting their asset management businesses to investment management firms in such a favorable market environment. In the same vein, one would expect discount brokers to roll in dough under such favorable market conditions. Financial reports from discount brokers like Charles Schwab (SCHW), TD Ameritrade (AMTD), and E*Trade Financial (ETFC) however portray a different story.

During the third quarter, trading activity increased at AMTD and ETFC but declined at SCHW. Adverse impact from low short-term interest rates, bite from charges taken to shore up capital, and expenses related to acquisitions combined to offset the benefit brokers derived from an up-tick in retail stock trading activity. 

Here are the specifics: 

Charles Schwab: A 9% decline in daily average revenue trades combined with waiver of $78 million in money market mutual funds fees caused SCHW’s quarterly revenue to decline 19% from the year-ago period to $1.0 billion.

TD Ameritrade: AMTD’s acquisition of options-trading specialist thinkorswim helped trading activity increase 35%. However, AMTD’s overall revenue grew just 1% to $658 million as low interest rates reduced income.

E*Trade Financial: ETFC’s daily average revenue trades increased 7% from the year-ago period helping quarterly revenue to increase 52% to $575 million. A massive $773 million charge taken for the $1.74 debt exchange thrashed ETFC’s income statement.

Are discount brokerage shares a buy, sell, or hold?

The prospects for discount brokers are getting brighter. GDP data for the third quarter suggest that the recession has ended.  Although there are concerns over the pace of economic recovery, following the lead taken by some countries like Australia and Norway, the Federal Reserve may increase short-term interest rates in 2010.  The profitability of discount brokers stands to benefit from a rise in short-term interest rates. Additionally, discount brokers earnings could receive a further boost if revenue trade volumes hold steady or rise. 

Among discount brokers, AMTD and SCHW are better positioned to prosper from an improved economy and a favorable market environment. Shares of AMTD and SCHW are suitable for most retail investors. E*Trade may break even in 2010 and enhance its takeover appeal. However, the discount broker is saddled with quite a chunk of toxic assets. As such, ETFC shares are suited only for venturesome investors. 

Disclosure: I do not have long or short positions in any of the securities discussed.

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A 4.6% increase in the price of gold over the past three days has helped the precious metal to break out of its two month trading range of $930 to $970 an ounce. Gold for December delivery hit a six-month high of $999.50 an ounce today pushing the price close to the psychologically important $1,000 an ounce mark.



This is gold's third attempt to break the $1,000 an ounce barrier this year. While the previous attempts have failed, there are reasons why the third attempt could be successful.

• Following a spectacular 52% advance from its March 6 lows, the S&P 500 has recently declined for four days in row. Investors' comfort with equities has eroded over the past few trading sessions. The CBOE Volatility Index (VIX) has vaulted as high as 29.57, an eight-week high. Equity investors are getting concerned that stock prices are leapfrogging an eventual economic recovery.
   
• Investor sentiment on gold has not been particularly bullish off late. Mark Hulbert of Hulbert Financial Digest reports that gold market exposure recommended by a subset of short-term gold timing services is just 25%, well down from 61% in early June. As such, it is conceivable that investors are under-weighted in gold and may continue to pull monies out of equities to put them in gold.

• Soaring budget deficits in the U. S. and U. K. are increasing investment demand for gold, more notably in Europe. Gold held in ETF Securities Ltd.'s exchange-traded commodities has risen to a record 7.99 million ounces. After some weeks of outflows, bullion holdings of SPDR Gold Shares (GLD) are starting to climb again.

• Limiting supplies of the precious metal, central banks are restraining their sales of gold. The European Central Bank, the Swiss National Bank and Sweden's Riksbank have agreed to limit gold sales to less than 400 metric tons per year over the next five years.
• The seasonal pattern favors gold. Coming just ahead of the surge in jewelry demand from the wedding season in India, September is often a strong month for gold.

What can go wrong with the above lines of reasoning? An up-tick in the U. S. dollar.

Upward moves in the price of gold have correlated quite well with declines in the U. S. dollar this year. And this is unlikely to change in the near-term. If economic data in the U. S. surprise to the upside and those from Europe to the downside, the dollar can pop hurting gold.

Given gold's impressive recent momentum and break-out of the trading range, the odds for a sustained downtrend looks remote at least in the near-term. SPDR Gold Shares (GLD), Market Vectors Gold Miners (GDX), and ProShares Ultra Gold (UGL) are a few ways ETF and ETN investors can use to join the gold bugs. Mutual fund investors can look to Fidelity Select Gold (FSAGX), First Eagle Gold (FEGIX), and USAA Precious Metals & Minerals (USAGX).


Disclosure: I own shares in FSAGX, GDX, and USAGX. I do not have positions in other securities discussed.

On July 27, I had commented on deals being one of the factors driving stock prices in the biotech group. The spate of deals continues.

Earlier this week, Sepracor (SEPR) agreed to be bought by Japan's Dainippon Sumitomo Pharma (DNPUF.PK) for $2.6 billion. This purchase will enable Dainippon to gain a U. S. sales force along with experimental treatments for asthma, allergic rhinitis, and insomnia.

Today, Biogen Idec (BIIB) made an unsolicited $356 million cash takeover offer for drug partner Facet Biotech (FACT). The $14.50 a share offer represents a 64% premium to Facet's share price. Earlier Facet rejected a higher offer from Biogen to collaborate with Trubion Pharmaceuticals (TRBN).