Insider Trading

When you hear the words "insider trading" do you immediately think of Ivan Boesky or Michael Milken? Maybe Martha Stewart? Insider trading is a phrase that has gotten a bad rap when all it needs is a bit of clarification in its application. The Securities and Exchange Commission(SEC) has made it clear that there is legal insider trading and illegal insider trading. The legal kind is the sort I want to examine today, particularly insider buys. During a weak market, heavy insider buying can pinpoint a particularly undervalued stock.

Perhaps you can decide if a sell is for reasons of diversification, to pay taxes, to pay the kids' college bills, but I can't. You can contact investor relations for some insight, but you might not always get the truth(see Enron). However, people only buy stocks because their trying to make money, but they sell for a variety of reasons.

Here are some basic definitions that will enrich our discussion.

Insider: An officer or director of a public company or an individual or entity owning 10% or more of any class of a company's stock. This group includes the chairman, vice chairman, trustees, COO, CEO, CFO, controller, directors, the president, vice presidents, the secretary, the treasurer, partners, and beneficial owners.

Form 3: Initial statement of holding by insiders.

Form 4: Reports changes to an insider's holdings; this is the most important source of information about insider activity.

Form 5: Yearly statement of holding by insiders.

Form 13F: Filed quarterly by institutional investors having assets under management exceeding $100 million and lists all equity holdings.

Form 144: Notice of intent to sell unregistered shares.

Schedule 13D: Filed by holders of 5% or more of any class of a company's outstanding shares.

Schedule 13G: Filed yearly by passive investors owning 5% or more of a company's outstanding shares.

Purchases can be either open or non-open market. An open market transaction would occur in the same way that we would purchase stocks. Non-open market transactions encompass options exercises, grants, gifts, dispositions(these are sales), and private sales.

Ownership can be either direct or indirect. Direct ownership means that the stock is registered under the insider's name. The SEC states that indirect ownership refers to "securities held by members of a person's immediate family that share the same household." Immediate family refers to children, stepchildren, grandchildren, parents, stepparents, grandparents, in-laws, and includes adoptive relationships.

The SEC further assumes that insiders have indirect ownership of shares owned by a partnership or corporation insiders are a part of, and of trusts in which they are involved.

Generally, irect transactions yield more information than indirect. However, indirect holdings can be just as instructive. For example, if a CEO was making trades for a child's trust fund, they probably wouldn't be terribly ill-timed.

In general, an open market transaction is more telling then non-open market one, and transactions by insiders with duties to the company are more significant than those of insiders without them,i.e. the trades of the CEO should carry more weight than a member of the board of directors.

Also, purchases by new insiders should be given less weight than those of long time insiders. When you first join a company or its boards, you often need to get some skin in the game as a matter of course.

Here are a couple of websites dedicated to tracking insider trading:

SecForm4
InsiderScoop
InsiderCow
EDGAR Online
MSN Money
Yahoo! Finance
Form4Oracle
Real Time Insider
InsiderScore.com
GuruFocus
J3SG.com
InsiderTransactions.com

Also, Investopedia has published some helpful articles on the topic:

Defining Illegal Insider Trading
Uncovering Insider Trading
Insider Selling Isn't Always a Bad Sign
When Insiders Buy, Should Investors Join Them?
Can Insiders Help You Make Better Trades?

Goldman Envy

"Our envy of others devours us most of all."
-Alexander Solzhenitsyn

The Romans called it invidia. The Catholic Church has made it the sixth deadly sin. It's part of the reason that Cain killed Abel and Kevin Spacey killed Gwyneth Paltrow in Se7ven.

Three days ago, The Wall Street Journal published a short, but interesting article about how other banks attempts to be more like Goldman Sachs contributed to their current financial troubles. This reminded me of how important it ignore the crowd.

Merrill Lynch and Citigroup shouldn't have tried to out-Goldman Goldman. It was doomed to fail. They should have instead focused on their strengths. I remember a strategy class that I took in school where we examined a case study involving Harley-Davidson. The company was trying to decide whether to enter the performance bike market(a growing market) or to continue chugging along with its familiar and iconic cruisers. The class was divided into several groups and each one made a compelling case for entering or shying away from the new market. At the end of class, the professor reminded us that when facing such a decision, we should ask ourselves, "is this the right move my company?" There is no reason to be in a market just because its growing. Is anyone making money? Or are we just trying to keep up with the Joneses?

Investment decisions are no difference. It's called personal finance for a reason. Financial goals and the means to accomplish them vary from person to person. Asset allocation should be tailored to your specific goals, age, and risk tolerance levels. The same goes for investment styles. Some people can make money trading, others can't. Some can make money on penny stocks; most lose their shirt.

I am not going to summarily knock message boards or social-networking stock sites. There are plenty of well-intentioned people who post to them. They can be very educational. However, there are also predators(Michael Lewis's excellent book, Next, details the exploits of Johnathan Lebed, a 15-year old stock manipulator who settled with the SEC regarding several pump and dump schemes he masterminded). There are also just plain stupid or innocent people, lacking malice, who unwittingly spread rumors or give bad information. The same goes for blogs, including this one.

When listening to investment advice, I suggest that you follow Ronald Reagan's maxim, "trust, but verify." It will save you a lot of money.

Go Sri Lanka!

Out of 43 major market indexes, only Sri Lanka didn't fall yesterday. People have been comparing it to Black Monday. Everyone is all of a sudden worried about a recession in the United States. I heard one market strategist genius say that the market was trading on sentiment. Silly me. I thought that the market always traded on sentiment.

The Fed is attempting to come to the rescue with an emergency 75 basis points rate cut. I think that this may be to little too late. As Andrew Leonard has observed, the Fed pushed the panic button.

I am very grateful that I've put on some hedges in the last month, but they've only taken a bit of the sting away. I believe the drop in the U.S. markets today is a buying opportunity for both traders and investors alike. I like Japan even more at these prices.

Sovereign Wealth Funds and your stock portfolio

America has become one big yard sale, filled with shoes, lunchboxes, and puzzles with pieces missing.

There's been a lot in the news about sovereign wealth funds. They are taking large stakes in our battered financial stalwarts and partnering with others in major buyout deals. The name might bring to mind images of Arabs rich from the world's addiction to oil, but that is but one face of the these powerhouses.

Singapore has a very long-established SWF, as does Norway, South Korea, Australia, Canada, Venezuela, and even Alaska. China finally set up its own last year, hoping to more efficiently deploy its hoard of currency reserves.

They are also lightning rods for political controversy and opportunism. Hillary Clinton has weighed in on their political motives. New York's other senator, Charles Schumer has endorsed these deals, largely because he's in Wall Street's back pocket.

Recently, The Economist published a great article on the risks and rewards of sovereign wealth funds. As this piece from the International Monetary Fund(IMF)points out, transparency is the biggest beef that people have with them. Treasury Secretary Henry Paulson would like to see the IMF develop guidelines for the funds in hopes that this would prevent a protectionist backlash.

So is there any money to be made piggybacking on their stakes or trying to anticipate their next move? That depends. Are you patient? Do you have an enormously long time horizon? Like politicians, investors must question the motives of SWFs. Some stakes are about achieving political goals, rather than just making money. Wall Street wants and needs these players, especially since hedge fund and private equity money is drying up.

If you think that political sanctions won't happen or will be mild, then you might possibly get a great deal on Merrill Lynch(MER), Citigroup(C), or other fallen giant. If I had to put my money on a horse in this race, I'd pick Citigroup. They have a global footprint and every measure will be taken to make sure that it doesn't fail.

Putting my money in gold and living to fight another day

There will be some football mentioned in this post, but don't worry. It'll have nothing to do with O.J. Simpson.

"Stocks Covered in Red" proclaims TheStreet.com. Tech stocks are swooning. American Express and Capital One reported a charge and slashed earnings forecasts. Europe and Asia were down. Most market pundits would say it's time to go defensive, meaning buy consumer staples and healthcare.

However, look at Pepsi(PEP). It's off over 2% today. Same with Coke(KO). Pfizer(PFE) is down. Bristol-Myers Squibb is down (BMY). These are not safe havens. Which stocks are working today? Mortgage Investments, insurance, mining, foreign banks, and gold. Of those options, I'm putting my money in the last two industries, mostly in gold. As my position in E*Trade confirms, I am not smart enough to wisely speculate on the various dead cat bounces and potential suitors of the battered financials sector(I'm still holding that position and think that the company and stock will recover, but I'm underwater 40% on the investment). So I am going to park my money in the cash and the streetTracks Gold ETF(GLD). I know, you get the advantage of leverage with the miners or a gold mutual fund, but this is exercise is about defense and not offense.

To use a football analogy, I would love to be a running back that makes incredible, balletic moves, but that won't work in these conditions. I have to make one cut and hit the hole, or just hit the hole full steam and fall forward for any sort of positive yardage that I can gain.

Gold is hovering around $900 an ounce and the market is skittish. I'm looking for safety above all else, and then potential for appreciation second. This is a no-brainer for me.

In other news, Warren Buffett has upped his stake in railroads. Perhaps this is him being greedy when others are fearful.

Breaking out the short ETFs

"I'm Winston Wolfe. I solve problems." The Wolf, Pulp Fiction

If you use inverse or short ETFs correctly, they can help you out like the Wolf helped Jimmie, Vincent, and Jules.

Since 2006, there has been an explosion in ETFs that allow you to short various equity or fixed-income indexes. These instruments have given investors, particularly institutional ones who often operate under restrictions on short-selling and with minimum holding periods of 90 days for stocks, flexibility. Short ETFs could allow you to stay fully invested in an index, while laying off the risk of particular segments of that index.

For instance, last year the S&P 500 was up, but it was a horrible year for financials(which comprise nearly 20% of the index). By buying shares in the ProShares' UltraShort Financials (SKF), some of that risk would've been neutralized. ProShares and Rydex are the current leaders in pushing these products. ProShares even offers leveraged short ETFs that allow you to double the return of index. ProShares accomplishes this feat of financial engineering by using derivatives like swaps and futures. Unfortunately, not all indexes have a short counterpart, so sometimes, you'll just have to step to the sidelines and cool your heels with cash or Treasuries.

Keep in mind that shorting the market, even through instruments such as ETFs, is a difficult tactic. It requires greater vigilance and often, capital, than simply going long. As you no doubt know, the market tends to rise over time. It's a good idea to use these as a hedge and not just a directional/timing bet concerning the market or a sector.

Of course, you can also short the actual ETFs in the usual manner or buy puts/sell calls on them. However, there is an advantage to letting an investment company do your shorting for you, says Roger Nusbaum of TheStreet.com. "If you sell short an ETF, you will have to pay the dividend paid by the fund. That's not the case with ETFs that themselves go short." Plus, while you cannot short an IRA, you can buy ultra-short ETFs for your IRA. If you would like more information on ETFs, take a look at this Vanguard ETF Guide or Yahoo! Finance's ETF Center.

ProShares short ETFs and an article from SeekingAlpha.com that has a good overview of inverse ETFs.

Rydex's stable of inverse ETFs.

Roger Nusbaum at TheStreet.com's take on the double short ETFs.

Three ways to short emerging markets.

There Will Be Blood

There Will Be Blood, a movie starring Daniel Day Lewis and directed by Paul Thomas Anderson, is hitting theaters today. How fitting, seeing as that as I write this, oil is sitting at around $99 bbl. Oil is on everyone's lips it seems. Yesterday, The Wall Street Journal had some excellent piece on the rise of crude oil from $10.72 to $100. Many are wondering if the price of oil will send the U.S. and world economies into recession. As regular readers of this blog know, I'm a firm believer in the commodities bull market; I have been riding the coattails of high oil prices for the last three years. I don't see the end coming yet. So I've decided to share with you some of my favorite books and websites for learning about black tea.

Books

Oil Titans: National Oil Companies in the Middle East by Valerie Marcel and John V. Mitchell. This is an excellent primer on the history, power, and scope of the national oil companies like Saudi Aramco and Kuwait Petroleum Corporation. These companies control most of the oil and gas reserves in the world, so ignoring them is foolish. They are also the engines behind the enormous pools of money wielded by sovereign wealth funds.

The Prize: The Epic Quest for Oil, Money, and Power by Daniel Yergin. Yergin is the dean of energy consultants, chairing Cambridge Energy Research Associates(CERA). This book won the 1992 Pulitzer Prize for nonfiction. No one makes a move in the energy patch without consutling with Yergin and CERA.

Twilight in the Desert by Matthew R. Simmons. Simmons is a Houston energy investment banker. He is a firm believer in Peak Oil Theory and posits that the Saudis have been lying for years about their reserves.

Oil on the Brain: Adventures from the Pump to the Pipeline by Lisa Margonelli. A big picture overview of the world of oil from a micro-level, man on the street perspective. It puts a human face on the industry.

Websites

www.resourceinvestor.com
www.hardassetsinvestor.com
www.nymex.com - website of the New York Mercantile Exchange
www.lifeaftertheoilcrash.net
www.oilonline.com
wwww.energycurrent.com
www.simmonsco-intl.com - Matt Simmons' investment bank's website
www.iea.org - The International Energy Agency
www.bullsector.com/oil.html- a list of oil & gas stocks
www.energy.gov - the U.S. Department of Energy
www.opec.org
www2.nrcan.gc.ca/es/es/main_e.cfm - Energy Resources Canada
www.pemex.com
www.brs-paris.com/index.php?page=drybulk - tanker rates

Finding the Next Starbucks

I know. This is a book about growth investing and I'm a value investor. Still, Michael Moe's book, has good lessons for investors of all stripes. Michael Moe also have a great website that accompanies the book and provides in depth interviews with some of the greatest investors, venture capitalists,and captains of industry. Michael Moe is a veteran equity analyst who currently heads his own shop, ThinkEquity Partners. His claim to fame is that he was early in predicting the amazing success that Starbucks would have, thus the title of the book.

The part of the book that will be of most use to value investors are the chapters that deal with megatrends and how they currently affect and will affect various industries in the future. As a value investor, it's very important to me to find a business will be effectively protected form such changes or only changed very little. Failing that, I want to at least align myself with these secular changes. The book does a very good job of providing examples of both public and private companies that will play a part in shaping and benefitting form these trends.