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Gal^Stad
Investments Inc.

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Year in Review

2004 in Perspective,
from the January 2005 issue

Put on the kettle for a nice pot of herbal tea and cue up Bill Evans on the CD player. After the excitement of blowout returns three years running -- a minimum of 47.3 percent -- the portfolio in 2004 turned in a mellow 6.0 percent. Last January, mindful of the inevitability of a regression to the mean, we wrote that we expected as much.

The decline in the U.S. dollar was one of the financial stories of the year, and it sure affected us. Eliminate it from the equation and our return would have been 10.0 percent, in line with the official benchmarks that all ended in positive territory: TSX, 12.4 percent; Dow Jones, 3.2; S&P 500, 8.9; Nasdaq, 8.6; and Wiltshire 5000, 10.9.

Our five-year return retreated to 29.0 percent, but the ten-year number actually improved a touch, to 25.1 percent, as 1994's paltry showing (1.5 percent) was eliminated from the calculation.

Speaking of the greenback, as pessimism around its future mounts, some have suggested that the contrarian position ought to be to expect a revival. It's an intriguing idea, and a short-term rally is quite plausible, but there are a few holes in this logic.

For starters, currency exchange rates are based much less on investor sentiment than are stocks. The actions of the "herd" therefore don't wield as much influence over the future value of paper currency. Instead it is government -- specifically, a small group of economic advisors close to the president -- and its printing presses that determine the shape of the big picture.

The current coterie of counsellors is of the Reaganesque cast, given to the belief that large budget deficits and a depreciating currency are no big deal. For them, the state's prime directive is to vanquish the nation's perceived enemies abroad, while keeping taxes low on the home front so that the rich get richer.

This paradigm is intended to produce the best environment for America's advantages of capital formation, innovation and unfettered industries to contribute to the common good.

Anyway, that's the theory. In fact, Reagan's polices in the 1980s culminated in the 1987 stock crash, the savings & loan debacle that cost taxpayers $175 billion, and a real-estate bubble that burst, wiping out many large commercial builders (sic transit Bramalea) and creating suburban ghost towns of unleased space.

A similar scenario may not play out in 2005, but may well come to pass a few years down the road. Much depends on how long there are sufficient fingers to be poked into the holes in the dike. The stubbiest digits belong to Asia's central banks, primarily those in Japan and China, which have been content to fund Bush's guns and butter program, profiting from the sale of the butter while they tolerate the guns pointed at another part of the world.

Here at home, the dynamic of the new Parliament is still a mystery. It will be a challenge for Mr. Martin to keep the various constituencies satisfied without opening the public purse at every turn.

He won't spend readily, as he is thrifty at heart, and fortunately, the national bankroll is healthier than in any other industrialized nation. Budget surpluses keep rolling in, rainy-day contingency accounts are bulging, Employment Insurance is overfunded, and even the Canada Pension Plan is in surprisingly fine shape according to the actuary's report.

Which gives our government a lot of room to maneouvre as it tries to mitigate the effect of the higher loonie on our economy. That development is hurting some sectors, and there is more damage to come, but Canadian business will be more resilient than many analysts suspect.

One aspect of Contra's year that was decidedly not mellow was subscriber response to the announcement of new purchases. Twelve months ago, we lamented the rush of buy orders that immediately forced prices in Analysts, Cygnal, Franklin Covey and Penn Treaty sharply higher.

"How can we buy these stocks at similar prices to what you guys paid when they go up like crazy at the market open?" was a familiar refrain that we heard. Well, the answer is straightforward: Ignore the market when it goes crazy.

There is an analogy here to the NHL hockey lockout. It's tough to have any sympathy for the crybaby millionaires (even billionaires) on either side of the dispute, but the owners' position seems particularly asinine.

If they don't want to pay the players so much, then we say, "Stop it!" Nobody is holding a gun to their heads and forcing them to pay insane salaries. They do it because they think they can gain a competitive edge on the other owners.

But does it really work? Tampa Bay won the Cup in 2004 without paying the highest salaries, while the runners-up from Calgary came very close with one of the lowest payrolls in the league. As proof that deep pockets and achievement don't go hand in hand, consult the record books -- particularly the section about the Toronto Maple Leafs.

Team owners claim to have racked up hundreds of millions of dollars in losses since the last lockout a decade ago, and some franchises seem poised at the edge of the abyss. It is the escalating arms race, driven by the herd mentality, that makes the league collectively worse off.

We must ask whether those subscribers who rushed in with their buy orders were better off. History suggests they were not. Cygnal spent months below our purchase price of $1.51, hitting a low of $1.03.

Analysts returned to our purchase point of $2.92 before the month of January was out, and hit a low of $2.68 in June. Penn Treaty held up fairly well over our buy price of $1.61, but it, too, faltered, reaching a low of $1.37 in August. Of the four, only Franklin managed to stay above our buy price of $1.55, and only just barely, with the stock retreating to $1.61, a far cry from the $2.80 where it ended up on December 31, 2003.

Are the trajectories of these four stocks unusual? Not a bit. Going back two and half years, out of 14 stocks purchased, only two other stocks besides the aforementioned Franklin stayed above our purchase price: Leitch and Network.

As for the other 11, their paths varied wildly, but on average they bottomed 22.2 percent below what we paid for them. Isn't it amazing what opportunities a bit of patience provides?

What should be abundantly clear is that we didn't manage to make a 25 percent return over the past ten years by divining when a stock was at its rock-bottom low. Cheap can easily get cheaper, as we all know well.

Nor do stocks recover in a straight line: the more frequent pattern is a step ahead, a half-step back, a hop to the side, fake left, spin, repeat. That's why we don't get too excited when a stock like Cygnal has a great month, as it did in February, or a horrible month, like this past August.

To traders, such moves are of grave importance; to investors, it's water off a duck's back.

So, what to do to avoid more awkward situations -- as arose with NQL Drilling? Remember, we buy shares in companies for ourselves, based on our own risk-reward parameters and personal portfolios.

They may or may not be worthy investments for our subscribers. If readers consider buying a stock we have purchased, they should: assess our logic for doing so, conduct their own due diligence, decide whether the risk/reward profile is in tune with their own tolerance, let the idea knock around in the brain pan for a while, and perhaps seek the help of a financial advisor or financial planner.

Then and only then is it time to come to a decision.

Considering that we send out our releases in the evening, it should be clear that this percolation process isn't happening before the market opens the next morning.

If it were, there would be no critical mass of new orders and no price spike. Instead, limit orders would gradually filter into the market over a period of weeks, and those who made a decision to buy the stock would be able to so at prices in the same ballpark as we paid, barring some other catalyst of change.

We do know for certain that many of our established subscribers do wait until the dust settles and thereby pay less for their shares. So it boils down to a choice between waiting and probably paying less, or buying immediately and being certain of ponying up more.

Put this way, the course of action should be clear: everyone shares the desire to buy just about anything at the best price they can get.

Another reason that patience is likely to be rewarded: by definition, the stocks we purchase are out of favour -- the companies, the entire sector, or both are on the skids. But a sudden rush of buy orders signals to despondent would-be sellers that there might be hope in holding.

(Tune into any financial show on TV and you stand an excellent chance of hearing a manager or advisor intone, "Hang onto your winners, let go of your laggards.") It may sound cruel, but if you want to acquire a position in the stock, it's best to allow the current owners' pessimism to stew for a while.

We do realize that this is a two-way street, and that our own socks need pulling up as well. Though we have frequently written about this issue, there is turnover in our subscriber list, and newer subscribers may not be familiar with the importance of lying low and playing their cards close to the vest.

Therefore, a new section is being developed for our website where information on this topic will be organized and hyperlinked so that subscribers can explore various facets of the logistics of buying and selling stocks.

We'll let you know when this project is complete. In addition, our prime buying season will be stretched forward to November, so hopefully there will be more sellers to meet overall demand.

Another idea we are bandying about is to wait to transmit our email updates until soon after the market opens. This would solve the problem of competitive buy orders being queued up before the market opens -- an instance that forces the stock to open at a higher price than where it closed the previous day.

At least then, some subscribers would be able to grab some shares before demand pressures kick in. On the other hand, it's not technically feasible to send 1,000 emails and faxes simultaneously, so this change in policy might well result in some -- especially professionals who are close to their computers -- getting the information before others.

The bottom line is that something must change, because the current situation is too disruptive and subverts the anti-herd contrarian approach we espouse. We will be vigilant in our efforts to do our part. And we thank you all for thinking this through and giving the matter due attention.

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