February 14, 2025

In today’s note, we discuss pertinent developments for some of the stocks in the portfolio, including Alcoa (AA), American Airlines (AAL), Berkshire Hathaway (BRKB), Sirius XM (SIRI) and SLB Ltd. (SLB).

Overall market liquidity remains ample, yet small-cap stocks have lagged in recent months, suggesting money availability isn’t as profuse as it was last year.

Inflation continues to run hot in the U.S., which is creating another headwind for equities.

Gold and silver demand is exploding globally, creating shortages—as well as a tailwind for our holdings in Agnico Eagle Mines (AEM) and Pan American Silver (PAAS).

Comments on Portfolio Holdings

[Note: Special thanks to Barron’s for mentioning the Cabot Turnaround Letter in the January 31 issue.]

Earlier this week, President Trump announced the imposition of a 25% tariff on all steel and aluminum imports into the U.S. The executive order cancels all exemptions and duty-free quotas for major supplying nations, including Canada, Mexico, Brazil and other producing countries.

Per Seeking Alpha, “The president also will impose a new North American standard requiring steel imports to be ‘melted and poured’ and aluminum to be ‘smelted and cast’ in the region to curb imports of minimally processed Chinese steel into the U.S.”

Analysts said the tariffs are likely to increase prices for domestic aluminum buyers, due to higher regional premiums, and force at least some rerouting of international trade flows for the metal.

An AZ China analyst noted, “U.S. aluminum buyers will have to share more of the cost increase as its demand is resilient, not replaceable,” adding that the U.S. has a “very limited number” of new aluminum projects.

Goldman Sachs, meanwhile, said “Assuming no significant exemptions, we expect the aluminum and steel tariffs to be largely passed through to U.S. prices,” further stating that the policy affects the cost of importing aluminum into the U.S. but has no direct impact on London Metal Exchange prices.

Although base metals rose categorically in the wake of the new tariff announcement, it remains unclear whether the move will significantly benefit domestic aluminum makers like Alcoa (AA), which remains a Hold in the portfolio.

After taking a one-quarter profit in our holding of American Airlines (AAL) on December 5, I’m now recommending that we sell an additional quarter of our position today, leaving us with half our original holding in the stock.

Although the U.S. airline industry remains in solid shape thanks to strong travel demand and tighter industry capacity, airfares across the country rose 7% in January on a year-over-year basis. The continued upward pressures on flying costs have led some analysts to predict a dampening of travel demand in the coming months, especially if consumers continue to feel squeezed by rising living costs.

Airfares have now increased in seven of the last seven months. American Airlines remains a Hold in the portfolio.

Berkshire Hathaway (BRKB) has raised its holding in radio broadcasting Sirius XM (SIRI), increasing its stake to over 35% between January 30 and February 3, according to the latest regulatory filings. The conglomerate purchased just over two million shares of Sirius for about $54 million.

While the once-hot Sirius has been largely abandoned by investors in recent years, there are growing signs the firm’s strategic plan could result in a successful turnaround, thereby justifying Berkshire’s bullish bet. Sirius’s management has said it’s focused on:

“…increasing retention and capturing additional growth opportunities within [the] valuable [in-car service] segment that underpins its scaled subscriber base. As a part of this effort, the company will shift marketing and other resources away from high-cost, high-churn audiences in streaming to focus resources on core revenue-generating segments.”

The strategic shift reverses the company’s recent forays into expanding its reach into the streaming realm.

Additionally, Sirius is actively working to reduce its debt load and expects to reduce its debt by approximately $700 million this year while remaining committed to its leverage target of low-to-mid 3X adjusted EBITDA.

What’s more, the company already generates significant free cash flow (FCF), which it intends to utilize for debt reduction and share repurchases, thus creating value over time. Specifically, analysts expect Sirius to generate around $7.3 billion in FCF over the next five years, which is projected to cover debt reduction, share buybacks (up to 50% of total equity) and a growing dividend.

Meanwhile, Berkshire also just added to its stake in Occidental Petroleum (OXY) and now owns more than 265 million of the company’s shares, worth $13 billion, as well as almost $9 billion worth of Occidental preferred stock and 84 million in convertible warrants that allow it to buy the common stock at slightly below 60 dollars a share. BRKB remains a Hold in the portfolio.

Oilfield services provider SLB Ltd. (SLB) is reorganizing some of its internal functions while continuing workforce reductions, according to Reuters. The news report said SLB “will create a new performance function, led by a new chief performance officer that will include a series of functions, ranging from security and operational integrity to global business services.”

The reorganization efforts are part of SLB’s attempt at reducing costs, which many analysts believe will allow the company to maintain operational resilience while mitigating market volatility in what SLB sees as a challenging market environment. SLB remains a Buy in the portfolio.

RATING CHANGES: After taking a one-quarter profit in our holding of American Airlines (AAL) on December 5, I’m now recommending that we sell an additional quarter of our position today, leaving us with half our original holding in the stock. SELL A QUARTER

We sold our remaining half position in Fidelity National Information Services (FIS) on Tuesday after its disappointing Q4 earnings report. The shares were up 24% from the initially recommended purchase price at the time of the sell recommendation. SELL

NEW POSITIONS: None this week.

Friday, February 14, 2025 Subscribers-Only Podcast:

Covering recent news and analysis for our portfolio companies and other topics relevant to value/contrarian investors.

Today’s podcast is about 15 minutes and covers:

• Small-cap stocks are a “canary in the coal mine” for the broader market.
• The Russell 2000 small-cap index is still strong, yet its lagging performance suggests discretion is of paramount importance when picking stocks right now.
• Earnings season has been a mixed bag for the market, with financial sector stocks outperforming and semiconductors mostly lagging.
• Final note
  
  • Despite continued risk-oriented investor interest in crypto assets, defensive holdings like precious metals are in exceptionally high demand.

Market Outlook

The latest earnings season has been a mixed affair, with each day seemingly presenting a fair number of stocks rallying by double digits on earnings beats, along with more than a few stocks tanking on missed estimates. The end result has been a mostly sideways trend in the major averages.

For the better part of the last two months, the Dow, the S&P 500 and the Nasdaq Composite have been range-bound, making no meaningful gains since December. There have certainly been areas of relative strength—most conspicuously in the financial sector stocks—but several key industries (notably the semiconductors) have exemplified the trendless environment by merely marking time over the last several weeks.

Despite the lack of short-term trend, market liquidity has been ample enough to prevent a major sell-off and has largely kept the bears at bay so far this year. Arguably the best major index for determining just how much liquidity is available for equities in the aggregate is the Russell 2000 small-cap index.

Why the Russell 2000? In the words of veteran market technician, Sherman McClellan (inventor of the famous timing indicator known as the McClellan Oscillator), small caps are important because…

“…the small-cap stocks are more sensitive to interruptions in the flow of liquidity (money availability). They are like the canaries that coal miners once employed for warning of deadly methane gas pockets; small-cap stocks are much more likely to suffer if liquidity begins to dry up. When liquidity is strong, it is easier for the entire market to go up, since there is plenty of money to go around. But when liquidity gets tighter, only the strongest can survive as investors abandon their more marginal stocks in favor of the more liquid ones.”

The above statement is the best explanation I can offer as to why big-cap and mega-cap stocks are commanding most of the investing spotlight right now, while smaller-cap names are increasingly struggling in the shadows. On that score, here’s what the small-cap tracking ETF, the iShares Russell 2000 ETF (IWM), looks like as of mid-February.

Unlike most major large-cap indexes, which are currently right at or just under their yearly highs, the average small-cap stock is conspicuously below its late-November high. In fact, the IWM is 6% under its nearest peak, showing that underperformance in the small caps has been far more pronounced than in mid-caps and large caps.

This isn’t a bearish argument, for even the lagging small caps are still technically in an intermediate-term rising trend and are within easy reaching distance of their all-time highs. However, the lagging performance of the Russell 2000 tells us that while overall liquidity is still fairly abundant, it’s not so profuse that it’s creating an “all boats are rising” market environment. Thus, I would argue a certain measure of circumspection is in order when it comes to initiating new long positions.

Meanwhile, the most salient headline to cross the news wires this past week was of course the latest U.S. inflation report. The monthly consumer price index (CPI) for January increased by the greatest amount since August 2023, rising 0.4% month over month and led by higher retail food and gasoline prices, as well as housing costs. Additional factors contributing to the inflation were higher insurance costs, airfares and a record monthly increase in prescription drug prices.

In the words of a Bloomberg report, the latest CPI increase “further [undercuts] chances of multiple Federal Reserve interest-rate cuts this year at the same time the Trump administration presses forward with tariffs.”

In response to the unwelcome news, the 10-year Treasury Yield Index (TNX) shot up 2% on Wednesday, reminding everyone that inflation remains a headwind. And while risk-oriented assets like bitcoin are still in vogue, showing that bulls haven’t completely pulled in their horns yet, defensive assets like gold and silver are strengthening, indicating that investors are also increasingly hedging their bullish bets.

Catalyst Watch

Speaking of precious metals, demand for physical gold and silver coins has become so acute that many dealers are reporting a scarcity of some of the most popular bullion coins. What’s more, the soaring gold demand is a global phenomenon. For instance, The Guardian newspaper of London reported last month:

“It’s not just the uber-wealthy who are turning to gold, as its price continues to soar. Whether going big on bullion or nabbing a gold sovereign for a few hundred pounds to pension-plan, more and more of us are at it. Welcome to a new gold rush. Last year, the Royal Mint, which buys and sells gold bars and coins, had a ‘record year’ for customer purchases. Revenues from its gold bullion sales were up 153% year on year.”

More recently, the Financial Times (FT) reported that a surge of shipments to New York is causing a “shortage” of bullion in the metal’s central marketplace and storage hub of London. Consequently, lease rates for a one-month gold loan jumped to a multi-month high of 3.3% per annum, while three-month gold borrowing costs rose by 1 percentage point to 2.34%, according to Reuters.

According to an anonymous source quoted by FT, “People can’t get their hands on gold because so much has been shipped to New York, and the rest is stuck in the queue. Liquidity in the London market has been diminished.” Reuters, meanwhile, quoted a former U.S. trading house executive as saying, “The Bank of England [can] not...handle the onslaught.”

One such recent example is JPMorgan Chase & Co, which will reportedly deliver gold bullion valued at over $4 billion this month against futures contracts in New York. “The delivery notices totaling 3 million ounces were the second-largest ever in bourse data going back to 1994,” according to Bloomberg.

The main driver for the surge in gold demand is the continued threat of rising inflation and the need to hedge against the dollar’s diminished purchasing power. For Canadian investors, an article in Reuters this week highlights the growing demand for physical gold and uranium company shares as a way to hedge against Trump’s recently proposed tariffs.

Often overlooked in the ongoing gold rush is gold’s sister metal, silver. According to Rick Mills of Ahead of the Herd, “Fearing potential tariffs on gold by the Trump administration, traders are moving billions worth of gold (and surprisingly, silver), from the Bank of England to other locations.” Delivery times from the BoE have risen from a few days to as many as eight weeks, causing a shortage in both metals, with silver bullion demand said to be exceeding gold demand in some locations.

Mills further observed that even as tariff fears have caused the prices of COMEX gold futures to exceed spot prices in London, a similar pricing dynamic is developing in the silver futures market, with the disparity so conspicuous that an arbitrage opportunity has emerged, with traders now flying silver into the U.S. for storage. Bloomberg said:

“The precious metal is usually too cheap and bulky to justify the cost of airfreight, and one industry veteran says it’s the first time they’ve seen it happen.”

From a supply and demand perspective, The Silver Institute has forecast demand for the white metal to grow by 2% in the coming year, led by an anticipated 20% gain in the solar PV market, while total silver supply is expected to decline 1%, producing the second-largest deficit in more than 20 years—and the fourth consecutive year the silver market would be in a structural supply deficit.

Moreover, UBS strategist Julian Wee believes silver could see a spillover effect from rising gold demand this year, with stronger industrial demand serving as an additional catalyst for higher prices—especially if China’s stimulus measures succeed in revitalizing global manufacturing.

Bottom line, the demand drivers for the precious metals are still strong as we head further into 2025, which should benefit our holdings of Agnico Eagle Mines (AEM) and Pan American Silver (PAAS).

Please know that while I don’t yet personally own shares of all Cabot Turnaround Letter recommended stocks, this will materially change in the coming weeks as I become fully integrated as your new Chief Analyst.

Please feel free to share your ideas and suggestions for the podcast and the letter with an email to either me at cdroke@cabotwealth.com or to our friendly customer support team at support@cabotwealth.com. Due to the time and space limits we may not be able to cover every topic, but we will work to cover as much as possible or respond by email.

Portfolio

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