Tax Loss Season - Threat or Opportunity?
From the November 20, 2017 HRA Journal: Issue 278
Thanks again to those of you who came out to MIF on November 10th and 11th. We had a full house again and a great group of speakers and presenters. The newsletter writer presentations have been uploaded to the Beneath the Surface channel on YouTube (https://www.youtube.com/user/BeneathTheSurfaceBTS) and the corporate presentation will soon follow for those of you that missed it or want to listen to them again.
As the editorial notes, it’s tough to be a buyer this time of year. Tax loss selling as a major feature of the junior resource sector and so is generally weak Q4 gold sentiment. You shouldn’t be buying just because something is cheap but cheap is better than dear if it’s a stock you already like for other reasons. I’ve noted a few I like in the updates.There wasn’t a lot of hard news since the last issue but I’m expecting results from several companies in the next couple of weeks. Some companies may be tempted to wait until January if they don’t have results back by the end of November. I’m not sure that’s the best plan but I wouldn’t be surprised to see it.
Note the updates that come from meetings with management at MIF rather than news releases per se. That’s a big part of the reason for attending events like MIF. The next one is coming up in January. See you there!
It’s that time of year again. Stocks you follow seem to fall for no reason. Issues that recently had great looking market depth, with lots of bids stacked up below the current trading level suddenly seem orphaned. Where did all the buyers go? It’s tax-loss season.
This time of year, traders are going through their portfolios (or should be) deciding which holdings, if any, should be sold to generate capital losses that can be used to reduce total capital gains for the year or carried forward to be deducted against future gains. Tax loss trading gets the most media coverage, but tax gain trading can also influence the timing of trades. Some traders prefer to hold large winners into January – if they expect the price to stay stable or better – to defer the recognition of the gain until the next tax year.
So just how big a thing is tax loss season, and should it inform your own trading decisions? The influence of tax loss selling will increase with the volatility of a given stock and decrease with the liquidity. Put more simply, stocks that had the biggest price moves earlier in the year, more specifically stocks that had large positive moves followed by big drops in price, will see more tax loss selling. Stocks that have less trading volume will be impacted by tax loss selling the most in terms of percentage price change, as there is less liquidity to absorb it.
You certainly see the impact of tax-loss selling with individual stocks, and it’s greater with smaller, low liquidity stocks like those that dominate the TSX Venture index. Even so, tax-loss trading is only one of many influences and only impacts shares that have already seen large price drops. If you look at a 10-year chart of the TSX Venture Index, you’d be hard pressed to pick out late year moves based on tax loss selling.
So far, this year, we’ve been on a weak uptrend since July. Those tend to last through tax loss season, or most of it, though we might see a small dip in December when the real procrastinators do their trades.
Note again however that there are many other factors that can overwhelm this effect, at least at an Index level. If New York crashes, it takes everything with it. If there is a giant new discovery or a new sector heating up that can also swamp the effects of tax loss trading at a market wide level. You’re better off focusing on individual stocks in your portfolio when deciding when, and if, to trade tax loss season.
Some thoughts on what to trade and when:
The Early bird gets the worm on the sell side, the late sleeper gets the deals on the buy side. - Tax loss selling seems to start and end a bit earlier every year. “Pro” traders, like brokers, who are taxed at the full rate for gains and losses, seem to be particularly diligent about selling early. Many of them started in September, or earlier, in fact. There are always stragglers though, so if you’re trying to buy on a “tax loss dip” you may see the best price in late November or early December. The stragglers aren't generally large volume traders though so you might now get fill on a large order if you wait until the last minute.
Selling doesn’t have to be forever but its even more important to be early. – You can sell to generate a capital loss and still own the stock again later. In Canada, You must be completely out of the stock for at least 30 days before buying it back, though. That means its best to sell early – and you should check with the company. If you’re going to be out of the stock for a month, try to make sure there are no important developments on the horizon.
For explorers, seasonality is a big factor. We’ve seen several companies exploring in Canada’s north getting their share prices savaged after putting out fair or even good results. Traders sometimes sell hard even on good news if they don’t expect anything material for several months. It’s a late year for results because of analytical lab delays. There are a number of companies with northern projects that will be releasing results for a couple of more months. That might delay tax loss selling for some but keep it in mind.
If what we’ve seen so far this autumn is anything to go by, the last set of results from a northern explorer will have to be pretty amazing to keep short term traders interested. That makes it more important than ever to book some profits before that last release if you’re in a position to.
Conversely, keep in mind that companies that do not have seasonality issues will be less effected unless they have suffered a major downward re-rating already. Even then, it pays to check with the company on when upcoming results are expected.
You can always wait and book losses for next year, or later. Look at what gains you need to offset, if any. You don’t need to sell if don’t have or want to offset gains.
But, before moving on, ask yourself “would buy this stock at this price if it was offered to me today?” If the answer to that question is “no” or if you have reasons to think the company’s situation won’t improve near term, it may be a good idea to sell just for portfolio management and simplification reasons. I’m much better at buying than selling myself so I try to force myself to sell occasionally.
You’ve got until Christmas Eve, but few wait that long. Take position size and liquidity of a particular stock into account. If you’re trying to sell 200,000 shares of a stock that trades 40,000 shares/day be prepared to be patient unless you’re happy knocking the price down heavily and getting a terrible price. Likewise, if you’re thinking of buying the dip during tax loss season on a stock that doesn’t trade much be prepared to put in “good until cancelled” bids and don’t wait until mid or late December unless you’re only looking for a small position.
Even stocks that are heavily hit by tax loss selling usually bottom out early in December, and many will bottom before that. There are always a few who wait until the last minute though. Even if a stock has moved off a bottom (assuming its not based on news) there could still be a few stragglers who will sell at the last minute. Could be worth moving your bid up but still keeping it below the most recent trading level.
One final note on this type of accumulation. I’m generally not a fan of “good until cancelled” orders for junior resource stocks. They are dangerous because of the high volatility inherent in these stocks and potential for news to move the price bigly, in either direction. Be sure you check with the company to see if news is expected during tax loss season before placing a good until cancelled order and forgetting about it.
The combination of tax loss season, colder weather and shorter days and seasonally weak gold prices leave resource stock traders down in the dumps this time of year. It’s a common reaction for traders to turn off the screen and come back in January.
That is a perfectly understandable reaction but, if there are things you do want to bid for, you’ll get a better price for many things in early December. It’s not easy going against negative sentiment but that is often when the best trades are made. Are their any other reasons to feel positive?
Well, gold isn’t doing us any favors (still) but there are some reasons to be optimistic as we near year-end. The main reason is precedence.
There are undoubtedly traders selling because they expect the Fed to increase rates next month. I agree with those traders. There will have to be some sort of negative event to stop the Fed from increasing rates now.
Take a look at chart for the 2-year US Treasury yield at the top of the next page. Other short-term yield charts look much the same. There has been a big move up since September and the bond market is pricing in virtually 100% odds of a December rate hike now. That makes a rate increase a no risk move for the US Fed. Its unlikely there would be any sort of negative reaction since the move is priced in.
Being fully priced increases the odds of a “sell on rumour, buy on news reaction in the gold market. We’ve seen this before. Traders sell in anticipation of an interest rate move, then buy or cover short positions when the market yawns on the day of the event. I think there are good reasons to expect a bounce in the gold price in December.
Base metals have continued to perform well. While most are off recent highs the pullbacks have been moderate. Warehouse inventories for most continue to decline. I don’t expect a lot of bad news on the base metals front anytime soon unless China goes off the rails. “China Bears” still expect that, but I’ve been hearing them expect that for several years now.
Inflation expectations are still very low in North America. The increases in market yields seem purely due to expected moves by the Fed, not expected higher inflation. I’m no inflation hawk myself but recent moves higher in oil prices and other staples might translate into slightly higher inflation. It wouldn’t take much to lower “real” interest rates and start helping gold prices specifically and commodity prices more generally.
The last item that might redirect some money at the gold and metals space is a correction, minor or otherwise, in New York. I don’t see a compelling reason for a crash near term, but a good-sized correction would not surprise me.
The main reason for that is sentiment. Q3 earnings and forward guidance have been pretty good. Traders in NY are highly optimistic. Historically optimistic.
The lower chart on this page shows the bulls minus bears spread in the weekly Investors Intelligence surveys. Traders haven’t been this bullish since right before the 1987 crash. That doesn't mean there is a crash coming but it does imply there is less buying power in the general equities space. After all, if everyone is highly bullish they are probably also highly invested. Based on these surveys, I think the “cash on the sidelines” argument used by S&P and NASDAQ bulls is becoming something of an urban fable. I don’t think there is that much sidelined cash at a retail level and insiders and funds have been doing more selling than buying. There is a case to be made for a NY correction on sentiment alone. That would take some pressure off gold, the key to sentiment in the resource space.
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