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Science, demand fuel biotech stock boom

Updated: May 3, 2013 12:14PM

Originally published: August 7, 2001

The biotech sector of the stock market has been hot, hot, hot.

In February, biotech sector funds averaged an 18.09 percent return-- and averaged nearly a 30 percent gain for the first two months of the year. Many individual stocks soared from the teens to nearly triple digits in price. In fact, biotech stocks have far outpaced the popular Internet-related shares that have had such impressive gains.

And why not? Biotech companies show as much promise to change our lives as the Internet does. Gene therapies, new drugs and new tests have the potential to cure or prevent dread diseases and prolonging life.

Surely there’s more potential impact in this sector than shopping online or even cutting costs from a corporate supply chain.

That’s partly what the soaring biotech stock prices are telling us. Some of the gains have come on reports of successful Food and Drug Administration trials or drug approvals. Last year 50 new drugs and 30 new chemical entities--the building blocks for drugs--were approved by the FDA.

That’s twice the rate of the previous year, and it reflects the long testing process for many drugs that was started in the early ‘90s when the last biotech stock boom took place.

Another factor in the recent surge in biotech stocks is the anticipation that the process of mapping the human genetic code will be finished this year. That could lead to another round of breakthroughs in treating and preventing disease.

As Alex Cheung, portfolio manager of the Monument Medical Sciences Fund, points out: “Previously, most medicines were created from a trial and error process. But the genome project gives us the ability to target diseases more directly and specifically. So we should expect the success rate of drug candidates to improve over time.”

You might be wondering why the larger pharmaceutical company stocks haven’t benefitted from the biotech surge. As one analyst noted, these large companies are set up to market highly profitable, blockbuster drugs--not a variety of drugs targeted toward a smaller group of potential users. But behind the scenes, the big companies are busy creating marketing alliances with the biotechs to profit from the ultimate distribution of new drugs. Still, large pharmaceutical stocks carry the burden of concern about government regulations and potential price controls.

Even all the good news about drug approvals would not, by itself, be enough to send biotech stocks soaring. There’s another element to this market: supply and demand.

I’m not talking about the demand for the drugs or cures these companies provide. In this case, it’s the imbalance between supply and demand for biotech stocks. Both individual investors and mutual fund managers are trying to get positioned in what is, after all, a very small sector.

Michael Murphy of the California Technology Stock Letter notes that the entire market cap of the biotech sector is only about $280 billion--just twice the market valuation of one big pharmaceutical company, Merck.

Thinly traded markets lead to a lot of volatility. That’s how biotech mutual funds have posted such big gains. For example, Monterrey Murphy Biotech Fund (800-628-94030) soared 64.41 percent through Feb. 29. Fidelity Select Biotech (800-544-8888) posted an astounding 59.75 percent gain since Jan. 1. Invesco Health Sciences (800-525-8085) is up 31.48 percent. And T. Rowe Price Health Sciences (800-638-5660) gained 37.23 percent.

It’s worth remembering that the same volatility is possible on the downside.

Michael Cheung’s Monument Medical Sciences Fund (888-520-8637) is one of the big winners with a gain of 74.25 percent through early this week. Cheung also manages the group’s Internet Fund, which has posted “only” a 25 percent gain year-to-date.

Cheung points out that biotech stocks have been very faddish in the past. But this time, he predicts, the cycle will last longer. His advice to investors: “Prices may seem outrageous at times, but don’t try to time the market. Just dollar-cost-average [buy at regular intervals no matter what the price] or buy shares in a fund. But lock it up for 10 years. Try not to be too clever. This overall uptrend is going to last for a long time.”

I’d add that this is a market that will tempt greedy investors in the short term, and that can be dangerous.

But you never know about biotech stocks. They could be big winners for you in two ways: They could save your retirement portfolio--or your life.

And that’s the Savage Truth.

Terry Savage is a registered investment adviser for stocks and commodities and is on the board of directors of McDonald’s Corp. and Devon Energy Corp. Send questions via e-mail at Her third book, The Savage Truth on Money, recently was published by John Wiley & Sons Inc

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