Looking at the losers of 2017 (TSX)

Purely for reference – look at the victims of 2017 market action. A lot of gold, oil and gas, and Aimia!

Some of these are also on the September 2, 2017 screen I did. The only difference with this table is that I did not restrict revenues and had a minimum market cap of $25 million.

Entities included also are ones that have not been delisted (e.g. Sears Canada).

Any pickings on these entrails that are worth looking at?

CompanySymbolYTD (%)
CPI Card Group Inc.PMTS-T-82.5
Platinum Group MetalsPTM-T-80.67
Asanko Gold Inc.AKG-T-79.37
Intellipharmaceutics Intl. (D)IPCI-T-74.41
Concordia International (D)CXR-T-74.39
Electrovaya Inc.EFL-T-70.89
Painted Pony EnergyPONY-T-69.85
Aralez Pharmaceuticals Inc.ARZ-T-69.37
Condor PetroleumCPI-T-68.65
Neovasc Inc.NVCN-T-67.67
Oryx Petroleum CorporationOXC-T-66.98
Mandalay Resources CorpMND-T-66.88
Bellatrix ExplorationBXE-T-66.09
Euromax ResourcesEOX-T-60.77
Western Energy ServicesWRG-T-59.68
Dundee Corp.DC.A-T-58.49
Pine Cliff EnergyPNE-T-58.41
Eldorado GoldELD-T-58.1
Perpetual EnergyPMT-T-57.87
Aimia Inc.AIM-T-57.83
Red Eagle MiningR-T-57.33
Crew Energy Inc.CR-T-56.86
Newalta CorpNAL-T-55.6
Peyto Exploration & Develop.PEY-T-54.17
Western ResourcesWRX-T-53.89
CRH MedicalCRH-T-53.84
Bonavista Energy Corp.BNP-T-53.22
Birchcliff EnergyBIR-T-53.04
Tahoe ResourcesTHO-T-52.57
Cardinal Energy Ltd.CJ-T-51.65
TAG Oil LtdTAO-T-50.65
Storm Resources Ltd.SRX-T-50.57

Raw transaction costs – Commissions

I’ve been compiling some data for the year-end.

One statistic I track is my transaction costs (i.e. commissions of transactions).

If I’m generating performance that is below the market averages, I should immediately quit and just invest in a bunch of low cost indexes (Canadian Couch Potato is mostly cited in this respect – I will not offer opinion on it, and Vanguard Canada in general is quite low cost). In general, you can invest in a basket of well-diversified stocks and bonds at a management expense ratio of roughly 0.1-0.15% of assets.

It actually isn’t readily obvious whether higher transaction costs is a detriment to performance when one’s performance is higher than the market averages. Can one instead make a case that lowering the volume of transactions will actually increase performance?

The way I try to measure performance is applying the “What if I were to be struck by lightning at any point in time, how would my portfolio fare” test, where if I would arbitrarily freeze things at one point in time – e.g. January 1, 2016, how would I have fared today compared to my present value had I not conducted any transactions since that date? (I don’t answer this question in this post, but consider it for your own portfolios – it is an interesting exercise when you discover that you have two-year streaks where clicking buttons is negative alpha!).

Getting back on topic to transaction costs, over the past decade, this number (as a function of year-ended assets) has been between 0.05% to 0.81% (the 0.81% year was in 2008, which for understandable reasons, was a very volatile year for trading – while losing 9% for the year, I out-performed the S&P 500 by over 25%). The number should decrease over time as asset values have increased.

2017’s year-end number (I do not anticipate making any trades on the last day of the year) is quite close to the low end of my past transaction cost range.

Commissions these days are so low that trading execution is a much more dominant factor in terms of reducing the frictional costs of transactions, but keeping records on raw trading costs I find fascinating. I cannot be accused of over-trading, but always look for methods to optimize how I scale in and out of positions – every basis point of performance counts, especially in today’s non-volatile markets.

Small notes on random equity research

I’ve been looking at some existing holdings and companies that I do not own, specifically what has been doing well and not doing well year-to-date. Some miscellaneous thoughts that are not so illuminating:

1. Natural gas has been getting killed lately. I’ve been looking at Birchcliff Energy (TSX: BIR) (I own the preferred shares but not the common shares), and they are going to face significant revenue compression in relation to past financial statements because AECO natural gas pricing is really, really, really low. We’re seeing continued pain in equity pricing (also looking at Peyto and others) and no signs of this getting better – demand isn’t rising that fast (especially since the dreams of the product being exported across the Pacific is completely dead), and supply is plentiful.

2. Any company with the word “blockchain” in the press release, no matter how junky, is getting a market reaction upwards as it is obvious there is algorithmic trading designed to pick up such releases, hit the “buy” button and sell an hour after.

3. Pulse Seismic (TSX: PSD) is a very interesting business with incredibly lumpy revenues. Their balance sheet is misleading in that they amortize their accumulated data, so the remaining asset is not really present in its monetarily realizable format. I am not interested in them with their existing valuation but from an analytical perspective an interesting business. They made a relatively large sale to a customer and they gave a lot of cash away to shareholders both in the form of a special dividend and a significant share buyback.

4. Other energy service companies have also been hammered. There’s a few that look interesting, although it is clear they are all still suffering from large amounts of overcapacity – it appears revenue margins are still quite low.

Macro: US Federal Reserve Balance Sheet

I rarely make investment decisions as a result of macroeconomic analysis. I find that it is too easy to confuse correlation and causation, and also it is too easy to miss data that one should be considering as part of an analysis – i.e. it is the things that you don’t know that kill any way to glean superior insight.

I still try my best to piece together certain pieces of information to strengthen my belief on where the market currents are headed – even if something gives you a half percentage point edge on a coin toss, while you might not notice it if you flip a coin a few times, over a period of time it will give you a statistical edge. Better having it than not!

The Federal Reserve yesterday raised interest rates another quarter point. Given the reaction in the fed funds futures, this was entirely expected, but the details are in the implementation note. In this note, I draw attention to the two paragraphs:

The Committee directs the Desk to continue rolling over at auction the amount of principal payments from the Federal Reserve’s holdings of Treasury securities maturing during December that exceeds $6 billion, and to continue reinvesting in agency mortgage-backed securities the amount of principal payments from the Federal Reserve’s holdings of agency debt and agency mortgage-backed securities received during December that exceeds $4 billion.

Effective in January, the Committee directs the Desk to roll over at auction the amount of principal payments from the Federal Reserve’s holdings of Treasury securities maturing during each calendar month that exceeds $12 billion, and to reinvest in agency mortgage-backed securities the amount of principal payments from the Federal Reserve’s holdings of agency debt and agency mortgage-backed securities received during each calendar month that exceeds $8 billion.

Normalization started in October 2017 with the $6/$4 billion in maturities. The new information is the step-up in January 2018.

We look at the Federal Reserve’s actions since 2007 and observe during the economic crisis they have pumped a gigantic amount of money into the economy (mostly held up in banks, but still available nonetheless):

(On the top graph you can see a tiny, tiny dip in the holdings on the right hand side – this is the start of the “normalization”).

(If you wish to play with the data yourself, just go to https://fred.stlouisfed.org/categories/32218 and have fun).

As of today we have 2.454 trillion dollars of US treasuries held and 1.767 trillion dollars of mortgage-backed securities. The mortgage-backed securities are an artifact of buying off garbage assets from banks that were afraid that securitizations of such debt would fail – the federal reserve essentially back-stopped this marketplace until it normalized (and given real estate valuations, it has mostly succeeded in doing this, and more).

The point here is that there is $4.221 trillion in cash floating around, mostly in the vaults of banks, but this money has been creeping its way into the asset markets, causing considerable inflation of asset prices (but not inflation of consumer prices, which is why the reported CPI is still so low).

The Federal Reserve has been reinvesting proceeds of these securities until now – they will be maturing off another 0.010 trillion in December and 0.020 trillion in January. For the next two months that will amount to 0.71% of the Federal Reserve’s balance sheet. If they keep the January 2018 pace for the rest of the year, it will amount to about 5% of their balance sheet drawn off.

The question that I am asking is when this will have an impact on asset prices. Cash is still cheap to obtain, but clearly it is going to get more and more expensive as the year continues.

For comparative purposes, the Bank of Canada is relatively boring – they hold roughly a hundred billion in government debt. Most of the financial action in Canada is with the “big banks”. The only on-balance sheet action the Bank of Canada took with respect to real estate-related financial activity was the $35 billion they accumulated in securities purchased for resale in 2008, and the majority of off-balance sheet actions were in the form of guarantees during the financial crisis.

My suspicion is that the Canadian dollar will weaken, but correspondingly US equities as an aggregate will have their gains capped. There will of course continue to be opportunities, but the headwinds are starting to build up.

Marijuana stocks – if there was any question of over-valuation

(December 18, 2017: Article featured on the Globe & Mail: TSX short sales: What bearish investors are betting against)

This post applies to the recent December 5, 2017 press release by the British Columbia government regarding how they plan on implementing marijuana regulations in the province.

Saving you from reading the actual release, they plan on having a sole wholesaler (the BC Liquor Distribution branch) and a private/public retail distribution mechanism.

This is very similar to how liquor in other major provinces are distributed – the government gets to keep the lion’s share of the profit on the wholesale side.

In British Columbia, liquor retailers can purchase product from the government monopoly wholesaler at a 16% profit margin for licensed retail stores. These stores will have to then sell enough volume in order to pay for the usual business expenses (leasing a physical location, maintaining inventory, staffing, etc.).

Using the liquor analogy, profits from the retail end of things will be minimal. The best example is Liquor Stores NA (TSX: LIQ) which, despite booking 25% gross margins on their product, when things are good, earn a 3% operating profit margin (not before financing costs, but this is after depreciation expenses).

People following this company will shout out that they are undergoing a significant restructuring, but the central theme still sticks – it is a very low margin industry when your only supplier is government-controlled and has every incentive to maximizing its own profit and not yours.

This is a miserable business climate to be in.

Another, much smaller, example is Rocky Mountain Liquor (TSX: RUM). They operate retail entirely out of Alberta. Cherry-picking their best results in the last year, they are earning a 2% operating profit margin (and this is BEFORE financing and depreciation expenses).

Is marijuana going to be any different than liquor?

I would float the claim that retail marijuana profitability will be even worse than liquor because people can easily grow their own product sufficient for their own consumption. Federal legislation actively encourages people to grow their own marijuana plants at home (4 plants that you can now grow larger than the original 100cm proposed in the initial draft of Bill C-45).

This leaves the question of wholesale – there will need to be suppliers of this. I will also make the claim this will be a race to the bottom, with the exception that the “grow it at home” market will erode profits to the point that wholesale will nowhere near justify the 3.6 billion market capitalization seen from Canopy Growth (TSX: WEED) today – even assuming they captured the entire Canadian marijuana market.

The hype is marijuana producers will be able to achieve tobacco company margins – Rothmans was the last publicly traded Canadian tobacco company and they achieved roughly 50% operating margins (before financing and depreciation). It won’t be happening this way again – this margin will be siphoned by the government from the very beginning.

Get ready for the biggest short squeezes of all times – Bitcoin

It seems pretty obvious to me that talking about Bitcoin as the “biggest short of all times” is only going to end up as one way – the biggest short squeeze ever known in the history of mankind before finally busting down on a slow journey to nearly zero.

I think the last time this happened was when the Hunt brothers were partially successful in cornering the silver futures market, before they lost control and it all collapsed underneath.

Another great example was when Porsche nailed short sellers of Volkswagen stock in 2008 by accumulating a hidden option to acquire 75% of the company, with the German state owning 20% – leaving precious little for short sellers to cover with.

The real issue here is marginability of Bitcoin futures – it doesn’t even matter if margin rates are 35% or 100%, if Bitcoins trade from $10k to $100k in a three-day period, we will start to see FXCM-type action in the brokerage sector and derivative clearing, just as the chairman of Interactive Brokers promised.

Once the short interest in bitcoin futures starts to rise, it is like adding gasoline to a six tonne pile of gunpowder and expecting everything to be all right while lighting up a cigarette next to it. Good luck.

This is starting to make gold look increasingly like a good bet.

Just for full disclosure, I’ve known about Bitcoin since it was under a dollar a coin, and clearly I was taken aback at how it has morphed into present day. I’ve been outright incorrect regarding pricing predictions.

Further disclosure: Have not owned, nor do I intend to take any positions on bitcoins, which is the closest thing one can get to legalized gambling.

Little activity to report

This quarter is looking to make records for low activity on my part. I’ve been attempting to scan the markets for various opportunities but have been coming up with blanks.

In general, most of the debt markets out there are trading out of proportion for risk. Blow-ups on unsecured debt like Toys R Us continue to be a reminder that something can go from 95 cents to 30 in short order.

The fossil fuel industry (specifically natural gas production) appear to have headwinds, and despite rumblings of a recovery in the crude oil market, I still do not see anything on the equity side that appears to warrant action at this point.

Retail has also been killed, but in many cases there is a lot of substance to the story – there is a generational shift occurring for physical shopping, similar to the digitization of newspaper media.

Indeed, it appears that two industries have been dominating the mind-share for investment capital: Marijuana and Blockchain technologies, neither of which I have any interest. I note with amusement that Village Farms (TSX: VFF) appears to be attracting disproportionate interest due to its announcement that it is preparing to grow marijuana in its greenhouses (presumably in British Columbia and not Texas!). I have no idea how far up the market can take these stocks (similar to Bitcoin itself), but it can always be father than one can believe is possible, let alone rational.

The good news is that when a few sectors dominate the allocation of capital, it usually means that other sectors do not receive the same attention and these can be scoured for opportunities.

Despite my antagonistic view on the general marketplace, most of my cash is deployed in cash-parking vessels and are earning incremental yields while I wait for higher risk/reward opportunities. Although I do not think a market crash is imminent, if one did occur, I would not mind.

Will Hurricane Irma cause insurers to drop?

Hurricane Irma is looking like it will blast a path through most of Florida in just over two days:

The media is making it look like that it will be apocalyptic. Indeed, the island St. Martin (famous for having an airport where you can sit on a beach and look up about 100 feet and see a landing Boeing 777 jet) was nearly annihilated. Right now Irma is one of the strongest (if not the strongest) in recorded history, but the question is where it will strike landfall in Florida (if there) and how much it will dissipate by that point – 75 miles can make a material difference in the damage calculation. If it goes through the heart of Miami, there will be tons of damage, but if goes through the western part of the peninsula, there’s a decent chance that the winds will slow down sufficiently by Tampa to still cause a lot of damage, but not the insane amounts the media is making it to be.

Thus while the media hype is overwhelming, the markets are treating certain insurers like the catastrophe is already a done deal, which may not be the case.

This is the classic information mismatch that creates market opportunity.