Spot oil

With a single tweet Donald Trump caused a ruckus in the spot oil market:

This is totally fake news. The Saudis and Russians couldn’t come to an agreement with oil production, their end objective was to ensure that they take more market share from US shale regardless. Crashing the price of oil would accelerate the process, so I can’t possibly see why they would come to any sort of agreement.

In addition, whether the price of spot oil is $20 or $30, it isn’t going to make much difference for the majority of shale producers – they’re still going to lose a ton of money.

The big story here is going to be demand destruction, at least while the lockdown continues and probably for some time after.

I wouldn’t get too bullish on oil yet!

A few more miscellaneous market notes

4. The winning trade of the quarter in all my estimation is going to be short volatility. There’s a pretty easy way to play it – short shares of TVIX (which holds a 50/50 notional short of the CBOE VIX futures front month and second front month, cost of shorting is about 5%), or just short the futures directly (margin on this is US$30k/contract, so that’s basically like posting 60% collateral at present). Be cautioned that an ongoing trade that worked for the entirety of 2019 was to short volatility, and this continued to work until about the middle of February, where sophisticated quant funds that structured paired trading (namely taking extreme advantage of volatility/index rollovers) were absolutely crushed as a result of the Coronacrisis.

I do not frequently have macro convictions but this is one of them where I do. The justification is pretty simple – bad news stemming from Covid-19 is going to continue flowing in, and the consequences are foreseeable (death, defaults, and dysfunction). That said, the probable scenario is that liquidity injections are going to mop up volatility like a dry sponge in water, and things will calm down to the “new normal”. There will be spikes up now and then, and these spikes should be shorted – similar to how taking such a procedure with Marijuana companies over the past 18 months would have been highly profitable. Unlike marijuana companies, however, you have a much smaller cost of carry to hold a short position on volatility.

Shorting puts on the S&P 500 also will work, but why muck around with the index?

5. More macro convictions (perhaps this is a sign I am mentally losing it during the self-isolation period) – The Hong Kong dollar is close to its lower band (the band being 7.75 to 7.85) – the last trade is at 7.752, which represents the strongest the Hong Kong dollar has been in quite some time – it was at its upper band (7.85) during the protests last year (which seemed so far long ago). There’s no leveraged way to play this, but macro-wise, I’d suspect shorting HKD will net a few bucks over the next year. The carry trade is negative (i.e. HK interest rates are higher than US currently).

CoronaPanic, Edition 14

Very random thoughts follow.

Throw all the rules out the window. Even though the economy is going to stall (and go into recession, if not depression), people are going to get dumb-founded when the market goes up. The explanation is pretty simple – with central banks pumping as much liquidity into the system, mostly anything that got sold due to liquidity will be brought back to life, and that liquidity will ooze back into real assets.

Dust off the 1970’s playbook because we’re going to see inflation. Not immediately but it’s coming. It will also hit quicker than what we are typically used to, just like how the Coronavirus kicked us all.

This makes bonds of any lengthy duration (let’s arbitrarily define this as more than 2 years) less profitable, in real terms, to invest in unless if you’re going to get a massive nominal return in the process. Ask yourself what will be happening to real estate when entities like Riocan can no longer borrow unsecured at 2.5% – when cap rates go up from 3% to 6%, you do not need a Ph.D in finance to realize that asset values go down, and when asset values go down, the mandated 50% or 60% loan to value that typical REITs manage themselves to will be heading down as well – previously the model was to take mark-to-market property gains, and then leverage the remaining fraction to buy more income-producing real estate, but look out what will happen when this process goes into reverse!

This should hit residential as well, although governments have a huge incentive to stem this, and you can see it when the Bank of Canada is out there busy buying residential mortgage portfolios from the financial institutions – socialized losses, privatized profits. One would also find it difficult to see the mortgages paid off when a third of your population is going to be unemployed… the nightmare scenario that Genworth MI (TSX: MIC) is prepared for is going to come to fruition – loan-to-value ratios will rise, and with this will come increased capital. Real estate valuations haven’t adjusted for this, but they will.

Will we see spot oil head below US$15/barrel? It’s possible. You just can’t hit a button and stop oil from flowing. Western Canadian Select is at US$6 today… will this go negative? It’s possible. Start digging a big hole in your backyard, and they’ll pay you to store crude.

Gold mining companies might seem like a refuge when gold commodity prices are rising, but the problem here is when somebody in a gold mine gets Covid-19 and then you have to shut down for a few months like everybody else. I don’t see gold mining equities as a refuge, but gold itself should do better. There will be a time that the inherent leverage of gold mining companies (at least the legitimate ones) will take over, but for now, the commodity is the place to be rather than the equity (short-term headlines of everybody saying “buy gold” notwithstanding).

With all this inflation, one would assume that government debt yields will rise to account for this. It will eventually.

The “confirmed cases” statistic is almost a useless figure at this point. The real figure is “how many people have Covid-19 that aren’t confirmed”, coupled with “how many deaths attributed to a trigger of Covid-19 were from individuals that did not fit into the main risk categories (age, lung/heart conditions, obesity, etc.) giving them a predisposition to dying?”.

Iceland is a fairly good laboratory, with the majority of its population in one major urban centre. It has sampled nearly 5% of its population, 2 deaths.

With all the fitness and recreational centers closed, I am forced to partake in exercise through two ways: running and cycling. Last week’s weather was unusually good for a March in Vancouver, but in the past few days it has regressed to the mostly usual overcast and grey, and today I forced myself to run 5km out in a mild drizzle at a balmy 7 degrees Celsius. I see other places in Canada today that it is still -10 outside, and will Covid-19 turn us all into couch potatoes? I did walk through the isles of the places that are still open, such as Canadian Tire, and notice that most of the exercise equipment has been cleared out. Bodes well for Nautulus (NYSE: NLS) and Peleton (NYSE: PTON) (seems to be priced in)?

How can the news get worse? Obviously we will hear about unemployment, we will hear about grossly negative GDP numbers, and we will hear about closures and lockdowns lasting months, and the general breakdown of society. Then we will hear about defaults (especially in the sectors that are heavily leveraged to begin with), and this other bad news. Barring a geopolitical invasion, I can’t see anything other than implied volatility heading down.

Finally, you’re going to see decisions that were going to be made anyway justified under the guise of Covid-19. Watch out for it. Get rid of paper cash? It’s because Covid-19 will infect paper currency and exchanging it will transmit the virus! Can’t build the Trans-Mountain Pipeline because that’s going to spread Covid-19. Shut down municipal roads and install socially-distant bike lanes, because of Covid-19! You name it, this is the time where politicians are going to do their usual thing in the name of Covid-19. Before it was climate change. The motivations have always been there, just the excuse to do it is different.

What’s left of Canadian oil?

A short post, the market capitalization changes of the various Canadian production majors (define this as anybody over $1 billion) by market cap to present:

27-Mar-2020: TSX Oil Producers

NameRoot
Ticker
MktCap 31-Jan-2020 ($M)MktCap 27-Mar-2020 ($M)Loss
Suncor Energy Inc.SU61,97325,17259.4%
Canadian Natural Resources LimitedCNQ44,18215,81164.2%
Imperial Oil LimitedIMO23,3439,81657.9%
Cenovus Energy Inc.CVE14,1552,88779.6%
Husky Energy Inc.HSE9,2303,22665.0%
Tourmaline Oil Corp.TOU3,6172,11641.5%
Vermilion Energy Inc.VET2,98558780.3%
ARC Resources Ltd.ARX2,4861,33546.3%
Crescent Point Energy Corp.CPG2,30848179.2%
Seven Generations Energy Ltd.VII2,22248878.0%
MEG Energy Corp.MEG2,02436582.0%
Whitecap Resources Inc.WCP1,97438780.4%

Notes:

1. Suncor alone can purchase the equity of all the remaining survivors with about half of its market cap. Note this isn’t a great comparison since all of these other companies have huge amounts of debt and companies with decent capitalization such as Suncor or CNQ can be patient and wait for them to go on the auction block during CCAA proceedings;

2. ARX presumably is less hit because it is very roughly half gas, half liquid. AECO has held up reasonably well. Likewise, TOU is majority gas and has done the best, relatively speaking.

3. What happens when spot oil heads to single digits? Oh wait! It already has in Canada. What happens when spot oil heads to negative values? Uh-oh!

There are 7 companies remaining with a market cap over $1 billion. Commodities boom and bust, and this is the worst bust since the late 90’s when oil was still trading in the low teens.

One last cigar butt puff – Gran Colombia Gold notes

There is a phrase that was associated with Warren Buffet, and that was the investing concept of grabbing a cigar butt off the sidewalk and giving it one last puff before throwing it away.

TSX: GCM.NT.U announced:

Approximately US$0.33095042 per US$1.00 principal amount of Gold Notes issued and outstanding representing a redemption price of US$0.30 for each US$1.00 principal amount of the Gold Notes plus the Applicable Premium, as defined in the Gold Notes Indenture, of approximately US$0.03095042 per US$1.00 principal amount of Gold Notes. The aggregate amount of the cash payments on the Payment Date will be approximately US$21,139,458, of which US$19,162,500 will be applied to reduce the aggregate principal amount of the Gold Notes issued and outstanding and the balance represents the Applicable Premium.

This works out to a redemption call of $1.103 per $1 of notes, a relatively large premium considering I paid a penny above par for these notes in what felt like an eternity ago.

With the remaining US$44.7 million in notes, another $4.875 million gets amortized on April 30, 2020. However, because the amortization is linked to the sale of a fixed amount of gold, the residual value over a gold price of US$1,250 is going to be disproportionately high – at the current gold price of US$1,650 that’s going to be about a 22% coupon return (8.25% interest plus the gold redemption). It is virtually certain that these notes will be called off on April 30, 2021 at 104.13. These notes are first in line on GCM’s capital structure and are secured by the Segovia mining operation. So if you want to take one last puff at the cigarette, see if you can get some liquidity. Even if they shut down the mine for a month or two due to Covid-19, GCM has the capital to pay the notes down to their amortization maturity – October 2022. Even though the notes on their face mature on April 30, 2024, the company is required to redeem $4.875 million a quarter at par. If they choose to do that and not call off at April 30, 2021, then the residual notes will receive insanely ridiculous gold payments at present gold levels.

(Subsequent note: The future amortizations will be reduced by 30% to account for the early redemption, so the assumption in the above was incorrect… this makes the April 30, 2021 redemption to appear to be ‘possible’, but not ‘virtually certain’)

I already have a healthy position in these notes (less after the upcoming redemptions) but am deploying elsewhere. I am content to let my position ride until maturity or redemption.