Database corruption

The site was down for quite a few hours apparently because of some database corruption. Using some wizardry that I haven’t had to use in quite some time (e.g. command prompt restoration of the database backup file) I restored the database and lost the two weekend posts which I recovered out of Google Reader.

Hopefully this wasn’t a result of a directed hack attack or anything.

Q2-2012 Performance Report

Portfolio Performance

My very unaudited portfolio performance in the second quarter of 2012 was +4%. For the six months ended June 30, 2012 is approximately 0% (flat).

Portfolio Percentages

At June 30, 2012:

38% Equities
62% Cash

USD exposure as a total of the portfolio: 26%

Portfolio Commentary

Given that throughout most of this quarter my portfolio was well over 80% cash, I was not expecting a high degree of performance. That said, Rosetta Stone (NYSE: RST) was a relatively well-timed entry (I wrote about it here) and did drive a substantial portion of performance for this quarter.

I am nearly dead-even for the year-to-date, which is a desired outcome of my relatively risk-adverse posturing I have taken generally since the 3rd quarter of 2011. Although I am not benchmarking my portfolio to the major indices, the S&P 500 is up 8.3% to date, while the TSX Composite is down 3%. This in itself is a hint that resource-based investments have not been performing well – of which I have none.

Later in this quarter, I started to accumulate shares in other companies. One is a low-risk, medium-reward scenario that has a depressed valuation because of a majority opinion that the industry the company is participating in will result in losses. The trading in this equity has likely baked in emotional sentiment in addition to extrapolating wrong parallels with the logical historical analogy. I am still trying to accumulate shares in this company and am hoping for some sort of spike down in the share price which would finish off my position. The margin of safety on this stock is massive and although it will not triple, my fair value calculations suggest that the low part of the price range is about 30% higher than where it is trading today. With a little bit of momentum, I am targeting a 50% gainer for this particular purchase. Despite my focus on non-dividend yielding equities, this company does have a dividend yield that represents roughly a 1/3rd payout ratio.

Company #2 and #3 are both in the technology field. They trade on a US stock exchange. The branding of one is probably recognizable by a decent number of people, while the other company nobody would recognize. Basically both companies have relatively unique positions in the marketplace and have significant moats. They are also in industries which will be very likely to expand and will have increasing demand. Unfortunately I can’t be more specific. Given the nature of these technology companies, I would rank the risk as medium, but the reward potential to be very good.


I am slightly more bullish on equities. Not just any equities, but rather equities in companies that do not give out yield. Almost anything with a yield has been disproportionately bidded up, which has lead my research elsewhere. As evidenced above, there were a few “hits” that managed to light up and I have subsequently been trying to deploy capital.

I note that the government bond rates have reached all-time lows during this quarter. In particular, as of today the 10-year Canada government bond is down to 1.68%. You can short a 10-year bond and re-invest the proceeds in some boring preferred share of a boring institution (e.g. Power Corporation) and make a 3% spread. The problem with this logic is that everybody else has likely done so and is continuing to push that spread lower and lower. The danger is not in the yield, but rather in the capital – your 10-year bond’s duration goes lower as it approaches maturity, but your perpetual preferred share’s duration will always be larger than the bond. So if interest rates decide to rise again, your price drop in the 10-year bond will be lower than the preferred share and you will start to lose capital and face an eventual margin call if your equity slips to the negative point. The other factor is credit risk in the company that issued the preferred share (although this is what you try to mitigate by choosing a boring company in the first place).

While people play this “race to the bottom”, or rather the “race to see who is leveraged the most before interest rates finally go the other direction”, money cannot be reasonably pumped into this yield arms race. Instead, it must go toward stocks that aren’t involved in the arms race.

For the same reason, I observe the debenture and corporate debt markets are pretty much a write off in terms of risk-to-reward. There are a lot of non-investment grade bonds out there that people are dumping capital into. Eventually we’ll see defaults, but not yet. A good marker on this would be the asset base of ETFs such as (NYSE: JNK).

I remain skeptical of commodity prices and thus commodity equities in general. The only industry that has really caught my interest from a valuation perspective is the utter cheapness of natural gas relative to its oil cousin, but considering there is little incentive for producers to stop capital projects that are already in progress, these projects will finish and continue dumping supply into the marketplace. Although you see power producers picking up some slack, it won’t be enough to put a significant spike on price. At least not yet. When I start seeing some bankruptcies and fire-sales of assets (perhaps Chesapeake is this example) then I’d start to get interested.

There are macroeconomic risks. In particular, the situation in Europe is hardly inspiring, but the spillover to North America will probably be somewhat more muted than the 2008-2009 US financial crisis was to Europeans. The other eerie piece of historical information is that when the Nikkei started to crater after 1989, that index basically bobbed up and down but remained in a relatively tight range for the next decade. I am not saying that the US indices will be the same, but that the only way to make money in a market where the major indices are locked is to look at much smaller companies.

It is always a point of guidance for fundamental type investing to consider more broader measures of demand, such as looking at demographics and where demand will be shifting.

Q1-2012 Performance Report

Portfolio Performance

My very unaudited portfolio performance in the first quarter of 2012, the three months ended March 31, 2012 is approximately -3%.

Portfolio Percentages

At March 31, 2012:

14% Equities
86% Cash

USD exposure as a total of the portfolio: 22%

Portfolio Commentary

A severe underperformance of the main indices – The S&P 500 was up 12% for the quarter, the TSX was up 4%. The lack of performance dealt with baggage concerning Yellow Media and other lingering items which have hence since been disposed of. The only unfortunate aspect of this is that the cheque from the government to offset the capital gains made in previous years will only be coming in April of 2013. It was a high-risk, very high reward-type bet and when you place some money on these types of ventures, you should always be prepared to take losses and that I did.

With 86% in cash, there really isn’t a heck of a lot to talk about – the 14% I do have in equity is primary in two US companies. One can be considered to be a “value” play, a company that had about two-thirds of its market cap in case, but has a business that has stable revenues and should be able to produce earnings once they learn how to cut their marketing expenses. There are growth avenues for their product line, but it should be considered a mature industry. The company has a good name brand and the target market is not going to disappear.

The other company is a growth candidate that is in a technology-related field that I am very familiar with and have done plenty of homework a few years ago on it. Only now did the stock crash sufficiently on an announcement, which I considered to be ordinary for the business but the investors obviously did not, to a valuation where it was worth picking up shares. Unfortunately I did not receive my desired fill in this or the other candidate when they were trading at relative low prices, but I will be patient and we will see. This is not a get-rich-quick stock, but it is a company that has had a very solid track record since going public of increasing revenues and earnings in a lumpy fashion – and currently these lumps have a downward trajectory.

I was aiming for an initial 10% weighting in both companies but instead got less.

While I am not that happy to see the portfolio stagnate, especially in the context of a rising broader market (fueled by the likes of Apple), I take solace in the fact that I have a mostly “blank canvas” for the portfolio and that I have not made mistakes by forcing money to be invested.


I have been severely time constrained this quarter from researching as many investment candidates as I wanted to, but when I do have the time I continue to focus on companies that are not giving out dividends, or giving out very low dividends, both in the USA and Canada.

I remain quite cautious with respect to commodity-related companies, and I continue to be mystified with the price of natrual gas compared to oil – how long will it be before we start seeing gas to liquid energy conversion projects that will finally be able to address supply issues in the natural gas market? The easy and low-volatility play in the natural gas market continues to be Encana (TSX: ECA), but you wonder how long the supply glut is going to last? At $2.20/GJ the margins are simply not there to make huge amounts of money.

I notice industry stalwarts like Canadian Oil Sands (TSX: COS) continue to lag the market despite relatively high oil prices. They were recently able to get a 10-year bond financing out at 4.5% and 30-years for 6.0%. Plays like these all have the investor assume the underlying commodity will continue to be worth more than what the futures prices say.

The low interest rate environment continues to force people to invest in increasing marginal areas – I notice on my yield scans that almost everything with a yield is bidded up to the roof. Generally this is a great formula to generate income but generate even greater amounts of capital losses. The time to play for yield was in late 2008/early 2009 and while I am glad I cashed in on that opportunity, I realize it is not going to happen again for a long, long time.

Long-term interest rates have crept up somewhat – 10-year Canada government bonds have creeped up from the 2% floor to slightly higher. I am not sure whether this is the start of a trend toward higher long term rates or not, but something I am observing. Whenever long term rates do rise, it will create its own financial repercussions as the yielding securities I mentioned previously will inevitably look less attractive.

I remain economically cautious – zero interest rate environments create strange excesses that are quite difficult to predict how they resolve – the inflating asset prices we see today are a function of cheap financing. Regrettably this also includes most of what is available in the stock and bond markets as the thirst for yield continues. The path forward in terms of how this ends is not so clear.

Q4-2011 Year-End Divestor Portfolio Performance Report – 2012 Predictions

Portfolio Performance

My very unaudited portfolio performance in the fourth quarter of 2011 is approximately +6%. For the year ended December 31, 2011, the performance is approximately -13%.

You can read the Q3-2011 report here. The 2010 year-end review with 2011 commentary is here.

My historical performance is as follows:
2006: +3.0%
2007: +11.7%
2008: -9.2%
2009: +104.2%
2010: +28.0%
2011: -13.4%

My six-year performance, compounded annual growth rate, is +15.4%.

Portfolio Percentages

At December 31, 2011:

0% Equities
16% Income Equity
0% Short Term [0-5 yrs] Corporate Debt
9% Medium Term [5-9 yrs] Corporate Debt
75% Cash
(Note: “Income Equity” is the term I used to describe equity/units in companies that give out over 75% of their cash flows as dividends. This also includes preferred shares.).

USD exposure as a total of the portfolio: 19%

Portfolio Commentary

What a crappy year in terms of my own performance. Most of the damage was done in the third quarter, where I significantly underperformed the main indexes. The source of the bad decisions stems from two fundamentally bad trades. The rest of the trades were also sub-optimal, but they were a knee-jerk reaction to the carnage that had happened back in 2008 and a desire to not repeat what could have been a potential 40% reduction in capital. Instead, I was relatively unhappy to settle for a 13 percent haircut for this year. Most of my post-damage analysis was in my third quarter report and I will not repeat it here.

The total return for the S&P 500 this year (including dividends) was approximately 2%. The return for the TSX (excluding dividends) was -11%. The big winner in 2011, had you been clairvoyant, would have been to concentrate your entire portfolio into 30-year US treasury bonds, which would have netted you a 30% gain as yields crashed from 4.4% to 3.0% at year end. Hindsight is 20/20, and who would have ever thought that the trillion-dollar deficit producing US government, with all of its money-printing facilities going at red-line speeds, would have such demand for its own long-term debt. Strange how the world of economics works.

There was no way that I would be able to sustain the performance I had from 2006 onwards, but I hope that future years will not be as damaging as this one was. Although the loss of capital does hurt, I am reassured by virtue of my very high cash position that I am starting from a relatively “blank canvas” and can continue to hunt for various opportunities as they come up. Unfortunately, I have not been finding many.

Outlook and 2012 Predictions

Traditionally at New Years Day, my crystal ball is usually quite clear, but as I write this report, it is incredibly cloudy. To quote Star Wars, there is a disturbance in the force, but I can’t quite tell where these disturbances will take us.

On the broad market, I see a good portion of large-cap companies trading at relatively cheap valuations. For example, you see Dell trading at 7.5 times estimated future earnings, which looks ridiculously cheap and an “easy” earnings yield of 13%, but if the whole world is seeing this, why is the stock not trading higher? Something is wrong there. Why the risk aversion?

The same thing can be said for a whole host of other companies, including financials, resources and other sectors – the P/Es look low, especially with respect to the risk-free interest rate (in Canada, that would be 1.3% on 5-year money and 2% on 10-year money).

More often than not, experience has taught me that when markets are valuing well-known companies for relatively cheap valuations and that you don’t have an explanation for such cheap valuations, there is something else embedded in the price that is signalling that the earnings projections are some sort of illusion.

A classic example of this from my younger days as an investor (around the time of the internet bubble collapse, 2001 or so) was investing in Kemet Corporation (NYSE: KEM) which specialized in capacitor manufacturing. There was a shortage of capacitors and prices and margins for the three big players in the field were very high – high enough to the point where companies were trading at P/Es of 7-8, which made share valuations look very good. Of course, the inevitable happened and profits fell as the market normalized itself, and the P in P/E went down, as well as the E going down. I managed to get out with small losses before realizing my mistake and have carried this lesson forward.

Incidentially, Kemet is trading at a future P/E of 5, which makes you wonder whether history is repeating itself or not.

So in terms of the broad markets, while things look cheap and things seem poised for an increase, will it occur? I don’t know. I am not a large cap investor at heart so it does not make much of a difference to me, but if I was forced to either be in cash or be in the major indexes at present, I would choose a simple high-yield savings account.

Interest rates are another puzzle – will US Treasury Bond yields go lower? Is the deflation bet the safe bet? Probably when everybody has capitulated and bought into the 2% long-term yield thesis that treasury bonds will make a good short. I do not think the long-bond trade has crowded in enough, although it feels slightly bubbly. Again, something to watch, but not necessarily to participate in.

The same thing goes for commodities – gold and oil – even with all the geopolitical instability brewing (especially revolving around Iran and the Middle East, which has always occurred), I generally do not have a good read other than that if deflation and economic slowdown is in the future, it would suggest that prices for both commodities will head down rather than up. North American natural gas ended the year at $3/mmBtu, which is getting amazingly close to the $2.50/mmBtu that was seen in later 2009 – at these prices, natural gas producers simply cannot make money. Should I be investing in a gas or electric range? I don’t know.

On the Western Canada side of things, will the Vancouver Real Estate market finally go into a price recession? Will the influx of capital from Mainland China slow down? I don’t know.

As you can tell, “I don’t know” seems to be a common answer to what my crystal ball is telling me about most macroeconomic scenarios going on in the markets at present.

Probably the only thing I am certain of is that US presidential polling will be driving the 2012 markets to a degree, especially if there is no certainty on who the Republican candidate for President will be. I always thought that Romney had it in the bag simply because he is the picture boy for “getting American business back in shape”, especially contrasted with Obama’s anti-business image. That said, as 2008 will attest to, presidential election years are always volatile for the marketplace as they try to feed in implied assumptions on how the next four year regime will be shaping up to be.

When you have a high amount of cash in the portfolio, every market rally stings because there is a psychological perception that you missed out on something – it is kind of like looking at the Lotto 6/49 results and saying “gee, if I had just picked those six numbers, I would be a million dollars richer” – absurd, but a very human part of the investment process. The trick with high cash levels is that when you do not have convictions that you believe are market-beating, the safest and most prudent action you can take is to just park your money in cash and go fishing, read a book at the library, or do anything other than investing it in some mediocre instrument. Eventually opportunities will emerge. I just don’t see them right at present.

Q3-2011 Performance Report

Portfolio Performance

My very unaudited portfolio performance in the third quarter of 2011, the three months ended September 30, 2011 is approximately -21%. For the first three quarters of the year, the portfolio performance is approximately -19%.

Portfolio Percentages

At September 30, 2011:

0% Equities
25% Income Equity
4% Short Term [0-5 yrs] Corporate Debt
3% Medium Term [5-9 yrs] Corporate Debt
69% Cash
(Note: “Income Equity” is the term I used to describe equity/units in companies that give out over 75% of their cash flows as dividends. This also includes preferred shares. Totals add to 101% due to rounding.).

USD exposure as a total of the portfolio: 20%

Portfolio Commentary


This has been my worst quarterly performance since the 2008 financial crisis. I do not measure myself against the S&P 500 (down 14.3% for the quarter) or the TSX (down 12.6% for the quarter) but even against these indices my relative performance was horrible.

There were several contributors as to the massive underperformance. Most of the damage was done in the last two months. Nothing seemed to go correctly.

Bad investment #1: I had invested in some debentures of a company that subsequently tanked 70%, in what turned out to be one of my worst investment decisions of all time. My analysis had indicated that while the underlying company was not exactly a shining diamond in the rough, the margin of safety I believed was sufficient to get a payout which the market now thinks is not happening. Upon a quarterly release I had downgraded my own valuation range significantly and subsequently this security got murdered by the marketplace. Management has a significant equity stake in the company (which has now depreciated significantly so their actual skin in the game has shrunk to a trivial amount) but they made certain claims on a conference call that I believe was not generally credible. My initial investment fraction was a mid-single digit percentage which got taken to nearly zero and it has been cleared out.

Bad investment #2: Yellow Media. Enough said. Went in a few days too early on the preferreds and debentures and this should probably be a reminder to put in a firm rule that “When I suspect a company is going to slash their dividend, it is never good for any part of the capital structure, including those parts of the capital structure that would stand to benefit from the dividend cut.” This is a high risk, high reward situation that is likely going to go south, but the upside reward in the event of a stabilization in the company is also quite considerable (estimate a greater than 5x return if and only if they can manage to stem the financial damage to about 40% of what they historically have been able to do over the past couple years).

Bad investment #3: Chasing a few hundred basis points of yield on a less than 2-year debt investment in a company that should have the financial space to pay them off, but there were adverse scenarios that emerged that would result in them possibly not being able to doing so. I managed to get out of that one by taking a 3% loss on investment, which was fortunate since it currently is about 10% less than what I bought them for initially. The risk has risen to the point where the current valuation is justified and I will not be touching this security at present.

Bad investment #4: I dumped Canadian Oil Sands (TSX: COS) at 24.60, nearly at the price I bought in at, despite it going up to 33 dollars a share at some point. The unrealized gains vanished. The liquidation is simply because that my projections for the oil markets and commodities in general has changed significantly downward. This was not a large fraction of my portfolio, but did contribute to the negative performance relative to the June 30 price point (it was about 28.25/share then).

Bad investment #5: First Uranium Senior Secured Notes (TSX: FIU.NT). Good grief – everything that could go wrong has gone wrong with this. The initial reason getting into this was that the conversion provision was a mightily attractive and cheap way of playing the equity, which seemed to have the markings of actually doing fairly well if management could execute to plan. The notes are secured by substantively all of the company’s assets that are worth anything and are first in line in the event of a liquidation, so you would think that this security feature would be worth something. Investors in these notes have encountered and realized operational risk concerning the mining project, financing risk (they had to do a common equity offering which effectively eliminated any real chances of the conversion option being worth anything), and worse of all, political risk (South Africa). The numbers would suggest that with gold at $1700/Oz, that you would see some value of the company once they finally got their act together but so far this has not materialized. This has subsequently been jettisoned.

When I diagnose “what went wrong”, the simple answer is that it was a lack of discipline. When I review my previous quarterly reports, while they were not perfect, they have still remained a fairly good strategic roadmap in terms of how to navigate what is happening in the markets today. I got fancy, tried to reach for yield and got burned. I should have held onto my cash and twiddled my thumbs instead. I attribute most of of this quarter’s loss to my own stupidity and lack of discipline. Using financial terminology, I generated significant negative alpha this quarter. I am not a happy camper because of this! Usually when I lose money I learn the lesson the first time. I do not like having to learn it a second time.

A couple notes that were not in the “screw-up” category was a diversifying operation where I offloaded a significant chunk of my Rogers Sugar (TSX: RSI) holding for about 5.30 a share in the quarter. Rogers is a very well-run company but the shares are expensive to reflect their operational simplicity and consistent cash generation. They did have a panic spike when somebody did a less than glamorous liquidation – 4.50 is at the lower end of my fair value range for the company, but I would be more than thrilled if they dropped down to the 3.20 level when I last picked up shares (then trust units) from them.

Decision number two was in early August when the markets had their first real meltdown. I made the decision to liquify mostly everything in my portfolio that could be liquidated. It was a couple days of very, very sloppy trading that was not executed terribly well, but I run the calculations on how much I have saved and it was significant when compared to today’s values. The big psychological boost is that the cash gave me the sanity to actually look objectively at the marketplace from a “nearly from scratch” position. It is very tempting to take high risk to make up the losses, but that is a wrong strategy – instead, having a huge cash position allows you to sanely re-evaluate your market assumptions and most importantly, gives you mental space to just get away from the computer – something I did. Unfortunately, if I did this a couple weeks earlier it would have been a lot more pleasant financially.


The shape of the markets has changed dramatically over the past quarter – volatility has skyrocketed. The resolution to the European debt crisis appears to be coming to some sort of close, but it will have to involve some resolution to the Greek debt situation. Whether this spreads to other vulnerable countries (in the PIIGS) remains to be seen, but confidence is not quite there.

Financial firms in the USA are also have their share prices suffering – Goldman Sachs, JP Morgan, Bank of America to name a few. Along with them and most other profitable large cap companies, forward-valuations appear to be cheap. Is this because the markets expect these forward projections to not come to fruition?

The typical safe haven, commodities, has not been so safe in the previous quarter. Gold has come off of its highs, as has silver and copper. In particular, copper has cratered in the last quarter. Since this is a bellweather industrial commodity, it does not signal well for the world economy.

China is another wildcard, one that accurate data is hard to obtain with – if their economic growth engine slows down, the rest of the global economy (especially commodities) will feel the effects because their $6 trillion GDP is now larger than Japan and third in line from the European Union and the USA.

Bond spreads are trading as if we are going to head into another recession – with short term rates in the USA at zero, the spread between short and 10-year is a scant 1.9%, while in Canada, the spread between the 1% short term rate and the 10-year benchmark bond is about 1.2%. In a zero-rate (or near-zero rate) environment, an inverted yield curve is a little difficult to obtain, so the spread is the key indicator. That key indicator says that the Canadian economy is not going to look good in the short term.

It makes one wonder whether the bellweather Canadian financial institutions (e.g. BMO, BNS, CM, RY, TD) will suffer equity hits in the upcoming future. They have always been perceived to be safe, but is the perception reality?

Given my rather lackluster performance over the past six months, I am taking my time before dipping my toes more deeply. While I do sense the concern emanating from the market, history would suggest it would need to come to some sort of crescendo before the ultimate low prices are seen – picking points such as the S&P 500 at 666 less than three years ago is very difficult to do since the panic and volatility at these low points is always so sharp – just like how Yellow Media preferred shares have cratered by 2/3rds in just three short trading days.

Q2-2011 Performance Report

Portfolio Performance

My very unaudited portfolio performance in the second quarter of 2011, the three months ended June 30, 2011 is approximately -5%. For the first half of the year, the portfolio performance is approximately +1.4%.

Portfolio Percentages

At June 30, 2011:

28% Equities
28% Income Equity
32% Short Term Corporate Debt
8% Long Term Corporate Debt
4% Cash
(Note: “Income Equity” is the term I used to describe equity in companies that give out over 75% of their cash flows as dividends).

USD exposure as a total of the portfolio: 36%

Portfolio Commentary

This quarter was my worst performance since the economic crisis started in 2008. The 9-quarter winning streak had to end eventually and it won’t be 10 in a row. I am butchering the following quotation: gains make you rich but stupid (because you don’t ever question your portfolio when it is going up), while losses force you to think whether your strategy is correct.

The highest contribution to the loss was an ill-timed decision concerning a non-resource sector microcap company (< $50M capitalization even before it tanked) that I thought had value at the then-existing price (it was not anything I have written about on this site). It seems that the market continues to believe otherwise and took it extremely lower, blowing through my limit purchase orders and much, much more. My weighting in this company went down from roughly 8% to 4% and quite frankly given the little news other than a lackluster quarterly report, I still believe there is value. The company itself clearly is in an industry that is unsexy (fortunately nothing that competes with Google) and is a pending turnaround case, but I believe the price I paid reflected a healthy discount in terms of the skepticism of the marketplace on management's ability to actually execute on such a turnaround. Now the company is trading at a probable-bankruptcy valuation. In theory, I should be adding to my position, but I want to see one more quarterly report before making a decision. Usually the most profitable trades are the ones you really are scared to make and this would classify as one. My valuation model would suggest that there is a good potential for nearly a triple from existing prices. I could also be completely wrong and the proper value for this could be zero, hence a classic case why you don't want to ever put too much weight in a microcap position. Even if I had not made that ill-timed investment decision, there was one other non-resource microcap issue (again, <$50M market capitalization) that had depreciated another 20% through the quarter and I added onto my position as it continued to drop. I have an existing 7% weighting in the company. It is profitable and it has insiders purchasing stock, and while its business is fairly boring, there is a good potential for the company to receive much more exposure than it has in the past as it is another case of undergoing a marketing transition. The only difference between this and the other company is that it is generating cash while undergoing a transformation, plus its transformation will not be damaging its existing business and more importantly, it makes sense. This investment I have also never written about on this site. One other investment which I have written a lot about is the notes in First Uranium (TSX: FIU.NT). The notes have traded down from par to about 93 cents on the dollar over the quarter. First Uranium reported their year-end and although they were successfully able to raise equity financing and are reporting improving metrics, their equity has been slammed. Fortunately, the notes are secured by substantially all assets of the company (beyond those assets that they have already entered into an agreement to sell gold streams) and there is no further senior debt to worry about; hence I believe this investment is secure as the mining assets would sell at least for the price of the notes in a liquidation. The only difference from when I made the investment is that there is no longer any real chance of the conversion option being worth anything – initially I had thought there was a good chance of this coming “into the money” and strongly so. Now it will be a slow wait over the next 1.8 years to collect the interest coupons and receive a maturity payment.

I moved a substantial portion of cash into short-term debentures to pick up some relatively low risk yield. I do not expect this to backfire and such debt matures relatively soon and can be readily liquidated if I change my mind. The amount of the portfolio that has been allocated to these short term debentures (that are relatively “safe” compared to the speculative stuff) is 23%. While I will not consider them cash, they are nearly cash and should even hold up even if there is another 2008-style economic crisis. More importantly, if there is an economic crisis this should drop less than equity.

I did deploy some cash into a very boring, midcap ($1-$5B) US company that was relatively undervalued compared to peers and trading this way for a unreasonable reason. While this company is not going to be the type to double overnight, the financial metrics would suggest double-digit appreciation and if the market multiple increases, even more.


The market is trying to figure out whether we are entering into another recession, trying to price what is going on in Europe (specifically with the sovereign debt matters in Greece and possibly other surrounding countries) and also what is going on in the rest of the world in terms of geopolitical instability. The marketplace is also trying to weigh the impact of the US domestic fiscal situation and whether the US will be on a growth path or not.

Commodity markets continue to be strong, although they are not hyperactive in any respect. Oil has been manipulated downward somewhat by the politicians, which makes me more bullish on crude, but I continue to see value in energy in general. One needs to predict a worldwide economic slowdown in order to have energy prices decrease. Natural gas is looking mildly interesting – it has been severely beaten up and may even go lower from existing levels before shoring up again. There are some geographical dynamics which have made a North American-centric viewpoint of natural gas different than other parts of the world – the pricing is considerably different here than it is elsewhere. These differences will eventually be neutralized over time when more LNG terminals are constructed.

My outlook continues to call for choppy markets. Without any sort of crisis, finding good value in the marketplace is for the most part limited to very small capitalization issues. Although this can change, I do not anticipate any significant investments in anything aggressive. I just don’t see a heck of a lot of opportunity out there to put some dollars into that will give me outsized returns (and indeed, one already has backfired in rapid order!).

Finally, with a parting word on losses – it is always painful to see losses in the portfolio, but it is nearly impossible to outperform in a straight line – returns in the portfolio are likely to be lumpy. Also, it is more vital to lose less money when the overall market turns south – preparing for the next crash (if/when it is) and making sure you are ready to pounce on the subsequent recovery is more important. The worst thing an investor can do is dial up the risk in order to “make back” your paper losses – doing this will result in more losses. Using a baseball analogy, continue concentrating on making singles and doubles instead of going for home runs. It may be boring, but the object is to win the game even if you don’t have any sexy cocktail party stories at the end of the day to brag about.

My year-end estimate for portfolio performance continues to be a single digit percentage. I can’t even tell you whether that number is a positive or negative value, but my nominal projections would suggest around +5% for year-end barring any catastrophes. We’ll see.

Q1-2011 Performance Report

Portfolio Performance

My very unaudited portfolio performance in the first quarter of 2011, the three months ended March 31, 2011 is approximately +6%.

Portfolio Percentages

At March 31, 2011:

15% Equities
1% Options
26% Income Equity
16% Short Term Corporate Debt
8% Long Term Corporate Debt
35% Cash
(Note: “Income Equity” is the term I used to describe equity in companies that give out over 75% of their cash flows as dividends; numbers round to 101% due to rounding).

The current yield of the debt portfolio is 7.2%; for the income equity it is 6.5%.

Portfolio Commentary

The quarter was unexpectedly and positively impacted by taking a position in a company that was the recipient of a takeover bid less than a month after I had accumulated an 11% position. I was aiming for a 15-20% position (depending on how far the stock would have dropped during the course of the market gyrations post-Egypt civil war), so I don’t know whether I should be happy that the takeover happened, or resentful that I didn’t get my full position and then have the takeover occur. The premium paid was approximately 30% over market value and I have liquidated the position. The position will be liquidated this year, so the tax bill will be in April 2012.

Otherwise, the quarter was mostly spent trimming positions. There were a couple minor additions to existing positions, and one medium-sized new addition to the portfolio.

My largest position in my portfolio I trimmed by about 1/3rd as it experienced a significant price increase over the quarter. I was happy that the price did increase as such in the quarter because I was over-concentrated in that security. If that security had risen about 10% higher, I would have liquidated most of it. But alas, the price had dropped about 6% from peak. It is a very low volatility stock in a very stable and boring industry, so the dividends I receive from it are relatively secure.

I cleared out all of my Davis + Henderson (TSX: DH) which has a rich valuation that assumes good business performance in the future. I don’t want to wait to see whether the company does or does not perform – my money can be deployed elsewhere. I see from current quotations that it is already trading below my sale price which is good for psychological reassurance, but ultimately it must go down further before I will consider it again.

I cleared out substantially all of my Holloway REIT debentures (TSX: HLR.DB.A) as they are financially ugly and will be facing considerable challenges as it tries to refinance its debt. Although I sold the debt at a substantial discount to par (roughly 64 cents on the dollar), I believe the company is going to undergo significant difficulty since its underlying business (hotels that are primarily concentrated in Northern Alberta and Eastern Canada) is not too profitable in relation to the interest bite. There is a chance that they will be able to rollover the debt, but there is also a good chance that they won’t, and when they suspend distributions they will trade well under this amount. It is a risk I do not feel like taking at present, but readers may. I wrote about this sale here.

I had a foray with the Prizsm Income Fund debentures (TSX: QSR.DB) which resulted in some sushi money for capital gains. There was no material portfolio impact, but it did result in an amusing research quest. You can read the gory details here. They subsequently declared bankruptcy (technically filing for creditor protection which is not bankruptcy, but close enough) at quarter-end and the market value I set to zero given its extremely compromised state and the fact that it is no longer trading. I might be lucky to receive a free Taco Bell 2-for-1 coupon in the liquidation proceedings. I own $1,000 face value (about $90 market value when it finally went belly-up). Maybe I should have bought Lotto MAX tickets instead.

I cleared out my First Uranium subordinated debentures (TSX: FIU.DB) which offer investors a fair risk/reward with respect to the underlying company’s gold operations. While I think it is likely that the company will be able to refinance their debt (and hence the subordinated debt holders will receive par), this is highly contingent on them being able to get their act together operationally and produce a profit – something that currently escapes them. There is also heavy sensitivity with the price of gold, which I believe is toppy. I do, however, still have a financial stake in the company’s secured notes – their asset coverage should be sufficient in the event of an adverse financial event.

Finally, Equal Energy redeemed their first series debentures (TSX: EQU.DB) at 102.5 cents on the dollar. It was slated to mature at the end of the year, but they were able to raise other funding and retire this series of debt. The good days of buying lots of debt in early 2009 are long since over.

The other debentures that I hold will likely mature at par. In light of the fact that I do not have better investment ideas and wish to defer capital gains, I am holding onto them. The long term corporate debt also seems equally stable and represent “bottled” capital gains. I implicitly take interest rate risk with them, but even if rates do not radically rise, I should be able to maintain principal.

The only other portfolio movement of note was an acquisition in some debentures of a company. The debentures were trading at an attractive valuation, and they are likely to mature. This will give some yield in the portfolio without taking significant principal risk – i.e. this is one of those “better than parking cash at 2%” cases that will give a significantly better return for risk taken. Given the liquidity (or lack thereof), I’m probably not going to mention the name until my position is cleaned out.


World events had molded this quarter. I had warned in my 2010 year-end letter that:

There remains unresolved geopolitical issues that one must keep an eye on – Iran vs. Israel, South Korea vs. North Korea, Russia’s influence in Eastern Europe and Central Asia, and finally the sovereign debt issues in the Euroland. All of these could appear on the radar for a lot of investors, or they may not.

I had probably listed all areas of the world where you were safe to travel in. I did not forsee a civil war brewing in Egypt, Tunisia and Libya. Also nowhere did I envision that a massive earthquake would strike the coast of Japan, causing huge amounts of disruption and setting back the nuclear power industry another decade.

By virtue of my very cash position, I remain highly skeptical of the markets. However, because I do not invest in indexes, I continue to look for individual opportunities as they arise and snipe at them. Sometimes you get lucky, as I did this quarter, and sometimes you don’t.

Although it is possible to find value out there, I do not find there is “great value” that gives you the impression that you are taking a margin of safety when investing. Certainly if you were brave and invested in uranium-related issues a week after the Japanese earthquake, you might be getting that margin of safety. You cannot use the BP/Transocean (NYSE: BP/RIG) analogy on the nuclear industry, however – nuclear plant construction is a heavy political topic in democratic countries and you can be sure that this incident in Japan will be stalling future consumption of Uranium supplies. Although uranium supply has been steadily increasing with the initial boom in commodity pricing in 2006, this ramped up capacity will be hitting the marketplace without the benefit of having increased demand – hence, I do not believe investing in Uranium at this time is a prudent use of capital.

Energy must come from somewhere, and consequently oil and gas has been bidded up as a result. This is not surprising, but as oil continues to rise, the tax on energy (in the form of higher prices) depresses economic output. Investors should be aware of the cyclicality and relationship between economic output and the cost of energy. In other words, I am waiting.

The US dollar is an odd case – it’s value relative to the Canadian dollar is the lowest it has been in a very long time which would suggest that diversifying into US equities may be prudent, at least in relation to the 10-year bond yield.

I have found tidbits of value in very small-cap companies, but in these companies liquidity becomes a concern. Position sizes in these smaller companies must be kept small due to the increased volatility and ability to clear out the position when something goes wrong. There are certain sectors, such as insurance, that seem to have value, but individually researching insurance companies is a very time-consuming endeavour, and time is something I have not had an ample supply of lately.

I am both happy and unhappy to have such a large cash position. I hope to be able to find some targets of opportunity. I also don’t expect the rest of the year to be nearly as rosy, and generally expect single digit performance in 2011. It’s depressing to see cash earning a piddly yield and getting inflated away by the world’s major banks, but a reckless deployment of capital will lose even more than being patient.

Q4-2010 Year-End Divestor Portfolio Performance Report – And 2011 commentary

Portfolio Performance

My very unaudited portfolio performance in the fourth quarter of 2010 is approximately +9%. For the year ended December 31, 2010, the performance is approximately +28%.

You can read the Q3-2010 report here. The 2009 year-end review with 2010 commentary is here. I also keep the links in the upper-right hand sidebar.

Portfolio Percentages

At December 31, 2010:

12% Equities [3 issues]
37% Income Equity [3 issues]
21% Short Term Corporate Debt (Average term: 1.5 years) [6 issues, 5 companies]
8% Long Term Corporate Debt (Average term: 18 years) [2 issues, 1 company]
22% Cash
(Note: “Income Equity” is the term I used to describe equity in companies that give out over 75% of their cash flows as dividends).

Blended together, the current yield on the portfolio is 5.5%. Excluding cash, it is 5.9%. Yield numbers are lower than prior figures due to income trust conversions (along with their lower dividend payouts).

Portfolio Commentary
The portfolio performed much better than my expectations. For the year I was expecting a high single digit return, but principal increases in my core holdings continued to buoy the portfolio. I have been taking advantage of price increases by trimming positions and reinvesting proceeds into other prospects that have a better price/risk ratio.

During the second half of the year, a substantial amount of the portfolio was in cash (between 20-25%). This dampened gains (or potential losses!), but also gave me the ability to fish for opportunities as they come. There were some candidates that came along the way, but many fish saw the hook and decided to swim away (i.e. they never hit my buy prices).

Price increases in the income equity category assisted with portfolio increases, and timely trimming of long term corporate debt positions early in the quarter also assisted with gains. Earlier in the quarter I also trimmed my largest income equity position.

The portfolio has accumulated equity in low-or-no yield companies. I made an addition in the oil and gas sector – this acquisition (a 3% stake which would have been larger had the units fell further than they did) was after an announced dividend cut after their corporate conversion, combined with large capital expenditure announcements. I was aiming for 5%, but 3% will suffice.

I also made a significant (7%) investment in a particular company that has exposure to defense and another technology that is directly transferable to the civilian sector. Due to some rather lucky market timing on my entry algorithm, this is now at 8% of the portfolio.

Incidentially, 2010 was a year of very low transaction volume – the commissions paid for the year was considerably less than 0.1% of portfolio value. While one never knows the volume they will be trading at the beginning of the year, 2010 had the lowest volume of trading relative to portfolio value. In contrast, 2008 was the highest, when volatility was like a yo-yo.

In terms of taxation, the CRA will be quite happy in 2010. A healthy amount of gains accrued from 2008 and 2009 were liquidated, substantively all of it in corporate debt. When you see the Canadian Ministry of Finance release lower than expected deficit numbers, you will know where some of it came from.

Economic Ramblings for 2011
There are many economic undercurrents in play in 2011. An investor has to successfully put on their macroeconomic hat in addition to knowing the industry and companies they invest in. It is very difficult to get everything correct, but investors that do get all of their variables correct will be handsomely rewarded with future gains. Here are some brief thoughts on the various issues and the risks that are entailed:

Canada – Domestically, we have a government that is due for an election. One political issue of contention will be the reduction of the large corporation tax from 16.5% starting on January 1, 2011 to 15.0% starting on January 1, 2012. Although polling would suggesting the existing Conservative government would be able to win the largest number of seats in the House of Commons, it is not at all certain that they can maintain government. If this happens, there will be significant instability and I would treat this as a buying opportunity… a couple months after the media goes nuts.

The Bank of Canada raised short term rates to 1% in 2010. The futures market also predicts that this number will be rising by 0.5-0.75% by year’s end. This obviously depends on whether economic growth can continue, and the state of the Canadian dollar. I do not believe the Bank of Canada will raise rates until the 10-year bond trades above 3.6%. Right now it is at about 3.2%.

The high Canadian dollar will also dampen economic activity on the exports side – especially with the USA, whom forms about 80% of our export market.

The rising commodity markets has assisted with Canada’s rise in currency value, much to the detriment of its manufacturing base. This is a classic East (manufacturing) vs. West (commodities) battle that will be forming the basis of domestic politics. Canada is a great place to invest because of the stability of its legal regime, but try not to pay a premium for it.

Vancouver Real Estate – From a valuation perspective, Vancouver Real Estate has long since traded above levels that could be rationalized by income generation. Indeed, when maintenance and other financial carrying costs are priced in, putting money into Ally at 2% is a more profitable decision. The market is dominated by price insensitive demand (especially Chinese capital flooding into condominiums in suburbs like Richmond) coupled with an implicit assumption of capital appreciation that financially transcends rationality. With relatively cheap (5-year 3.7% fixed) and government subsidized (CMHC) mortgage debt, a relatively small amount of equity transforms into the hopes and dreams of easy money – until the party runs out. When might the lights turn off? My guess is when the Chinese economy goes into recession.

China – Keep your eye on the following chart of the Shanghai Index:

As the stock market should be a leading indicator of economic activity, you wouldn’t expect Chinese growth to be reported at 9% levels judging from how their stock market is trading. As the Chinese economy has been growing like the USA during the 19th century industrial revolution, their economy should also exhibit the same booms and busts. Time will tell.

Already you hear of stories “on the ground” of significant inflation, which suggests that they will need to raise their interest rates in order to rein in surplus capital. The only downside to them doing this is that it will provide huge pressure for a positive revaluation of their currency, and this will kill their export market – and result in their market crashing.

The real question is how does a North American investor react to a Chinese stock market crash? The ripples would hit Canada and the USA in the form of decreased commodity pricing. Along this line of thinking, buying longer-dated puts in China-related ETFs may be a profitable venture – both price and volatility.

USA – After the 2010 midterm elections, Congress is hamstrung, which would suggest that the US economy should perform better than expected, barring disruption in China. As to how much better is difficult to say, but I would generally be more bullish on the US than most are at present. I am focusing a lot of my research in the USA and am looking for options to deploying my US currency. The markets have already picked up on this, with increasing government bond yields and the S&P 500 at year highs.

Although the USA has huge fiscal issues, I do not expect them to show up federally – the canary in the coal mines will be municipalities and states. Whether the federal government will choose to carry the states’ debt burdens or not is another matter. But they will be passing the buck until the bond market tells them “no more”.

Despite what a basket case the USA seems to be, especially in the government and fiscal management of government jurisdictions, it is astonishing to think that they may perform better than expected – at least in the first half of the year.

Oil – Crude oil continues to be everybody’s energy of choice. It has a strange dynamic with all the other economic variables as higher prices act as a friction on nearly everything. As oil goes higher, everything else will dampen. That said, the supply-demand dynamic of oil continues to suggest that it will head higher. People have gotten well-adjusted to US$80/barrel oil, and until the media starts to pump daily headlines about the price of oil, they will continue to pay. I do not expect oil to skyrocket to US$150/barrel like it did during the 2008 speculative binge, but it could get close.

Barring an economic crash in China, crude oil investors should continue to smile in 2011. Although there is some supply hitting the market in various areas (Canada and Russia), fresh supply will be overshadowed by increasing demand. There may be a “head fake” or two in the oil futures, but the reality is starkly obvious – finding easy oil is gone.

Natural Gas – Major producers such as Encana have stated that current prices (around $4/mmBtu) are unsustainable. Commodity pricing is determined by supply and demand, rather than cost and consumption. Inevitably natural gas has to rise, but I expect that 2011 will not see a “turnaround” for the commodity as “use it or lose it” drilling leases encourage supply flooding the marketplace. It should be pointed that the raw energy differential between Crude Oil and Natural Gas continue to remain at all-time highs and this will attract some investment on conversions. However, one year is not a long time to shift energy demand from one fossil fuel to another. 2012 should be a different story for natural gas.

Gold – I would prefer to invest in oil than gold, but if enough people believe in the erosion of the monetary system, gold seems to be the default standby. I do not know much about this metal other than when you hold a physical gold bar, it feels powerful because it is a high density metal. The same can be said for Uranium.

Rare Earths – Take a look at Uranium in 2005-2006 and extrapolate what part of the curve most Rare Earth companies are trading at. An elementary analysis of a company like Molycorp (NYSE: MCP) will highly suggest that valuations are very frothy, especially for companies with no operations. Cyclical markets will correct themselves as new reserves are established. Unlike oil, finding rare earths is much easier at present. You might be able to trade in and out and get a quick double on your investment, or you might have caught the top – speculative froth like this is very difficult to game without deep pockets, and stocks like these attract plenty of gamblers.

Geopolitical – There remains unresolved geopolitical issues that one must keep an eye on – Iran vs. Israel, South Korea vs. North Korea, Russia’s influence in Eastern Europe and Central Asia, and finally the sovereign debt issues in the Euroland. All of these could appear on the radar for a lot of investors, or they may not.

Outlook for 2011

The general theme of 2011 is to prepare for shocks, but in the meantime your portfolio should climb the “wall of worry”. While the nominal course of action would suggest that the economy will plod along without surprises, there should be a few curveballs thrown around. It is impossible to predict what the curveballs may be or when they are thrown, but it is important to get a good swing at them when they arrive. You can only swing at the curveballs when you have cash in the portfolio, hence this is why the portfolio allocation of low-yield cash is currently quite high.

A 2010 example of a curveball was dealing with the Deepwater Horizon Oil Spill. Investors that were patient and waited for their opportunities when the geopolitical risk was maximized was rewarded with speculative returns.

Another example was the investment climate concerning the European Union’s debt crisis in Greece.

The baseline state of the marketplace, however, suggests that equity assets, especially high yielding securities, have all been bidded to the roof – as interest rates are low, investors have been trying to chase yield. The ultimate consequence of this are inflated asset prices on stable dividend-yielding securities. Utility companies, for example, are completely off my radar due to valuation. Most income trusts that have converted to corporations are trading at their upper price ranges. Preferred shares are also giving skimpy yields. Most of the money to be made in the markets are likely to be made if the securities don’t give out a yield.

If I were to guess the geography that was to cause a volatility shock in the marketplace, I would be most concerned with China. However, predicting when their economy has lit too much gasoline is impossible. It could happen in 2011, or it could not. Without having the research arm of Goldman Sachs on my side, it is very difficult to determine what goes on the other side of the Pacific Ocean – figuring out what’s going on in Canada is difficult enough.

It is entirely possible that cash will be the best performing asset class in 2011, but I would want to “lock” in this statement sometime in the first half of 2011 – right now, fighting the flow of very easy monetary policy will be damaging to my portfolio.

I am sure this expression is intruding upon a Yogi Berra quotation, but I will say it anyway: volatility will be muted, except for when it isn’t. I do not know if we will see shocks, but until we do see some volatility, I do not think we will see much in the way of opportunity.

Predictions for 2011

Take these predictions with a grain of salt:

* The US Federal Reserve raises the short term rate by the end of the year. Thus, it follows that:
– The US Dollar will rise relative to the Canadian Dollar in 2011 (close of 2010: 0.9945 USD = 1 CAD).
– Spot Gold ends lower at the end of 2011 than the beginning of 2011 (close of 2010: US$1421/Oz).

* An equal-weighted basket of the five big Canadian banks (BMO, BNS, CM, RY, TD), purchased at the December 31, 2010 closing price, will underperform a 1-year CAD treasury bill yielding 1.4% on December 31, 2010. (NOTE: dividends and interest are not reinvested in this prediction).

* My unconventional prediction for 2011 is that US cash will outperform the S&P/TSX Composite Index (link) starting February 28, 2011.

Q3-2010 Divestor Portfolio Performance Report

Portfolio Performance

My very unaudited portfolio performance in the third quarter of 2010 is approximately +8%. For the 9 months to September 30, 2010, the performance is approximately +17%.

You can read the Q2-2010 report here. I also keep the links in the upper-right hand sidebar.

Portfolio Percentages

Currently, there are no equities in the portfolio. Income trusts (soon to be in a category I call “income equity” due to corporate conversions) are 40% of the portfolio, short term debt (maturing less than two years) is 22%, long term corporate debt (average term of 18-19 years) is 14%, and cash is 25% (note: totals add to 101% due to rounding). Blended together, the current yield on the portfolio is 7.1%. Excluding cash, it is 8.7%.

Portfolio Commentary

I was not expecting such a strong positive performance this quarter. Most of the appreciation came from the bond side, both the short term and long term bonds. The income equity valuation has remained mostly static in the quarter.

Most of the transactions performed in the portfolio has been selling long term corporate debt. I believe the long term corporate bond market is topping, and while investors might realize pre-tax 7-8% yields on (lower-class investment grade) long term corporate debt, there is a good chance between now and maturity that they will be facing yield increases (price decreases) simply due to macroeconomic factors. If this occurs, spreads should widen against treasuries, and also face the double-whammy of having treasury yields increase.

Of course, this could be a paranoid delusion and long term B-grade corporate yields compress even further to the 6% range, but I am playing it safe. There is nothing safer than having large cash reserves, waiting to be deployed. I have been rather constrained with research time and researching quality candidates, but I have been looking on the equity side rather than the debt side. My rationale for investing in long term debt (getting equity-like gains, plus a cash yield in exchange for higher seniority for low prices) has now been extinguished simply due to prices at or close to par. Long term corporate bonds now have considerable risk associated with them, and an investor has to choose carefully. This is compared to early 2009, where an investor could blindly purchase anything and still end up with a gain at year’s end, thinking what a genius they are.

US Investment Grade Corporate Debt Yields

As we can see by this chart (initially sourced from the Bank of Canada, chart 2), absolute yields on US investment grade corporate debt is lower now than it has been in a very long time. The spread above treasury yields is still not at absolute lows, but it is quickly approaching 2007 levels (where nothing could go wrong in the corporate debt world).

It is no longer like the previous year, where there was still plenty of low-hanging fruit on the tree to be plucked. Debt that is trading significantly below par at present have underlying companies with problems and you are likely to be taking more risk than what the price might indicate.

For tax reasons I will be retaining some of the long term debt, but in early 2011 it is likely I will be liquidating the rest of it if valuations keep up (or heaven forbid, yields continue to drop). I’m just gritting my teeth, although the yield I get in the meantime is somewhat soothing. What hurts more is to see capital losses from present market values, and present market values on September 30, 2010 are very high. I just have the impression that it goes downhill from here on in. I don’t know when the downhill starts, hopefully not until the new year.

Economic Ramblings

The great debate whether the economy will go into the second part of a double-dip recession continues. In the meantime, life continues and we are seeing a continuation of the recovery in Canada, and the Bank of Canada raising short term interest rates. It remains to be seen whether these rates (or more importantly, long term rates) will rise further.

While American economic prospects are very important to Canada, Chinese and Indian economic prospects have profound implications on the commodity markets – according to the CIA Factbook, the GDP of USA and Canada are about $14.59 trillion and $1.5 trillion in 2008, while the GDP of China and India are $4.33 trillion and $1.16 trillion, respectively. If the latter two economies are growing at around 10%, this is the equivalent of injecting about a third of Canada into the world market – this means demand for commodities, especially energy-based commodities such as oil and natural gas.

Another way of looking at this is that if China and India are both growing at 10%, and the US is contracting at 3.8%, and the rest of the world remains constant, world GDP remains static. As it is likely the US will continue in the economic doldrums, other markets will be growth drivers for consumption. Let’s not forget about Brazil, a $1.6 trillion GDP economy still growing at around 5-6%.

This is why, for the long run, look seriously to Canadian resource companies as being a natural store of value. Barring technological innovation in the transportation fuel market, it is highly unlikely that fossil fuels will be replaced in my lifetime. The big drivers for growth in energy consumption will not be from the USA, but rather from rapidly growing economies – people that study history will know that the success of civilization lies on the ability to harness energy.

There are a few wild cards out there, such as whether the USA will have its fiscal problems translate into bigger issues for the world – such as if investors suddenly decided they no longer want to be funding their deficits. Another wild card is geopolitical conflict, especially in the Iran-Israel budding conflict. Events of these sorts are exceedingly difficult to predict, and thus are difficult to price and prepare for in terms of evaluating portfolio risk. Anything that increases risk will decrease most equity prices in the marketplace.


Given the large cash balance and heavy weightings in securities that are already inflated due to the flight to fixed income, I have my doubts whether performance will be higher than 2% between now and year-end. It is a very conservative portfolio and I will continue keeping it that way, unless if my research comes with some candidates to invest in. There is concentration risk in one issue, but it is a case of “Having most of your eggs in a single basket, but watching that basket very carefully.” I have been doing some fairly broad scans, but have been too shy to pull the trigger on anything so far.

It also appears that US equities are somewhat undervalued, and I have not been excluding American companies in my scans. It is a little difficult investing in the USA knowing that their federal tax is 35%, and their average state tax is an extra 4%, while in Canada, your average corporation is taxed at 18% federally and 12% provincially. In Canada, there have already been legislated decreases to 15% federally in 2012 and moving slowly to 10% provincially in the major jurisdictions (BC, Alberta and Ontario). This assumes that the Conservative government can last that long in office, currently 11 seats short of a majority government. The major corporate tax decreases are on January 1, 2011 and January 1, 2012 which are 1.5% each.

Despite tax differentials, there is likely to be some value in US equities, but I have scratched the surface of my initial research efforts. As pointed out previously, I have been time-limited.

In the longer run, resource-based companies, especially Canadian oil and gas, seem to be attractive stores of value compared to currency. This is relative to gold. I am reasonably sure that firms like Encana (with huge natural gas reserves) will be around in a decade and they will be profitable entities. Those same companies, however, will not double overnight, and thus equity in big energy players should not be considered growth candidates. They are inflation hedges.

Finally, it should be considered that the best performing asset class over the next year might be cash. Although I do not like dividing investments into generic asset classes (as the actual investments themselves define the risk/reward characteristic), the asset class of cash might do better than most may think. I am in no rush to deploy cash, even when cash is at next to zero yield. It may not make for exciting portfolio management when the best thing you can think of is doing nothing, but doing nothing keeps you out of trouble.

Q2-2010 Divestor Portfolio Performance Report

Portfolio Performance

My very unaudited portfolio performance in the second quarter of 2010 is approximately +0.3%, so rounding this off it is 0%. For the 6 months to June 30, 2010, my performance is approximately +9%. Most of the positive portfolio performance could be attributed to the CAD-USD exchange rate – indeed, if exchange rates were unchanged, my performance for the quarter would have been around negative 2%.

You can read the Q1-2010 report here. I also keep the links in the upper-right hand sidebar.

Portfolio Commentary

This has been a relatively boring quarter in terms of performance, but boring is better than the alternative, which is dealing with capital losses. An index investor in the S&P 500 would be down 8% for the year. As the general intention of the portfolio is geared toward risk aversion, while taking some snipes at various issues, I believe my financial intentions are being realized. Nobody said portfolio management has to be exciting.

I did make use of the “flash crash” to add to my existing positions in two names, but the dollar volume amounted to approximately a percentage of my portfolio. I also unloaded a slight amount of one of my debenture positions because there was some guy/computer putting up a rather high price on the bid that I couldn’t resist nibbling at.

Because of the end-of-quarter volatility, there was some trades that I engaged in less than liquid issues, amounting to a few percent of the portfolio. Looking at the ticker tape, it looks like that computer traders were randomly liquidating some of their shares. Although I am not too confident in the state of the economy in general, there are nuggets of value to be picked up here and there (on the equity side) which my research flagged and recent valuations have triggered some price alerts. I will continue examining these short-listed prospects and likely allocate some cash to them if they continue their downward trajectory.

Economic Ramblings

My issue with the economy is that stimulus spending has not translated into private sector investment, especially in the USA. Not helping the US picture is their pending tax increase in 2011 (specifically an expiration of the Bush-era tax cuts). There was a significant drop in inventories in 2009, but now that inventories have been built up in 2010, it is unlikely that we will see any sort of extra investment from the private or government sector that should lead the broad markets into a premium valuation multiple. It is seemingly likely that the rest of this year and a good part of this decade will represent a Japan-type scenario where you have a deflationary environment and a liquidity-trap situation. The only way to cure this is to liquidate bad debts, get the losses on the income statement, take the hit, and move on with life. This is not going to happen.

I have been closely examining the BP incident (as well as a lot of other financial, political and media analysts on this planet) and have some mental orders put in for the various drillers, but nothing has hit yet. Given the market action of the past month, I doubt those transactions will come to fruition unless if the US government decides to launch a frontal legal assault against them in addition to throwing BP under the bus and shaking them down for more money.

I will make a bold call and state that I believe Q3, at least the months of July and August, will be relatively boring, and fraught with conflicting stories on whether the economy is really recovering or whether the “double dip recession” scenario occurs. All one really has to do is look at the commodity and import/export markets to see the best leading indicators of economic activity. I continue to be long-term positive on crude oil, although there might be demand shocks (in the form of economic retardation, especially as the financial markets reverberate) and supply shocks (in the form of conflict arising in the Iran-Israel theater) that will result in price volatility.

It is a simple thesis that watching the world around me that I see planes, trains and automobiles continuing to function. They all require gasoline to run and as long as this is the case, the only thing that will prevent usage of gasoline are higher prices. We will get them eventually, along with $200 oil. It is just a matter of time. The only story that ends the inevitable climb up for crude is demand destruction due to high prices.

Minority governments and the Bloc Quebecois aside, Canada remains one of the most politically stable jurisdictions on the planet to do petroleum business with; as such, we should remain very attractive to international investors, especially considering that Canadian corporations have a huge incentive to doing business here compared to the USA in terms of the corporate income tax regime the Harper government smartly enacted in their late 2007 fiscal update. This is going to pay off massive dividends for Canada and it will pay off massive dividends for Canadians that choose to invest in their own corporations. Still, Canada is very dependent on trade, and our biggest partner (the USA) continues to be the overwhelming majority of our export market. When America gets sick, we will sneeze.

Portfolio percentages

I am going to introduce a new term, mainly the concept of “income equity”. Now that income trusts are converting into corporations, there will be quite a few Canadian corporations that will have relatively high dividend payout ratios. For those companies that have payout ratios that consist a “substantial majority” of their earnings, I will be classifying them as income equity. All other common shares will be considered plain “equity”.

Currently, equity consists of about 1% of my portfolio, income equity 40%, short term debt (maturing between December 2011 to June 30, 2012) is 23%, long term corporate debt (maturing between 2028 and 2033) is 28%, and cash is 8%. Blended together, the current yield on the portfolio is 8.2%. Excluding cash, it is 8.8%.

Assuming I twiddle my thumbs and security prices in my portfolio do not change for the rest of the year, my portfolio will have a 12% cash balance. The short term debt also includes debt that I consider to be a 99% guarantee for maturity at par, so those could be readily liquidated in the event I need to raise some cash. However, for tax reasons and also for the reasons that those securities still give off a fairly high single digit yield, I am not touching them unless if I find significantly better opportunities elsewhere.


The investment outlook has changed little – while I am looking for places to deploy cash, I am finding little opportunity out there although May and June’s dip gives a little inspiration. As such, I am keeping a dry powder keg (of cash) ready in the event that investment opportunities arise. My research time (and effectiveness) has been somewhat compromised lately with the arrival of a newborn child, but one of the reasons why I have a low maintenance portfolio was just for this reason. Given what I do see out there, I would lean much more toward the equity side than the fixed income side, but I will not chase yield (or total return). Except for special situations (e.g. picking winners out of the BP fallout) I would also avoid large cap issues.

As such, I continue to wait and be patient. Rule one of investing is: don’t lose money. You lose money by forcing trades in sub-optimal situations. Right now is “sub-optimal”. If we saw more panic like we did in the month of May, I would start to get a little more optimistic. There’s a lot of doom and gloom out there – this generally bodes well for the markets.

However, in the meantime, caution is the name of the game. There is very little chance of any good performance (e.g. double digit returns) in the next quarter without taking more risk (which means selling debt and going for equities). I do not think this risk is warranted at this time.