Activating a credit card – telemarketing spam

Since my Starbucks Duetto card was discontinued by Starbucks and/or Royal Bank of Canada, my intention was to take the new credit card RBC delivered and just use it as a backup card (after cashing out the 3000 points for gas money). When calling the credit card activation number, I was fully prepared for the script. You punch in your credit card number over the phone, get transferred to a person that then asks you for your credit card number (presumably because the information doesn’t get passed onto his computer screen?), name, birthdate and then says “While the activation is processing, as a valued RBC customer, I would like to offer you……..” and then went through a bunch of legal gibberish about their “balance protector insurance”. I have heard this spiel before. The guy’s accent (obviously Indian) was so thick that I had difficulty listening to him. He spoke it so fast that I’m amazed anybody would be able to understand him.

However, what was interesting was how they phrased the last question. “So, Mr. Peter, do you believe that maintaining your credit rating in the event that you cannot pay your credit card balance is important?”. This was a new way of phrasing it. Before they just simply asked “Would you like balance protector to protect yourself against your inability to pay a credit card if there is a life-threatening hurricane in your area?”

Most people have a huge psychological difficulty in saying “no”. I am not sure why, but it is taking advantage of the old-style Victorian culture of politeness. Most charities and aggressive marketers always love phrasing questions in such ways that it is very difficult to say no – from political life, “can I count on your support?” is the typical question asked. As soon as you answer in an ambiguous manner, they draw you in for more.

Anyhow, I said “NO, I am not interested in the offer” and left it at that. The fellow on the phone continued, “Because RBC values your opinion, tell me why…” – as much as I would like to get into an argument with the call center guy, I know it would be just a waste of time. First of all, RBC doesn’t care what I think. In fact, I know what RBC and all credit card companies think – I’m part of a statistical pool, and they don’t care what I think at all, as long as I pay the balance (with or without interest, preferably with interest) occasionally. The even more insulting part is that the line “While the card is activating, let me sell you this crap” is complete garbage, simply because activation happens as soon as the guy clicks a button on the keyboard and doesn’t take one minute to go through the system. The guy just says it to launch into a marketing pitch that his employer tells him to.

I can’t believe that people actually agree for the ancillary garbage, but since they have it on the books, they must be able to get enough suckers to warrant annoying the 97% of people that just want the card activated and to get on with their lives.

Volatile week in the markets

The markets, reeling off of last week’s volatility spike, started up Monday massively when the European Union did their trillion-dollar backing/bailout. Then later in the week, the market began to sober up again.

It is difficult to know whether the markets will continue to be volatile or not, but last Friday’s trading action took everything down for reasons that are not entirely clear other than volatility and presumably a drive to safety.

I did not perform a single transaction last week, but continue to watch intently whether there is anything worth picking up. I still don’t find anything trading below a value worth considering and thus will continue to be patient. I get sufficiently rewarded by waiting and thus am not in a hurry to deploy cash.

I do note at present that the risk-free pre-tax long-term rate is around 3.9%, and if you asked me to cobble together a portfolio that would give a relatively stable and long-term income stream, I could probably make a balanced portfolio with enough diversification that would give around 7% in about half interest income and half eligible dividends over the next 20 years. Such a portfolio would be roughly half long-term corporate debt, quarter preferred shares and quarter equity. Stable income does not equate to stable capital, however – it would be highly sensitive to rate changes, and opportunity for appreciation would be limited. At least it would beat inflation.

Annual Energy Outlook 2010

Always good to know what the world’s largest consumer of energy is thinking. I have my grave doubts about biofuels – they do not scale at economical prices.

The development of economical shale gas is the probable cause of the divergence between crude and natural gas pricing, but this seems to be mostly baked into the marketplace now.

Fossil fuels, from a physics perspective, continue to be the only real portable energy option. They have the highest energy density and the technology is mature and developed. Every other alternative is poorer. There are advocates claiming that plug-in vehicles will solve car fuel issues, but they are sadly mistaken. The only real alternative at present seems to be natural gas driven vehicles, but natural gas engines are much more fickle and require more maintenance, in addition to requiring natural gas fuel stations. If the price between crude and natural gas continues to diverge even further, you may see a resurgence in technology in this general direction.

Countries like China and India, with developing economies and zero regard for greenhouse gas emissions, will continue to pick up much of the demand for fossil fuels.

There is also significant geopolitical risk with respect to Israel and Iran that would have a disproportionate effect in the event of a war developing in the region. I do not believe markets currently are pricing in this to its proper degree.

It is a virtual guarantee that the combination of US dollar devaluation plus the increased demand and decreased supply of fossil fuels will result in a long-term price increase of fossil fuels. The question is how to time it and how to ensure that even if you are correct that your fossil fuel assets are not going to get expropriated by a national government – at this point I would only count on Canadian assets. Even our country faces geopolitical risk due to our lack of military infrastructure, but fortunately the country is so big that it would be nearly impossible to invade by force. A political invasion, however, is completely plausible.

Valuing Western Financial Group Preferred Shares

Western Financial Group (common: WES.TO) is primarily an insurance brokerage in Western Canada. They have been able to grow their top line consistently over the past few years, while their bottom line, although profitable, has fluctuated with the market. It is likely they will continue to be making money in the future, so payment of debt and preferred securities should not be an issue, barring any huge global financial crisis.

They have an issue of preferred shares (series 5, WES.PR.C) that has the salient details:

$100 par value, 9% coupon, payable semi-annually;
Holders can convert into common at $2.81/share anytime;
Issuer can convert if common is $3.79/share or higher after September 30, 2012;
Issuer can convert if common is $2.81/share or higher after September 30, 2014.

As I write this, the common is trading at $2.87/share and gives a 4.28 cent annualized dividend (1.49% yield). The preferreds are illiquid and the bid-ask midpoint is $113/share.

To value this preferred share, you must break down the fixed income component and the embedded call option that you (a preferred shareholder) sell to the company.

The fixed income component is simply [coupon / (share price / par value)], which in this case is 7.96%.

The more difficult valuation is with the conversion component. This creates a few scenarios, and note that we assume we sell the common shares immediately after conversion:

1. If the common trades above $3.79/share on September 30, 2012;
2. If the common trades above $3.79/share between October 1, 2012 to September 30, 2014;
3. If the common trades less than $3.79/share after September 30, 2012, but trades above $2.81/share after September 30, 2014.
4. If #1, #2 and #3 do not apply and if the common trades less than $2.81/share after September 30, 2014 until X date.

Scenario 1 is fairly easy to calculate – if you anticipate this happening, you really should invest in the common shares rather than the preferred shares. If the common stock ends up at $3.79/share on September 30, 2012, you will essentially be receiving $135 of value for your preferreds, plus 5 semi-annual coupon payments. A $113 investment will result in $135 in capital gains, plus $22.50 in coupon payments over a 2.40 year period. Annualized, this works out to a 7.69% capital gain, plus a 7.96% income yield. This is contrasted with a common stock performance of 12.3% capital gains and 1.49% income yield (assuming no dividend increase) over the same time period.

In this event, the preferreds seem to be the better investment, especially when seniority is considered. If the common shares go higher than $3.79/share before 2.4 years, the returns between the preferred shares and the common will be proportionate.

Scenario 2 will result in the same absolute return, but depending on when the threshold common stock value is reached, it will result in the same absolute return in terms of capital, but the annualized yield will be less because of the extra time taken to reach the conversion threshold. As an example, if $3.79 is reached on September 30, 2013, the preferreds will have an annualized capital gain of 5.37%, and an income yield of 7.96%, while the common will have a capital gain performance of 8.52% and income yield of 1.49%.

Scenario 3 – assuming the common stock does not go anywhere (i.e. stays at $2.87/share) for the next 4.4 years, a common share investor will receive a 0 capital gain and 1.49% income yield; the preferred holder will receive a 6.4% capital loss on conversion (annualized will be 1.42% loss), but retain an income yield of 7.96%. There are multiple variables at play – when the conversion price is reached and what price occurs at September 30, 2014. For a 10% increase in common share value above $2.81, the preferred shares’ effective value on conversion also increases by 10%, but is capped to 35% when $3.79 is achieved.

Scenario 4 involves a loss – in this event, the fixed income nature of the shares will be more apparent and the conversion privilege becomes less valuable. A common shareholder will lose more capital than the preferred shareholder.

At a value of $113/share, the value of the common shares needs to be $3.18/share in order to avoid a loss of capital upon conversion. This is approximately 11% above the current common share price, but the preferred share holder is compensated for this by the higher coupon payment – they would receive payback for this difference in about one and a half years of coupon payments.

As such, somebody interested in Western Financial Group should be better off buying their preferred shares rather than the common shares as their preferred shares, for now, has a relatively high correlation to the appreciation of common shares, but will be giving out a significantly higher income stream. The only disadvantage is that the preferred shares are horribly illiquid and getting a fill at a decent price and/or size is not easy when nobody is trading.

Gold is gold

Typically the price of gold is anti-correlated to market fortunes. However, during last week’s market calamity, it has seen a huge price influx, even when adjusted for Canadian currency. When all the world currencies are seemingly being debased, investors retreat into hard assets – this means claims to cash flows (through shares), bonds, and also commodity assets.

My only fundamental issue with gold is that it doesn’t serve much function other than being the psychological crutch of the monetary system. It is a good commodity to store value simply because of other people’s perceptions that it is valuable – paper currency works exactly the same way. When I go to a grocery store and exchange green pieces of paper for actual food I can consume, the person on the other end of the counter presumes they can buy something with the green pieces of paper. The same works for gold.

If you were to take out $100,000 in value in gold you would still have to carry 2.6 kilograms (about 5.7 pounds) of gold. Gold’s density is 19.2 grams per cubic centimeter, so this can be represented in a cube about 5.1 cm on an edge. This is slightly smaller than stacking a 3×3 cube of Las Vegas craps dice. This is quite practical when you consider that the equivalent in paper currency would be 1,000 $100 bills (think about how thick a 500 page laser printer stack is when you shop for office supplies), and you would presumably be able to avoid counterfeiting issues with a gold cube.

I am wondering why a more useful commodity, such as crude oil, has not been bidded up. Maybe one reason is because it would be difficult to stuff a few barrels of oil in your pocket or inside your safety deposit box. Knowing something about regulations concerning the storage of petroleum, it would also be impractical to pump thousands of barrels in a backyard tank.

What is mysterious, however, is why shares of gold production corporations haven’t risen in relation to gold prices:

Maybe there is value somewhere in gold equity?