Government Bond yields have dropped significantly

The one impact of the US debt ceiling extension has been that government bond yields have dropped significantly over the past week. For instance, the 10-year Canadian government bond benchmark has lost about 25 basis points which is a huge drop:

10-year bond yields are now lower now than they have been since January 2009 (the depths of the financial crisis). The bond markets are highly pessimistic about any form of economic recovery and are trading as such.

Short term rates are no longer pricing in a sure chance of a rate increase – BAX futures are as follows:

Month / Strike Bid Price Ask Price Settl. Price Net Change Vol.
+ 11 AU 0.000 0.000 98.670 0.000 0
+ 11 SE 98.685 98.690 98.685 0.000 23202
+ 11 OC 0.000 0.000 98.655 0.000 0
+ 11 DE 98.660 98.670 98.660 0.010 42832
+ 12 MR 98.630 98.640 98.610 0.020 35992
+ 12 JN 98.590 98.610 98.560 0.040 16408
+ 12 SE 98.550 98.570 98.510 0.050 7649
+ 12 DE 98.500 98.510 98.450 0.060 2729

The December BAX Futures are at 98.66 (1.34%) compared to 98.46 (1.54%) when the Bank of Canada made its last pronouncement on short term rates.  It no longer appears that short term rates will be rising at all.  Three month corporate paper is still at 1.17%.  If there is any hint of economic recovery, it is not seen in the bond market.

Now that is a lot of volume

A few lines of code wrong in your database engine and you get really whacky results such as this:

I lost count after counting quadrillions. This is probably the entire float of Canadian dollars traded a trillion times in a single day!

A mental break from the markets

I have been taking a mental break from the markets and will likely continue doing so this week.

The only comment I have is that because of the US fiscal situation (which I will consider to be a crisis), companies that are highly reliant on US government revenues are getting hammered. Some of these may make viable investment candidates and would likely warrant some research attention.

Zarlink hostile takeover

Zarlink Semiconductor (TSX: ZL) is facing a hostile takeover bid. I have no idea whether investors should sell the equity or wait for something sweeter, but the relevance of this for me was that when I was looking at companies to invest in during the peak of the economic crisis, Zarlink debentures came on my radar screen. The debentures were trading at about 40 cents on the dollar back then, while the underlying company was not terribly profitable and seemed to be going along the wrong trajectory.

I was also concerned back then that you had a company which had a market capitalization that was a low fraction of the debt outstanding which would have made capitalizing the debt more difficult if the company went down that route (like Arctic Glacier, which will be condemning its unitholders to dilution purgatory at the end of July).

In retrospect, the decision to not invest was bad compared to some entities I did put my money in, but back in the middle of the economic crisis, capital was scarce and I made other investment decisions. Zarlink was a close candidate but barely did not make the cut.

Now when you look at various investments, the potential returns for risk is depressingly low. Back then you didn’t need to take much risk to get a very handsome potential reward. Today those risks are much, much higher.

Petrobakken short squeeze

For other articles I have written about Petrobakken, you can click here.

A lot of people are asking “Why did Petrobakken go up 14% in a day?”.

The quick answer is because this is a classic short squeeze, fuelled by a cascade of stop orders taking the stock up higher.

We have the following 6-month graph:

Nearly everybody that has invested money in the company is sitting on a losing position. Conversely, those that were short Petrobakken are sitting on money. In order for short sellers to maintain their fraction of PBN, they must be able to add to their short positions. Short interest in PBN has been about 3 million shares since October and about 4.8 million shares in June. Short interest in Petrobank (which owns 59% of PBN) has also been proportionately higher, so one can’t automatically assume that the short position in PBN is hedging off ownership in PBG.

Eventually there has to be a spike as marginal short players have to cover their tracks – it is nearly impossible to tell when this happen, but when they do, the liquidation is swift and sharp:

PBN continues to trade above my fair value estimate and I will continue spectating as I have no position in this or PBG. My guess, from a trader’s perspective is that there is a good probability that we will see one other sharp spike up and then the shares will continue their steady descent down to fair value. The valuation mismatch between today and what it was a year ago, however, is much less than when the shares were trading at $25. The company also still has the material financial issue of figuring out how to spend more money and issuing dividends beyond the cash flow coming in.