Canadian Finance, Economics and Fiscal Analysis
In today’s trading there are a few oil and gas companies that are tripping my price range thresholds – i.e. they might be worth further research and consideration.
I am generally of the opinion that the markets at this time are greatly oversold, with presumably most of the selling done across the Atlantic Ocean in Europe by panicked investment bankers and hedge funds. Unfortunately (or fortunately), I am still looking for areas to safely deploy cash.
Jim Cramer is very well known to anybody in the financial domain as a former hedge fund manager, but also a hothead on CNBC television hosting a daily show called Mad Money, where he praises and pans every stock on the book. He knows, and the audience should know that his show is purely for entertainment value (Cramer is really an excellent host that seems to never run out of his child-like adrenaline surges), but a whole bunch of amateurs take him seriously.
It used to be when his show came to the air that whenever he made recommendations that the stocks would go up, significantly, in after-market trading, only to recede to their previous levels a couple days later. Traders would usually target this phenomenon and try to capture the demand by short selling and taking profits later.
If anything, it was a very fascinating exercise of how sharks try to eat fish, akin to a poker game – that type of stock trading was definitely zero-sum, and Cramer had the ability to attract a lot of amateurs that were also trying to make the fast dollar off of each other. It was undeniable that in the first few months of the show, Cramer had the ability to move stocks and somebody was probably able to consistently take advantage of it (e.g. being associated with somebody directing or producing the show, for example).
So it was with interest when a fellow named Controlled Greed, who has 5,514 subscribers according to Google Reader, on May 22 mentioned that he took a position in the previous week some illiquid smallcap company (XETA). It has a market capitalization of 39 million and an average volume of 6,700 shares or roughly $25,000 traded a day.
Most notably, on no news, the stock opened up Monday about 5% on 1900 shares. So his article did attract a few market buyers, which I found to be fascinating.
My econophysical studies of situations like these suggest that “immediate popularizations” of stocks has an impulse function effect on the share value, but the value of the impulse declines substantively as the value of the popularization exponentially decays, and eventually reaches a null point (where it is indistinguishable from background noise) a few days later (the decay rate being variable). But you have to wonder how many of those 5,500 readers now stick XETA on the watchlist, waiting for some sort of substantive news. I will not. One of my rules is that by the time you read about any obscure stock pick on any popular medium, it’s already too late.
The last three weeks of market volatility have had a profound effect in driving demand for risk-free, liquid government investments. The Bank of Canada has been a recipient of some of this inflow, as demonstrated by the 5-year benchmark government bond rate:
Speculators would have made a fairly good gain had they bought around 3.1% and sold today at around 2.6%. Of course, the best trades are done in retrospect, so this is just like saying that I could have picked the last 6 digits of the lottery and won a million dollars. Whether the yield will go lower or not remains to be seen.
What this does mean, however, is that 5-year fixed rate mortgages are likely to drop from their existing levels of around 4.54% (at ING Direct) or 4.39% (a typical mortgage broker) to something down 25 basis points or so. I would expect the 5-year rate to be around 4.25% for most retail customers. I generally ignore the posted bank rates since they are always inflated and when negotiating, they usually have a standard rate that is a good percent and a bit below those rates. Competition has whittled that process down to a formality of just asking, but I am sure there are some financially uninformed people that believe the posted rate is the only one they can get.
The Bank of Canada will be raising the target (short term) rate on June 1. This is inevitable, but the question is whether they will be raising 50 basis points or 75 basis points. Right now the 3-month banker’s acceptance futures (the only short term interest futures instrument actively trading in Canada) is implying a June rate of 0.81%.
My prediction is that the Bank of Canada, on June 1st, will raise the overnight target rate 0.5% to 0.75%.
Since this is mostly baked into the markets, the effect this will have on longer-term rates is nil. However, for those that are on variable rate mortgages, they will be paying 0.5% more since the prime rate will go up a corresponding amount. On a $300,000 mortgage, this would mean $1,500/year in payments or about $125/month additional.
My projection for the end of December will be 1.5%, down from 1.75% as projected a month earlier. My prediction is that rates will go up another 0.25% on July 20, 0.25% on September 8, no change on October 19 and up 0.25% on December 7.
The reason why you hold cash, as opposed to yield-bearing investments, is to take advantages such as times as this one and be able to purchase securities at low prices.
Right now, the markets are trading heavily down, presumably as a function of some fallout of the European economic situation and a not-so-hot US jobs report.
In the 21st century world, at least in western countries, the reality is that employment is not a proxy for corporate profitability. An investor invests to get a claim on a company’s cash flows or assets.
The following is a monthly chart of the S&P 500 volatility index, which is at around 45 right now:
The volatility of the main indexes are such that are equaling what happened during 9/11 and the Enron/Worldcom blowup. The only bigger spike in volatility was when Lehman Brothers went belly-up. This European sovereign debt crisis is nothing close to what happened during the Lehman Brothers time (late 2008). Although Greece is a canary in a coal mine, it is not that important in the grand scheme of economics.
The one thing I do know about markets is that there will never be a grand pronouncement that this volatility spike is ending. It could go to 50, or 60, or 70, but it could just float down from this point. One never knows. If I was going to guess, this financial soap opera has another month of legs left in it.
What a good investor does, and a good investor holds onto cash for this reason: to pick off the targets on your watchlist, that are being sold by international financial institutions carte blanche, that are trading well below what your assumed fair value for the securities are.
A third-hand report about Canadian Natural Resources stating that capital costs to hire critical contractors (e.g. for drilling and such) are increasing and leading to significant project budget overruns.
This is the nature of commodity markets – when prices are high, all companies rush in to expand projects and try to increase capacity so they can sell more product. When they are finished, they dump into the marketplace, depressing prices. Because of the fixed capital investment, it makes better economic sense to keep pumping product out even when the price of the underlying commodity does not make economic sense if you were beginning the project from scratch. As an example, if you include all fixed costs and it comes to $60/barrel, if you expect oil to be above $60 then it makes sense to build the project. If marginal costs of extraction are $40/barrel after that point, then it makes sense to keep operating even if you are below the break-even point for the entire project.
This is how you get commodity busts – even below the cost of marginal extraction. It happens when all of the producers have put in their fixed-cost investments, and it is more profitable for them to mine the product than to idle their machines.
Figuring out when this happens on a global scale is very, very, very difficult to perform. It requires a lot of industry-specific knowledge and a lot of data mining, and a lot of gut instinct. There is also the demand-side of the formula – if you expect consumption to increase faster than the supply expansion then you can still anticipate price increases. However, the big downside risk to the crude oil mining industry is not the increasing cost of providing supply, but rather determining if sufficient demand exists to warrant high future prices. Executives of oil companies are more or less trying to predict whether oil prices will continue to remain high two or three years out, when capital project decisions today are made.
Companies like the newly public Athabasca Oil Sands will not begin production until around the 2014 time-frame; they are incredibly leveraged to oil prices.
The futures markets do give a small hint of what is to come – January 2015 oil futures are at $86/barrel, compared to $72/barrel for July 2010 prices.