Ray Dalio / Paradigm Shifts / Gold

Ray Dalio doesn’t need much description, but his latest post (which can generally be summarized as: the party is changing tone, buy gold) gives one consideration.

Why just gold?

In theory, if dollar devaluation is the name of the game, then I would think that any natural resources that have future demand would be eligible for consideration – especially since most of these companies (thinking fossil fuels) have huge debt loads. The debt becomes cheaper due to the dilution of underlying currency, and the underlying commodity becomes more valuable in nominal terms.

The post would also suggest that the low rate environment will continue and asset prices will continue to be pushed higher (and yields lower) – hence, if cash is trash, leveraging via margin would be opportunistic (one could have made this argument right after the economic crisis as well).

I would also think firms with in-demand fixed infrastructure (e.g. wireless telecoms) will reasonably retain value in such an environment.

Interactive Brokers – Sports Betting

Interactive Brokers (IEX: IBKR), in terms of their competitive positioning, has always been a cut above the mainstream retail brokerages. Their advantage in technology and automation (which results in significantly reduced costs) has been whittled away over the past decade by competition (indeed, commission-free trading has enabled most retail brokerages to rip off their customers on execution slippage yet give the appearance of cheapness), but they continue to find ways to experiment with new ways of finding new markets.

One is broaching the connection between sports betting and securities trading – there are characteristics in common with both branches.

A press release on July 1st announces that IB has a sports exchange where people can trade (imaginary money) futures on sport event outcomes.

“We expect this promotion to attract customers who may be new to the Interactive Brokers platform, and who are more familiar with spectator sports than they are with the financial markets,” said Thomas Peterffy, Chairman of Interactive Brokers.

“Our intention is to teach people about the probabilistic nature of markets, trading and investing. We are illustrating this by our Simulated Sports Betting Exchange where each winning bet pays 100. A player who assesses a team’s chances to win at, say 40% may want to buy a bet at less than 40 or sell it at more than 40. As more information emerges and as the event gets under way, these odds will change and the price of the bet will begin to fluctuate, similar to the price of a stock,” Peterffy said.

“By partaking in this promotion, our players will learn about our platform, how to trade and make investments and how to keep track of their finances, all while being entertained. We are betting that many of these participants will also try our free demo brokerage account and that eventually many will become Interactive Brokers’ clients,” he added.

People that are successful in the virtual sports betting will be able to receive an IB account with up to $1,000 in commission credits (first million people to do that). They are given a virtual account of USD$1,000 in currency, and if they accumulate USD$1,000 in virtual profits they can use that to offset commissions in a future IB account.

It is a fascinating promotion, to say the least. I’d expect nothing less from IB.

I don’t do sports betting but I can easily see the connection between the two.

Gran Colombia Gold notes

A brief update on TSX: GCM.NT.U – the company is required to sell 3,900 ounces of gold on the open market, take the first $1,250 of the sale price and amortize the notes, and the remainder gets distributed to noteholders.

Gold today is roughly US$1,410 an ounce, so I calculate that noteholders will receive an extra 0.79% premium on their notes this quarter, assuming that is the average sale price.

(Update, July 16, 2019: Price received was US$1,412.40/ounce, thus the premium is 0.81%)

If the price of gold remains steady for this quarter and the subsequent 3 quarterly transactions, the total premium received will be an extra 3.53% par value on the notes – the same amount of gold (3,900 ounces) is amortized over a smaller principal of notes as they are amortized, so each quarterly payment becomes slightly larger (0.85%, 0.91% and 0.98%, respectively) – sort of like the effect on EPS of a company executing a share buyback with fixed earnings. This commodity-linked debt amortization arrangement is very uncommon in exchange-traded fixed income securities.

In my estimation, there is a high probability that the notes will be called out shortly before April 30, 2021 for the 3 year government of Canada bond yieldUS Treasury Note yield plus 100bps, so this can be used in your YTM calculations. At par and present gold values, right now investors are looking at about a 13% YTM on senior secured debt, but this will fluctuate depending on gold and 3 year bond yield pricing.

(Update, July 16, 2019: The above paragraph is totally incorrect. Please see the comments below for elaboration.)

Unfortunately for people interested in getting in, the notes have been trading lately above par, which will reduce the yield to maturity.

I have a full position in these notes and I am not interested in adding as they are amortized.

Re-visiting Canadian preferred shares

Back on June 24, 2019 I put a notification out that Canadian preferred shares were looking interesting, but really flubbed with the timing. At the time 5-year government bond yields were 20 basis points less than today.

Sadly my sense of market timing let me down and I was only able to procure a 1% position in a rock-solid issuer’s preferred shares. Too bad – was looking at deploying a significant amount of cash there but this one got away from me. Early June perhaps was the time to get in.

It’s pretty obvious a bunch of institutional money stampeded into the market and this gets bubbled into algorithmic purchases of these securities, which typically have quite large spreads.

In general, however, I do note that physical infrastructure preferred shares (e.g. energy, Brookfield, etc.) exhibited a much higher price increase than financials – the typical rise for a physical infrastructure preferred share trading at 2/3rds of par value has been around a dollar, while the financials have had about half of it. In most instances, securities trading with “minimum rate resets” have been ridiculously overpriced, but there was one that looked reasonably attractive for “boring capital”.

If 5 year yields drop again we could see prices on preferred shares drop again – I’d welcome it. In the meantime I’ll look elsewhere.

Reitmans / Substantial Issuer Bid / Taxation

Hat tip to Tyler for getting this on my radar. I’ve personally been following Reitmans (TSX: voting stock RET, non-voting stock RET.A) on-and-off for the past decade or so. Not that I’ve been a purchaser of women’s clothing but financially it is a typical story of the decline of a fairly benign women’s fashion retailer facing the steamroller of competitive marketing and the internet.

Fortunately for Reitmans, they are highly un-leveraged. As of May 4, 2019, they have $122 million cash and zero debt. As Tyler pointed out, IFRS 16 had a disproportionate impact on the reporting of their balance sheet – I will point out any accounting system does not change the actual economics of a company’s operations (other than covenants and restrictions that are governed by the stated accounting values!).

On June 3rd, RET announced their quarterly results, which were less than inspiring (sales down, margins down, cash drain increased from the previous year’s quarter) and their stock tanked. There was a panic sale before somebody with larger pockets decided they wanted to accumulate shares in the low 2’s.

On June 17, RET announced a substantial issuer bid (SIB) for CAD$3/share of up to 15 million shares of RET.A stock. There were 49,890,266 shares outstanding, so the 30% SIB is not a trivial amount – and also nearly 40% of the cash on RET’s balance sheet. The voting stock has 13,440,000 shares outstanding and this will be untouched – directors and insiders have 56.9% control of these shares, although if you want to be a muzzled voting partner, the stock does trade a few thousand shares a day on the TSX.

Shareholders have until July 26 to figure out whether to tender.

The SIB was filed on SEDAR, but I will spare you the trouble and attach it here.

I always find these documents interesting to read, specifically the background of the transaction. Merger documents also have to include the timeline of discussion and negotiations. For RET’s SIB, it is as follows:

During the spring of 2019, senior management of the Corporation was approached by a significant unrelated Shareholder indicating its desire to realign its portfolio and to sell all of its Shares. As a result, such members of senior management and the Board of Directors began engaging in preliminary discussions concerning possible strategic activities and opportunities that may be in the best interests of the Corporation and could provide enhanced liquidity for all of the Shareholders. Among the alternatives discussed was the possibility of pursuing a substantial issuer bid to repurchase a portion of the issued and outstanding Shares.

“a significant unrelated Shareholder” is not defined in this document, but my first guess is Fairfax.

I’m sure another alternative was trying to find a buyer for the company, but this would require the control group agreeing to it.

In May 2019, following discussions with senior management of the Corporation, certain independent members of the Board of Directors seriously considered the possibility of pursuing a substantial issuer bid and the alternatives thereto. Given the Corporation’s significant cash on hand and marketable securities portfolio, certain independent members of the Board of Directors and senior management of the Corporation considered that, in light of the trading price of the Shares, the low return from its investment in marketable securities and interest rates earned on the cash balance, a substantial issuer bid would be a good use of the Corporation’s funds and sought preliminary advice from Davies Ward Phillips & Vineberg LLP, legal counsel to the Corporation, in order to further consider and evaluate the possibility of making an offer to repurchase a portion of the Shares.

The key word is “certain” in “certain independent members of the Board of Directors”. Clearly this was not a unanimous decision.

The rest of the document is bureaucracy to adhere to MI 61-101 and is not terribly juicy.

Taxation (hat tip to Fred for this one)

This is for Canadian residents.

A Resident Shareholder who sells Shares to Reitmans pursuant to the Offer will be deemed to receive a taxable dividend on a separate class of shares comprising the Shares so sold equal to the excess, if any, of the amount paid by Reitmans for the Shares over their paid-up capital for income tax purposes. Reitmans estimates that the paid-up capital per Share on the date of take-up under the Offer will be approximately $0.66. As a result, Reitmans expects that a Resident Shareholder who sell Shares under the Offer will be deemed to receive a dividend. The exact quantum of the deemed dividend cannot be guaranteed.

Careful – if you tender your shares, you will receive a deemed dividend of $2.34/share! Fortunately your capital gain will be reduced (in most cases, one exception is if you just bought the shares before/after 30 days of the final disposition) by said amount, which will lessen the tax bill somewhat. Unfortunately, almost all shareholders of RET are sitting on loss situations – so in order to take full tax advantage of the situation you would need to be able to offset 3 years’ prior capital gains, or future capital gains. Otherwise, you are taking a very large tax hit to tender your shares.

Putting on my individual CPA tax advisory hat, in general, if your desire is to dispose your shares of RET, you should ask yourself whether taking a dividend with a relatively large capital loss (the tender route) or a relatively small capital loss with no dividend (sell in the open market) is better for your personal taxes. RET.A shares are trading at around $2.85 presently so going through the open market approach will involve surrendering a potential 15 cents per share, offset with the tender route uncertainty that at a minimum, only 30% of your shares will be tendered.