Pinetree Capital Re-visited: Another debt opportunity

Please read my prior article, Pinetree Capital: Possibly the worst closed end fund ever, for a good backgrounder on what I am writing about here.

How would you like it if you bought an equity interest in 70 cents per share for the market price of 20 cents?

Normally most people would snap up on the opportunity. Every dollar you invested is backed by over 3 dollars of real net financial assets! What could be the catch?

The catch, of course, is that the assets you are purchasing are illiquid, of dubious value beyond a thin market quotation, and is managed by somebody that has an impressive track record of losing money.

Otherwise the market would not be giving such a steep discount to the whole consolidated operation.

What is interesting is that the capital fund continues to be hampered by debentures that have a 33% ceiling on the debt-to-asset ratio. Last year the fund breached this and had to pay handsomely for the privilege of obtaining more time.

Management has a huge incentive to not let the debtholders take over – surely the big players in the debenture space would liquidate the fund piece by piece and would not be hamstrung by pesky management or their insanely huge salaries.

The debentures, by virtue of the debt-to-asset covenant, are functionally secured, first-in-line debt, next in line to the margin loans the fund has been taking to fund its incredibly speculative investment portfolio.

They also mature in 1 year and 7 months time.

Now that the whole world stock market has tanked over the past month, speculative issues get hammered the most. Pinetree has been suffering, and its equity has thus gone down to the huge discount over stated asset value that you see today.

There is probably some value in the equity, but it will take time to realize the value due to liquidity issues.

However, the real value is in the debentures mainly because they have the noose over management at the moment, who have shown every indication they will dilute and use every trick in the book to maintain control of their lucrative salaries.

Who wants to invest in this train wreck? I don’t know, but if you have a very thick stomach wall for scraping the bottom of the investment barrel, consider purchasing some Pinetree Capital Debentures (TSX: PNP.DB) if you feel brave. There is a reasonable chance that you will be made whole.

Disclosure: I own the debentures.

Market rallies in downward trending markets

It is fairly well known that the largest one-day market rallies occur in the middle of bear market trends. I don’t have the table immediately in front of me, but suffice to say today reminds me of one of those days:

spy

So instead of getting this trickle increase of climbing the “wall of worry”, the rallies are now consisting of manic one-day rallies.

It is thus also not surprising that volatility is trending upwards.

Whatever is happening in the markets is not likely over yet. My guess is that this has to do something with the continuation of the withdrawal of liquidity from the US federal reserve, coupled with trade issues in China and a lacklustre economy in Europe and Japan, with the appreciation of the US dollar vis-a-vis other major world currencies. That was a mouthful?

The only question is that the financial markets make it very difficult to tell which variables are causes of others, and whether the chicken or the egg came first.

Bitcoin valuation review

Here is a chart of milli-Bitcoins to US dollars over the past month:

2014-10-04-BitCoinChart

Anybody having bitcoins over the past month has seen a 1/3rd drop in their US-denominated equity. (As a side note, investors in precious metal gold would have seen a 5% drop in the same time period).

However, the gist of this post is that Bitcoins has long since moved away from the “novelty” factor where people would speculate on them just on the basis of being collectibles (think of Beanie Babies in the late 90’s) and now the market is pricing in true economic worth of Bitcoins – in this case, it is far, far less than what it has been trading for.

Companies and entities that are collecting bitcoins for payment (Overstock.com!) inevitably have to liquidate them or they will continue to face currency risk in transactions.

In addition, it is perfectly obvious at this point that using bitcoins as a currency medium for illicit (silk road, etc.) transactions is just inviting the relevant authorities to digitally track the transactions and make the appropriate associations with the wallets to the identities of the people holding such wallets – the illicit marketeers might as well be writing paper cheques to each other. These illegal trades likely constituted a high amount of the initial bitcoin traffic but this has now ceased.

The only transactions I would see at this point that are economically viable for the medium are currency transactions to avert low denominations of capital controls in countries that are constrained by such measures (think of examples like Argentina, Venezuela and most African dictatorships). I do not see this being particularly viable considering the liquidity of bitcoin markets is nowhere close to institutional levels. In addition, such transactions are indeed illegal in their host countries!

There are structural issues with bitcoin that will continue to hamper its viability, of which I have addressed in earlier posts on this site.

One is that as the blockchain gets bigger and computational difficulty rises, it will become more incumbent upon large digital processors to maintain the transactions. I have already written about the well-known 51% risk where somebody with sufficient computational power over the rest of the network can subvert transactions and simply ruin it for the other 49%. In addition, computational difficulty of Bitcoin continues to increase to levels where it makes no sense except for industrial data-center levels of computational power to operate Bitcoin networks. Ironically, this is not what was envisioned by the pioneers of Bitcoin, which preferred a much more decentralized mechanism to arbitrate the transactions. Instead, concentration will be leading to an obvious state of the union where the 51% owner to the network will be, in effect, the central bank.

Large scale data centers such as ghash.io have pledged to keep under 40%, but why kill your golden goose so prematurely by scaring away dumb money from coming into the marketplace?

There are also more and more other digital currency schemes (Litecoin, Dogecoin, etc.) which continue to trade, but are simply there just to be an alternative to bitcoin – most of the mindshare out there is on bitcoin compared to the alternative currencies. However, with all of these new digital currencies, there are always incumbent advantages – the group establishing the coins will have all the advantages of mining them first, and then with the hopeful attempt to build a marketplace for it so they can just dump it for real currency. Bitcoin has some inherent advantage than other digital currencies simply because the implementation of this was relatively “innocent” compared to most crypto-currencies being created today that are simply there to steal money from other gullible people.

There is the casino-type element of currency trading. I continue to read the Reddit thread and continue to see people with less financial knowledge give out wisdom on Bitcoin. I would be very curious to know the total amount of bitcoin float out there that is simply being held for speculative (i.e. nothing other than for the reason they believe others will believe it is going up) purposes. Now we are reading threads like this or like this, both of which remind me of Canadians that said “I have shares in Nortel purchased at $80, what do I do?”.

Finally, there is the risk that the cryptographic features of Bitcoin that make it very difficult to access other people’s wallets, may be cracked. While this is unlikely, if such a discovery were to be made, it would clearly cause a collapse in the entire Bitcoin system. The only analogy I could make to this in the central banking fiat currency system is having other people being given access to your own bank account at any time without any reversibility (although you can go and find their wallet and spend it right back if you know the algorithm to doing so!). The system would simply collapse.

I can’t see any reason why any Canadian would want to purchase Bitcoins at this time other than for the novelty factor. If you’re planning on buying currency to prepare for the end of the world (whether it be war, hyperinflation or alien abductions), I would not buy something that depended upon a reliable electrical connection, let alone internet connectivity!

Alibaba IPO – thoughts

If you ever had any thoughts of investing in Alibaba (NYSE: BABA), I will just summarize it in this following chart:

94-047

The most relevant footnotes are as follows:

(1) Includes approximately 70 subsidiaries and consolidated entities incorporated in China and approximately 120 subsidiaries incorporated in other jurisdictions that are not illustrated in this chart. In addition, the entities pictured in this chart hold, directly and indirectly, an aggregate of approximately 40 additional subsidiaries and consolidated entities incorporated in China and approximately 40 additional subsidiaries incorporated outside of China not pictured in the chart.
(7) Each of these variable interest entities is 80%-owned by Jack Ma and 20%-owned by Simon Xie, other than Zhejiang Taobao Network Co., Ltd., which is 90%-owned by Jack Ma and 10%-owned by Simon Xie.

Good luck figuring out what is beyond the first layer of the corporation and what these variable interest entities are all about. I am reasonably sure insiders will do quite well as long as they are continued to be sanctioned by the state.

Make no mistake – Alibaba is an incredible commercial operation on the level of Ebay and lesser to Amazon, but the people that are going to get rich out of this operation are not going to be the people investing in Alibaba Group Holdings Limited (Cayman Islands) common shares.

Signs of a crash coming up

I don’t like using this sort of language (mainly predicting a crash), but the following are some tea leaves that I am reading in the teacup:

* The market has completely baked in the fact that the money spigots from the Federal Reserve is coming to a close. Yields are rising (take a look at the Bank of Canada).

* Speculative issues (specifically on housing, and small-cap venture type firms) are getting dumped away. Just look at the TSX Venture, or anything resource-based on the TSX (including most commodity issues).

* Likewise, leveraged financial products (e.g. most REITs, financials) are trading down. For example, Genworth MI (TSX: MIC) has traded down over the past month from its highs of about $40/share (where I was fortunate enough to get rid of a bunch of it). I will be able to attribute this due to the implied real estate market risk in Canada, combined with an anticipated increase in interest rates. Compared to the financing firms (HCG, EQB), I would view mortgage insurance as being relatively better in terms of continuing to provide earnings and cash flows. Tangible book value is $34.11 from the previous quarter so the company is still not a huge bargain at present prices.

* The strength in the US currency is now starting to weigh in on commodity prices and this is not good for Canada’s economy in general.

* Liquidity appears to be entirely centered around large cap issues.

So here are some general ideas with the assumption that you’re going to bank on a market crash (or less dramatically, a correction):

* Volatility futures – I bring to your attention the following 3-year chart of the VIX, which is correlated deeply to the implied volatility you get on short-dated S&P 500 index futures:

vix

Be warned that it is not unusual for this index to be well below 20 for extended periods of time (e.g. a long-dated chart is here).

* Buying puts on the Russell 2000 (IWM). If there is a flight to liquidity, almost by definition less liquid small-cap issues are going to receive the brunt of increased demand to offload them into the marketplace, resulting in lower prices.

You do pay for this, however – a January 2015 at-the-money put on the Russell 2000 is at about 18% implied volatility, while the S&P 500 is at 12%. The S&P 400 midcap (considerably less liquid) is around 14.5%.

* Buying long-dated treasury futures.

* Or even more conservatively, just holding onto plain old cash and brace for impact.

In general, it appears that we’re headed to some sort of decompression of the utilization of leverage, which will have ripple effects.