Start of a correction or just a pause?

The uptrend in the market indexes over the past 7 months has been noted by many, but due to geopolitical instability and the rising price of crude, the uptrend has taken a break. I note before when this also happened:

I do not know whether this is the “top” or whether this is a head-fake on the way to an S&P 500 at 1400. Time will tell.

Although one day does not make for the market’s direction, crude equities fell significantly today. The long commodity trade is very crowded and whenever this condition occurs, the risk of being long becomes progressively higher – momentum can only take you so far. Prudent investors will take money off the table and be patient, and let the greedy ones get burnt.

I wish I had something more to write other than that I have been continuing to take money off the table, and also putting capital into one other obscure US-based equity position that is not listed on any index, and appears to be relatively under-valued at the moment.

Places to park US dollars

If you have US cash collecting dust in your brokerage accounts, you are probably wondering if you can scrape a percent or two from them in relatively safe instruments instead of surrendering that money to your brokerage firm. After doing some exhaustive research on the matter, I believe there are three relatively low-risk ETFs to park them into, all of them offered by Vanguard and ranked from most risky to least:

  • Vanguard Short-Term Corporate Bond Fund (Nasdaq: VCSH) – MER of 0.15%, duration of 2.8, yield to maturity 2.2%, invested in relatively safe corporate securities;
  • Vanguard Short-Term Bond Fund (NYSE: BSV) – MER of 0.12%, duration of 2.6, yield to maturity 1.2%, invested in mostly government/treasury securities;
  • Vanguard Short-Term Government Bond Fund (Nasdaq: VGSH) – MER of 0.15%, duration of 1.8, yield to maturity 0.6%, invested completely in government/treasury securities.

There is still interest rate risk embedded in these securities and you never know if there will be a 2008-style meltdown in the financial markets that would only render BSV and VGSH as cash-like instruments.

Want more yield? You have to invest in junk bonds, a much more dangerous ballgame – and potentially more expensive for investors!

As readers know, I have been in a bunkering down mentality with respect to the markets. I am very defensively positioned and do not expect much returns in my portfolio in 2011.

Bank of Canada leaves rates at 1%

As predicted, the Bank of Canada leaves rates at 1%, citing:

The recovery in Canada is proceeding slightly faster than expected, and there is more evidence of the anticipated rebalancing of demand. While consumption growth remains strong, there are signs that household spending is moving more in line with the growth in household incomes. Business investment continues to expand rapidly as companies take advantage of stimulative financial conditions and respond to competitive imperatives. There is early evidence of a recovery in net exports, supported by stronger U.S. activity and global demand for commodities. However, the export sector continues to face considerable challenges from the cumulative effects of the persistent strength in the Canadian dollar and Canada’s poor relative productivity performance.

While global inflationary pressures are rising, inflation in Canada has been consistent with the Bank’s expectations. Underlying pressures affecting prices remain subdued, reflecting the considerable slack in the economy.

This language is similar to the previous release, and suggests that at the April 12th release that the Bank of Canada, barring any major events between now and then, will be keeping rates steady at 1% for that meeting.

BAX Futures are a shade higher, although it should be noted that the June future is at 98.545, implying a coin toss for a 0.25% rate hike at the May 31, 2011 announcement.

First Uranium – Raising equity financing

First Uranium (TSX: FIU) announced they closed a $52 million equity financing at $1/share. They had originally had $46 million subscribed with a $6M greenshoe embedded.

This is about a 22% dilution of equity interests in the company, but they need this money to bridge their future operations and implement their capital plan:

----------------------------------------------------------------------------
FIU CONSOLIDATED                 end       end       end       end       end
(000's)                      Mar '11  June '11  Sept '11   Dec '11   Mar '12
----------------------------------------------------------------------------
MWS: Cash generated from                                                    
 operations                   12,032    16,295     7,444     8,619    13,873
MWS capital expenditures    (17,816)  (12,649)   (7,093)     (337)     (143)
Ezulwini: Cash (utilized                                                    
 in) generated from                                                         
 operations(1)               (9,449)   (3,823)     (411)     4,964    10,098
Ezulwini capital                                                            
 expenditures                (5,236)   (6,580)   (6,677)   (5,938)   (4,927)
FIU corporate expenditures   (2,875)   (2,726)   (3,726)   (2,726)   (2,726)
Interest on convertible                                                     
 debentures                  (7,301)   (3,156)   (7,301)   (3,156)   (7,147)
----------------------------------------------------------------------------
Cash movement for the                                                       
 quarter                    (30,646)  (12,639)  (17,765)     1,427     9,027
Minimum proceeds from                                                       
 financing raise(2)           46,000                                        
Less: estimated financing                                                   
 transaction costs           (2,675)                                        
Opening balance               29,979    42,658    30,019    12,254    13,681
----------------------------------------------------------------------------
Closing Balance               42,658    30,019    12,254    13,681    22,708
----------------------------------------------------------------------------

----------------------------------------------------------------------------
COMMODITY AND EXCHANGE RATE                                                 
 ASSUMPTIONS                                                                
----------------------------------------------------------------------------
Gold price US$/oz               1380      1390      1390      1390      1390
Uranium price US$/lb              65        65        65        65        65
Gold price ZAR/kg            301,703   303,889   303,889   303,889   303,889
ZAR/US$ exchange rate           6.80      6.80      6.80      6.80      6.80
----------------------------------------------------------------------------

What this means is that if the company did not raise money by the end of the month, they would be out of cash – but they need about $42M in capital expenditures in order to buy themselves enough time to build the Ezulwini mine to the point where it can start generating free cash flow.

Assuming they have the operational side covered (which is never a given considering the sketchy history of the company), their next looming financial issue is how to pay off the subordinated convertible debentures, of which $150M is outstanding and due to mature on June 30, 2012. It is low cost debt (4.25% coupon), but if the company is generating free cash flow at this time, it is likely they will be able to rollover the debt at a higher coupon and extend the term out another five years. This will not happen until the first half of 2012.

If the company gets to this point of being free cash flow positive, the equity will be worth well more than a dollar a share. But this is a very risky play – if it works, investors will likely get a very handsome return on investment over a two year period. If it blows up, the common shares will go to zero.

The other embedded risk is commodity pricing – both currency and gold pricing.

The subordinated debt has traded at around 82-83 cents today, which is the highest it has been since early 2008. Disclosure: I do have a position in First Uranium’s notes.