Finance – Page 24

ETF products that use short-term future contract maturities

If you hold the products mentioned in the title of this post, such ETF products are a legal license to have money stolen from you, specifically in the rollerover mechanism.

There are ways to mitigate this (i.e. involve the rollovers continuously over a longer period of time), but this mitigation removes linkage between true spot pricing and the underlying ETF value.

Also if the ETF is a small fraction of the underlying market, then it doesn’t matter. Life can go on as normal. However, in today’s modern era, there are huge amounts of money swimming around in ETFs, waiting to get picked away by professional traders.

USO was a great example last month. ETFs that blindly were forced to short the short-term month and long the second month – this came in all sorts of forms other than USO as well. Retail oil investors in China, for example, got duped into this. As a result of the widely known rip-off (culminating in the negative 40 dollar futures price), such ETFs were forced to reform their practices to make their trade rip-offs less obvious. Most of them do it much more slowly.

But there are other examples.

Right now I have something on my quote screen that is so glaringly abberant that I had to wipe my glasses and double-check to confirm it was there. It’s something that institutional traders can take great advantage of (quantitative hedge funds must be making a fortune right now) but ol’ retail people such as myself can take some minor benefit to it, being restricted with the amount of margin to put up with such trades.

This chart is a relationship between two financial products. It should not be above zero (it can be at times, but right now is not a circumstance it should be above zero). But it is.

When checking some ETF databases, I can see why this is the case. There’s just too much money moving out of the front month to the second month, especially in relation to the ETF size versus the actual market size.

I’m purposefully vague here because this is clearly an actionable idea.

The lesson for people here is that investing in the wrong ETFs are financially hazardous. But this has always been the case. Just that the inherent structure of certain ETFs always lead to the same outcome – getting your pockets picked by traders.

More Misc market notes

Too much going on today, so will consolidate it into one post.

Everything that is going on is liquidity-fuelled. Central banks buy bonds. Bond yields go down. The equity to bond spread goes in conjunction with this, and hence prices rise. Doesn’t matter what the heck happens to the economy and it will drive most people crazy that do not see this relationship. Eventually they will capitulate and buy at the top, but right now there is a huge wall of worry which favours further equity upside.

* A week ago, I told you about Birchcliff preferred shares – they’re up today and as natural gas strengthens these present a good risk-reward, coupled with some income to boot. I’m sure there are better ways to play the natural gas space with equity (TOU, ARX?). The floor is pretty much in. Dollar-cost average on anything fossil-fuel related over the next couple months and a year later I’m sure it’ll work out.

* Atlantic Power’s performance (and utilities in general) has been disappointing in the COVID-19 recovery, mainly because power demand has dropped as a result of the economic slump. It doesn’t really matter for them as the price of their power generation is secured through power purchase agreements, but it doesn’t bode well for the residual value of their power plants after the agreements expire. After repurchasing 12.5 million shares of their own stock on May 1st, they will not be able to repurchase further equity until 20 business days after the offering concluded (i.e. not until June). I would expect them to resume share repurchases in June, so I suspect that the common shares will be a reasonably good bargain in May. I won’t be adding since this company is a low-medium reward and low risk entity, so it will be like watching paint dry compared to many other offerings in the stock market. But I’m pretty sure that June will see higher prices for ATP than in May.

* I watched Planet of the Humans, available on Youtube until mid-May, which puts a huge hole through the motivations of various environmental activists. Surprise surprise, it’s all about money and not the Earth! Blair King (a professional chemist which I have a very high degree of respect for) has an excellent review on the movie.

The only reason why I mention this movie is because they tear a good strip out of biomass plants as being “renewable energy”, and for a very brief moment, Atlantic Power’s Cadillac plant (the one which had a major explosion and plant fire earlier this year) was mentioned.

* Firms are going to be throwing everything under the bus for the first and second quarter, citing COVID-19. There will be write-downs of all sorts of junk on the books that have been accumulating. Firms that do not blame COVID-19 during the two quarters for various one-time write downs of financial performance are likely to be more honest than not.

* An example of this is BWX Technologies (NYSE: BWXT), which reported earnings yesterday. They have a competitive advantage in nuclear engineering services. They did not blame COVID-19 for anything, probably because nuclear engineering services are booming and they should become at least a US$65/share stock by year’s end. Yes, I own shares. The most profit to be had in the nuclear value chain is not in uranium, people!

* There is an interesting tug-of-war happening in the Yellow Pages right now, which traded more shares today than it has in a long time. Somebody at RBC is very interested in shares, while Canaccord has been on the selling side of the large blocks, mostly around the $10 range. Just announce the takeover bid already, folks!

* I find it probable that the central banks will target a stabilization of equity levels, so they will adjust the rate of their liquidity injections that go into the market. Still, the trend is for further liquidity until unemployment metrics begin to moderate. I will have a comment on unemployment/employment rates in a future post, as this is an interesting topic in itself which has market implications.

* REITs, financials, and insurance companies, in general, I think will disappoint. You can almost take anything that somebody is bullish on whatever that is posted on Reddit CanadianInvestor and just take it off your list of consideration. It is quite remarkable how useful it is, entirely for the oppositely intended reason.

Better to be lucky than good

With sentiment on nearly everything getting better (“Economies to open up”), (“Remdesivir positive results”), (“Deaths less than models projected”), etc., stocks have received a flood of bidding from people sitting on the sidelines.

Things never work in straight lines. Markets never move continuously up. There will be spouts of fake news now and then to throw some sand in the gears. You’ll hear about (“Second wave”), (“Shutdown to last until December”), (“Food shortages”), etc.

This is all media noise. The paradoxical thing is that even though the media is spewing mostly noise these days, one has to pay attention to it since it gives you a very general barometer as to sentiment – if you assume something to be false, but others believe it is true, the fact that you know others think it is true is in itself a valuable piece of information.

Placing orders is always an inexact science. On the buy side, sometimes it makes sense to pound asks, but in most of the cases it is more efficient to just passively place orders on the bid and let the market come to your own price.

However, I have a phrase which is “better to be lucky than good”, which is to say that sometimes you get a clairvoyant fill on your orders, and sometimes it comes up annoyingly short.

A couple days ago I had a limit order in for a stock, and I missed it out by two cents. This wasn’t a penny stock either. That stock is now up about 13% from where I initially placed the order, so I am kind of steamed about it. Unlucky. It was definitely a case of ‘too much too fast’, and they will regress down, but I very much doubt to the price where I nearly hit my limit order.

You probably are asking, “Why not just hit the ask when it is two pennies to your order?”. I usually don’t set my orders in the middle of the trading day, and if the price I set for this particular security was 5 cents higher, I probably would have gotten filled. That’s just the roll of the dice occurring. That’s trading life – psychologically it is irritating (hence this post) but you have to forget it and move on and deal with the reality the market gives you, not how you wish it to be.

Next chart, the May 2020 VIX futures, where you can see my liquidation on blue triangles:

I liquidated my VIX short orders in the market euphoria, and I say I did pretty well on this one. The last order to cover the short was at 31.50 and the low was 31.45. Needless to say – lucky on the exit. I’m looking to get back into this trade at higher prices.

Investing involves a lot of skill, but in short-term situations as these, sometimes you need a good dose of luck.

Lending Loop – Why even bother?

Lending Loop is one of those peer-to-peer financing companies where you can allow yourself to be the recipient of future defaulted loans in the name of some business cause or another spending it without any real accountability. When you sign up, on top it states “Start investing today and earn a projected return of 5-8% per year*”

The “*” leads to a link with a model that uses words like “projected”, “estimated”, and other such mumbo-jumbo that is nearly as good as a COVID-19 mortality prediction.

Why the heck would anybody want to lend some random small business money at 5% when you can pick a brain-dead debenture (e.g. Rogers Sugar RSI.DB.F, 6.25% YTM) of a publicly traded company that has a billion more layers of accountability, and actual consequences (i.e. owners lose equity) if there is a default?

Finally, during this COVID-19 crisis, we have the following:

We have implemented a temporary hardship program for borrowers that are currently distressed as a result of impacts of COVID-19. This program will allow Lending Loop clients that meet certain criteria to make interest-only payments on their loans for a period of 3 months to accommodate this unexpected event.

I am guessing they are not doing this with the consent of the lenders. If the terms and conditions of the loans are so malleable, why would anybody ever bother putting their money in Lending Loop or other peer-to-peer lending services? This never made sense to me.

This is also why companies like Alaris (TSX: AD) never made sense to me. Companies have to be pretty desperate to lend money at double-digit coupons, and if you’re willing to sell royalties on revenues, you’re likely to destroy the margins that are required to keep your business competitive. It might make sense in specific scenarios (e.g. gold mining streams can make economic sense at times, e.g. “some percent of something versus 100% of nothing”) but gold miners are not like widget manufacturing where you have to squeeze out 200 basis points of margin in order to make a living. (Very abstractly, the less competitive the industry is, the more possibility that royalty selling makes sense).

And finally, if you want your double digit yields on questionable debt of corporations, there’s always gems like Bombardier unsecured, which when I last checked would net you 20% YTM if you feel brave. Less riskier than most stuff on Lending Loop and higher potential return, in addition with the likely possibility of getting a few morsels of recovery if they defaulted!

The blowup in oil – and what’s next

I posted about it the oil situation earlier, and here are some ramifications: Interactive Brokers took a $88 million hit on client margin accounts on oil futures:

Several Interactive Brokers LLC (“IBLLC”) customers held long positions in these CME and ICE Europe contracts, and as a result they incurred losses in excess of the equity in their accounts. IBLLC has fulfilled the firm’s required variation margin settlements with the respective clearinghouses on behalf of its customers. As a result, the Company has recognized an aggregate provisionary loss of approximately $88 million.

Other financial institutions and/or funds were probably cleaned out on this transaction as well.

Anybody investing in the USO ETF (US Oil) is actually investing in a combination of the two front month futures contracts (retail is crazy to use this ETF as an oil instrument – if they really feel like ‘safely’ speculating on oil, better to put some money in XOM, COP, or if they insist on Canada, SU or CNQ). At the time of the May 2020 contract calamity, USO had zero exposure (they already rolled over to June), but today there was visibly obvious trading action on the charts that are classic liquidation trade signs:

Whenever you see “V” type charts, especially sharp ones that you see here, this is most likely due to a function of margin trading and customers getting cleared out en-masse – a cascade of market sell orders in the accounts with insufficient equity. Conversely if you’re bright enough to put some layered orders on the buy side (and have sufficient fortitude to not catch the absolute bottom since you have no idea when the forced selling will end) you can make huge profits in a very short period of time.

Needless to say the negative oil prices on the May 2020 contract (coupled with some rumours of Supreme Leader Kim) has increased the perception of market volatility and risk, and I have been nimble enough to reduce risk and get out of the way of any potential blowups of this magnitude. The net result of this is that a whole bunch of oil producers are going to go belly up and this will drastically reduce the supply going forward, probably at a higher rate than the decrease in demand exhibited to date.

Now my next question is: Are banks the next to drop? They are ultimately backstopped by central banks, but I deeply suspect they are in more trouble than it may seem. People looking for “safe dividends” in Canadian financial banks should be very, very cautious right now. It’s very difficult to predict how much of their lending will go belly up.