Category: Finance

It has been an unusual month in that I’ve been nibbling and taking some small positions on some reasonable bargains.

I’ve taken a half percent position in a very trashy penny stock that will most likely go permanently unnamed. This isn’t a microcap play, it isn’t a nanocap play, it can only be called a picocap play. Suffice to say it is illiquid, infrequently traded, but I managed to get a reasonable fill on what I wanted to get and we’ll see if it goes to zero or whether it’ll triple on some business developments which I believe will stand a good chance of occurring over the year. If anything, at least there is a corporate shell that can be sold as a quick TSX listing.

I find rolling over options to be a royal pain in the rear for stocks that have infrequently traded options. The only reason why I’m in options in the first place is because I believe the implied volatility is badly underestimated (trading in the 20’s when it should be closer to the 40’s) which makes the options a more optimal usage of capital than the common stock. When trading options the only problem is timing, and dealing with a large chunk of a barely in-the-money option when there is a month left to expiry always makes me nervous. So I’ve rolled that over into the latest dated options which is roughly half a year later in time for a moderate cost of about 4.5% of the equity price. The cost of purchasing delta is quite cheap on this one, especially when it is trading under book value and they are buying back shares, coupled with a profitable business operation. Quite frankly I expect a takeover bid.

The mechanics of dealing with a barely in-the-money option is made slightly easier with Interactive Broker’s option spread utility which will automatically perform a transaction whenever the market allows for it. It prevents you from having to manually leg in and out of positions which comes with huge amounts of execution risk.

The most significant of acquisitions has been both equity and debt of a USA entity that was the stinker that I had alluded to earlier. My timing appears to have been quite sharp in that the equity is actually up over 10% since I accumulated the position. I managed to get a fill on 80% of what I had seeked. On the debt side it has hardly budged, but it is trading at such a ridiculously good risk/reward situation that I had to nibble on both debt and equity. If all goes well (and this is always the big “if”), the income this will generate will be very pleasant to receive over the next few years plus a healthy capital gain if there is a payout at maturity. Time will tell.

I’ve acquired some long-dated out-of-the-money warrants (which are thinly traded but there is daily activity and a patient investor will be able to get fills in at the bid) of a reasonably-known firm. Performing a valuation of the overall entity (which has leverage issues but is still quite profitable and has been paying down debt considerably over the past couple years) suggests that given a moderate trajectory, the warrants should get at least at the money in the timeframe of expiration. There is considerable potential, considering past valuations, that the company will be significantly above that valuation so therefore the warrants present themselves as being cheap leverage. The common shares underlying the warrants are trading close to the 52-week lows. This story will take some time to resolve, but the results will become obvious much more sooner than the expiration date.

There are also provisions concerning change of control in the warrant indenture that would result in some form of payout if there was an acquisition bid under the strike price of the warrants. The company’s debt is trading above par.

The last acquisition has been of a company related to the economic crisis that Alberta will be facing. Their shares and debt have been hammered to death as a result of some exposure to capital spending in the oil fields. While my conviction is not huge (and this is represented by the relatively small stake I took), I purchased some debt relatively recently. Insiders have also been purchasing both equity and debt of this issuer and while financially speaking the company looks like it is going through a rough patch, they do have sufficient time to realign their operations where they can satisfy their bank creditors. Once again, time will tell.

Nothing that I have been acquiring is on any major index. I’ve been avoiding anything on an index that is tracked with lots of money for various reasons.

I’m also down to nearly a 25% cash position. The other component is that over half the portfolio is trading under tangible book value of the underlying companies.

Be warned that the following is a very unfocused financial commentary on a bunch of topics.

Everybody is trying to figure out when the US Federal Reserve will raise interest rates.

My own opinion is that they will wait as long as possible and not get caught up in the market mania that is currently projecting a 1/4 point increase sometime mid-year. December Fed Funds Futures say that the year-ending rate will be 0.5%:

While unemployment figures would suggest a rise in rates is warranted (as part of the Fed’s mandate is employment, unlike the Bank of Canada, which is purely inflation-driven), with very obvious global deflation occurring, the Federal Reserve should merely be happy that the markets are buying into the threat of higher rates, rather than having to do the job themselves. This persistent threat, but consistent inaction, of higher USA interest rates will likely be the theme for the rest of 2015.

Absent of World War 3, it does not appear that inflation is rearing its head. Too many central banks are trying to stir up inflation with their versions of quantitative easing programs. Japan and the EU are trading moribund, while even China is lowering interest rates and loosening credit policies (as they do not want to precipitate the collapse of their finance system quite yet).

What does this mean for Canada?

Part of Poloz’s strategy is to wean markets away from forward guidance. I’m not sure what the master strategy in doing this is, but by eliminating forward guidance, effectively Poloz is telling the markets to come to their own conclusion in absence of information from the central bank. Thus, it is likely that the Canadian central bank will lag markets rather than lead them. My guess at this point is that they will be standing pat for the indefinite future to see where all the cards lie. Effectively the quarter point move was a signal to the market that “We’re not going to play the soothsayer game anymore.”

The threat of higher US interest rates can only take US currency so high relative to all others. If the threat is executed on, then the next threat will be even higher rates, etc. Since I do not believe the threat is going to be executed on, it would stand to reason that we will be in a holding pattern in the macro scene for the next little while.

Institutions that have taken advantage of extremely cheap money are likely to pare back their leverage, but non-financials should do reasonably well, excluding US exporters.

The forward curve on crude markets is at an extreme point right now and does not bode well for future prices beyond that of the contango slope. That said, there are a few entities out there that are trading as if the entire province of Alberta is going to shut down and while things should get bad in Alberta, they should not get that bad. So watch for opportunity in that area.

As for Canadian real estate, the calls for its demise are loud and clear, but absent of sudden rises in interest rates, I very much doubt it is going anywhere. There is simply too much capital flooded in the market and still too much availability of leverage (either by bona-fide purchasers or investors, whatever the case may be). One item of relevance in Canada vs. the USA is the heavily urbanized and sectorized nature of the distribution of our country’s population and effectively each population center has its own variables affecting real estate valuation.

There is a good component of foreign investment (whether by nominally “resident” Canadians or whether it is through offshore capital) in Vancouver and Toronto’s markets and I do not see signs of this drying up, specifically from China.

Finally, something that I am looking at but is nowhere close to the point where I would want to be accumulating yet, is an odd choice. Gold.

One of the arguments against Gold is that it does not bear any yield. In economies where you end up paying negative yields to invest in sovereign debt (e.g. Switzerland, Denmark, and a lot of the EU), it actually makes some sort of sense to hold value in alternative vehicles, whether that be paper currency or the world’s historical store of value. At CAD$1480 it doesn’t make too much sense from a risk/reward benefit, but in the odd scenario where this goes down a third like the rest of the commodity market, it will be worth looking at. As always, time will tell.

There is also one other commodity that has caught my attention, not for being exciting, but rather for being nearly dead and having very unfavourable supply/demand economics to the point where nearly all interest in it is gone. In fact, the only ETF I could find is rather undiversified to say the least simply due to consolidation in the industry. Still doing research – although the metrics look horrible, when one looks at the rise of other commodities, nobody ever tells you when things will rocket up. Just look at Potash Corp (TSX: POT) from 2006 to 2008:

Getting the “when” correct is always the big challenge.

Economically speaking, it is rational for oil to get back to a “new normal” at US$70-80/barrel given ever-increasing world demand, but I think it will get there later than sooner. We need to see actual shutdowns rather than simple statistics of drilling counts being gutted. When I see companies like Lightstream still dumping $100-120M in capital expenditures (albeit they are going to drop about 20%-25% in production from year-to-year) this is a relatively good sign for upcoming supply drops, but there needs to be time for this to get worked in the system. Most companies are incorporating US$65-ish prices in their financial models and with those rosy projections, it still means they are going to be overspending on the oil patch.

Better to look for businesses that were disproportionately hammered by the plunge in oil prices rather than the commodity itself at this point. Unfortunately my assessment of the situation back in the second half of 2014 was completely incorrect and I have moved on.

Sometimes there are stocks out there of companies that have such bad financial statements, poor execution and operations, and just simply make one wonder “what the heck am I doing investing in this entity?”.

However, in the world of the public marketplace, if you pay a price that assumes a terrible operation and instead the actual performance is simply mediocre, you will make money.

I’ve taken a 3% position in one such company. It is traded in the USA, definitely in the microcap category (although historically it has been well in the triple digit millions category in terms of market capitalization), negative tangible equity, negative gross margin, etc, etc. They are on the threshold of not being able to maintain their NYSE listing, and will likely have to cure that one whenever they release their 2014 audited financial statements.

I’m surprised they haven’t issued a going concern statement yet, although in their 10-Q for September 30, 2014 they did state they have sufficient liquidity for the next 12 months of operations. We’ll see if that changes in the 10-K.

If you look at the stock chart, it looks like the elevation profile of a long dammed river.

Anybody investing in this company is clearly nuts and the stock trades that way.

However, they do have a strategic asset which is not listed on their balance sheet that would cost several billion if somebody else were to do it from scratch. Right now that asset is not profitable, but it is plausible that in the medium term future that it could be (and hence worth a fortune since it would be the low cost producer of this particular item that I do not want to mention otherwise I would give away the story).

Again, the stock trades like it is going to bankruptcy. Financially, it looks like that they are on life support. However, if they spend enough time treading water, it is conceivable that the valuation could be 50 times higher than what it is presently.

A small position is warranted. But I’m too embarrassed to admit what it is I’m investing in.

If we are in the Japan-like scenario of what happened after 1989, it would suggest that we will be seeing very choppy equity markets over the next decade (this includes up and down swings of 40% or so over multi-year periods, just look at the Nikkei index) and one should wrap their heads around the ability to make money in the marketplace when the overall indicies are not moving in the long run. Some basic financial theory would suggest that if the market gives equities a modest 2-3% risk premium, the most we will be seeing out of the S&P 500 on an annualized basis is around 4-5% nominal returns. The ultra-low bond yields we are seeing internationally are also a symptom of huge problems.

As a small factoid, Canadian 10-year debt is at 1.3%. Looks relatively attractive when comparing it to Japan’s 0.38%, Germany’s 0.37%, or the wonderfully fantastic -0.1% yield you’ll get by buying Swiss Government 10-year debt.

Smarter people than myself have already figured out that one of the primary arguments against gold is that it has no yield. But gold looks very attractive when viewed in relation to either sitting on a pile of Swiss paper (literally Swiss Francs underneath the bed mattress) as you wouldn’t want to be investing your money in negative-yield debt. At least when your house catches on fire, the gold is reclaimable.

Once all the gyrations in the fossil fuel market work their way through, having a swimming pool of crude oil in the backyard isn’t going to hurt either.