Checking in after a month – Miscellaneous thoughts

I’ve been on radio silence lately on this site, but suffice to say world events over the past month have dramatically changed the calculus. Similar to how Covid-19 (or rather the policies and psychological reaction in response to Covid-19) accelerated certain prevailing trends, the invasion of Ukraine by Russia is doing likewise.

This is a miscellaneous post. I had intended to write “The Turn” but this work is being preempted by geopolitics, and indeed it is pretty sad since I have made predictions on a draft post which is already coming to fruition, so I’ll have to strip out that spicy content.

I consider it quite instructive that my own personal calculation of an open-air nuclear detonation this year has moved from near-zero to around 2%. One such detonation will significantly transform the psychological landscape and indeed open a Pandora’s box that will accelerate trends beyond anybody’s imagination. A very long time ago in a previous life, I took a couple courses on radiation biophysics and have brushed off the dust from my memories. Better to be prepared today to interpret the Geiger Counter when it tells you you’re exposed to 10 microsieverts per hour, caused by the Cesium-137 ash blowing in your direction… is it safe to eat the food on your table or not?

I have been noticing the commodity complex has received a considerable amount of attention from speculator-types. One stock in particular that I own (ARCH) is being traded around like a dot-com company like it was 1999. Indeed it is obvious there is a rotation of demand going on, and has been going on since last December – technology/SaaS issuers into “stuff”. This trend is likely to continue as “stuff” becomes more and more precious. Electrons (aside from those generated from power plants) are not nearly as precious as they were back in November.

Readers will also note I have been diligently updating the DCOGI Index. All companies have reported their Q4-2021 results. While spot oil as I write this is about US$110/barrel, for modelling purposes I try to level each company at US$75 equivalent (not a prediction, rather a margin of safety). Even at this deflated level, these companies are trading well below a EV/FCF of 10x, which still prices in extremely negative sentiment in terms of market expectations. All of the companies have reduced the level of debt (adjusted for acquisitions) – CNQ is the leader in the group with a $7 billion reduction. All of these companies, with the exception of Peyto, are in the process of either jacking up dividends or buying back stock – the latter of which should be exceptionally accretive to existing shareholders. If you assume US$100 as your baseline, the valuation metrics become even more ridiculous.

Be warned these sorts of conditions do not last forever. But they can last longer than most people expect. Resource companies can produce commodities today and sell it at spot – and a bird in the hand today is slowly being valued more and more than the two in the bush due to the upcoming rising short term interest rate.

The Bank of Canada raised rates a quarter point last week and all indications suggest that another quarter point rise is in the cards for April 13, June 1 and July 13, which will bring the summer short term rate to 1.25%. The next meeting is September 7, after a 2.75 month break, where I think they will evaluate conditions and determine whether to continue raising rates. The question will be what happens to longer term interest rates – will the central bank invert the yield curve by year-end?

Also, it is an interesting intellectual exercise to model out M2 in Canada for the past little bit, and there is an obvious rise in the curve which does not help the inflationary situation. This M2 curve is even worse (steeper) in the United States. Both central banks will be trying to quench the creation of money supply and QT is bound to occur. Similar to 2017-2018, it will take some time for the true impact for these monetary decisions to be felt. But the punch bowl is being taken away, bit by bit. Do not be the last person at the party. It is likely not an ideal time to take on additional leverage. We might get a good rally or two from here, but definitely we’ve reached an inflection point of sorts – until the next calamity that hits.