Category: Commodities

Price of crude

It is an important benchmark to see that the price of crude oil is at an all-time high, at least in nominal US dollar terms, since the economic crisis:

Every day when I look around me, I see people in their automobiles, and I see trucks on the road, and airplanes flying in the sky. While the sample of one is statistically insignificant, when you start to think about world-wide demand for concentrated portable energy (which is what crude oil represents), coupled with the increasingly high costs to mine supply, leads one to suspect that hedging their energy consumption in the form of owning energy assets would be a prudent portfolio decision.

This isn’t new – I have been discussing this for the past couple years. I believe in crude much more than gold in terms of hedging your purchasing power.

Large-cap oil sand companies like Suncor (TSX: SU) and Cenovus (TSX: CVE) are highly correlated to the price of crude oil. They also have significant bitumen reserves which become increasingly valuable as the price of crude rises. Due to the nature of the financial structure of these companies, they are not going to double overnight, but they will retain their value as long as you believe in the stability of the Canadian and Alberta governments.

Companies with oil assets outside “safe” jurisdictions (e.g. Venezuela) involve much more risk, hence you will find them cheaper.

There are also some other smaller cap companies in the oil sands space that are worthy of consideration, and they contain a bit more financial leverage which would result in potentially larger gains.

A very brief primer on Canada-US petroleum trade

The US Department of Energy releases a weekly bulletin on energy, and this week they chose to look at the Canadian energy exports to the USA, and the impact of a pipeline blockage.

The oil sands is a huge strategic advantage, especially as fossil fuel mining becomes progressively more difficult. In particular, transport fuels are going to face huge demand pressures as China and India continue their very high economic growth.

Technical analysis of gold

Here is a chart of spot gold prices over the past 6 months. I have added in three “trendlines” to the chart, which was a rough hack job:

For technical analysis fans, here are some questions:

1. Is it a foregone conclusion that gold will continue rising, or at least no lower than $1260, plus a few dollars each day?
2. If so, what is the proper trendline to use?

Technical analysis also suggests that if the trendline “breaks” that you can no longer assume the trendline exists, and that there is some other trend that is occurring. How do you figure this stuff out without using the chart as a retrospective explanation?

The only reason why I look at charts is a measure of sentiment over time, rather than trying to derive future prices from chart movement.

The Canadian Dollar see-saw

Attached is a chart of the last six months of trading of the Canadian dollar, relative to the US dollar:

One issue I have with technical trading is that in retrospect it is obvious there are “trends” and “momentum” factors as participants try to load up (or dump) the product in question, but when does the party end? Today? Tomorrow? Next week? How will you know the party ends? Right now, “sell at 98, buy at 95” seems to be the optimal algorithm. We will see if that’s the case or not.

Even though I’ve got exposure to both currencies, I will only be watching this from a distance. It’s very difficult to know whether the Canadian dollar is “fairly” valued or not – how do you even begin to construct a fundamental model? This is why a lot of currency traders are primarily technical – hop on the bandwagon, and hope others are still keeping the cart going before you dump your trade.

Potash – Corporate takeover bid

Many years ago, the first time I heard the word Potash, I thought somebody was referring to a narcotic. I quickly educated myself (Wikipedia is a good primer) and nodded, and didn’t think about it otherwise. Potassium compounds aren’t exactly rare, nor are they terribly exciting – you can use potassium chloride instead of sodium chloride to replace your table salt, and more importantly, its usage as a fertilizer.

Canada apparently has the majority of potash reserves, and the major corporation is Potash Corp (TSE: POT). Never in my wildest imagination did I think back then that it would result in a triple over the past 5 years, but apparently agricultural fertilizer is in such demand that companies with potash reserves have been bidded through the roof.

Yesterday, Potash Corp received a hostile takeover bid for US$130/share, while the day before the takeover trading closed at US$112. After the takeover was announced, trading closed at US$143/share, which likely means that the takeover bid will fail at the present price.

Potash has about 297M shares outstanding (304M diluted), which implies that the price paid is around CAD$40 billion for the equity, plus CAD$4 billion in debt for a total price of around CAD$44 billion. The balance sheet has about $6.5 billion in equity, so there is a takeover premium of about $38 billion over book value. Presumably this is because of the embedded value of their resource reserves, but I skimmed their annual report and couldn’t find any clean quantitative data – it has to exist somewhere, but I couldn’t find it when wading through the many pages for a minute.

Apparently 2008 was a banner year for the company, where high prices allowed the company to mint about 11 dollars per share in earnings. 2009 was a more moderate year, with $3.25/share of earnings. The first two quarters of 2010 have an EPS of $3.02/share, so strictly from a backward looking P/E ratio, it looks expensive. Even if you assume every year is like 2008 from here on in, the CAD$44 billion valuation (roughly CAD$145/share) appears to be “average”.

Because of my investment laziness, combined with a lack of knowledge of the dynamics of the potash industry, I wouldn’t make a firm statement on the valuation of the merger. I don’t plan on touching this stock without doing a lot more research (which I am not going to do). Just strictly looking at the financial statements, it looks like the party willing to pay $44 billion for the company is over-paying, while the board of directors that are recommending the rejection of the takeover are likely playing for more money from their potential suitor.

Still, the general lesson here is that when you learn about some obscure compound or mineral, it might pay to look a little more carefully at it and see if it is plausible whether it will be an in-demand commodity in the future. Everybody knows about petroleum and potash, but what is next? Uranium already had its hype period in 2007, while “rare earths” and lithium are making the headlines currently – what’s next? Antimatter?