Encana – cutting back capital expenditures

Encana (TSX: ECA) is a very large natural gas producer. In their recent quarter, they announced they will be cutting back capital expenditures and reduced expectations due to lower natural gas prices. Hydraulic fracturing is saturating the marketplace, leading to reduced prices. This is well known by the marketplace, and as such, Encana’s stock was only down by 3% today on the news.

The two charts will explain the story, one is of Encana’s stock price, and the other is the spot rate for natural gas, and one will see the correlation:

One can easily see the connection. Encana is a type of company that will not have its equity double in value in a short period of time, but it does represent a fairly good store of value in terms of the vast reserves it can control (especially reserves in politically stable climates such as Canada). It also represents a fairly good proxy for the price of natural gas.

One of the worst ways to play an increase in natural gas, however, is through the Natural Gas ETF (NYSE: UNG) which I have written about before. I will let the chart do the speaking here:

Bank of Canada leaves target rate at 1 percent

The Bank of Canada has left the overnight target rate at 1%. The announcement is here.

Key quotation:

The global economic recovery is entering a new phase. In advanced economies, temporary factors supporting growth in 2010 – such as the inventory cycle and pent-up demand – have largely run their course and fiscal stimulus will shift to fiscal consolidation over the projection horizon. While the Bank expects that private demand in advanced economies will become sufficiently entrenched to sustain the recovery, the combination of difficult labour market dynamics and ongoing deleveraging in many advanced economies is expected to moderate the pace of growth relative to prior expectations. These factors will contribute to a weaker-than-projected recovery in the United States in particular. Growth in emerging-market economies is expected to ease to a more sustainable pace as fiscal and monetary policies are tightened. Heightened tensions in currency markets and related risks associated with global imbalances could result in a more protracted and difficult global recovery.

To translate this into everyday English, the Bank of Canada believes that the growth in the economic recovery is now leveling, and that it is not entirely certain what the next stage will be. They are reading the same tea leaves that everybody else is reading.

Inflation in Canada has been slightly below the Bank’s July projection. The recent moderation in core inflation is consistent with the persistence of significant excess supply and a deceleration in the growth of unit labour costs. The Bank judges that the output gap is slightly larger and that the economy will return to full capacity by the end of 2012 rather than the beginning of that year, as had been anticipated in July. The inflation outlook has been revised down and both total CPI and core inflation are now expected to converge to 2 per cent by the end of 2012, as excess supply in the economy is gradually absorbed and inflation expectations remain well-anchored.

The Bank of Canada will be putting the brakes on further interest rate increases until 2011 at the earliest. I do not project a December rate increase.

Three month corporate paper is yielding 1.17%, and three-month treasury bills are yielding 0.89% yesterday. Today, this will decrease a little bit.

More important are the spread to longer term bonds, which 5 years will yield you 1.95% and 10 years will yield 2.76%.

Pay attention to the 30-year treasury bond

With all the talk of the US Federal Reserve performing another round of quantitative easing (which amounts to repurchasing medium and long-dated government debt securities in an attempt to lower long term interest rates and frustrate people into purchasing anything else where they can get a decent yield on cash), the markets have started to get a bit antsy on the macroeconomic front.

Since the strength of the US dollar is a huge global variable, whenever the US Federal Reserve does something, the rest of the world, including domestic US investors, will notice. And indeed, the world has reacted by tanking the currency. More interestingly, however, is the rise in treasury yields (lower treasury prices):

In theory when you have the full force of the US Federal Reserve behind a position (in this case, purchasing government bonds), you try to get out of the way. This time, the market’s reaction appears to be one of indigestion – an exit from bonds. This is very interesting and if the trend continues, will have huge ramifications on investor’s calculations as to what exactly constitutes a “risk free rate”.

It is increasingly clear that US government debt is not as “risk free” as people may think, and this risk should be appropriately adjusted in financial calculations.

The easiest way for an investor to directly take a stake in this (other than buying or shorting treasury futures, which is a relatively trivial transaction to perform) is to buy or sell units in NYSE: TLT, which is an ETF that contains long-dated treasury instruments of 20 years and above. TLT is down about 8% from two months ago, when US Treasury bonds were trading at a local minimum of 3.5%. During the pits of the economic crisis, the US Treasury bond traded as high as 2.5% as investors dove for the safest haven.

A question in the financial markets should now be – exactly how safe is the “safest haven”? If the answer is anything other than US government debt, this would explain the currency exodus.

As a comparison, Canadian long term benchmark yields have generally gravitated down from August – reaching a high of 3.72% in August, and currently trading at 3.45%, and a low of 3.33% seen in late September. Clearly, the crisis hitting the US bond market is not hitting the Canadian bond market, at present.

My perception is that if this is the beginning of a “run” on US long term debt, there will be huge financial ripples in the US marketplace – for example, what do you do when you see a corporate long-term bond trading at a yield of 7%, when the 30-year US government debt is trading at the same yield? We are not there yet, but rising US government bond yields will crush the corporate debt market window that is currently open.

Watch out, because I suspect things are getting exciting again.

Canadian dollar at par

The Canadian dollar is once again at par with the US dollar – if you are performing currency transactions, just remember to get the CAD-USD vs. USD-CAD conversions correct!

The currency rise has not as much to do with the Canadian dollar rising as it does with the US currency depreciating – the world is strongly reacting to the imminent quantitative easing 2 that the federal reserve is apparently planning on to spur inflation.

Whistler-Blackcomb going public

Whistler-Blackcomb, owned by Intrawest, filed to go public on the TSX. The salient numerical details, such as the total amount of the offering (rumoured to be $300 million) and pricing of the company’s stock remains to be seen.

Intrawest used to be public, but was taken private in 2006 and is now owned by Fortress Investment Group.

Although I have not completely read the document (and won’t until the issue has a price), of note is that the public entity will hold 75% of the Whistler-Blackcomb partnership (page 128); the corporation will have an additional $261 million in debt taken out; and the entity will generally have historically made about $50-60 million in income from 2007, 2008 and 2009. Note that because the corporation has a 75% interest in the partnership, that some accounting rules will kick in and subtract the 25% minority interest, so the net income figure will be lower.

This offering is being touted in the media as an income play, which is likely why the company is going public right now – to get out while the premium paid for income-bearing securities is red hot.

I have a paper napkin valuation which will likely be lower than what the actual selling price will be. I also think there are a whole host of risks that this venture are correlated to – including the resort real estate business, and BC tourism in general. I believe the company is using the elevated 2010 numbers from the Winter Olympics to tout their equity, which will be a mistake for investors to depend on. The 9 months ended 2010 show a $52 million income year, compared to $58 million the year before. Note the last quarter of the year is a money-loser.