He has power to move markets

John Hempton of Bronte Capital writes very entertaining articles. Most of his extensive postings are about companies that have “issues”, such as his strong suspicions of financial wrongdoing at the Chinese company Universal Travel Group (NYSE: UTA).

His latest spread is regarding Northern Oil and Gas (NYSE: NOG), which I found thoroughly fascinating, for a few reasons.

The first reason is that my earlier article on Petrobakken (TSX: PBN) and its steep decay rate of oil flowing from newly drilled Bakken-shale wells assisted his thinking with respect to NOG’s depletion rates. He is very gracious to link to my article.

The second reason is that apparently the rest of the market has “picked up” on Northern Oil and Gas’ low rate of expending of depletion and has decided to price this in (note the article hit the wires on Tuesday, although it seemingly was digested on Wednesday):

Interestingly enough, before this all hit the wires, NOG had about 20,000 shares available for borrowing at Interactive Brokers. Today there are none.

Thirdly, he writes good analysis. There is good reason to be skeptical of NOG’s management and their intentions. Even disregarding that, it does appear the valuation of the company is well above fair value. That said, the company’s balance sheet does show a net cash position (assuming those balances are truly there!), so the shares are most certainly worth something, unlike most of the other likely frauds that Hempton has been writing about.

Disclosure: No positions in any stocks mentioned in this article, nor do I intend on opening any. I’m watching this purely for entertainment value, although others likely have money on the line.

Back to normal volatility

Curiously, the VIX, after spiking in the aftermath of the Japanese earthquake, and the onset of the military action in Libya, went to a peak of about 30, has slid back down to about 20:

Most people make the mistake of thinking that the VIX is predictive – it is not. It does anti-correlate with the S&P 500, however.

The real question that investors should be asking themselves is that was this just a single ripple in the market pond, or is this a good time to be loading up on index put options while the volatility is still cheap?

Notably, the April VIX futures closed at 21.50 today; going further out, July closed at 23.10. These products are not easy to trade profitably unless if you have a sharp computer model working in your favour.

Group Contrarianism and Japan

My very quick judgment is that “buy Japan” has been contrarian mantra issued to so many people that it now is conventional wisdom.

There is always opportunity to invest in companies that are in the middle of massive public scandals (e.g. BP), but whether such opportunities become a good value is whether people massively misjudge expectations.

In the case of BP, it was a political execution that translated into a disproportionate hit on the share price. In the case of “Japan”, it is very difficult to make the same judgment.

Hence, I’m keeping my eyeballs elsewhere.

Canadian Interest Rate Futures

Examining the short-term interest rate expectations of the futures market:

Month / Strike Bid Price Ask Price Settl. Price Net Change Vol.
+ 11 AL 0.000 0.000 98.710 0.000 0
+ 11 MA 0.000 0.000 98.640 0.000 0
+ 11 JN 98.660 98.665 98.670 -0.005 17877
+ 11 SE 98.490 98.500 98.500 0.000 25173
+ 11 DE 98.310 98.320 98.310 0.000 32785
+ 12 MR 98.130 98.140 98.140 0.000 15601
+ 12 JN 97.950 97.970 97.960 -0.010 4616
+ 12 SE 97.770 97.790 97.790 0.000 945
+ 12 DE 0.000 97.640 97.610 -0.030 648

The Japanese earthquake and general instability in the marketplace has driven the June futures up from 98.545 on March 1st to 98.66 today – which is pricing in a small chance that the Bank of Canada will increase interest rates on their May 31 interest rate announcement. It is far more likely that the short term rate will be 1%.

The futures still anticipate that the year-end short-term rate will be 1.5%, so it will be interesting to see if this comes to fruition. With reports of food inflation rising (primarily due to commodity price increases), the Bank may have to make an undesirable decision to raise interest rates to stem inflation, which would have an adverse effect on the economy and stock markets.

I stated earlier I do not expect the Bank of Canada to raise interest rates until 10-year government bonds go above 3.5%, and they are presently at 3.19%:

Notably, the Canadian 10-year bond is trading at a yield of 10bps less than the US 10-year note.

A misconception in retail investing

When I have tolerance for it, I browse the Canadian Money Forum. There are a staple of regulars there, some that know what they are talking about, and some that sound like they know what they are talking about, but don’t. Then there are the batch of people that don’t know what they are talking about. It is a surprisingly good indicator of retail sentiment, especially in the younger age category (who presumably don’t have access to millions of dollars of capital and can’t move markets, but would generally be indicative of the mentality of higher risk-taking individuals).

A large misconception I see concerns dividends. I will state the misconception:

Misconception: Dividends add value.

They do not. Dividends represent a direct transfer of cash from the company to the shareholder.

Sometimes dividends subtract value, when the consequences of taxation are considered. In Canada, the eligible dividend tax credit mostly eliminates the penalty of double-taxation for non-registered accounts. In the USA, qualified dividends receive preferential tax treatment, at least until December 31, 2012 with existing legislation.

A mistake that retail investors make is that a higher dividend yield means the company should be more valuable.