2016 will be for traders

In prior years since I've started this blog most of the time I would look upon the new year and have a decent sense of what lied in store because there were at least a few major indicators that suggested the bull market since 2009 had room to go. I was generally bullish long term and always suggested to give the bulls the benefit of the doubt during corrections. I advocated buy and hold as a result. This time around I can't say that because we are in a situation where corporate profits as a whole are rolling over and monetary conditions are tightening which are not the ingredients for an advancing bull market that is 6 years old. At the very least this suggest the bull market will be on hiatus characterized by choppy action for months with a reasonable possibility of a full blown bear market.  The bulls would argue that profits have only rolled over marginally (so far) with energy and the strong US dollar as the culprits and although interest rates are now on the rise, we're a long way from monetary policy being restrictive.They can also argue that with energy being so oversold it's poised for a bounce back which would be positive for overall corporate earnings in 2016. These are a good points, however, the burden of proof is now on the bulls and until we actually see evidence of earnings turning the corner for the better, investors will be skittish. Also, with the fed in tightening mode there is always going to be the fear that they will over do it and cause the economy to tip into recession not to mention the belief many have that this entire bull run was predicated on the fed's easy monetary policy which is now being unwound. As a result of the above, the market will have a very hard time making headway and the best we can hope for would be a range bound market. 1994 and 2004 were the last times the fed tightened monetary policy for the first time coming out of recession and although there was ultimately a bullish resolution,  the markets were range bound for months as investors took a wait and see approach to see what kind of economic damage if any, the tightening would do. Once the market got the sense that the fed was just about done with little or no damage to the economy, the markets took off. Will this happen again this time around? We will see....I think it's certainly doable but then there's the bear case which is not weak by any means.

There is an eerie parallel of the energy crash to that of the tech and housing crashes of 2000 and 2007 respectively which lead to recessions and major bear markets for stocks in general. Both those aforementioned sectors were important drivers of the cycles that preceded them, responsible for significant earnings and job creation. When they crashed they created stresses in corporate bond markets and resulted in job losses which at first were dismissed as isolated events that wouldn't spill over to other sectors. Energy state Texas was by far the greatest contributor to job creation in the US since 2009.  In fact about 40% of all job creation in the US since 2009 was due to Texas!

To believe that this prosperity in Texas was not due to the oil boom would be very naive. I've heard the  argument that Texas is no longer as energy dependent as they once were as their economy is more diversified but I'm quite sure the energy sector in Texas leads their economy and  drives other important sectors such as housing and retail - it certainty can't be the other way around.  Now that the oil sector is in the tank we are at serious risk of seeing the reverse of this Texas wealth effect kick in.
There is a silver lining to the oil crash in that it's an economic windfall to consumers which is different compared to the tech and housing crashes whereby there's no such windfall. I'm not sure that's going to be enough to offset the negatives but at least there is a positive effect.

The bottom line though is that flat/down earnings when there's monetary tightening is simply not a good recipe for bullish action when you have the market trading at arguably high valuations. I think the best the bulls can hope for at this point is a range bound market but as I've mentioned many times on this, I never felt we reached the euphoria stage of this bull market and people are always so quick to turn negative at the first hint of trouble and so the contrarian in me is not writing off this bull market yet, however, for the first time in a long time, I'm giving the bear case a lot of respect. Be careful.

A true bear market feels different

The market as measured by the SPX is off about 10% from its peak but based upon all the hoopla in the media and the pundits, you get the sense that we've crashed more than 30%.  I've seen plenty of bear markets in my time and I can tell you that what I'm seeing here at least from a sentiment perspective, doesn't fit the bill as classic bear market action aside from a "mini-bear" like what we saw in 2011.  Do you remember what the sentiment was for gold and oil near their peaks and after they rolled over into true bear markets? I do. When gold was at $1800, it was simply a matter of when not if  gold was going to hit $2500. I clearly remember many pundits saying "gold is good to own during inflationary and deflationary periods" in other words, you couldn't go wrong owning gold! I pointed this out out at the time how this was complete nonsense and it's these types of rationalizations  that you tend to see near the peak of a sector. The same thing applied to oil. The financial/business section of Chapters was littered with "peak oil" and energy crisis related themes which predicted $200 oil. I also mentioned in December how there were pizza delivery boys earning $56k/yr + benefits in one of the hot spots of the US shale boom. Well folks, that's the type of exuberance and excess you see when a sector is in danger of topping out. Of course, trying to time the exact top is very difficult as the top can still be a year or 2 away when you see such signs of giddiness. When those hot sectors did roll over, how many pundits did you see on TV call it? How many articles in the financial papers warned you about huge damage to come? I bet it was close to or at 0.

Now ask yourself these questions. Did you see the average investor/pundit become giddy with the stock markets in general just prior to this peak? I'm taking about "you can't go wrong" type giddiness. The answer to that is no in my opinion. This has been the most unloved bull market ever and I don't think it was ever fully embraced. Now that the markets have dropped 10%, is there complacency or worry? I'd have to say there's definitely worry. There's no shortage of doom and gloom articles in the financial media warning about the fallout from China or the looming rise in interest rates in the US, or the fallout from interest rates not rising! I noticed Cramer using the term "bear market"when describing the action. When I was working at TD talking to retail clients on a daily basis they were often citing things like China or the Greece as causes for concern and so I know that I'm right when I say that the financial media is quick to point out issues/problems with the markets anytime they have a sizable decline. 

To play the devil's advocate there were some signs of excess in the market building up, namely, margin debt levels and lower quality of IPOs hitting the market. I would argue though that these are more so the symptoms of a maturing bull market and we didn't see things get truly giddy. We saw market debt starting to build up rapidly just prior to the 20% drop in 2011 and just like this time around, the froth get washed away rather quickly which is healthy for the market. Margin debt has been declining notably and the IPO market has been practically shut down. The one thing we're still missing though is more equity fund outflows. I'd like to see more panic in the market by retail investors and I myself don't feel as nervous as I think I should be. I know that in the depths of 2011 I had more doubts about the market although I gave the benefit of the doubt for a bullish resolution. You know you're near the end of a correction when even the bulls like me start having second thoughts! 

What catalyst could ultimately get us out of this funk? I think what we will see is a very big push from China's authorities to support/stimulate their economy beyond what we've seen so far. If there's one thing the authorities have learned since 2008 is to not stand idle. Like it or not, that's the way it's going to be so embrace it rather than dogmatic, ideological beliefs you have about how the markets and the economy should function like Hussman and the other self important permabears. Save that bs for friends and family over coffee or something. 

Update

It has been quite some time since my last post and a lot has happened since. As it turned out, the oil sector went into a bear market. Although I wasn't sure of it in December, I knew this was decent possibility and so I avoided the sector entirely. I was able to sell the remaining small portion I had in hwo at 4.25 back in May which brought my portfolio to 80% cash. I have small holdings in fom, czx, nsu and nus which are all great prospects that are being trumped right now by weak commodity prices and sentiment. Given the carnage in the resource sector, it seems to me a generational buying opportunity is in store in the not too distance future.

So now the big question is, are we in general bear market with equities with this latest rout? It doesn't appear to me that this is the case. It seems more like this is just a correction, albeit a severe one like in 2011. The classic conditions for a bull market peak were simply not met i.e. tight money and greed. Instead this looks more like a case where the market is correcting itself after a torrid run since the lows in 2011. Remember back then the market dropped 20% from the high but the bull market carried on. This feels a lot like that. Yes, China is important but the US is more so and the US is the boss,  as it it makes up 25% of world GDP. All major global downturns like 2008 and 2001 were led by weakness starting in the US, not China, not Europe. I will of course keep an open mind but I'm skeptical at this point that we're in the beginning stages of a big bear market.

There is however one thing that does worry me and it's not China. It's the oil market. A lot of the jobs that were created during the recovery since 2009 were oil related. There's also a significant presence of oil companies in the high yield bond market. Energy was a leading sector and so it's quite possible that the implosion in this sector could result in material negative feedback loop within the US economy leading to a recession much how tech did in the early 2000's and housing did in the late 2000's both of which were leading sectors during their respective cycles. In Canada we're already technically in recession due to the energy sector which is a more significant component of the economy vs the US,  however it seems to be isolated to that sector and not widespread....at least not yet.

It's going to be interesting to see how things play out. Given the negative sentiment in place now, I think at the very least there will be an intermediate term rally beginning anytime between now and late October (with a good chance of one more downside scare before it starts). After that I'm not sure but for now I'm giving the benefit of the doubt to the bulls. I'm going to remain heavy in cash until I see a good set up.

By the way, my bet is that the fed doesn't hike rates this week. I think the memories of 2008 are still fresh and that they've come to believe that when there's doubt you should be remain accommodating and there's clearly a lot of doubt/uncertainty out there with the global economy and inflation pressures are absent. I think the fed is not stupid and they know that the implication of a rate hike and therefore stronger US dollar could create further turmoil across the globe would could eventually harm the US even though as of now the harm to the US has not been material. Yes, the US is still the global boss but they it's a global economy and they won't be completely immune to the problems of the rest of world forever.

Oil Crash

The collapse in the oil price has been the center of attention and a popular topic of debate. How low will it go and how long until it rebounds? The consensus view is that sub $70 oil is not sustainable in the long run but it wouldn't be a surprise if prices stay low for at least a few months as the markets digest the glut. Well, we all know the motto of this blog and if it hold true then either the oil price will rebound a lot quicker than people expect or we are in a new bear market for oil which will last a lot longer than people expect (2+ years). Another real possibility is that we do see a rebound shortly but it ends up being a short lived oversold bounce.


The logic behind the LT bullish case is as follows. OPEC nations needs on average $100 oil to balance budgets, the marginal cost of production for shale oil is about $70-75 and so  it would be a matter of time before some of the high cost US supply starts declining. The crash appears to be supply related. US production of oil has been rapidly increasing over recent years hitting 30 year highs. I've noticed it all along and said to myself "It's a good thing they found all this oil for imagine what the price would be without it". Well there's a flip side to that coin because all this new found oil turned out to sow the seeds for its own demise as supply finally caught up with demand and exceeded it. So, the issue is how long will it take for the oil market to make the adjustment. Like I said, there's a lot of people hopeful that it won't be long but recall what happened with natural gas a few years ago when the shale boom resulted in a supply gut. The bust that followed was painful and prolonged and gas traded a unfathomable low prices for a long time, and although it finally bottomed in 2012, it still remains historically low . Then there's the bust in gold and uranium in recent years as well which were multi-year events not mutli-month ones and that's the way it usually it with commodities. Projects takes years to come online and many can't simply be turned off like a light switch and so oversupply conditions can last for a long time With oil however there's the unique dynamic of  OPEC which other commodity markets don't have.  OPEC seems to have the ability to turn off the taps quickly and are playing a game of chicken with US producers. But will they cut or can they cut and when? At what price?

In the midst of the oil crash I noticed some complacency. On a whole, oil companies have not announced material reductions in spending plans during 3rd quarter reports unlike what happened in q3 2012 when oil prices had declined in the summer that year. Perhaps they just need a bit more time and spending cuts will be announced in the near future or during q4. I can't see how there won't be material spending cuts with a 40% drop in oil as well as a huge wave of analyst cuts to earnings. Much of that could already be factored in to the stocks prices. I read an article about how the CEO of Continental Resources Harold Hamm lifted hedges as oil slid towards $80 in early November as he's so confident that a rebound is immanent. That kind of bravery is not what you want to see when looking for a bottom. However, after this latest plunge to sub $70, we're not seeing complacency anymore and more people are starting to believe that these "low" prices are going to be longer lasting. Where are all the peak oil guys now? BNN and other financial media are featuring segments that discuss which sectors and stocks will be beneficiaries of low oil prices. That's nice but you guys are $40 late.

In Canada, the plunge in oil is a double threat. The obvious one is the damage that will be done to oil producers especially the higher cost oil sands projects but the other, less obvious threat is with the nascent LNG industry. There's been a lot of hype and high hopes about it in recent years. The pricing of LNG contracts are oil linked and so they too have crashed along with the oil price. Right now with the spot price of LNG in Asia is about $10.50/mcf which makes LNG in Canada uneconomic. From what I've read most projects need to lock in LNG prices of $14-15/mcf to justify the risk of spending billions of dollars and so I was very much expecting last week's news that Petrnonas is delaying their final investment decision regarding LNG in Canada . They cited high costs as the reason but the true culprit IMO is low oil prices for not only does it make LNG pricing less attractive but it also squeezes their existing cash flows making them less able and willing to take risks with multi-year capital intensive projects like LNG.

If this downdraft in oil is simply a major correction similar to the summer of 2012 then the energy sector is a very attractive sector to invest in right now. If though, we have entered cyclical bear market in oil then it's going to be bad place to be in for the next 2-3 years at least unless you take a trading approach and play the swings. While we can certainty see an oversold bounce soon, I really don't have a good feel for oil here longer term at this point. There's mixed signals but there have been indeed signs of excess which typically accompany the peak of a boom. One of the hot spots of the shale oil boom was in the state of North Dakota where incomes are booming and unemployment is at lowest rate in the US at sub 3%. I  read about how there was an advertisement for pizza delivery jobs offering a $56K/yr + benefits and how one Walmart was offering $17.40+/hr for entry level employees. It gives me dot-com mania nostalgia when I see things like that and makes me think that this has to end badly. This is obviously just a couple of examples and it would require more DD to get a more complete understanding as to just how much excess there  really is in the US shale boom. I've been looking at a few natural gas weighted plays because I think that ultimately, gas prices will go higher with or without LNG but I don't want to have to deal with any oil related headwinds that could weigh on it for several months, plus the markets overall are overbought and I don't want to get caught in any general market weakness. I'm frustrated at this point. 

Still Alive

It's been a while since my last post. After a month long trip to Korea, I've had lot's of time to reflect and think about what's happened to me this year. It's been a terrible year and I put myself in the position to get hurt the way I did. I still believe that in life you need to be bold and take risks but I crossed the line from being bold to reckless. How can you tell if you're crossing that line? You will know if you answer yes to this question: If things don't go my way will I regret it? Obviously you're not going to happy if you take a risk and you lose but that's not what I mean by regret. What I'm talking about is regret rooted in the notion that the action you took was fundamentally or morally wrong. Despite the fact that I was so confident in Greenstar and got to purchase the bulk of my shares at a discounted price to what the market price was at the time, it was reckless for me to have risked as much as I did. It warranted a sizable bet but I broke the number one golden rule I had for myself which is never put yourself in a situation where you get wiped out or crippled if you're wrong. I believed I had good reasons to make an exception to this rule but I was wrong in the worst possible way. There are no exceptions to this rule because there's no way you can be certain of anything in this game. Whether it was bad luck, bad judgement or both you simply can't expose yourself the way I did.

I've been beating myself up a lot going over the thought process I had during ever step of this fiasco but I over it now and come to terms with it. The bottom line is that what I did  was what a naive, overconfident amateur would do. Given my experience I should have known a lot better and I'm so ashamed of myself but there's really 2 ways to handle something like this. You either let it destroy you or you learn from it and do whatever it takes to recover. I've chosen the latter. I've had many setbacks in life but I was never the type who stays down for long wallowing in self pity. I've always bounced back becoming stronger in the process. I went through some very dark times in recent months. Many days I felt dead on the inside and I  didn't even want to get out of bed. But I'm doing what needs to be done to recover. I've taken comfort in my family, namely my daughter. She motivated me to get back on my feet because I don't want to end up being a loser deadbeat dad and have a negative impact on her life. That would be something I could not live with. I'm taking steps to recover. I've found a "real job" which I know I can do well and could lead to growth and I continue to look for investment opportunities with the capital I still have.

As far as Greenstar goes, there is currently a class action against the directors and auditors led by Siskinds. They had success against another Chinese company named Zungui which basically allowed investors to recover 30% of their investment cost but the whole process took 3 years to play out. I'm not holding my breathe on this but these guys appear to have a good track record.

I recently watched a documentary about the World Wars on the history channel. In it they document the struggles and triumphs of the allied leaders. Winston Churchill is regarded as a hero of WW2 but few people know that in WW1 he spearheaded the invasion of Gallipoli which ended up being a disastrous defeat costing many lives. His political career was effectively over at the time and he was forced to resign. What did he do? He picked up a gun and fought in the War. In time he regained his former post and eventually became Prime Minster of the UK leading the allies to victory in WW2. I like Churchill, feel  I have to return to the front lines in order to build myself back to where I was. If I fail, then I fail but I will never surrender.

Game over with Greenstar

As expected there was something sinister going on with Greenstar and mgmt finally coughed it up. There is no chance it will ever trade again and depending on what the status of the company and its assets are, investors will either get a fire sale salvage value or nothing at all. My greatest fear when this debacle first began was that the asshole CEO Guan was purposely sabotaging the company to get it delisted so that he could in effect take it private and try to run away with the assets somehow or have GRE sold to an arm's length 3rd party for peanuts (and then later getting involved with them) knowing that investors would be inclined to accept such deal so as to salvage at least something. Why would he do such thing? Because he's either a ruthless, greedy asshole who was unhappy about how Greenstar was being valued by the market or he ran into personal financial problems, needs money and is setting up to offer GRE to lenders/creditors at a fire sale price in exchange. It's also possible that the company is a sham but if that was the case how and why did they start a dividend then raise it 50% and why would|Guan put $300K of his own money in the PP? Nobody knows the truth of Guan's motives right now but he's either either fucked up mentally or is a sneaky, conniving asshole who did everything he could to stall the board from uncovering his hidden agenda for as long as possible. In late August after several weeks of haggling/stalling he finally agreed to fly in the auditors so that they could complete their work. He even authorized to pay for their flights. Then when they got there he made excuses to deny them access to the bank and tax info they needed. What piece of shit.

If Greenstar is indeed a viable company and the financials were at least mostly accurate then there is a lot of value that would be theoretically available to investors. Assuming the above, GRE would have at least 0.60/sh in cash by now with at least $1/sh in working capital. Hanfeng was another Chinese company that went through a debacle similar to that of Greenstar and their situation appeared worse yet their board managed to salvage a deal whereby the company is to be liquidated to a 3rd party giving shareholders a payout of what looks like to be 0.60-0.65/sh which is not bad considering the 0.71 price the stock last closed at. If GRE is indeed viable and Guan is trying to take this company private on the cheap by purposely not co-operating with the board then there's hope that something could be salvaged such as  0.40- 0.50/sh. That would be a fucking ridiculous low ball value but I'm sure most people would take it. One thing we have going for us is that there are Chinese investors who are also holding the bag and are going to go after Guan. They would be much more effective in getting legal authorities to take action against him than any Canadian would. I know Newman is also going to exhaust every means possible to salvage something for the sake of investors and his own.  If however the company was a mirage like APX was then forget about it. The only recourse for investors would have is to go after Guan personally and the board and that will probably not yield much if anything. 

Despite everything I said, I think it's best to not have much hope and assume the worst outcome here. This is not to say don't bother trying to recover something but rather to assume that this will most likely end up being a total write-off. False hope is a terrible thing to have.

Orca Exploration - a turnaround in the making

Another one of my holdings is Orca Exploration (ORC.B). I've been following this one for about a year and (luckily) took a position a couple months ago just before it started this breakout rally.  Orca is basically a natural gas producer operating in Tanzania in partnership with a government owned company called TPDC. During the past few years the company has been plagued by problems starting in 2011 with the accusation that they were cheating the government for some $20M in revenues. Those accusations turned out to be false as this $20M was due to an accounting error in the government books. Meanwhile Orca's largest customer, government owned utility company TANESCO, was cash strapped and started delaying payments to Orca and to this day still have $45M+  in arrears. This has been the biggest problem with the company. There is also an ongoing dispute between Orca and TPDC regarding $34M of costs that were recovered by Orca from 2002-2009. This issue is not as big as the overdue accounts receivable from TANESCO in my opinion and may end up being resolved by an arbitrator.

The stock broke out above $3 about a month ago when the company announced that there was negotiations with 3rd parties regarding a range possible transactions with the company which includes the possibility of a financing, the sale of the entire company or a sale of assets. The rally was further extended when Q2 results were released last week which indicated that the arrears situations with TANESCO has notably improved. TANESCO had made significant payments to Orca during q2 and subsequent to it whereby Orca now has a cash balance of $60M or $1.69/sh. That's quite large and it's about double the cash they had at the beginning of the year. TANESCO is still $40M in arrears but in the words of the company, the situation has "stabilized" and if this trend continues a large black cloud will be lifted from Orca.

Tanzenia is hungry for more electricity and the country is subject to brownouts. As a result, there is  presently a capacity expansion project in the country which should be completed by mid 2015. Orca owns significant gas assets that would be able to supply the feedstock for this expansion which would give the opportunity for Orca to just about double their current production. However, to do this Orca would need to invest a large amount of capital and is not willing to deal with TANESCO regarding this expansion unless among other things, TANESCO pays up what they owe and there's some sort of payment guarantees for future delivery of gas. If not, Orca has the right to seek other buyers for their additional gas but I'm sure it would be in everyone's best interest if they sell their additional gas to TANESCO.

Orca's fundamentals look pretty good right now and momentum appears to have finally swung in their favor given the significant improvement in the balance sheet due to what appears to be a turnaround in the arrears situations with TANESCO. Tanzenia is getting aid from the World Bank which is probably why they are starting to pay their bills more. Orca also has a huge potential growth catalyst in the not too distant future. Compare the q2 stats that Orca has now to that of 2010 which was prior to when problems started occurring:

                                                             q2 2010      q2 2014

Net CF from operations (YTD)           0.33          0.45
Cash per share                                    0.61         1.69 (present day)  
Working capital per share                    0.85         1.04
Debt                                                    nil             nil
Book value per share                           $2.51       $3.62

This is a  very basic analysis but the fundamental situation with Orca appears quite better now vs 4 years when the stock price was $4 and the company had no "issues". The stock climbed further to $7 before getting derailed by recent problems. The arrears situation with TANESCO resulted in mgmt making what I think are overly dire remarks in the financial reports in recent years always warning about how Orca may not be a going concern in the near future if TANESCO didn't pay up. Well, if  you looked at cash flows from operations in recent recent years, it suggested that Orca was doing just fine.

                                                      2013    2012     2011    2010

Net CF from operations (000's)   22491    30883    4577    15537

The big drop in CF is 2011 is when TANESCO started becoming late in making payments but as you can see they didn't stop paying all together. These numbers are quite healthy given the market cap and debt free position of the company. Despite the problems the company has had in recent years,  it has steadily grown both its cash and equity values which means there's not only been positive cash flow from operations but also free cash flow generation.  With Orca's current $60M in the bank, they are by far in the strongest financial position they have ever been but yet the company still mentions going concern issues in the financials! Q3 financials are poised to be quite good from a cash flow flow perspective given that $18.6 M TANESCO has paid Orca since June 30th.

The company is fundamentally quite undervalued even with this move to $3.60 especially given the news of their significantly improved financial position. They have a reserve value of $11/sh and are poised to double production starting in mid 2015 but they will need some luck for that. The bottom line with Orca is that the "problems" that have plagued the company in recent years were not as dire as they appeared to be and they look to be at least stabilizing if not dissipating which should provide for improved investor sentiment and therefore higher stock price should the trend continue. The company may end up getting acquired or consummate some other transaction which presumably would result in further upside but if those talks should fail there would be sizable dip. The fact that 3rd parties are looking to possibly acquire Orca or get involved with them somehow indicates I'm not alone in thinking it's an attractive company at these prices.