Category: Investing

Keystone Pipeline and Canadian Dollar Speculation

On By Jay UnniIn Investing1 Comment

If the Keystone pipeline is approved, the Canadian dollar (CAD) will go up because of the sales of petroleum to the United States. Thus, I am now watching the political issues surrounding the Keystone pipeline.

The CAD has fallen to a recent low on lower employment and growth numbers than expected. But this short term trend would be countered by the stronger and longer lasting effects of the pipeline.

The pipeline has virtually zero opposition in Canada, but it is running into some issues in the United States because the opposition questions the claims that it would substantially stimulate the economy. In addition, environmental groups are pushing back after the latest Arkansas oil spill, so the future for the pipeline is murky.

The former claim has some validity in the short term. There would be dueling forces of construction employment (building the pipeline) and lower oil prices (decreasing employment in the oil industry). But the longer term effects would be positive for the U.S. economy. By building the pipeline, we will, in effect, set a ceiling on gas prices. This, plus the shale oil boom, will have the same effect as a tax reduction – it will increase consumption, and thus stimulate the economy.

I do not know enough about environmental issues to substantiate the latter claim. But I do know that in political battles of environmental groups versus large industries, the industries generally win. I am biased to think that the pipeline will be passed, but I will wait to make any moves on the Canadian dollar until I am more certain of the outcome.

Bad Trading Discipline Pays Off (Sometimes)

On By Jay UnniIn InvestingLeave a comment

In my previous post, Short Term Speculation on the Yen, I outlined the reasoning behind my short Yen, long Dollar trade. I described the reasoning from the dollar perspective, but I had not described the yen perspective, as I believe the story has been better describe by people like Kyle Bass much better than I can describe it. Here is his latest video on CNBC.

The Bank of Japan has moved as I had expected. They have released an unprecedented stimulus measure of essentially doubling the monetary base. Put another way, they will print out the same amount of currency that is already in circulation.

However, I was wrong in my reasoning from the dollar perspective. I did not realize that current fundamental relationship of the dollar to the stock market is a positive correlation – global players have shifted into the U.S. markets as China and Europe have performed poorly. If the U.S. stock market fails to perform at the same pace, these global players may move elsewhere.

Because the stock market performed poorly earlier in the week, the dollar moved lower versus the Yen. There was additional pressure from the other side, as people who had shorted the Yen previously were covering because they were unsure what the BOJ would announce. This resulted in the USDJPY exchange rate hitting my stop limit of 93.70, and plowing all the way down to a low of 92.33.

However, I committed the cardinal sin in trading. I moved my stop. I set my limit down to the 91 mark set in late February. (Moving the stop limit is dangerous, because it changes the risk/reward profile of the trade. By moving down the stop, I was risking more, to gain the same potential profit).

Why? I was convinced the BOJ had been backed into a corner. There is no way out of Japan’s mess but printing money, and even this measure is not sure to work. Therefore I justified the move to myself. While it paid out in this case, it may not in the future, and moving the stop is, in general, not a good practice to adopt.

Short Term Speculation on the Yen

On By Jay UnniIn Investing2 Comments

I have established a small short term position long USD and short JPY (Japanese Yen). This is ahead of the Bank of Japan meeting April 3-4, on the expectation that they will announce a more ambitious plan to devalue the yen than the market expects.

I believe this will occur because, in the current risk-on environment, the US Dollar has been sinking. I do not believe this will last. Equities are continuing to make all time highs, however, if stocks continue much higher, they will be entering overvalued territory. I believe the markets are getting ahead of themselves.

However, the theory of reflexivity would predict that this strength in stock prices would subsequently strengthen the economic fundamentals. An advancing stock market draws foreign and domestic capital and allows companies to issue their own stock at advantageous prices to fund acquisitions and organic growth. In such an environment, the risk-on environment may continue.

The reason I am not paying attention to the reflexive implications of a rising stock market is that the positive bias that would normally accompany such a move is not there. More and more, so-called experts are questioning whether the current economic strength can continue in the absence of the Fed’s monetary stimulus, which will be coming to an end this year. If the conclusion of the Fed’s program pulled out the legs from the market, we might end up with a “sell-in-May-and-go-away” type scenario.

The government’s sequestration lends further support to the “sell-in-May” hypothesis. Economic think tanks are reducing their estimates of the impact of sequestration. I think these estimates are short-sighted. The full effects of sequestration will only be felt later in the year, and I believe they will take the market by surprise. As a consequence, I believe the stock market will suffer a pullback sometime in the coming months. I am watching the markets closely for signs of technical weakness, so that I can make an opportunistic short.

A decreasing market would lead to a “risk-off” environment, in which the US Dollar would go higher. This, coupled with the Bank of Japan’s plans to devalue the yen, should propel the USD-JPY exchange rate much higher. To help matters, there was a doji reversal in the one-day charts last week. I have set a stop limit at the bottom of this reversal, near the 93.70 mark.

Closing the 3D Systems Corporation (DDD) Short

On By Jay UnniIn InvestingLeave a comment

I closed out my 3D Systems Corporation (DDD) short position early last week. The trend has become unreliable.

As I pointed out on March 5, the downward trend was imperiled by Stratasys’s (SSYS) strong earnings. Further, rumors of an acquisition have been floating around.

Owners of manufacturing companies and conventional printer companies would like to get in on this trend, and may consider $3 billion a small price to pay for DDD’s patent portfolio, plus its future earnings. And, with a larger company’s capital at its back, DDD would no longer need to resort to equity-financed acquisitions, which put it at the risk of such reflexive boom-busts as we have just seen.

My March 2012 puts were saved in the nick of time on March 15, closing in the money before expiration. In retrospect, these were the wrong tool to use; I must remember to use puts further out into the future to avoid such a high time-value depreciation.

My May 2012 puts fared much better, and made a many-fold profit. In addition, my short equity position generated a substantial profit.

The negative trend may continue a little longer, but we are currently in a test period. There have been numerous articles recently highlighting the DDD’s fall in stock price as a bargain. This kind of positive perception is not what I would expect in a typical reflexive bust. I would expect the perception to turn increasingly more negative as the stock falls, until a true capitulation point.

I cannot predict what will happen with DDD until I see the next earnings report. If that shows a disappointing low earnings growth figure, then we will have proof that the negative perceptions have affected the fundamentals via the stock price, and it may be safe to re-engage in a short until the stock capitulates.

Given that the next earnings is not due for another couple of months, I cannot justify taking any action on DDD. If the stock reaches levels of ~$20/share, I would consider purchasing it as a long position, but until then, I am simply watching.

For more updates on my portfolio, check my blog BetterStockIdeas.com

Portfolio Review

On By Jay UnniIn Investing, Speculation, Uncategorized1 Comment

I am no longer as confident about my hypothesis that 3D systems (DDD) is in a bust phase. The better-than-expected revenue and earnings at competitor Stratasys (SSYS) has buoyed optimism in the space. I am worried that this will turn around the tide of negative perception that has driven DDD lower in recent weeks.

However, I am encouraged by the fact that 3D systems has not made any recent acquisitions. This would seem to fit with the thesis – that as the stock price declines, the ability of 3D systems to trade overpriced stock for companies with real earnings will decrease. Now 3D systems will have to be measured by its organic growth alone, which is not enough to sustain its lofty multiple – a P/E ratio above 70.

Stratasys seems to be at a different place in its own reflexive process. The results reported were better than expected partly due to a large acquisition. However, the boom has not been as strong as 3D systems’. Reflexivity plays a smaller role in Stratasys’s earnings – the company does not rely as heavily on stock sales to finance its acquisitions, thus the effect of perception on fundamentals is less direct. In addition, the organic growth rate (i.e. growth rate independent of acquisitions) seems to be larger than that of 3D systems.

For now, I am in wait-and-see mode. But I am edgy. I upped my short position on Friday, after reading 3D systems earnings report and seeing the fall on Monday at a much larger volume of transactions followed by a rise that was sustained by fewer transactions. Thus, I established that the rise was temporary, an effect of smaller-sized market participants, and the big money is still selling the stock.

In addition, I have been killed on my puts for March 14. This was a trading mistake. I never should have bought options that close to expiration, and I have paid for that lesson. The time value depreciation is much larger than the potential gain from a stock fall, unless the stock breaks $30/share before they expire. My May puts are hovering at profitability as well. In the future, I will probably steer clear of options as a tool – my type of reflexive reasoning has been better at predicting eventual results than the timing of those results. I purchased the options to take advantage of the short-sale restrictions that had been in place, and these options should have been replaced by short stock positions at a good opportunity.

As for my other positions, they are not fairing as well as I would have hoped. Though C&J Energy (CJES) finally broke its resistance at $23-$23.50, it is still testing this price, now as a support line. It remains to be seen whether the price will hold. WTI Crude has been in a steady decline for the past few weeks, so I believe that CJES holding above $23 is dependent on WTI holding above $90.

I have more confidence in Core Labs (CLB), because of its dependence on overseas operations. However, Core Labs does not offer an attractive value at this price. I would be willing to trade it for something more undervalued that is exposed to the same trends.

Bassett Furniture (BSET) has been a reliable play in my portfolio, as the housing boom seems to be continuing uninterrupted. It still has not reached a multiple of book value that I would be uncomfortable with, and the housing boom is far from over, so I am sticking with BSET for now.

The banking stocks (BNCC.pk and BBBI.ob) are relatively flat since purchase. They likely will not move much without a major announcement.

But BNCCorp’s annual statement provides an insight to a potential weakness in the company. Though it has been making a killing issuing mortgages in North Dakota, profiting off of the Bakken Shale explosion in the region, BNCCorp’s interest income has been steadily falling in an environment of low interest rates. If the mortgage banking revenue begins to fall off, the company will not be able to sustain its current level of earnings. At a 40% discount to book value, the stock is still worth owning at this point, but this is something to watch.

PGS (PGSVY) has declined significantly in recent weeks. It released fantastic earnings for 2012, however the guidance was below analyst expectations, and the stock dropped. It is sitting at an attractive price; with Price to Free-Cash-Flow ratio is sitting below 10, excluding expenditures on its MultiClient operations (P/FCF is a useful ratio to evaluate PGS because it has to depreciate those large Multiclient expenditures over time). I have confidence that PGS will be able to find buyers for its current MultiClient projects, since they are in high interest areas like offshore Africa. With Brent Crude prices above $110, offshore Africa will become more and more attractive to the big exploration and production companies. I would be willing to accrue more shares if I can get a price in the low $16 range.

As for Food Technology Services, Inc. (VIFL), I am waiting for the next earnings release and conference call to review the investment.

Investing in Undervalued Banks: BNCCorp and Bank of Birmingham

On By Jay UnniIn Investing3 Comments

I have spent so much time speculating that I have been neglecting the more long-term investment side of my portfolio. Here are two purchases that I made today to rectify that situation.

BNCCorp (BNCC.pk)

Since I wrote about BNCC.pk, a lot has changed with the company: the stock price has nearly quintupled, the assets and equity have both skyrocketed, and the company has been increasing earnings at unfathomable rates (year-over-year earnings growth was 505%). (Read the article for the whole story on this investment idea.)

BNCCorp still remains undervalued. The Price/Book ratio sits at just under .58. For such a fast growing area as North Dakota, I would expect most banks to be trading above their book values, not significantly below it. Therefore, it is probably a safe investment until it reaches .80 or so. At that point, it will begin to look significantly less attractive.

I am regretting selling out 80% of my position when the stock went up by 150%. I thought the move was largely over, and was eager to invest in other areas, but I neglected to check the real value of the company’s earnings potential and equity in relation to the market capitalization.

I am glad however, that I decided to let 20% of the position run. I have since purchased more shares, though it is always painful to buy back a stock you sold at a lower value.

The bank has increased its equity-to-assets ratio to 8.9%. Thus it is no longer a “cigar butt”, but instead is a well-capitalized bank in the fastest growing area of the nation. (For reference, Peter Lynch recommends an Equity-to-Assets ratio of more than 7.5% to qualify as a well-capitalized bank.)

North Dakota has exploded in population, and as these people settle into more permanent arrangements, the need for home loans and commercial loans will continue to be enormous. The Bakken Shale will remain attractive as an oil play at WTI prices above $80, and now that the European crisis fears are on the decline, oil prices have stabilized in the $90 range. They will likely remain high until the next financial crisis threatens global demand.

Though most of the explosion in the Bakken region is already played out, and though a large portion of the oil workers in the region have already found permanent housing situations, I expect the growth in the Price/Book multiple coupled with steady earnings (if not growing earnings) to secure the safety of this investment for the near future.

Bank of Birmingham (BBBI)

In addition, I have begun a new investment in the Bank of Birmingham (BBBI). The company has been sitting at a price/book ratio just under 1 for a few weeks, but a recent pre-announcement by the company suggests that the current Price/Book is closer to .58, suggesting the company is undervalued.

The Equity/Assets ratio is 11.1%, indicating that the bank is significantly under-leveraged.  This is a good thing: a less leveraged balance sheet makes a less risky investment. In addition, the extra equity means that the bank has significant room to expand its loan portfolio and increase earnings in the future.

With these low amounts of leverage, the bank was able to increase earnings 54% over the course of 2012 (excluding a deferred-tax asset recognition in 2011). This rapid earnings growth rate is a testament to the earnings power of this bank.

So why has this bank been growing so quickly? The answer is simple: the rebound of the car industry.

The Bank of Birmingham is located in Birmingham, Michigan, on the outskirts of Detroit, so it is dependent upon the comeback of the auto industry. As Birmingham is a wealthy suburb, it is less-exposed to pullbacks in the U.S. automotive market than urban Detroit. As long as the auto industry comeback is not derailed by a significant U.S. recession, we should expect more suburban migration and an expanding population in Birmingham, leading to more deposits, loans, and mortgages issued.

Disclosure: I am long BNCC.pk and BBBI.

Corning (GLW) Warning

On By Jay UnniIn InvestingLeave a comment

I did not realize the extent of the correlation of Corning’s earnings to the Japanese Yen. For every percentage point the yen decreases in dollar terms, Corning’s earnings for Q4 2012 (will decrease by $6mm, as the CFO stated in the last conference call. This article nicely sums up the situation.

The yen-dollar exchange rate decreased 10% through the fourth quarter, and it has become apparent to the Forex markets that Shinzo Abe will actively push for further devaluation. This means a $60mm maximum impact to Corning’s earnings.

This is a risk I am not willing to take. I want to see how the market reacts to the results, which will be announced on Tuesday. I am willing to sacrifice the profits that might be had if the stock pops on excellent results as a payment for more information on the stock. Selling a significant portion of the position on Monday.

Rapid Repositioning

On By Jay UnniIn Investing, SpeculationLeave a comment

So I have not followed through on the moves suggested in my previous post; I have done things very differently.

The trading in Activision (ATVI) does not make any sense to me. In the wake of the Newtown shootings, Vice President Joe Biden has been spearheading an effort to reduce gun violence, and a discussion on gun violence in video games is in the agenda. Several media outlets specifically mentioned Call of Duty (Activision’s best selling game) when discussing the story.

This, to me, reads like negative news, which would affect perception negatively, and cause the stock to fall. However, last Friday, when the story was breaking, the stock popped instead.

I cannot find sufficient reason for why the perception would get so positive, save for perhaps the recognition of Call of Duty’s success by its infamy. I have not been enthused with the stock’s performance, and there is no blockbuster video game on the horizon. The two biggest drivers of revenue planned for this year are a Starcraft expansion and continued growth in Skylanders. A quick chart of Google trends confirms the idea that Skylanders was a huge seller this previous holiday season. The Starcraft expansion could be a hit or a miss. It is a huge question mark as to whether the Skylanders earnings boost is enough to counter the lack of other major titles during the holidays and the negative perceptions of gun violence. To avoid the uncertainty, and perhaps out of my own negative bias, I have sold the stock. It will remain to be seen whether this was the right decision or not.

There are many less risky plays. The oil price has resumed the upward climb as global demand revives from its dip. The place to be is, and has been, in international and deepwater projects. I still have no exposure to the emergence of African oil, and the ensuing consumer-products boom, which is unfortunate. I was expecting perception of African investments to grow positive throughout December and January, so I was originally planning on speculating in AFK (a broad Africa index), but the index has not performed well enough to suggest that perception is turning around. I will continue to monitor AFK, and look for more targeted ways of playing the African growth story.

C&J Energy (CJES) is now becoming dangerous. Though it remains VERY undervalued, the perception has gotten stronger against fracking. CJES has returned to the resistance point at $22-23, but I do not think it will break through. The anti-fracking movie “Promised Land” has come out, and though it has not been very successful, it should turn the perception even more negative, and depress the stock price. In addition, natural gas prices have not risen as fast or as far as I would have hoped to use up the spare fracturing fleet supply. The U.S. onshore activity (represented by the rig count) dropped throughout the 4th quarter, so I expect that competition was more fierce than the rest of 2012 for CJES’s fracturing services. So I have sold out a portion of the position.

I am unsure how much should be sold out, because 2013 will likely be a much better year for CJES. The natural gas price will probably continue to slowly rise, and oil and gas companies may begin to spend again on natural gas drilling. In addition, the price of oil is already much higher than it was during the 4th quarter, so demand for U.S. onshore oil will increase.

But the combination of a worsening perception for fracking and weak 4th quarter earnings will drive the stock down, so I must sell some of the position.

I have traded out the CJES shares for an investment in Core Labs (CLB). I respect the management of this company more than any other oil service company for their knowledge of and foresight in their industry. The company shifted to international and deepwater projects several quarters ago, so they are relatively immune to the poor 4th quarter earnings that I expect for most U.S. onshore oil service companies. While the profit margins at CJES have worsened, the profit margins at CLB have widened. CLB has a wide moat around its core analysis business, while CJES has a relatively small moat. CLB trades at $113, $2 less than what I sold it for a year ago, though the earnings have increased by 22.6%. It is one of the few companies I would buy at a P/E to growth ratio above 1 (it currently stands at 1.13), because of its excellent management, high profitability, and relative monopoly in the core analysis business.

I have invested in Corning (GLW), which is in the glass business. The TV industry has been experiencing a cyclical trough period as an after-effect of low employment. As employment picks up across the United States, the down-cycle in TV sales should end. In addition, I believe that new buyers of homes will also be likely to buy a new TV for their home. With the housing industry fully on the rebound, a pickup in the TV industry should be close behind.

LCD TV glass has been the most important driver of GLW’s earnings in the past, so the pickup in the industry should cause the fundamentals and perception to become more positive and lead to a stock price increase. As an added bonus, GLW has a near monopoly on smart phone and tablet glass, a segment which has been continually growing. The earnings for these devices is very small compared to TV glass (because of the size of the devices), but this segment should provide an additional earnings boost on top of the TV rebound.

GLW is currently trading at a cheap 9.23 Price/Earnings ratio. I think this is more than reasonable given the prospect of a TV industry rebound. I have invested a fairly large position (~10% of portfolio).

The speculation in 3D systems corporation (DDD) continues. I only wish I had more on the table. I am wary of adding to the position now, because there is really no telling when it will reverse. I will not be shy in shorting the stock when the reversal comes.

Disclosure: I am long CJES, CLB, GLW, DDD. I may sell shares of CJES in the next 72 hours.

Portfolio Overview

On By Jay UnniIn InvestingLeave a comment

The speculation on 3D Systems Incorporated (DDD) has been paying off in spades since I started it. I forgot to post my more recent article on the stock. It goes a little more in depth into the reasoning behind the conclusion that it is in a reflexive bubble.

But recently, I have noticed the trend in perception has worsened. The DDD articles on Seeking Alpha have gotten more  lukewarm recently (1, 2). Since we have already seen that Seeking Alpha articles have an effect on DDD (the Test phase in early October was sparked by these articles: 1, 2), it is not a stretch to imagine that recent articles may sway the general investor opinion in DDD.

I have not picked up any clear technical signals of a reversal, so this may be tricky. I may have to pay back some of the gains to know whether this is merely a pullback in the uptrend or whether the downtrend has started in earnest. Soros says that in a reflexive bubble there is usually a twilight phase, where people are still playing the game, but no one believes in the long thesis anymore. This may be where we are now…

I slashed my GMCR holdings in half at $41/share. I got a near-100% return so far. It still appears undervalued on a P/E-to-growth basis – the P/E is 17.6 and the growth rate is ~42% year-over-year, giving a .42 PEG. This would suggest another double could be possible if it can keep up a 30%+ growth rate. The public perception of Keurig brewers is still pretty good, and I have seen K-cup levels pretty low in the stores I have visited, though that is a very small sample size. I have seen worrying commercials for plastic generic K-cups that fit the Keurig machines recently, but it is too early to tell whether this will accumulate any substantial momentum with customers.

I also sold off my IMAX calls. I think this momentum will last for a while, but my calls were dated for the end of this month so I had to dump them. This may be a great year for 3D movies because of the many sci-fi genre films scheduled. I got a 73% gain on the position, so, not bad for a few months.

These last few trades have left me with a bit more cash to invest. I am looking at a few ideas:

I am considering a purchase in Intercontinental Exchange (ICE). I believe they got a great price on NYSE (a much-better price than their last minute bid last year), and NYSE throws off so much free cash that ICE will be in a great financial position for share buybacks or future purchases. I will admit I have a bias, I know the business model well, and I like the company. Sprecher seems to have a good eye for getting the right purchases at the right time. Once retail investors start to come back on the market, the core NYSE business will pick up, and once the European crisis is behind us, NYSE’s Liffe business will also pick up, so they got a great asset on the cheap.

I am also considering getting more heavy on my C&J Energy Services (CJES) and Halliburton (HAL) positions. I still believe these companies are best of breed in their sector, and it seems that the perception is starting to get more positive for oil among investors. However, a new movie starring Matt Damon about the environmental dangers of shale exploration has been showing in theaters. It remains to be seen whether this will have a significant impact on the public perception for the sector.

I was too eager in selling off the bulk of my BNCC position. The stock doubled again after I sold off the majority of my stake, and it is still only at 55% of the book value.

I am working on compiling some performance results for last year. It was a good year, but it will be worth it to check exactly how good.

The near future for oil

On By Jay UnniIn InvestingLeave a comment

I have entered my short SPY trade as described previously. However, the global recession is causing a necessary pullback in oil prices that have gotten ahead of themselves, and I am suddenly realizing that I am far too exposed.

Oil prices have been running up, I believe, in a correlation with markets, for two main reasons: Asia, and Southeast Asia in particular, has not been as affected by the slowdown as investors are expecting – they have generated enough capital on their own to become more immune to international financing problems – and because Saudi Arabian oil production was decreased in June/July.

But now several factors are converging to hit oil prices at the same time.

Russia’s entry into the WTO, which has been well signaled for over a year, will continue to have further negative impact on oil prices, as the Russian oil will be available to more nations and more markets, increasing the worldwide supply.

In addition, Israel has publicly announced that it will not go to war with Iran. In fact, Israeli officials seem satisfied with the current level of international pressure on Iran. This removes the impetus for speculators to bet on further instability in the Middle East. Though there have been minor skirmishes related to an American video released, it is too early to tell if this will be a significant new outbreak of violence.

Without the speculative aspect, Brent Crude cannot sustain a level much higher than $100.

This is OPEC’s intended target, and they have wisely recognized that more oil is coming online and are not increasing production yet. This is one positive in the near term, however with more countries receiving Russian oil, and the possibility of Iranian oil being removed from the market being removed from the table, will provide enough negative force to push Brent to $100 or below.

The effect on WTI is less clear – the pipelines to the Gulf of Mexico have been okay-ed by President Obama, which will allow American oil to reach the world markets. However, the effects of this project will not be felt for the near future. I would expect WTI to trade roughly in correlation to Brent, though the supply/demand characteristics are completely different.

Supply in America is continuing to increase as a result of exploration and production companies concentrating on Shale oil, rather than gas. Though this will change as natural gas prices increase this winter, the glut in supply is likely to overwhelm demand in the near term, especially as unemployment remains disappointingly high.

What does this mean for my stocks?

As far as the companies themselves, I don’t expect C&J energy services or Halliburton to experience severe negative impact to earnings – exploration and production companies tend to plan on a much longer term than daily market movements. In addition, rising natural gas prices should juice earnings as exploration and production companies will likely increase their production this winter.

However, the stock prices themselves will likely be hit by the negative perceptions. Without another conference call for either company for at least a month, there will be no fundamental data to counter the negative perceptions.

The best move may be to purchase puts to hedge my investment, but I am reluctant to do so until I am sure that this will decrease my risk rather than increase it.

For the time being, I am going to sit tight, let my SPY short play out, and keep my ear to the ground for rumblings from international markets. As long as $100 forms a floor for Brent oil prices, my stocks should remain strong investments. If oil falls below $100, I will have to reevaluate my strategy.

 

Disclosure: I own CJES and HAL. I am short SPY.