Market Position May 15, 2013

I have had some big successes in the market lately. The short yen position has been yielding truly incredible profits lately. Almost simultaneously, the long position in Tesla (TSLA) has nearly doubled. Nearly every day after the earnings announcement has given us a new breakout to higher prices. This signals that there is a big money position being established in the stock, or that short covering is occurring now. If the huge money behind these moves are capable of mobilizing so quickly to positive news, this signals to me that they will be equally quick to mobilize in reaction to negative news.

I am not sure how long this continuation move will last. Eventually there will be a pullback – that is almost certain. But I still suspect we are only in the early phases of this boom for Tesla. I expect Tesla to generate more buzz and excitement as the year goes on.

In addition, I re-established the position in 3D Systems (DDD), according to the logic outlined in my article. Events are playing out as I had expected, with upgrades in the stock, and higher prices. This lends credence to the idea that we experienced a test phase from January to March, and we are now in a phase 4 type boom. Therefore, there should be additional room to go with the DDD long.

C & J Energy  (CJES) continues to be a dead weight in both the portfolio. The bad news about the state of the hydraulic fracturing market is out, and I believe it has been priced in. I think we have put in a bottom in this range (~$18). I dont expect the stock to dip below $17 unless the market turns worse.

I expect the market to improve as the year goes on and higher natural gas prices lead to renewed excitement in dry gas plays.

I am working up a position in some dry gas E&P companies as we speak. I do not want to reveal names and tickers, as they are tiny companies, and I have to be very cautious to establish a position at the prices I would like. I have been able to find several that are trading well below book value currently, and I have reason to expect that the book value itself is artificially low, because it is based on a past price environment, where natural gas prices were much lower than today. I will write an article soon explaining the logic.

I am using my unleveraged portfolio to purchase the dry gas companies. I am selling off a previous purchase of Halliburton (HAL). Halliburton has also come to a fair valuation in the current environment. After the settlement of the Deepwater Horizon litigation, the shares have been relieved of the pressure that was depressing them. I suspect HAL will benefit if the activity in the North American gas market picks up, but I believe the benefit will be more pronounced in CJES, so I prefer an investment in the latter.

I also sold my shares in Petroleum Geo Services (PGSVY). It is a shame to sell off such a well run company, with such growth potential. It is still undervalued, and I expect that investors at these prices would do reasonably well holding this for the long term. 3D and 4D seismic technology is only becoming more and more important, and PGS has already accumulated the Multiclient studies for the vast offshore Africa fields. However, I think there are better opportunities, like BBBI.

I am slowly accumulating more shares of Birmingham Bloomfield Bancshares (BBBI). It is currently trading at a price to book of .5, and it seems to be generating earnings at a comparable pace to BNCCorp (BNCC). The deep discount offers a considerable margin of safety, and the growth, fueled by the automotive industry boom, is bound to continue for the foreseeable future.

Today’s ideas

I was considering speculating on the power outage occurring in the Eastern U.S., but I am not seeing what I thought I would see.

In the power outage of the Northeast in 2003, the company most affected, First Energy (FE), dropped a lot after taking blame and the brunt of the damage. However the most affected companies in the power outage, AEP and FE, have increased since the outage. Something else is at play here… or these are good short candidates.

GMCR is up another buck today. I am feeling foolish for not trading out my ATVI this morning.

But perhaps there is a silver lining. Vivendi is seeking a buyer for its majority stake in ATVI. I think this could be bought out at a significant premium – but only if Vivendi pushes for it. ATVI is probably worth close to $17 a share, but Vivendi has to hold out for a company to step in and buy.

Who might the buyer be? Perhaps media giants like Viacom (VIA), Disney (DIS), or News Corp (NWS) after it splits. But who really knows? Corporations are still sitting on a lot of cash, so they may be willing to pay up.

Ideally, multiple companies will start a small bidding war for the ATVI stake, and we will get a price that is between $14-20/share. Worst case, Vivendi is desperate to raise cash and sells to the first bidder it can get for a price that may be slightly lower than the current price. I’d say that $11 a share is a minimum in the worst case scenario.

Vivendi does probably want to shore up its balance sheet – as a French company, it needs to insulate itself from the worst of the crisis, which is yet to come. This means that the maximum upside of $20/share is unlikely.

So we are looking at a risk/reward of about a 10% loss to a 15% gain, with a remote possibility of as high as a 65% gain. The risk/reward ratio dictates that I should hold my ATVI shares.

With GMCR, I’d say that we have seen a bottom of $20 ($19.83 to be exact), which is a 15% downside at least, and the stock could tank further if the SEC brings up charges. However the upside is probably around $60 a share, which is 155% higher, albeit over a longer time period.

The rises in the price must have scared out short sellers, which explains why the upward momentum has lasted for three sessions.

There is a similar story playing out across three different stocks, GMCR, TPX, and DMND. Let’s call them the “fallen angels”; stocks that were once revered and pumped up by Wall Street, rising in a reflexive manner as highly-leveraged momentum players ploughed in, that crashed precipitously as problems arose. There is even similarity in the prices of the stocks post crash – with GMCR and TPX almost mirroring each other down to $20, then back up $23.50.

However the fundamentals of each situation are far different. The problems facing GMCR have already been discussed – concerns about competition, patent expiration, an accounting question, and a slowing growth rate coupled with ridiculously high expectations. The margin call on the founder pushed the stock downward in a reflexive deleveraging.

The concerns on TPX are verified by management – a low guidance, and an expectation of an earnings decline by 50% or more. The concerns on DMND are also quite justified – an accounting problem seems more likely, and DMND has missed a crucial filing deadline, suggesting a real management problem.

So short sellers have been making a killing on these stocks – and perhaps these are the same entities on all of them. This would mean that rises in one might trigger short covering in the other. But whether or not that is true, all three have been rising, which should trigger shorts to cover and propel the stocks higher in a reflexive fashion.

The real question is are the shorts done covering? Which stocks are they leaving hanging, and which ones are the jumping out of? To answer this we can consider the short interest as a % of Float.

“Fallen Angels” Short interest as a % of Float
GMCR 17.74%
TPX 7.92%
DMND 49.11%
So DMND is the most heavily shorted, but probably for good reason. TPX is the least, which is odd, but perhaps all the shorts have exited.

The short interest in GMCR has decreased since June 15, when it was 19.7%, but it is still substantial – shorts have a ways to go before they finish covering, or they are holding out for the accounting questions to come back with some negative news.

The spike at the end of today signals that there was a rush to cover… perhaps this could continue into Friday. I am thinking that a short seller would not want to hold the short over the weekend… but I have not been a short seller before, so I don’t have a good understanding of the mental state…

On the macro side… the European regulators cut rates, leading the Euro down against the CAD. I am continuing to watch at this point, though I am kicking myself for my cautiousness in avoiding the trade. I am waiting for some sort of a pullback before I enter. After such a sharp move, it should experience a pullback and some kind of consolidation around a price. Around that time it may be good for entry.

Canada is probably the strongest bet I can think of currently – it has the safety of a developed nation coupled with an export economy. Plus, it has the upside of the Keystone pipeline.

I expect that Obama will concede to the Keystone pipeline after the election. If Romney takes it, he will certainly pursue the pipeline. Obama likely could not agree to the pipeline pre-election because he was depending on environmental groups for campaign financing. By delaying the decision, he has ensured their support in the election, and to a large degree, the nation is not really upset that the pipeline was not acted upon, because most people are not really aware of the benefits.

Japan has been having problems obtaining funding from its parliament. It seems that after years of sitting on massive debt/GDP levels, they are finally starting realize that this may become a problem, after seeing how investors have been treating European nations with high amounts of sovereign debt. However, the effect of this realization has been detrimental. I am reminded about something that George Soros remarked in Alchemy of Finance – once regulators recognize the problem, they tend to take action that actually makes it worse, before taking any action to make it better. That seems to be the case here.
The situation is similar to what the U.S. experienced last fall, when Republicans in Congress threatened to block the raising of the debt ceiling. If the result is similar, then one would expect a lower yen against the dollar. The dollar dropped versus the yen 250 ticks during the debt ceiling debacle, but the largest drop happened in the wake of the Standard and Poor’s downgrade of U.S. debt, which triggered massive volatility in U.S. markets. The drop in the dollar probably occurred because of outflows from the equity markets and treasuries…
We might get a similar flight from Japan if the debate really reaches a fevered pitch, but I have not seen enough evidence to act yet.

The Norwegian Kroner has been bullish versus the Euro pretty consistently over the last 5 years.  The Kroner ought to do well in an environment of $100+ Brent, which it looks like we are entering – provided the oil worker strike in Norway ends soon. And my Norwegian seismic companies, PGS and TGS, may finally see some profit. They are seeing growth coming from West Africa… which leads me to wonder who is ordering these seismic studies…

Oooh, a juicy one here: Chariot Oil and Gas. It trades on the Grey Market here in the states, but it is a stock listed on the AIM market of the London Stock Exchange. It has a large acreage position offshore West Africa, and it has done huge 3D seismic studies on its acreage. The sheer size of the play involved is mind-boggling – it may end up dwarfing the North Sea plays…
The plus on this acreage is that it is not a salt basin, like the huge offshore South American reserves.
Chariot looks pretty good, with a low estimate of prospective reserves sitting at 7,032 bbls, unrisked. With a market cap in the 300 millions, this looks like a solid bet.

Chariot has not gotten very far in exploring this find – it has only finished one exploratory well, which was a dud. It has 4 more exploratory wells planned, with one that is to be completed at the end of this month. If even one of them pans out, the stock could double, triple, or… ?