Weekend Update

Equity markets: My long-side trade earlier this week failed because it was one day early and I didn’t have the stomach for the downside volatility which was the first move. Short-term, equity markets are still neutral – with a slight upward bias absent headline news. That “absence of news” could last for the rest of the summer. But the volatility is going to remain. Equities are still not pricing in an economic slowdown – much less another deleveraging/crisis cycle. But they are heavily oversold. That said – half of the “oversold”ness has already been corrected – simply by going nowhere for a few days. So any new equity investment has to lean bullish rather than simply leaning towards an oversold scalp. And intermediate-term – I am more bearish than I was this time last week.

Credit markets: Like last week, these are the key markets. But these generally deteriorated a bit this week. In Europe, Italy/Spain yields fell (presumably because of ECB buying) while Germany/France yields rose. Interbank/overnight/TED spreads are still widening – but are not a problem yet. The ECB may have succeeded in buying a bit of time – but at the cost of directly revealing to Germans what the cost is going to be for them. Ultimately, any credit crisis from Europe is going to be indicated by a)debt auction timing from the four key eurozone sovereigns, b)spreads between the four, c)a banking collapse because of those spreads, and d)indications from Germany as to which way they (the taxpayers not the govt) are leaning re a longer-term fix. I suspect fiscal/transfer union may become the ultimate fix here but that is gonna be a tough sell to Germans who don’t work in banking/exports.

In the US, riskier credit bounced a bit. But the financial sector did not and the first post-AAA 30 year Treasury auction did not go well. And none of it has priced in another deleveraging/default cycle. Treasury funding could become a problem – but the bad news cycle on that is almost certainly over for a few months.

Currencies: The downgrade last week did not affect the dollar as much as it could have. The swissie was the worst performing currency after they intervened. So much for a post-downgrade safe haven. Followed by the two commodity currencies (C$ and A$). Gold was the best performer followed by the yen. The dollar and euro are now lashed together via swap lines. The safe haven trade is still the operative one which doesn’t bode well for equities or commodities. And since the dollar is not going to be downgraded again this week – and since gold/yen are, like the swissie, at/near their breaking points for intervention – I expect the dollar/euro links to weaken a bit and for the dollar to resume its role as safe haven. There simply is no alternative right now and until there is one – the dollar is both the reserve currency and the safe haven currency. Period.

Precious metals: All four performed better than currencies – in order gold (because of the gap up over last weekend), platinum, then a gap to silver, palladium. Going forward, I think the forces that are driving them and the price volatility that results are going to provide for good trades. Longer-term, they will all outperform currencies so offer good risk-reward v cash. Cash however still has the optionality value. All will get some safe haven demand. Gold/silver are the two most vulnerable to deleveraging in the very crowded Western “paper precious” market – and that WILL create big fast price swings. Silver/palladium are the two most vulnerable to poor economic outlooks. Gold/platinum have the lowest-risk downside – but gold’s potential downside is $300 lower than platinum’s – and both will likely respond first to whatever the central bank “trickle-down” (aka QE/bailout) response is to this deflation run. Platinum/palladium have the best response to either short-term supply shocks (S Africa strikes) or longer-term physical supply/demand bottlenecks. In a word – there is opportunity here, and if one is wrong about the shorter-term trade then its ok because the longer-term picture is good. But this applies mainly to the metal/physical itself — not to the miners or options or futures or ETF’s or anything else.


Equity trade failed

Markets are still completely unable to price anything. They are holding at the lows of the last three days – but today the Euro crisis has spread to France. Societe Generale has fallen 20% today. Too much downside risk. Something has to resolve itself – or explode cathartically – in Europe before any rational human buyer steps in. And the real downside risk of a Societe Generale collapse is a 1931 CreditAnstalt.

Gold is the immediate beneficiary of this. I still prefer platinum though. If Europe does explode, the CME will eliminate all margin for gold – and all the speculators will either have to ante up the full $180,000 per contract or sell. Add to that – even if Europe merely continues to hemorrhage, margin calls and hedge fund redemptions are gonna be a real problem.

Weekend Update – part2

Now for indicators:

Equity markets:
Short-term – Slightly bearish
Intermediate-term – Very bearish

Markets may be extremely oversold – as in historically oversold – but show no indication of a bottom yet. The tiny number of individual equities that are showing early signs of reversal/strength are – exclusively – either the bearish ETF’s (where technical analysis generally doesn’t work because it triggers too late), bond/safe haven proxy ETF’s, or penny stocks. Sidelines for me.

Credit/bond markets:
Are showing early signs of stress. Riskier, lower priority, and longer-term are being sold relative to higher rated, short-term, or higher priority. Not signs of stability or bottoming or EOTWAWKI priced in. Credit is a leading indicator. This is not a correction for equities. Credit is where the first buy opportunities will pop up. In particular, this is where to get out of the dollar after the current dollar-inflow panic stabilizes/subsides.

International equities:
Nothing looks good here. On an intermediate-term basis though, this is where to focus equity buying when this panic runs its course.

Precious Metals:
Gold is looking OK here. That said, I suspect that going forward, it is too late to buy/add for short-term play here. Safe-haven demand is likely to be met/exceeded by ETF holdings sold to meet margin calls elsewhere. India is not going to be the physical demand savior at these prices. Silver is looking bearish. The inflation play is dead for now. And the SLV ETF is far too crowded with day-traders and speculators. Platinum is looking VERY good. Chinese are buying it hand-over-fist – for jewelry and long-term physical investment – now that platinum is roughly the same price as gold. The platinum/gold ratio of 1:1 is now where it was in the depths of 2008 and before that in the 1990’s (when China was far poorer). At these prices, auto industry demand does not matter. If platinum takes 5% of the gold jewelry market, that will equal auto industry demand. So, the most likely scenario is that it tracks gold for the short-term with far better upside/downside risk when things settle down. Palladium will follow platinum but with a bit more short-term downside risk and a bit more long-term upside.

Fuhgeddaboutit. Agriculturals are the best buy here and there is no hurry. Metals and oil are hugely subject to dishoarding of stockpiles – ie what was demand over the last 2 years can turn around in an instant and become supply.

Uggh. The swissie is the only major safe-haven currency that has not successfully debased. It is extremely overbought and Europe is clearly panicking into it. But the SNB has just announced its version of QE so as/if either the panic subsides or peaks, the swissie will plummet. Shorter-term, at current levels, the swissie is riskier than the dollar. I think the price is now too high for “recognized safe-havenness”. Way too early for commodity currencies – but a mix of second-tier “safe havens” – pound? swedish krone?

Ugly Ugly

Equity markets worldwide dumped 4-8%. Commodity markets dumped. Junk bonds fell 2-3%. Investment grade and sovereign bonds rose a bit. Gold skyrocketed – and then fell (probably the beginning of margin calls). The TED spread is still low at 26 bps – but rising fast. Given zero interest rates for short-term debt – the risk of a global liquidity crunch or flash crash will rise sharply if it hits 40 bps. Still however a long way from a 2008 level liquidity crunch (100-400 bps). S&P500 VIX is at 31.6 – so now in parabolic panic mode. The swissie and the dollar were the only safe havens today – and both are now in full QE mode to debase themselves.

Technically, markets are still ugly. Oversold but no indication that any tradeable bottom has been reached. The S&P500 just hit “correction” mode today (10% off peak). European markets are in full bear market mode. I really don’t see how the massive numbers of serious problems can just be dismissed/ignored by US equity investors as part of a normal “correction”. More pain is due.

On an intermediate term basis, the technicals are as ugly as I have seen since 2008. On a short-term basis, markets are heavily oversold but zero zero indication of any buyers out there. Given the selling today, any short-term bounce is likely 3+ days away. And the risk of a crash is very high. My guess is that the markets will drop until a new globally coordinated QE to debase fiat money is hinted at. Right now, the most oversold/bearish/negative sentiment sector is industrials. That could change – but if it doesn’t and there is a bounce, that is the one that will likely bounce hardest.

Asia is now dumping. Gold is steady. Rumor is that Italy had bank runs today – so unless the ECB intervenes successfully – tomorrow – the euro experiment will end by next week.

Anyone who is using leverage or who has debt or anything is about to discover how painful that is in a deleveraging deflationary cycle.

We don’t need no steenkin safe haven

Well so much for the swissie and the yen as safe havens. The Swiss National Bank just announced their version of QE in order to halt-reverse the skyrocketing appreciation of the Swiss Franc. The Bank of Japan just announced an intervention to crush the yen. Brazil and Philippines — yeesh – safe havens?!? – just announced their versions of a currency war. Bank of New York just announced that they will charge 13 bps for all large cash deposits. The 3 mo T-bill is now yielding negative interest. Italy is now on the “bailout” list — markets all now shut down — but is too large to bail out. All markets are projectile vomiting – down multiple %.

Gold is up — big — but be very careful buying here. It is a dead bang certainty that CME will raise margins real real soon in order to wash paper longs out. Why the freak don’t they just raise margins to 100% and leave them there. The whole point of gold as an alternative currency is that it is UNLEVERAGED unlike all the other leveraged fast-money speculations out there. And that it therefore does not have to suffer from occasional deleveraging bank-based fiat currencies. Forget about gold mining stocks here — the risks of nationalization and confiscatory taxes worldwide are rising in line with the gold price. Central banks are now panic buying gold — and they will have no problem confiscating gold in the ground if they can’t get gold in the market. These stupid greedy fucks running the world are driving every single fucking economy in the world into a depression. It is time to pry their hands off the levers of power — cold dead hands if necessary.

With all the developed world sovereigns in, basically, various stages of bankruptcy; we could be nearing the Kondratieff winter credit crunch of all credit crunches. Right now, bond vigilantes are only focused on Eurozone – Italy, Spain, etc. But that could change in a nanosecond. All major nation public finances are crap and none are remotely capable of growing out of their debt load. The only thing preventing the emergence of true bond vigilantes – ie investors who are concerned with not only getting paid a reasonable rate of interest but also interested in getting their principal back — is that they have no safe “base” where they can withdraw to if necessary. Currency wars and trade wars are imminent.

Sharks Eat Themselves Too

Every minnow understands that the investment ocean is a perilous place since we are usually the ones who are eaten by the sharks. But once in a blue moon, the sharks fight amongst themselves. Presumably only when there aren’t enough minnows around. These rare fights are the only opportunity to see behind the curtain to see the standard M.O. of sharks. Here’s one of those fights. Coca Cola is accusing Goldman Sachs of manipulating metals prices via its ownership of the metals warehouses at metals futures exchanges. I’m excerpting pieces from the links on the assumption that the linked content will disappear at some point:

Wall St Eyed in Metal Squeeze
Goldman Sachs Group Inc. and other owners of large metals warehouses are being scrutinized by the London Metal Exchange after being accused by users like Coca-Cola Co. of restricting the amount of metal they release to customers, inflating prices.

The board of the LME met on Thursday to discuss complaints from aluminum users and market traders, who say operators of warehouses, which also include J.P. Morgan Chase & Co. and Glencore International PLC, should be forced to allow the metal out more quickly to meet demand……..

Goldman, through its Metro International Trade Services unit, owns the biggest warehouse complex in the LME system, a series of 19 buildings in Detroit that house about a quarter of the aluminum stored in LME facilities…..

Coca-Cola and other consumers say that Metro in particular is allowing the minimum amount of aluminum allowed by the LME—1,500 metric tons a day—to leave its facilities, and that Metro could remove much more, erasing supply bottlenecks and lowering premiums for physical delivery in the process…..

Coca-Cola, which has complained to the LME, says it can take months to get the metal the company needs, even though warehouses are allowing aluminum to come in much more quickly. Warehouses, meantime, collect rent and other fees…..

Since Goldman bought Metro early last year, the wait time for aluminum delivery in Detroit has increased to about seven months.

Metro charges its customers 42 cents a day for storing one metric ton of aluminum in Detroit, which is about the industry average. At 900,000 tons in the warehouses, Goldman is earning $378,000 a day on rental costs, or about $79 million in seven months.

Metro, meantime, is taking in metal. Metro also offers cash incentives to producers like Rio Tinto Alcan to store their metal in Metro’s sheds for contracted periods, sometimes as much as $150 a ton, according to traders.

Once the metal is in the warehouse, the producers sell ownership to this metal on the open market. The new owner can’t collect his metal for seven months because of the bottleneck. For that period, the new owner is stuck paying rent to Metro.

In recent years, major investment banks like Goldman and J.P. Morgan and commodities houses like Glencore have been snapping up warehouses around the world, turning the industry from a disperse grouping of independent operators into another arm of Wall Street…..The transformation has raised questions about whether the investment banks, which also have big commodity-trading arms, are able to use their position as owners of warehouses to manipulate prices to their advantage.

How Goldman Sachs Created the Food Crisis

Futures markets traditionally included two kinds of players. On one side were the farmers, the millers, and the warehousemen, market players who have a real, physical stake in wheat. This group not only includes corn growers in Iowa or wheat farmers in Nebraska, but major multinational corporations like Pizza Hut, Kraft, Nestlé, Sara Lee, Tyson Foods, and McDonald’s — whose New York Stock Exchange shares rise and fall on their ability to bring food to peoples’ car windows, doorsteps, and supermarket shelves at competitive prices. These market participants are called “bona fide” hedgers, because they actually need to buy and sell cereals.

On the other side is the speculator. The speculator neither produces nor consumes corn or soy or wheat, and wouldn’t have a place to put the 20 tons of cereal he might buy at any given moment if ever it were delivered. Speculators make money through traditional market behavior, the arbitrage of buying low and selling high. And the physical stakeholders in grain futures have as a general rule welcomed traditional speculators to their market, for their endless stream of buy and sell orders gives the market its liquidity and provides bona fide hedgers a way to manage risk by allowing them to sell and buy just as they pleased.

But Goldman’s index perverted the symmetry of this system. The structure of the GSCI paid no heed to the centuries-old buy-sell/sell-buy patterns. This newfangled derivative product was “long only,” which meant the product was constructed to buy commodities, and only buy….

This imbalance undermined the innate structure of the commodities markets, requiring bankers to buy and keep buying — no matter what the price. Every time the due date of a long-only commodity index futures contract neared, bankers were required to “roll” their multi-billion dollar backlog of buy orders over into the next futures contract, two or three months down the line. And since the deflationary impact of shorting a position simply wasn’t part of the GSCI, professional grain traders could make a killing by anticipating the market fluctuations these “rolls” would inevitably cause. “I make a living off the dumb money,” commodity trader Emil van Essen told Businessweek last year. Commodity traders employed by the banks that had created the commodity index funds in the first place rode the tides of profit…..

Since the bursting of the tech bubble in 2000, there has been a 50-fold increase in dollars invested in commodity index funds. To put the phenomenon in real terms: In 2003, the commodities futures market still totaled a sleepy $13 billion. But when the global financial crisis sent investors running scared in early 2008, and as dollars, pounds, and euros evaded investor confidence, commodities — including food — seemed like the last, best place for hedge, pension, and sovereign wealth funds to park their cash…..

The result of Wall Street’s venture into grain and feed and livestock has been a shock to the global food production and delivery system. Not only does the world’s food supply have to contend with constricted supply and increased demand for real grain, but investment bankers have engineered an artificial upward pull on the price of grain futures. The result: Imaginary wheat dominates the price of real wheat, as speculators (traditionally one-fifth of the market) now outnumber bona-fide hedgers four-to-one.

Today, bankers and traders sit at the top of the food chain — the carnivores of the system, devouring everyone and everything below. Near the bottom toils the farmer. For him, the rising price of grain should have been a windfall, but speculation has also created spikes in everything the farmer must buy to grow his grain — from seed to fertilizer to diesel fuel. At the very bottom lies the consumer.

Don’t expect the US (or UK) government to do anything. The Vampire Squid owns the government and those same government bonds are what are being used to finance those warehouse operations. The bigger the deficit our government runs, the more money the squid has to do stuff like this. There is no end/reversibility to the cycle because it costs nothing to create money itself. Those warehouse operations are pure central planning — Goldman Sachs via the release of physical is deciding which metals/oil/food consumers get to live and which will die. Pretty neat — in a “those bastards should be hung” sort of way.

As a minnow, the best thing to take from this is — never assume that commodities prices are actually an expression of actual supply and/or demand.

Closed End Funds

There is only one exception that I make to making my own investment decisions. Closed end funds provide three things that I can’t get on my own:
1. A way to invest in some asset classes that are difficult to invest in in any other way.
2. A vehicle that is less immune than either ETF’s or mutual funds to the crowd behavior of either minnows or sharks.
3. A level of instant diversification to make decision making easier so I can focus my attention elsewhere.

Two CEF’s currently meet my buy criteria. No CEF is ever a screaming buy-now. More like a nibble so dollar-cost averaging can work in them.

CHN – China Fund – portfolio is mostly small/mid cap growth companies listed in Taiwan, Hong Kong and Shanghai (A, B, H shares) – portfolio is currently overweight healthcare and consumer and underweight tech and financial – fund has been around for 20 years – selling at a 13% discount to the underlying equities – one of which is a company called Fook Woo (couldn’t resist pulling that one out)

CEF – Central Fund of Canada – portfolio is entirely gold and silver bullion in a ratio of 1:50 (by oz) held in a segregated, allocated account in Canada – fund has been around for 50 years – current gold holdings are roughly comparable to the gold holdings of the central bank of Finland – currently selling at a very slight discount to the spot price of gold/silver (for the first time since 2005). This fund is a far better vehicle for gold/silver exposure than the big ETF’s – for reasons which I won’t explain but which give CEF a premium when gold/silver prices are rising. The current discount is also very revealing. CEF never sells at a discount unless gold and silver are stagnant/choppy for a somewhat extended period. The discount itself is a far better predictor of gold/silver prices than the hype/BS of those who prognosticate about gold/silver. So it makes for a better insurance hedge part of a financial portfolio (that can’t invest in physical – which is the EOTWAWKI hedge). Never chase CEF just to get an order filled.

Rare Earth Elements

Rare earths are a group of not-generally actually “rare” elements that comprise (generally) one of the lines from the periodic table – here in the middle shade of blue:

These elements are increasingly of strategic importance. They are used to make high-tech magnets, catalysts, high-tech ceramics, superconductors/lasers, etc. Like almost everything else it touches, the US government has completely clusterf@#ked itself and us. It created all the financial structures that ensured that “dirty” businesses like manufacturing and mining would leave the US — in the thought that the US would advance into the post-industrial age and thrive in a world where our economy depends on us buying and selling real estate to each other while we export interest-rate derivatives and credit-default swaps to the rest of the world. So much for that idea of economic progress.

Now, the rest of the world depends entirely on China for mining the stuff — and the Pentagon thus depends entirely on China to supply its contractors with the high-tech material that is used to make the high-tech weaponry with which the US government can attempt to contain emerging global power threats — like China. China has now figured this out — and is now restricting the exports of these materials. The US government is still stuck on stupid but will, at some point, either learn or it will deserve to die. In the meantime, there are a couple of legitimate investment opportunities and a few dozen mining scams that have emerged.

The best opportunity IMO is a Canadian/Chinese producer of the high-tech “stuff” made out of rare earths. Their Chinese branch (Magnequench) is a formerly-American defense contractor and is THE major producer of stuff like high-tech magnets and such. Being Chinese-located now, they will have access to the raw ores and they already have the purchasing contracts from the major Japanese/American/European companies who put the components into end-use things. It is highly unlikely that China will restrict the exports of those products (for now at least) since that would almost be tantamount to a declaration of hostilities on the rest of the world. The company is NeoMaterial (NEM on the Toronto exchange – C$4 — and NEMMF on the pinks). It trades at a P/B=2; P/S=2: P/E=13; P/CF=18; market cap of $500 million — which is OK compared to the last 10 years. For them, however, the game going forward is completely different. They now have near-monopoly ability to set prices for their products for the next few years. And more significantly, if the share price does remain at these levels, then the Chinese will buy the whole company and keep the monopoly (and the embedded technology to turn ores into usable stuff) for themselves. The company seems to understand this and is buying back shares at levels that are only a bit below the current price. There are a huge number of catalysts for this company over the next couple of years unless the US government remains totally brain-dead beyond belief (which though unlikely is honestly an increasingly real possibility).

On the ore/mining side, the big new shiny IPO is Molycorp (MCP – $15). They own the mine (Mountain Pass) which used to be the main global supplier of rare earth ores until it was shuttered in 2002 because of low prices. They have just gone public and are currently owned by the usual crop of sharks and bailout/welfare squids. The current market cap is $1.2 billion – assets composed mostly of cash from the IPO and the old mine. Very different from most IPO’s, operating insiders bought part of the IPO. The cash they raised is almost – but not quite – the amount they’ll need to open the mine by late-2012. But guaranteed, until then the institutional squids/sharks will be flogging this stock like a recalcitrant donkey in order to try to get another bubble going here so they can sell into it. Whew – enough of the confusing metaphors. At any rate, there are a lot of catalysts here. Plus, they have signed a technology transfer agreement with NeoMaterials (in exchange for ore guarantees) so that they won’t get stuck with claims to a big pile of uneconomic dirt if rare earth mines open up all over the world in the next few years.

Most of the other rare earth companies – and there are lots of them that have staked a claim to big piles of ore and been hawking their penny stocks for the last few years for the impending “rare earths scarcity” – are basically huge risks now. One in Australia is probably OK since it is actually opening a mine in late-2011. The overall market simply is not anywhere near big enough to support new mines everywhere. I suspect that the story/hype will be big enough to keep many of them going “Vancouver-style” – but not for me.

I like these stocks in the order presented. NeoMaterials is the better buy here — in large part because it does have a liquidity premium attached and is more complicated to purchase from the US. Molycorp will likely be the better trading vehicle – and be the recipient of far more hype – but will also have the downside volatility and be overvalued. In truth, it is hard for me to know what that overvalued point is. The entire global market for rare earth ores was about $1.5 billion last year. Hard to know how much prices will rise in the next two years before new supply comes in and kills the high prices. But it seems to me that at current prices, Molycorp is already pricing in a near doubling of them. NeoMaterials just seems better positioned — at least until it gets bought out.

Acadian Timber

The lumber/pulp market has been dramatically affected by the housing crash. New home starts are near post-WW2 lows and little is likely to change in the short-term. The paper industry is in terminal decline. Softwood prices are at near-historic low prices. Hardwood prices remain in OK shape due primarily to Asia furniture demand. And there is no reason to expect any serious improvement for, potentially, decades. With all this bad news, one would expect timberland company stocks to be at low prices. But, in general, they aren’t. Timberland prices seem very high. Plum Creek Timber (PCL) sells at an equivalent of $780/acre. This really is outrageous — until one understands that most public timber REIT’s are mainly anti-timber plays. These REIT’s generally earn their money by selling timberland to convert it into something else (tax deductions, vacation homes, etc) – not mainly by harvesting timber from timberland. At core, they are land developers. Likewise, “timberland” in the US has really been hyped as an asset for a couple of decades so institutional investors have plowed into it like lemmings — driving up timberland prices — while the housing crash has shown just how cyclical that business can be. At those sorts of land prices, actual timber production will never produce more than a 2-4% return even if wood demand increases back to bubble prices. And with the debt that timberland at those prices requires, there is gonna be a need to overharvest (hence oversupply) just to pay the debt loads. There is gonna be a bucketload of institutional selling of timberland over the next few years as they realize how stupid they’ve been. Asian forestry is mostly either a Kyoto carbon-credits scam or hardwood poaching. The underlying long-term supply/demand equation for forest products is still sound though. Shrinking forest acreage — and a lot of people in emerging markets who will use more forest products as their incomes rise. Not to mention the “option” possibility of game-changers such as biofuels.

Acadian Timber (ADN on the Toronto exchange – C$5.90, ACAZF on the pink sheets) is the only cheap forest-only company I’ve found. It owns about 1.1 million acres of New Brunswick and Maine forests and manages another 1.3 million acres in Canada. It owns no mills and depends on a limited number of customers to process its trees – so a bit of risk there. It makes virtually no money selling its land for development – and not much money “renting” its land for vacation/campground type stuff. It used to be structured as a Canadian income trust – but changes in the law are making it convert to regular corporation. That change (along with the housing crash) has created some selling pressure on the stock in Canada as income-oriented investors (who were used to a 15-20% yield) look for other high-yielders. It now yields 4% or so. Its former parent company (Brookfield Asset Management – BAM on NYSE) owns 45% of the company so a bit of a risk there.

It has a bank loan that is coming due in Feb 2011. That bank loan of $35 million is secured by its Maine timberland (310,000 acres – or $113/acre). Acadia won’t be able to pay off that loan in full (currently has cash of $11 million) so there are two options the bank can take — partially/fully extend/renew the loan (Acadia earns more than enough to pay for it) or take possession of the Maine timberlands and try to sell them – and one option that Acadia has — find a buyer for the Maine timberlands. It’s unfortunate that it is stuck doing bank loans because those are likely to always be on a short-term basis making it impossible for the company to accumulate a slug of cash to pay off its debt and rendering it victim to bank sector problems.

However, assume the bank takes the Maine forests because it can make a profit selling those forests to some shark looking for a tax deduction. Acadia will then be virtually debt-free (only a $10 million line of credit for its working capital) — with 800,000 acres of owned forest land (with a good mix of hardwood and softwood) in New Brunswick. With 16 million shares outstanding – selling at C$5.90 each, that’s roughly C$100/acre. It can currently make about a 10% return on timberland at that price – with half returned to shareholders as a dividend. If the lumber market ever recovers, it can double that return and probably triple the dividend. And even better if the bank renews the loan and leverage provides a bit of juice. THAT is what timberland investments used to look like before the land prices ran up.

Why is this stock selling so low? IMO – it is mostly because it is almost completely illiquid. The changes in the Canadian law re income trusts eliminated the stocks natural buyers. There are only a few hundred shares that trade hands every day. So institutions can’t possibly get in. Hell, that is almost too illiquid for anyone who even wants to invest a few thousand dollars if they might need to sell it anytime soon. Can’t imagine who is selling — people who need normal liquidity and the few Rip van Winkles who just woke up to discover a housing market crash. This is, by illiquidity, a buy-and-forget-about-it-for-awhile stock.

Risks — apart from illiquidity. A controlling shareholder who might just screw minority shareholders and take it over. Personally, I think the risks of that are somewhat low since that shareholder spins off assets regularly and might be hesitant to piss off precisely the sorts of shareholders it needs for future spin-offs. But it is still there. Obviously the bank loan is a risk — but that has a clear and certain date attached. The dependence on a few customers is a bit of a risk. I don’t think softwood prices or new housing starts recovery are a risk. They are already at marginal production costs (or virtually zero) and can’t go lower. An existing 4% dividend yield is completely sustainable in almost any circumstance. Even if they have to shut the forest down completely — the trees will still grow at 2-3% per year and the land itself is well-split between over-mature, mature, growing, and young forest. Final risk is geographic concentration. Climate changes or infestation/disease could wreak havoc – but perhaps less so with the variety of hardwoods/softwoods.

I think this stock is worth a GTC bid at current prices — on the Toronto exchange. Maybe with a relook in late Feb 2011 – the bank loan date – for another bid. Do not bother with “day-only” bids and don’t bother with the pink sheet. It literally might take two weeks for even a small order to fill. This is precisely the sort of market/time/stock where one buyer can create the floor in a stock.

On the pulp side, there is another Canadian income trust called CanFor Pulp Income (CFX-UN on Toronto; CFPUF on pinks). It’s only asset is a 49.8% ownership of pulp mills. It currently sells for C$13.75 and yields 19% (dividends paid monthly) — but that is hugely at risk. Pulp prices skyrocketed earlier this year because of some strikes/damage in Finland/Chile – which combined with low inventories which shrank over the last 10 years with pulp mills closing down and with the credit crunch last year. Pulp prices are already falling — but this stock has already seen its own skyrocket. From C$2 at the low last year to C$13.75 now — yeesh, 700% stock price appreciation and a near 100% dividend yield if you bought last year at the lows. This makes shipping stocks look like pikers. That said, it seems too late for this one. Might be a good one to watch if/when the markets tank. With all commodities, high prices ALWAYS create the seeds of their own destruction — and the time to buy them is when prices are low because they can’t go to zero.


It appears to me that the energy market in the US at least is now irrational. I don’t really know why but here are current prices (per MMBTU) for different forms of energy

Coal – $2.27/MMBTU
NatGas – $4.38/MMBTU
Crude Oil – $13.46/MMBTU
Ethanol – $12.82/MMBTU
Gasoline/Products – $18.03/MMBTU
Electricity – $18-20/MMBTU (flyover country); $30-40/MMBTU (policymaker country)

These don’t all compete directly with each other (and some are inputs for others) but they should, in a free market, tend to either converge or spur innovation that would allow multi-uses for fuels (and hence tend to converge). Why isn’t that happening?

Coal – Clearly the cheapest fuel but for political/social reasons will not be expanding its use. Carbon emission costs are not priced into the market with the fuel directly but are somewhat priced in on the consumption side. Coal will continue to be used for electricity generation – and electricity may become more used for transportation. Currently for most of the country electricity is only a luxury transportation fuel. Politicians will unfortunately make sure that those parts of the country where electricity is cheaper (or can be much cheaper) do not attract immigration because they a)don’t want to lose personal power to currently depopulated places like the Dakotas or Wyoming and b)keeping the housing bubble inflated is priority one for pols and that can’t be done if people move from where they currently are. Given that political constipation, there is a large potential price upside for coal if not a volume upside – but very few investment opportunities. The Powder River Basin is the present/future coal center — but the biggest beneficiary of expansion/price there is actually the federal govt (via leases) and railroads (UNP and BRK.A and maybe, in future, CP) – not the miners (BTU,ACI,CLD).

Crude/Gas – Obviously the core of transportation energy but also obviously pretty damn expensive for the US. It really wouldn’t take a lot of innovation or even infrastructure buildout for natgas or biofuels to compete with crude at the margin. And it doesn’t even need to be some government subsidy. Personally, I am not sure the US government really wants to eliminate our dependence on imported crude. It ensures demand for reserve dollars (which helps fund deficit spending) and it provides a rationale for busybody wannabe empire administrators re the MidEast/China/etc. As well as slimy perpetual electoral rhetoric about how we need to “become independent” – which would disappear if we actually were to take steps to become independent. Absent change, oil price and investment opportunities will all be driven by overseas entities. There are plenty of them – but this post is focusing on the other stuff.

Ethanol/Biodiesel – Currently is priced comparably to crude-derived fuel. But that is very much dependent on the price of the source fuel. In the US, corn is the main feedstock for ethanol and corn is really cheap right now. Biodiesel has a variety of feedstocks. Long-term, biofuels are the sustainable liquid fuel for transportation but they will also require innovation in order to diversify the feedstocks so that the biofuel product remains somewhat stable in price. Short-term, the best investment opportunities are in the feedstocks themselves — but not because of fuel/energy but because of food problems. A topic for another post. Long-term, the best opportunities are in the enzymes/microbials that chew up those feedstocks and allow for things like cellulosic ethanol derived from much broader feedstock (garbage, forests, inedible grasses, etc) that doesn’t require expensive farmland to produce. Two companies in particular — Novozymes of Denmark (NZYM-B.CO or NVZMY) which is a legitimate dividend-paying growth company that already dominates the market for enzymes used in food/detergent/water treatment/pharma/etc and Codexis (CDXS) a riskier development-stage company. I’m gonna do a writeup on Novozymes. Too expensive right now but any stock market fall is a great opportunity to buy (and hold).

NatGas – is stuck. The price in the US is half of what it is in Europe. It can’t compete with coal. Greens/left in the US are off in lala land about wind/solar/walnuts and so don’t like natgas. And in order to really compete with liquid transport fuel, it needs some high-profile bully pulpit stuff and/or some big guaranteed orders (city fleets, corporate fleets, post office fleet, etc). Current price is profitable enough only to keep the gas pipeline full to the gills. The best opportunities for potential price-upside are UPL,RRC,ECA. The best opportunities for continuation of status quo are SE (pipeline), royalty trusts, oil sands stocks (need a high differential between crude/natgas), and nitrogen fertilizer companies or other non-utility natgas consumers. Topic for yet another post.