AMS And Still River Systems

I recently attended a trade show in Houston for the Radiological Therapy industry. I was able to visit the booth of Still River Systems which has developed a unique, compact and relatively inexpensive Proton Beam Radiation Therapy tool. Still River Systems is still a privately held startup company. But some of its shares are owned by partner American Shared Hospital Systems (AMS).

AMS is a stock I have owned for a little over a year. It is a very small cap stock (around $12M total capital). There are 5M shares outstanding with a stock price today of $2.40. The stock is very thinly traded and bounces quite a bit as a result. A couple weeks ago it was less than $2. Last year it was over $6 while it was still issuing dividends at a yield over 6%, so was popular as an income vehicle.

But the middle of last year, AMS decided to drastically reduce its dividend and instead use its cash to make investments (which cratered its stock price). One of those investments is an ownership position in Still River Systems, more of which I will discuss shortly. but first more on AMS as it stands today, without the prospect of Still River being a home run investment.

AMS has cash and other net (shareholder's) equity on its books of almost $20M. With 5M shares, this means the tangible book value is $4/share. The stock is trading at about 50% of tangible book value! And this with a very good cash flow profile. AMS reported earnings on Tuesday and it reported: "Cash flow, as measured by earnings before interest, taxes, depreciation and amortization, increased to $2,657,000 for this year's second quarter and $5,025,000 for this year's first half, compared to EBITDA of $2,381,000 and $4,634,000 for the second quarter and first six months of 2007, respectively."

So, cash flow to stock price is almost a 1 multiple ($12M (P) to $10M (CF)): absolutely unheard of. 4 or 5 is a screaming buy. The cash flow is well secured as this is a long term lease business to a very good customer base of large hospitals. And again, Still River Systems, which apparently AMS continues to buy into, is not even reflected in these figures.

So, what is Still River Systems: I would refer you to their website for more information: www.stillriversystems.com. But I did meet one of the directors on Monday morning and he was guarded (as he should be at a show) but still enthusiastic. He somewhat discretely congratulated me for buying AMS as a way to buy into Still Rivers' future. They are going into the final stages of FDA "marketing approval" and expect to have equipment to market in mid-2009. AMS is purchasing, managing and installing their test systems (2 are installed and have been for some time). The results have all been very positive. Here is an article from late 2006 on the advatanges of compact PBRT technology. It is a bit dated, but still valid: http://medicalphysicsweb.org/cws/article/industry/25886

As the article comments, the low installed cost of the Still River Systems equipment is the key to its future success. They have developed a novel new way to deliver protons to cancer victims for therapy. The low cost of the systems will allow them to be deployed much more widely to hospitals and therapy centers. It should also permit Medicare reimbursement for the procedure which will open up a large new customer base. AMS, as a part owner, will control the distribution of those systems, which it does not now with the Leksell "Gamma Knife" systems it currently buys and leases. So, it is a double win: Still River Systems has a well funded partner with industry connections in AMS to rapidly expand its sales; while AMS should get preferential treatment and a share of the profit on every Still River System it buys and installs. Hard to beat this combo.

I can't offer any solid projections based on what I now know, only speculation, but this could easily be a 10 or 20 banger within the next 5-10 years (stock price of $20-40 / share based on $200M revenue / $50M cash flow).

Another Opinion on the Rotation from Commodities to Financial (soft) Equities

Just picked this up off the E-Trade News. The article from this PM confirms the points I have made recently regarding a rotation from the commodities to the financial equities. It sure is nice to see someone independently come up with the same technical indicators that I have identified ;o) The rotation may not be long term in nature, but it sure looks tradeable over the next few months (today's action notwithstanding).

The chart below compares the Financials index, XLF with the oil index, OIL. The relationship between the two is almost perfectly inverse the past month. So, as oil and commodities decline, financials and other related equities will increase. This makes sense because oil / commodities are a reflection of inflation denominated in the home currency. Higher inflation must mean higher interest rates, which must damage financial equities.




"Goodbye commodities, hello financials" 1:01 PM ET 7/24/08 Marketwatch

NEW YORK (MPTrader) -- It seemed as though there was no place to hide when Apple and the technology sector, along with Bank of America and the financials, got clobbered with the rest of the market at Tuesday's open. Though by mid-day, the market did recover in a big way and left behind another significant low within a "rolling bottoming process."

Tuesday's action in the Standard & Poor's 500 Index (SPX) established a low of 1248 and high of 1277. That dwarfed Monday's daily range, closing well above Monday's close and high, so from a strict technical prospective the blue chip index had a key upside reversal.

In addition, unlike the rally off of last week's July 15 low, Tuesday's rally did not have the feel of a temporary oversold rally. The morning sell-off wasn't as dramatic, with the S&P 500 only down 11.5 points from its previous close as opposed to nearly 28 points on July 15. So it was a higher, secondary low -- more corrective looking than that of the previous week, and less susceptible to a mere reactive bounce.

Driving the S&P 500, which has now recovered 6.8% from its July 15 low (through Wednesday's close at 1282), are the financials, which have room to go higher. Over the last several months the percentage that the financials make up of the S&P 500 has diminished just by virtue of the price deterioration, while the energy sector percentage of the index has increased. But institutions in the last week, in particular, appear to have begun to shift their money out of the once high-flying energy sector into equities.

One way to play this trend is through the Financial Select SPDR (XLF) or its sister ETF, the Ultra Financials ProShares (UYG), which moves two times that of the XLF. Since its low of 14.08 on July 15, the UYG is up 68% through Wednesday's close at 23.67.

Traders should look this week for a break of 26.40. That's where the major resistance trendline from Sept. 30 of last year cuts across the price axis, a break of which would be the first major signal of damage to the downtrend that's transpired since the fourth quarter of last year. Beyond that, if the UYG can sustain above 33.75, it would indicate the end of the bear market in financials.

Likewise, the Ultra Short Oil & Gas ProShares (DUG) provides an opportunity to play the downside move in energy shares. The DUG has put in a rounded bottom at around 25.30, closing Wednesday at 36.16, up 42% from its low, as oil prices have declined 15% from their $148 high. Its chart points to 39.50-41.00 next.

Another way to play the trend is through the iShares Dow Jones Transportation Average (IYT), which for obvious reasons is getting a major lift from declining energy prices. The IYT chart shows it made its bear market, corrective low on January 6 at 72.86, and went to new highs after that at 99.09 on May 18. The July 15 low at just under 82 was the pullback low after that new high, and from there it's gone to just above 92 as of Wednesday's close, a 12% gain in just a week. Tuesday was the first time it closed above its 50-day moving average since the first week of June, suggesting the IYT is in a new upleg and heading directly back to 99 to test that high.

Other commodity indexes are confirming what the IYT is suggesting, like the PowerShares DB Agriculture ETF (DBA), which closed below its 200-day moving average for the first time in a year on Tuesday. The PowerShares Commodity Index Tracking Fund (DBC) closed for the second day in a row below its 50-day moving average and looks like it has considerable room to go down as well.

In addition, the streetTRACKS Gold Shares (GLD) looked like it was on its way to retest high levels at around 98 early Tuesday but instead ran out of gas at around 96.20 in the pre-market hours and then reversed in a big way and closed at 93, falling to 90.57 as of Wednesday's close. Chances are the GLD now will move back to below 90, and possibly towards a full-fledged test of its rising 200-DMA, now at 86.80, which must contain any further sustained weakness to avert a total breakdown in gold prices towards $800 ($80 in the GLD).

The financials, transports and stock index ETFs are turning up, while we have sell signals in the, energy, agricultural and precious metals sectors. For people who have followed markets for a long time, this inverse relationship between equities and commodities makes intuitive sense and suggests there are trading opportunities developing that will last longer than a few hours!"

Mike Paulenoff is author of MPTrader.com, a diary of his intraday technical chart analysis and trading alerts on ETFs for gold, oil, equity indexes and other major markets. (mptrader.com)

Bank Stocks continue to Strengthen

Today the banks are continuing to look better on the charts. The earnings reports have been good for some and poor for others, but nothing substantially below expectations. It is the actual vs. expectations that drives the market, not the absolute performance.

Following my charts, I see that all of the worst banks are now showing a positive breakout. UYG (double of the XLF index) made the buy signal a couple days ago. And now I see that FRE, FNM and WM are also showing a positive breakout. C and BAC made their breakout on Monday afternoon. Because they went down so far the past eight weeks, the banks can bounce quite a bit before they hit resistance levels from mid-May. For example, the first point of resistance on UYG is around 26. If it breakes through that, which should be easy enough, it will face significant resistance around 35 where it was through late April into mid-May.

But I am using a August 25 Strike sold put to capture the first leg of this move, with UYG at 21. It had a $4.20 premium on Monday. Now that is down to $3.20 as of the close yesterday and showing an even lower open today. So, already, I have captured more than 25% of the premium available. On 20 contracts, that is over $2000. This is a bolder play than normal, for me, but I feel strongly about the bounce in banks, though am suspicious of another leg down. So, I will be out of the banks by the time UYG gets to 26. I had a scare on Tuesday morning when the banks cratered at the open on bad earnings from Amex and Wachovia and UYG dropped to 19.13. Options on a levered index make for an exciting ride!

Bad Open on July 22

Wow…didn’t take long for more bad news to hit the stock market.

Merck and Pfizer and other big pharmas are getting killed today and in after-hours. Merck is down to $33 from $37 just a couple days ago. Glad I am out of Merck and Pfizer.

Apple is also getting beat up. Bad earnings report and disappointing I-Phone sales (just a few days after the launch of the new 3G version was declared a major success). There is also a story about Steve Jobs being sick. But this just shows how neurotic the market has become.

Financials were looking better and then, wham!, along comes American Express’s Q2 report and depresses the whole market. The good pop on UYG and XLF this morning were all but gone by the end of the session and are well below their closes in after-hours.

So, if the market continues to act grumpily in the morning, I will be selling forward my recently acquired (this morning) UYG August sold puts to September at the same strike of 25. This will get me a little more premium and also more time. It should not be too hard for the Financials to get back the 25 strike when the market decides to be happy again, as it was there as recently as early June. The BAC and C quarterly reports showed clearly that unless there is another big bomb in the Financials, that the market should start repairing itself. C and BAC look good as does JP Morgan and Goldman. Freddie and Fannie have been backstopped, so no real danger there. I don’t think Obama or McCain will get tough on government bailouts. Obama would be very favorable to bailouts as a large government Democrat. And affordable housing for the middle class is sacred to Democrats, so politically, Financials should do well as the elections approach.

Jeff, you must be happy the market is finally looking kindly at Valero. Funny how a little story in Barrons makes such a big difference.

Buy UYG - Financials have made a turn

Maybe the Financials are making a turn....Finally. And they should bring the entire market along for the ride. BAC came out with relatively great earnings this morning (Monday, July 23) and its stock price is off to the races, showing over $31 in early trading, up from $27.

Jeff and I talked about buying more call contracts on Citibank on at our weekly coffee on Saturday. Take a look at the January 2010s, strike price at $30 for $1 a contract. This is looking like an even better move as of today. Citibank is back to $20, up from a low of $14 last Tuesday (July 15). BAC had gone from $40 to as low as $18.44 in the past ten weeks. And now the open for BAC looks very good, as mentioned. It might pay to wait until Tuesday afternoon or Wednesday morning to make this move, or use limit pricing to not overpay.

I understand that WM, Wachovia and Countrywide report tomorrow. Those have been the weaker of the banks as they are heavily involved in the mortgage industry (Wachovia had bought at the top in 2006, Golden West, a California lender with heavy sub-prime and Alt - A exposure). It is unlikely they will have good news to report and will probably pull the financials back down tomorrow (Tuesday), though even "not so bad" news may be greeted with a pop in the stock price.

I have started using Investools to time my trades in my short term trading account. Their basic technical signals work very well both for buying and selling. Had I been following this system earlier, it would have gotten me out of the volatile Financials at all the right times, such as May 8 on the latest downturn. At that time, C was at (24.50), BAC (38.50) and UYG (32.50). The Investools chart on UYG shows it just now again reaching the buy signal (MACD, Stochastics and Moving Average all turning green). This was last given on April 23 and before that on March 23, just after the infamous Bear Stearns bottom on May 19.

In order to capture this uptrend, I am selling short the puts on UYG, which is the leveraged XLF Financial Index fund. I will do so with a tight stop to the downside. UYG is a good way to play the financials to diversify the risk in that sector. There may still be individiual bank blowups. But as the market bids up the price of the fincancial group stocks, their capital base expands accordingly, putting less pressure on their coverage ratios.

This buys time to liquidate their commercial paper portfolios at decent prices. They don't have to dump them at losing prices, or lose the entire portfolio to bankruptcy (Indymac) or a takeover (BSC). We are convinced that the banks' commercial paper portfolios are worth a lot more than their current artificially low valuations (based on the mark-to-market requirement of GAAP reporting). When the paper is properly valued and sold, the banks will be able to show a lot more capital on their books than they are now credited with.

It may not be over for the Financials, so we will keep a close watch on UYG and other financial stocks.

Fannie and Freddie: Does America owe every citizen a Home?

I am posting an intersting editorial from this week’s Barrons. It makes many good points and questions the concept of Freddie and Fannie. I think the editor’s line of thinking will be echoed by many and may cause a monumental change in the mortgage markets in America. At the least it will cause a great debate: does America owe easy mortgages to all citizens, regardless of their ability or interest in repaying their debts?

Cbass will be proud of this piece:

“Is This Capitalism?

Thomas Dolan - Barrons Editorial Staff

EVERY ONCE IN A WHILE, THE MARKETS serve up new evidence that a lot of investors don’t really care what happens to their money. The past two weeks have been awash in proof. Just look at the recent declines in share prices for the stock of Freddie Mac and Fannie Mae (Feddie) on “news” that the two mortgage behemoths may face large losses and may have to raise more capital to make good their guarantees.

To whom did this come as a surprise? Who was stunned by this news? Who had held firm during the past year, while Fannie’s and Freddie’s stock fell 80%, and indeed the whole financial sector took a haircut that reached all the way to the belt?

Was this “capitulation,” when the last stubborn bulls give up? Was it bottom-fishing by people whose lines were too short? Or was it a rude awakening of people who have been sleepwalking in the Street?

Investors’ eyes were closed to so many things:

For years, F&F could not even issue clean financial reports. For years before that, F&F issued financial reports that sophisticated investors questioned, loudly and publicly. For decades, F&F ran on thin margins of capital, creating leverage that would shame an insolvent savings and loan — or the federal government. For years, Fannie was operated by overpaid Democratic political operatives (Freddie made its political accommodations more discreetly).

Yet people who considered themselves risk-averse bought stacks of F&F paper as higher-yielding substitutes for “risk free” Treasuries. They thought that Fannie and Freddie are backed by the federal government — even though the government always shrank from saying so explicitly.

Myth Becomes Reality

Regrettably, some of the naive investors were right. Fannie and Freddie — henceforth to be known as Feddie — are backed by the federal government. The Treasury, the Federal Reserve, the Congress and the White House have tuned up and now sing in chorus, declaring that Feddie is indeed the ultimate example of “too big to fail.” They will buy Feddie stock, lend to it from the Treasury or the discount window of the Fed. They will do whatever else it takes to be sure that holders of Feddie-guaranteed mortgages don’t lose their money.

Officialdom still shrinks from a straightforward declaration of unconditional support for Feddie or a straightforward nationalization, because it hopes to muddle through this crisis without adding $5 trillion or so of mortgages and guarantees to the national debt.

Fannie and Freddie and the whole mortgage mess represent capitalism at its worst — the Invisible Hand in the taxpayer’s pocket. First, it pays out bonuses and benefits to politically connected big shots. Then, it takes money from some citizens to redress the bad investments of others. It’s the classic “mixed economy,” in which rewards are private and risks are socialized.

As an economic adage tells us, “Capitalism is the exploitation of man by man; with socialism it’s the other way around.”

The Blame Game

We are hoping that regulators find a way to go back and strip the former executives of Fannie and Freddie of all their ill-gotten bonuses, but we also blame the game as much as the people who played it.

That game was created by those who believed that political advantage lay on the side of cheap credit, especially cheap credit for houses. They were right, of course, but they extended the idea much too far. Among their serious mistakes:

• Permitting F&F to “guarantee” timely payment of principal and interest without requiring them to have adequate financial resources.

• Allowing F&F to hold mortgages in their own portfolios, like banks, only with inadequate capital.

• Letting F&F sell stock to the public with a wink, signaling that the federal government would never let them fail.

• Encouraging banks and mortgage brokers to travel a path well-marked by F&F, using easy credit to foster subprime loans, Alt-A loans and liar loans, all with associated high fees, passing them on to investors lulled into a false sense of security by F&F and their market power.

As so often happens in American financial crises, these failures are not failures of capitalism, but instead failures of a phony regulatory system that assures people that their speculations are sound investments.

What Is This?

The famously prescient investor Jim Rogers, who took his money and his family out of the U.S. economy and out of the U.S. entirely, raised some good points last week:

“I don’t know where these guys get the audacity to take taxpayer money and buy stock in Fannie Mae. I mean, what is this? What are they doing guaranteeing their debt? The people who bought debt in Fannie Mae and Freddie Mac can read a prospectus. It says it is not guaranteed by the government. Anybody who can read a balance sheet knew that both of those companies were a sham and they had problems. Now, we have to bail out the Japanese? The Japanese own hundreds of millions of dollars of this stuff and so we are going to bail out the Japanese and the Chinese and everybody else in the world? What is this? It ruins the Federal Reserve’s balance sheet, it makes the dollar more vulnerable, and it increases inflation, and it drives down the dollar.”

A good question: What is this? A panic, surely, but not so much a financial panic as a governmental one.

The federal chorus stands behind Feddie like a midnight choir standing behind the chief drunk. The lady of the house comes out to see what’s going on, and the choir denies all responsibility. Anyway, he will be sober in the morning, they promise.

That’s what they said the last time, and the time before that and the time before that. Using the money of its innocent citizens, the government is trying to prop up Feddie until it can stand on its own again, attract capital again, pour money into the mortgage market again, raise the price of housing again, and, of course, collapse again — perhaps not taking the banking system with it.

Fannie and Freddie are not too big to fail, but there’s a bigger question: What about the federal government itself?”

Possible Lithium Plays

Jeff and I were having our normal post-Saturday run breakfast and coffee this morning. The subject of lithium came up as we were discussing alternative energy plays. Lithium is the most efficient element that has been found to work well in batteries. It is a basic element and relatively prevalent / available, so it is not likely that something more effective will be found for battery construction. We agreed that the battery companies themselves, or the fuel cell companies, are a riskier play since it is not certain which configuration of battery technology will end up as the winner. So, Ballard Power (BLDP), Energy Devices (ENER) and ENER1 (HEV) are interesting, but risky plays on alternative energy.

No matter what alternative energy electrical source is developed, batteries will be very important to store the energy, whether for vehicles, or utility power production. Solar, Wind, and Fuel Cell technologies all require some form of storage to allow for changing production conditions (weather, night/day, etc). Lithium batteries are likely the best option to store that produced power, since lithium is a very efficient exchanger of ions. It ssems that there are many variations on lithium-ion batteries, but the difference is in the material for the cathode and anode. In all cases, the free-ion material remains lithium.

First, the basic science with reference to Wikipedia: Lithium-ion batteries (sometimes abbreviated Li-ion batteries) are a type of rechargeable battery in which a lithium ion moves between the anode and cathode. The lithium ion moves from the anode to the cathode during discharge and from the cathode to the anode when charging. Lithium is readily available and low cost to mine. It is derived from igneous (volcanic) materials such as granite. It is so reactive that it is not found on earth in its elemental form. It quickly gives up its spare electron to other elements and forms compounds, which is why it is a great battery material.

Lithium is a Group 1 (IA) element containing just a single valence electron. Group 1 elements are called "alkali metals". Lithium is a solid only about half as dense as water and lithium metal is the least dense metal. A freshly cut chunk of lithium is silvery, but tarnishes in a minute or so in air to give a grey surface. Its chemistry is dominated by its tendency to lose an electron to form Li+. It is the first element within the second period. Being in the second period, it has a very low mass (few protons and neutrons) which makes it very light. This is another reason it will always be the best material for battery construction where weight per unit of electrical storage is a key factor.

Lithium ion batteries are commonly used in consumer electronics. They are currently one of the most popular types of battery for portable electronics, which require a great energy-to-weight ratio, Li-Ion has no memory effect, and a slow loss of charge when not in use (5% per year). In addition to uses for consumer electronics, lithium-ion batteries are growing in popularity for defense, automotive, and aerospace applications due to their high energy density. However certain kinds of mistreatment or contamination during production may cause Li-ion batteries to explode during use. Making Li-ion batteries safe to use in high power applications like automotive, is a key technical challenge to be solved.

The three primary functional components of a lithium ion battery are the anode, cathode, for which a variety of materials may be used (Carbon/graphite, Iron, Maganese, Cobalt),and an electrolyte. Commercially, the most popular material for the anode is graphite, although materials such as TiS2 (Titanium disulfide) were originally used. The cathode is generally one of three materials: a layered oxide, such as cobalt oxide, a polyanion, such as lithium iron phosphate, or a spinel, such as manganese oxide. The electrolyte is lithium which does not vary from one battery design to another.

For more info on Lithium Battery technology see: http://en.wikipedia.org/wiki/Lithium-ion_battery

So, how to invest in this essential material for transportation and power storage? There are several lithium mining and chemical companies. FMC, SQM (Chilean company) and ROC. SQM is based in Chile and it is a almost pure play in lithium with a big increase in production in its future. At $44 a share on the NYSE (as of June 13), it is hardly undiscovered -- there are 1.2 billion shares outstanding and it carries a market cap of $54B and is selling at a P/E of 37.7. It was a $5 stock 5 years ago. But, if you want to speculate on lithium -- without having to guess who the big battery winner will be -- SQM is a good bet. SQM might be like POT before the ag plays really started to run. Even though SQM is already very large by market cap, if lithium eventually becomes the key component to all vehicles and a large percent of power generation, the global lithium market could easily exceed $1 trillion.

FMC is a diversified chemical company with a big exposure to lithium. It is selling at 20 times 2009 projected earnings. This stock was $7 five years ago and is now $77 so it too is not undiscovered. It has a much smaller market cap than SQM at $5.7B, so has a lot more room to run on that basis. With FMC, you have a broader based company and a small dividend to entertain you while you wait.

ROC specializes in specialty chemicals and advanced industrial materials but it is debt heavy. Today it trades for $40, is selling at 35.9X earnings and has a $3B market cap. It IPO'ed in mid-2006 at $20 so it is up 100% in two years. Although it is starting to gush cash, it is selling for 2x its PEG and vulnerable to an economic slowdown. It is, though, one of the big three in lithium mining and processing so, if lithium prices spike, this stock will benefit. It is probably the best bet as of today as it has more opportunity for growth than SQM and is a purer play than FMC.

Refining lithium from seawater brine has been discredited due to the inefficiency of separating out the other sea water minerals to get to the lithium, though there are some micro-cap companies continuing to promote this scheme. Another possibility is refining lithium from re-circulating water from geothermal sites, which are often in igneous formations since igneous materials come from volcanic / thermal processes. But this concept is unproven and still just a theory. So, earth mining remains the best option in the forseeable future. It would not be surprising to see other broad based miners like BHP, RIO, FCX to become involved in lithium in the future.

Oil Heavy Trusts Could Fill Your Wallet

The Cash is pouring into the Oil and Gas Canroys right now, and it will continue to do so at oil over $100 a barrel and gas over $10 a MCF.  All this cash must be redistributed if not reinvested.  Two weeks ago (May 21), PennWest announced it was acquiring a small oil company for $125M.  This will add 3500 barrels a day of production to PWE.  However, $125M is only one month of cash flow at PWE, so this does not really put any pressure on cash.  There is still plenty of excess to distribute with increasing dividends.

 

Isn’t the best way to beat the high prices at the gas pump investments in Canroys?  This has been my mantra for the past 3-4 years.  To underscore this idea, there was an article in the Canadian Globe and Mail that I read while in Calgary last week.  It was called: “Oil Heavy Trusts Could Fill Your Wallet”  https://secure.globeadvisor.com/servlet/ArticleNews/story/gam/20080530/RPARKINSON30   It references several recommended oil trusts and has Baytex and Daylight on its recommended list.  It does not list the gas trusts, though they are about 50/50 oil and gas.  They will also be increasing their dividends soon.

 

 

 

Boone Pickens and Gary Kaminsky on Oil and Energy, Yahoo-Microsoft Update

Great Squawk Box this morning if you like oil and energy. We had the very watchable Boone Pickens offering his opinion that oil would make it to $150 a barrel by the end of the year, and would keep going up from there. He mentioned the possibility of $12-15 gasoline at some point. That will kill our economy, but also will accelerate the development of alternate fuels and vehicles. Question: do the refiners find a way to make money at $12 gas?

Boone has rarely been wrong the past 10 years. He also is pushing the heck out of wind energy which is a good reason to own GE, the biggest maker of wind generation equipment in North America, if not the world (I own a lot of GE stock and options). I wish there was a more direct play on wind energy, but there is not. This is a tough business. A friend of mine, who was CFO for a local wind energy company in Minneapolis, just quit because his little company cannot get any generators from suppliers like GE. They are all committed for the next 4-5 years to big players like Pickens.

Pickens mentioned Solar as part of our national energy solution. I don't know if he has a play there, but I do know that I am helping my employer, SICK, get positioned in that market. After a company meeting last week, it was decided I will be focusing more of my time on the Solar energy market. We are attending several solar equipment trade shows the rest of this year and I am working on brochures for applying our products to that industry and have a couple of sales proposals in the work to equipment suppliers. It is the new oil and will be big over the next 20-30 years. (I own a small stake in solar company ETF fund - TAN and will keep adding to it).

We also had Gary Kaminsky of Neuberger Berman funds on CNBC this morning. Gary's column in Forbes is what got me into PennWest in 2004. He was the first to recommend this way back then, and still does. He also has been promoting Suncor for just as long. I already knew about the Canadian oil sands having worked up there since 2000. But Gary has reinforced the message about oil sands and makes me want to own more (have Candian Oil Sands - COSWF, today, plus Daylight and PGH that have some oil sands exposure).

As for the Yahoo-Microsoft deal: what fun! I have stock and options in Microsoft and also options in Yahoo. Carl Icahn's involvement in a new board of directors for Yahoo is the catalyst needed to move Yahoo towards MSFT. (Boone Pickens agrees as he said he bought 10M Yahoo shares behind Icahn, though $240M is play money for T Boone). However, Steve Ballmer is not playing along with Carl and proposed last weekend an alternate plan to only buy part of Yahoo. Question: is this truly Ballmer's intention? or, is this a negotiating ploy to get the price for Yahoo down, as in: MSFT thinks part of Yahoo has value, and the rest is not worth what Yahoo shareholders think. It will be entertaining for sure.

Dialogue on Housing Deflation - from ArizonaRealEstateNotebook.com

Cbass // Apr 27, 2008 at 7:12 pm

Brian,

So you mean to tell me that prices for goods and services can not increase while our economy stops growing or goes into a recession just becuase there is supply?

en.wikipedia.org/wiki/Stagflation

“Demand-pull stagflation theory explores the idea that stagflation can result exclusively from monetary shocks without any concurrent supply shocks or negative shifts in economic output potential. Demand-pull theory describes a scenario where stagflation can occur following a period of monetary policy implementations that cause inflation. This theory was first proposed in 1999 by Eduardo Loyo of Havard University’s John F. Kennedy School of Government.”

Just an example of some smart dude who agrees my thoughts are possible.

Brian McMorris // Apr 28, 2008 at 9:19 pm

CBass, I don’t think you and I are very far apart on this. I concede the idea of some level of stagflation at a time like this. Today we have “demand shocks” rather than supply shocks. That demand comes from the BRIC nations and is outside our Fed’s control.

I don’t know that residency at Harvard makes this guy smarter than you or me. But yes, anything is possible. But there is no real proof, yet, for this theory that was postulated in 1999 (stagflation that results from loose monetary policy).

The most often cited example of Stagflation came in the 1970s and was the result of supply shocks (in oil and base metals). The supply constraints, accompanied by rapid demand increases in Asia (as Japan and Korea underwent a huge expansion) did result in inflation. But monetary policy probably had little to do with it. A wage inflation spiral was a reaction to the “materials” inflation, but that was in a time of powerful unions that no longer exist. It took Volcker’s interest rate shock therapy in 1980 to break the cycle of wage increases gained by striking unions ending the phenomenon known as “inflationary expectations”.

The “stag” term suggests flattish growth that is behind the rate of inflation. If inflation is at 5% and nominal growth is at 4%, that is stagflation, and not really so bad. It is just important to be invested in hard assets during such a period so that investment earnings beat inflation.

But this scenario is a lot different than the Depression that many are predicting, which requires a Deflation. I say we already have a housing depression (deflation), as compared to the 30s for example. But the other elements of the 30s Great Depression, are not in place and very likely won’t be if the Fed keeps the economy from panicking by pouring on liquidity.

packerbacker // Apr 29, 2008 at 5:52 am

Brian-

I think you are smart. I like what you say, but someone should slap you for this. You say, “we are already in a housing depression-as compared to the 1930’s” A quick google would show you that during the Great Depression, around 25% of people were forclosed on, unemployement was over 20% and household income dropped 40%.

Brian McMorris // Apr 29, 2008 at 6:20 pm

Thank you for the compliment and comments. But see that I limited my statement to “housing depression” which I borrowed from Dr. Shiller himself. He is the greatest authority maybe in the world, on the history of housing pricing, and has lots of historic data to back up his comparisons. So I am comfortable with that statement.

Average national price is down about 15% from its peak now, and more or less in freefall. He concludes, and I have no reason to differ, that it could easily drop another 15% before it bottoms. That will be as big a drop as the 30s. I am not sure the source where 25% of homes were foreclosed in the 30s. I have not seen numbers that high. I don’t necessarily believe everything I read when I google.

As for unemployment and household income dropping, this time is different. I am not saying we are in another Great Depression, just the contrary.

What makes this time different, is we have the lesson of the 30s to teach us how to respond to the housing depression, so problems will not be magnified. We will probably not have 40% foreclosure, because this time, the banks started acting early to deal with their bad loans. The Fed also got into the act early because of Bernanke’s expertise on dealing with conditions that lead to broader economic depressions, including acting aggressively to cut interest rates and simultaneously supply liquidity (in numerous ways) to keep the banking system from imploding.

It did implode in the 30s and that is why foreclosures went so high, the banks could not afford to negotiate with the home owner, do short sales, or hold bad mortgage portfolios. The banks then were S&Ls with no where to go for help (there was a Fed, but it wasn’t ready for the problems it faced).

If you find economics interesting (you can probably tell that I do), I will share with you a very credible source on Depression era statistics, causes and effects: Mr. Ben Bernanke. Here is a speech of his from 2004 (so not colored by the current situation):

http://www.federalreserve.gov/boarddocs/speeches/2004/200403022/default.htm

In it Bernanke quoted a study by economist Milton Friedman, published in 1963, that proves that monetary contraction was the proximate cause of the Great Depression. There are many examples given as evidence, but I will let you read it there rather than fill this space with quotes. This is why we see Bernanke’s Fed has been so dramatically increasing liquidity, much to the consternation of CBass and others. But Bernanke and others are on record saying it is much easier to fight easy-money induced inflation, than contraction-induced deflation. The housing crisis on its own contracts money supply (basically evaporating paper money in the form of mortgage liabilities). Bernanke’s Fed has responded by expanding it in other places, probably for a net zero effect. But we won’t know for a few years.

So, I stand by my earlier positions defending monetary expansion, but appreciate the opportunity to explain why.

Microsoft is a BUY! and Another Buy Signal? - Consumer Confidence Lowest Since 1982

As Friday's "Prudent Speculator" newsletter suggests, I have bought more Microsoft on Friday (already held some sold puts on Jan 09 at $35), as one of the best values today and also sold some Daylight Energy to capture profits.

The case for Microsoft is very compelling. This is a company with an ROE that is through the roof at over 45% (one of the highest of any stock). The gross margin is also through the roof at 80% (as it has maintained for 20 years). It is a cash machine with revenue growth of 17% YOY. Earnings growth is 25%. Yet, the P/E at today's closing price of 29.83 is only 17.3

This is the best price on Microsoft since the mid 80s, before the launch of Windows, in my estimate. And there is a catalyst in the Yahoo deal. You have to love the way that CEO, Steve Ballmer, is playing his hand with Yahoo directors (and founder Jerry Yang). He is refusing to overpay and throw investor money (Bill Gates' and mine) at Yang. He will get Yahoo for a fair price and that will help MS in its competition with Google. In fact, I won't be surprised if after Yahoo, Ballmer goes after AOL, which Time Warner has on the block (I also own TWX betting AOL gets sold). I think MS will go over $40 by year end as the tech cycle leads us out of recession.

I also have trimmed a little on energy, just to lock in profits. I still think energy is the place to be for the next 10 years, (and have added solar to broaden exposure), but there should be a little pullback as the dollar turns around the next couple months. I will buy back the Daylight I sold when it is around $8. I am not selling any PennWest or PGH at these prices, as they should get back to $40 and $25 respectively, before I consider trimming some.

From April 26 Prudent Speculator: ...The fact that an early decline, one that accelerated after the price of oil spiked following news that U.S. war ships had fired on Iranian vessels in the Persian Gulf, gave way to a broad-based advance that closed near the highs of the day and that the S&P 500 finished above the apparently technically significant 1395 level have to be viewed positively.

The market also had to overcome word that the University of Michigan's consumer confidence survey fell to its lowest level in 26 years. Interestingly, the expectations index component of the Michigan report hit its worst reading since November 1990, while the current conditions gauge plunged to levels last seen in November 1982. Of course, as we have discussed in recent Hotlines and Buckingham Reports, the release of extremely weak economic statistics often marks a major market bottom. Such was certainly the case in 1982 and 1990, as Al Frank's TPS Portfolio gained 123% in 1983 and 55% in 1991.

Leverage Bank Loans - Great Returns with Limited Risk

In today’s Barrons (I get online a couple days early) there is a good article on commercial bank loan funds, which is the same as floating-rate funds. We have liked these, although I have been early with DWS Dreman Value Fund (DHG). I think you liked a Van Kampen version of this type of investment. The interview is encouraging for the future of this investment. I just checked mine, and though it is paying 11% dividend against today’s price, with my higher cost basis (from purchases last year), I am averaging around 8.5% yield, which is still very good. And there is a lot of market price upside. DHG is trading for 13.35 as of yesterday. But the NAV is almost 16. So it is trading at a 16% discount to NAV. When the market starts liking these investments, that discount will narrow or disappear. The NAV should climb as the market begins pricing up the previously discounted bank loans for the reasons in the article. Bank loans have variable rate interest, so are not exposed to inflation risk (which is why I got into these in the first place).

Note that the TXU debt that Steve Tananbaum likes in the article, is the no. 1 holding of DHG, which is managed by Dan Dreman and his team for DWS.

From Barrons, Monday, April 21, 2008

Leveraged Loans: Ready for Lift-Off
Says Steve Tananbaum of GoldenTree Asset
By LAWRENCE C. STRAUSS



STEVE TANANBAUM'S ROOTS ARE IN HIGH-YIELD BONDS, which he began analyzing at MacKay Shields in 1989. He became head of the department two years later, while still in his mid-20s. Since then his horizons have expanded to all sorts of asset classes, including equities. No surprise, he remains a value investor.

Eager to run his own firm, Tananbaum left the mutual-fund world in 2000 and launched GoldenTree Asset Management. With nearly $14 billion in assets, much of it in hedge funds, the New York firm devotes a lot of its time and energy to alternative assets. One of Tananbaum's favorite investment themes right now is bank loans used to fund leveraged buyouts. Amid the credit crunch, which has caused the spread between yields on high-yield bonds and Treasuries to widen, these loans have come under pressure. This kind of debt isn't widely available to retail investors, though some mutual funds, such as Eaton Vance Floating Rate Fund (ticker: EVBLX) and AIM Floating Rate Fund (AFRAX), specialize in bank loans.



Steve Tananbaum

So-called loan-participation funds haven't done well lately, and are down about 4% year to date through April 14, according to Lipper. But that's better than the broader market's total return of minus 9%. GoldenTree's flagship offering, the $5 billion Master Fund I, which looks for value in equities and bonds, was down 5.39% in this year's first quarter, but more than two percentage points ahead of the Merrill Lynch high-yield credit index that's used as a benchmark. The fund's five-year annual return of 11.34% bests the high-yield index by nearly three percentage points, as of March 31.

Barron's recently caught up with Tananbaum, 42, at his midtown office, which houses a portion of his art collection, including the spacesuits by artist Tom Sachs shown in the photo at right.

Barron's: What is happening in the credit markets, where conditions since August have been very tough?

Tananbaum: The credit problems that started last year, and which were perceived to be isolated, really spread throughout the system. In different pockets of credit, things were mispriced. Right now you're seeing a repricing of credit. Whereas last year you were being underpaid to own credit, now you are being overpaid.

You mean, in terms of much wider spreads?

That's right. Against that backdrop, the investment banks have been damaged. Normally they provide credit to the financial system. But things aren't working the way they normally do. You're seeing the banks' inability to provide credit to a lot of their corporate customers.

Are the banks lending less because they have to put more of assets on their balance sheets?

The banks are playing defense. They are more worried about their current relationships than beginning new relationships.

Are hedge funds paying higher interest rates to borrow from banks?

The terms are different from what they were six months ago. The banks are looking to provide less leverage at wider spreads, and only on larger pools of assets.

How has that impacted GoldenTree?

First of all, most of the money we run isn't levered. We have about $10 billion of alternative assets, of which $7 billion to $8 billion doesn't have any leverage associated with it. Also, we have favorable terms, with four to five years left on our credit facilities, so nothing is coming due right away. Having said that, if you have access to borrowing money, then bank debt, or leveraged loans, is very attractive. That's because the spreads on bank debt have widened considerably, to somewhere around 600 basis points [six percentage points] above Libor [the London interbank offered rate], meaning the prices have come down significantly. Those spreads are as wide as they've ever been. In the next two years, you could see spreads going back down to 400 basis points. That would give you double-digit returns over the next two years.

So this is a good time to be buying?

This is a great opportunity to be buying. It reminds me of earlier credit crises, such as the ones involving Mexico in 1994 and Russia in 1998, and the one that unfolded at the end of 2000. It was clear: The markets correctly predicted that defaults would pick up, and there is usually indiscriminate selling at those points. That's what we have today. But the credit market right now favors those with the money to buy. Earlier in the year, some of the easiest purchases were investment-grade names like American Express [AXP]. It had a new debt issue that was trading 362 basis points, or 3.62 percentage points, over Treasuries. That's what the high-yield index was yielding about a year ago. Now that debt's spread is in the mid-200s above Treasuries, meaning the price has appreciated. But there was definitely a disconnect.

What was driving bond prices to such low levels?

Leverage was a big part of the story. The first phase, as I said, was indiscriminate selling, much of it driven by a lack of liquidity. A lot of people had taken out lines of credit, leveraging up in some cases on bank debt, or loans used to finance buyout deals. When the value of the bonds went down, say 10 points, these investors got margin calls and were forced to liquidate, because they couldn't come up with any equity. It was basically a bunch of margin calls in February, and then in March it became a systemic issue with Bear Stearns [BSC].

What is your take on Bear Stearns' collapse last month, and its pending acquisition for about $10 a share by JPMorgan Chase [JPM]?

The Bear Stearns situation initially was about whether fraud was involved. The market got comfortable that it wasn't about fraud, but more about Bear not having the right capital structure. Then there was a run on the bank. The market has gotten healthier since the Bear episode, and the Fed has done a terrific job providing liquidity and telegraphing they intend to provide more.

What's the next step in the credit markets?

On the debt side, it's about finding companies whose balance sheets work. By that I mean which companies are self-sustaining in the current environment, as opposed to which balance sheets potentially are at risk of defaulting. The debt of Calpine [CPN], which has emerged from bankruptcy protection, was a large holding for the investment banks. Calpine had too much debt. But now, after the restructuring, it's a healthy company. The leveraged loans of Clear Channel Communications [CCU], the radio and entertainment company whose buyout has been stalled, could be a more challenging investment.

Table: Tananbaum's Picks…

Do you hold Calpine bank debt?

Yes. On the bank-loan side, we are focusing much more on companies where we are at the top of the capital structure. Calpine and TXU Energy, the Texas utility taken private last year, are interesting loans.

What does it mean to have a good position in a company's capital structure?

It means you get paid before others if things go wrong. You're first in line, ahead of the common equity holders.

As investment opportunities, how do you view junk bonds versus leveraged loans?

A lot more leverage was used for investing in bank loans. There wasn't as much leverage in high yield. Bank debt had a lot of margin calls at the beginning of this year, creating buying opportunities. And because there was such an overhang from the investment banks that held these loans on their balance sheets, it was a more attractive market.

There was no forced selling in high-yield bonds. Thus, bank debt, which is more senior in a company's capital structure, fared worse than junk bonds that were more junior. Bank debt offers better relative value than high-yield bonds.

What is on the horizon for bank debt?

April is starting off terrific, but there will be twists and turns. At the end of the day, what is going to determine returns, whether for high-yield bonds or leveraged loans, is the performance of the company. When certain companies can't grow into their balance sheets -- they can't, in effect, make their debt payments -- that's going to create opportunities, as well.

Any examples?

First Data, a financial-services company that helps process credit-card transactions, comes to mind. They were taken private last year. They have a big capital structure, and it will be hard for them to pay off debt.

Bank loans aren't readily available to retail investors, though there are some bank-loan mutual funds. Let's talk about some themes that have a wider appeal.

We've always looked at arbitrage between the public and private markets. In equities, there was a big discount to the private-market values of deals. That's opened up some terrific values because there is no private-market value right now. Many companies, including some in the media industry, traditionally were valued off of private bids. Now, in many cases, there is no private- market value because deals can't get done.

Some argue it's still too early to get into bank debt. Should you wait?

It depends on the situation. If you're talking about retailers or home builders, absolutely, it's early. We are avoiding home builders and retailers. The bonds of home builders, particularly the investment-grade issues, look extremely rich. But that's not true of all industries. Some bank loans related to utilities look attractive. For those companies, it depends on the dynamics of the region a utility is operating in.

Tell us about some equity holdings.

The television market in general has very good fundamentals. This is a presidential- election year, and the expectation is this will be the biggest spending year ever for TV broadcasting in terms of advertising. We are long the equity of Sinclair Broadcasting Group [SBGI], which owns a string of television stations around the U.S. It's a well-managed company with strong free-cash flow. And they have been benefiting from retransmission.

Which is?

Basically, getting fees from cable companies for their stations. We also like some cable companies, including Time Warner [TWX]. These companies have always traded at discounts to their private-market values. But we expect them to have high-single-digit cash-flow growth this year. Warner has a catalyst, given that [President and Chief Executive Jeffrey] Bewkes has telegraphed he's going to be splitting up the company. Time Warner trades at a significant discount to what we think its intrinsic value is, and it doesn't have a lot of debt. We believe, whether it's through dividends or buying back shares, they are going to releverage their balance sheet.

Time Warner and other cable companies are pretty much going to deliver the growth rates they've achieved over the last 10 years, yet their valuations are around 40% of what they've been historically. As recently as six months ago, these cable companies had double-digit multiples, based on earnings before interest, taxes, depreciation and amortization. And you can buy them for roughly half that now.

Any other thoughts on the cable industry?

We like international cable a lot. There's less competition overseas and we feel good about earnings. Liberty Global [LBTYA], is our largest holding.

Where else do you see value?

With casinos, take a look at MGM Mirage [MGM] compared to Harrah's Entertainment [HET]. Recently you could buy the debt of Harrah's, which has a better collection of assets, yielding close to 15% and trading at six or seven times cash flow. At the same time, MGM's equity was trading at about 10 times cash flow. We felt Harrah's debt was a better buy. We were short some MGM equity earlier this month, given that growth in Las Vegas is under some pressure in this economic environment, but we covered after the shares went down. MGM is a terrific company, but it turned out to be a good short for us.

Thanks very much, Steve.

Missed it By THAT Much!

Okay, so I missed the breakout by one day. After the great results on Wednesday afternoon and post-market announcements by IBM and EBAY, I thought Thursday would be the BIG DAY. So, what did we get? One measly point on the DOW. Some big breakout day. Maybe just a breather for big things to come.

I have been pointing to today for a couple of weeks. Today is the day for Citibank to announce earnings. It started looking good for Citi a couple days ago as its price starting creaping up. Great insight, or leaked information? Who knows, but good news is usually working into the price before the news is official.

So, this morning the news is out. It isn't stunningly great and was a loss of $1 per sahre, but is apparently good enough. New CEO Viktor Pankrit said the credit markets have become much more liquid and Citi is able to move its paper now. He is confident in their future. Citi is up to over $26 in the pre-market, up from around $20 on March 19 (the BSC bottom day). It can move up with a loss and a small miss because many traders were short figuring that Citi was going to zero.

Google also announced much better than anticipated earnings this AM. GOOG is another market leader, like it or not. It is now considered a metric on the economy since a large percentage of corporate advertising budgets has moved to Google. What is good for GOOG is good for the economy.

These two stories, along with other better news and a generally more positive vibe on Wall Street means a good day is coming (the day I thought would come yesterday!!) The good news is improving the case for the end of the bear. The S&P500 is now above its 50 day moving average. As it continues to move above its 100 and 200 day averages, the price action creates a floor for traders. Averages that at one time were ceilings become foundations. The critical psychological level for S&P is 1400. It could go through that today on a big rally.

We also are now 18 days out from the turn in the VIX signal (breaking below its 100 day moving average on March 31). The further out we go, the stronger that signal is. If you look at charts going back a couple decades, the market never turns on this signal when it is two month long (VIX is below its 100 day average for that length of time).

I think we will all be a lot happier (financially and hopefully otherwise) at the end of today.

Investing in Canroys for Long Term Success

From Jake:
Brian I am still not fully invested in the oil group, with the commodity bubble expected to bust I have invested lightly in this area. Any suggestions? Maybe short term? I have CANROYS but wanted to invest more before the run up but did not want to be taken out in a couple of months. I know hard to answer but any thoughts.
Otherwise a great day for me positioned well in all areas! Thank you!


My Response:
I think the Canroys will do very well short term and long term. In the mid term (2 mths to 12 mths) I am expecting a commodities correction. I think there is a lot of hot money in commodities that is parked there while the recession worries play out. I think that hot money (traders and hedgies) will move back to U.S. equities once the all-clear is called for the market. I expect that to happen anytime from June this year to March next year, sooner more likely.

Short term (next 2 months) I think Canroys will benefit from the hotness of the energy market. The Canroys hedge some of the product forward, but not all of it. So, they are benefiting from the higher energy prices on a daily basis, as they sell some production into the spot market. Also, as futures contracts expire, they will write new futures contracts at the current higher prices to lock in this level. So, there cash flow will dramatically increase the next 12 months, way above their budget forecasts, which are mostly in the $60s for oil and around $7 for gas (this info is in their annual reports).

Regardless of market concerns over the Canadian tax consequences, eventually, the value of this cash on the books must be rewarded. There could be a large special dividend, an acquisition which would increase future revenue and cash flow per share, or a takeout, which would result in a large premium on the stock price. I expect a 50% increase in price in the stocks if not taken out. If one of the small Canroys, like Daylight or Baytex for example, are taken out, they could double in value over a couple of days.

So, I think this is a great entry point for the Canroys, though it would have been even better a month or two ago (Daylight has gone from $6 in mid-January to $10 today, for example)

Regarding the Long term, 12 months to 10 years or more in the future, oil and gas will get more and more expensive as demand increases and supply stays flat if we are lucky. After 10 years, I expect alternative technologies to began increasing energy supply in general, shifting demand. I think solar will become a much bigger factor as new technology improvements drive production costs down. Wind, geothermal and wave energy will also be increasingly important. As fuel cell and battery technology improves, more vehicles will operate on electricity which can be produced by solar sources (wind and wave energy is indirectly derived from the sun, as is hydro power from rainfall into reservoirs). I expect biofuels like ethanol to become less and less important. They are very inefficient to produce and compete with the food supply.

I think Solar will be the most immediate winner in alternative energy and I am working in this industry, so can keep an eye on it up close. Today I am buying a small tracking position ($1000) in a new ETF for solar energy called TAN. Solar has had a big run and might pull back quite a bit in the likely coming commodity correction. So, I will buy more gradually looking for a better point to add a big position.

Intel Showing the Way Up

It has been a few days since I have posted my market moves. Thought I would update you today, April 16.

The market opened strong this morning based on the decent Intel quarterly report after the close last night. Tech is a market lynchpin. There has been a school of thought that Tech can't do well if Financials are hurting, since the banking industry is a heavy consumer of computing, software and data storage. But the Intel quarter disproves that theory.

At the same time, the banks continue to do what is necessary to reposition themselves for a less ebullient economy. I think most market participants are coming to the conclusion that the worst is past, though it may take quite a while for bank growth to get back to where it was in 2006. But a more conservative banking industry is okay by most participants.

Also, more educated observers, including Jack Welch, ex-CEO of GE, this morning. are talking about the great benefits to profits of reversing the mark-to-market of the bank assets. It is likely they have mostly been over-discounted. Those assets will be a source of profits for years to come. Expect savvy bank execs to use those assets to "beat the estimate" for the next several years, which will drive P/Es up on banks.

Here are my moves today: bought more Daylight Energy (DAYYF) for my IRA account, added to FXI, the China index, added to DOW Chemical (DOW).

I am still sitting on my AEM (Agnico Eagle) gold mining shorts. Today it is at $75, so I am in the red on this. But I have more than the same number of AEM May Puts shorted at $65 which just about covers my losses on the stock shorts. I will continue paying for the stock shorts with the close month put shorts, basically averaging up my cost. I am using the AEM shorts to protect my several precious metal mutual fund positions, since this commodity bubble will likely correct significantly as soon as the market believes the bottom is in for the stock market, and that the Fed will start raising rates as the economy begins to improve.

When it does correct, history shows that commodities correct very quickly and aggressively since so much hot money is chasing such a little base of equity.

As for the price of oil: I am just glad I am loaded up on energy stocks, which eases the pain at the pump. The Canroys are finally starting to move. The can go a long way from here in playing catch up to their USA equals. If oil and gas prices hold, I think $40 on PWE is a good possibility in the next 2-3 months and $25 on PGH.

Hope you have a great day in the market.

GE Crashes: OUCH

So much for the almighty GE. We just talked this week what a good company GE has been and how it was priced relatively attractive. After all, GE is a global infrastructure play, with its jet engine, locomotive, electric power (including solar) and water businesses. But we always new that GE was also loaded with financial assets and had to be exposed to some of the problems of the banks. And the appliance business HAS to be hurting with home sales through the floor.

GE's miss should have been no surprise to anyone, but apparently it was. It is just unacceptable to the market for GE to miss on earnings. This is how earnings season will go (and why volatility will stay relatively high for a while longer). There will be some bad announcements this month with results that were not anticipated. But no one should be surprised if any company with consumer durable or financial industry exposure had problems with earnings in Q1. So, once the shock has worn off, the stock market will be fine. All of this bad news really IS already in the price.

So, I just put my money where my mouth is. I sold 3 GE April 33 Puts for 0.75 with the price right now at 32.75. If I end up with the 300 shares, by cost will be 32.25 with a 4% plus yield. I am fine owning GE at that price.

What do you think about Macquarie Infrastructure?

I should say, Jake, that even though I like the concept of Macquarie Infrastructure (MIC), I don't really understand its fundamentals.

It invests in tollroads and parking garages, which are pretty dependable cash flow sources in all markets. I think it is probably a good anti-inflation play since its yield should always exceed the rate of inflation. It would have pricing power as a monopoly. And the assets of MIC should appreciate along with inflation. This is a little different animal than some of our other investments and I would research it thoroughly before investing in it (by reading their SEC filings, for starters) and maybe checking old news articles online.

There is a big question mark on the 2007 income statement. The SG&A expense is very large for the size of the business at around $194M vs. revenue of $831M. That is way too high. But in the 4th quarter, SG&A was a much more reasonable $6M vs. $264M revenue. That is what you would expect for a company this size. How much "selling" expense can there be in infrastructure? People use your facilities or they don't. There must have been some kind of one-time expense in 2007, but I don't know what it was or why it appears on that line. Normally, big one-time expenses are something like writeoff of goodwill after a big acquisition which is listed under "Other" or "Non-Recurring" expense.

Another concern that may be related to acquisitions last year is the fact that the dividend payout exceeded operating cash flow. You would never want to see that in any company. That means the company has to borrow or issue more stock to pay the dividend, lowering the owner equity per share. Borrowing in this type of company can be a concern if interest rates go way up. But for right now, that is not a concern. Maybe their need for financing for projects is cauing their stock price to go down, since they probably use municipal bonds to finance projects. Muni bonds have had problems recently due to the trouble at the monoline insurers.

You can't use earnings for any guidance in this type of company due to the large amount of depreciation for fixed assets in parking garages and toll roads (the toll booths and the roadways themselves). So, Operating Cash Flow is most important and I would keep a close eye on cash on the balance sheet, return on assets (as opposed to equity, since there will be a lot of borrowing in an infrastructure company like this). There should be some leverage, but I would want to see the debt to equity less than 1:1.

MGU is also interesting as is all of Macquarie Bank. It is an Australian company and has a global infrastructure perspective because of its location in the world and the Australian economy, which is very commodity and infr. related.

The IGF fund does not look that interesting, but I am sure it is fine.

Let me know how it works out.

Those Overlooked Canroys!

Yesterday it was reported that Apache Petroleum had made a huge new discovery of gas deposits. Its stock price shot up to new all time records. Any where was this big new discovery?

You guessed it, in Canada, in the Northeaster BC shale oil deposits, where all the Canroys already operate and have large lease blocks on their books, along with plenty of current production.

So how is it that Apache, dealing with the same provincial taxes / royalties and a 40% American income tax rate (according to its own documents), but only a 0.6% dividend yield, is shooting up in price, while the Canroys tread water? This is a huge anomaly in the investment world that must be resolved at some point. The Canroys are only paying out 50% of their cash flow currently (on average), and are reinvesting in acquistions and organic growth so that their growth rate is on par with Apache, Chesapeake, XTO, etc.

This development effort is building large tax loss reserves that they can use to offset future income (some are stating they will have no tax affect until 2015 with the reserves that are in place). The development programs create depreciation and tax credits that are available for exploration. Both the development credits and depreciation can be carried forward many years in Canada so that any future tax change can be put off for years into the future.

If anything the Energy E&P Canroys are getting cheaper all the time in comparison to their American counterparts.

UYG: an Interesting Financial Options Play

The UYG Sept 08 45 option is now at $15. (UYG is an ETF from Powershares and is leveraged to double the XLF index). Maybe get a couple more contracts to average up? Could also wait a few more days to see if the financials decline some more. It is possible. They have been trading in a range, though I don't see much to drive them down short of some surprise blowup at a big bank.

Commodity Prices Peaking?

Regarding the commodity price discussion by Stephen Leeb in a recent newsletter, I think we can have it both ways, both the Barrons and WSJ positions. We are in the midst of a "short term" correction in commodity prices. Basically, the price increases got ahead of themselves at a time of weakening demand. The commodities markets are heavily influenced by speculative cash flows in today's market. It has become a favorite play ground of hedge funds and hot money. The size of the commodities markets is relatively small compared to the amount of funds available to chase those commodities, so the prices are easily moved around by speculative money flows. I agree with the 30% correction forecast by Barrons, and we are just about half way there on gold with the price in the upper 800s.

But I also agree with the WSJ article which makes the case for supply constraints as the "long term" problem for commodities pricing. New supplies of natural resources and ag products are hard to bring on line. Demand will not create instant new supply like it might for financial products or electronics, which are very easy to ramp up in terms of production (all financial products require is a paper and pen). New mines or oil wells require land acquisition, permitting, support infrastructure (roads, power, etc), labor in places where it may not be already available (Northern Canada), large capital funding, plant design and engineering, etc. And as the most accessible resources are tapped out, the remaining resources are in harder and harder to develop locations (mining seems to go with mountainous terrain for example).

So, I think we can consider both arguments and invest accordingly. If you like to trade short term, like me, the trade now is to be short the commodities. But if you are more of a buy and hold investor, then the proper trade is long. And the new lower prices make this a decent entry point for gold, copper, iron, etc. Ag commodities will also be a good buy if they pull back a bit more.