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Thursday, May 14, 2009
Baupost's (Seth Klarman's) Latest Thoughts on Hedging Strategy
I wrote about Baupost's (Seth Klarman's) Hedging Strategy based on his view in 1995-1997. In a recent speach he updated his thoughts on insurance (hedging).
"Do you overpay for insurance — or do you go uninsured?
Klarman: In terms of our firm, I tried so hard to learn
the lessons of 1998 in particular, which were: Don’t be
unprepared for something out of the blue that’s really bad.
To some extent, we were prepared this time. However,
you can never be prepared enough. We had a lot of macro
protection in terms of credit default protection on bonds
where we were just betting that credit spreads would widen.
That’s been incredibly helpful. But we’ve gotten really tired
of buying market puts, or anything like that, because they
inevitably are expensive and expire worthless.
So as an investor, you have terrible trade-offs. Do
you overpay for insurance — or do you go uninsured?
That’s just one of those dilemmas for which there are really
no perfect answers."
Outstanding Investor Digest March 17,2009
"Do you overpay for insurance — or do you go uninsured?
Klarman: In terms of our firm, I tried so hard to learn
the lessons of 1998 in particular, which were: Don’t be
unprepared for something out of the blue that’s really bad.
To some extent, we were prepared this time. However,
you can never be prepared enough. We had a lot of macro
protection in terms of credit default protection on bonds
where we were just betting that credit spreads would widen.
That’s been incredibly helpful. But we’ve gotten really tired
of buying market puts, or anything like that, because they
inevitably are expensive and expire worthless.
So as an investor, you have terrible trade-offs. Do
you overpay for insurance — or do you go uninsured?
That’s just one of those dilemmas for which there are really
no perfect answers."
Outstanding Investor Digest March 17,2009
Sunday, May 10, 2009
Baupost's (Seth Klarman's) Hedging Strategy
Lots of blogs have been linking to Seth Klarman's Annual and mid year statements lodge with the SEC from early 96 to the end of 2001.
There hasn't been much analysis of the filings.
Put Option Strategy
I looked over four of his filings from Oct 95 - Apr 97. Over that period his put contracts ranged from 0.5% - 2% of assets. In the 0.5% case, I expect it's because the market ran away from him. It seems likely that his target is 1%-2% of assets.
In early 95 the majority of his puts were on the Russell 2000, by late 95 they focused on the S&P 500. By 96 they focused on the Nasdaq 100.
New positions appear to be placed at around 10%-15% below market. The days to expiry started off at about 305 in early 95 and had dropped to about 140 by late 96. This is easily explained by volatility. By late 96 he was buying Nasdaq 100 puts. In 6 months the Nasdaq 100 had risen by 16%. In such an environment you want to purchase puts with less duration as the value of duration declines as the market rises. This is offset by the discount you get for buying duration when rises are small but crosses over as the market moves away from your position.
Are 1-2% of assets enough to hedge? Yes. In late 95 the fund had $89M in assets. Assuming 20% was in cash then 72M is exposed to market moves. Let's assume that Seth is buying insurance against a substantial move of 30% or more and that the loss on the invested portion will only be 20%. This is reasonable as value investments generally outperform on the downside (even though they didn't necessarily in the current bear market). The portfolio would have lost $14M and the hedge was worth 11M. In 96 losses would have been around 16M and the hedges worth 21M. As noted previously, the Nasdaq 100 puts got away from him and only offered about $6M in protection from a $20M loss.
Based on a 30% drop, the average upside of the put portfolio was about 17 times for each period (using the annual cost of options with < 1 year to go).
When volatility is at historically normal levels, using 1%-2% of your portfolio can provide a reasonable hedge against substantial market drops. Such an approach will reduce the volatility of your returns and provide cash to buy when others are selling. Klarman doesn't seem to be mechanical about his option buying but broadly stays within bounds of 1-2% of assets, a strike 10%-15% below market and a duration of about a year under normal (average) market conditions.
There hasn't been much analysis of the filings.
Put Option Strategy
I looked over four of his filings from Oct 95 - Apr 97. Over that period his put contracts ranged from 0.5% - 2% of assets. In the 0.5% case, I expect it's because the market ran away from him. It seems likely that his target is 1%-2% of assets.
In early 95 the majority of his puts were on the Russell 2000, by late 95 they focused on the S&P 500. By 96 they focused on the Nasdaq 100.
New positions appear to be placed at around 10%-15% below market. The days to expiry started off at about 305 in early 95 and had dropped to about 140 by late 96. This is easily explained by volatility. By late 96 he was buying Nasdaq 100 puts. In 6 months the Nasdaq 100 had risen by 16%. In such an environment you want to purchase puts with less duration as the value of duration declines as the market rises. This is offset by the discount you get for buying duration when rises are small but crosses over as the market moves away from your position.
Are 1-2% of assets enough to hedge? Yes. In late 95 the fund had $89M in assets. Assuming 20% was in cash then 72M is exposed to market moves. Let's assume that Seth is buying insurance against a substantial move of 30% or more and that the loss on the invested portion will only be 20%. This is reasonable as value investments generally outperform on the downside (even though they didn't necessarily in the current bear market). The portfolio would have lost $14M and the hedge was worth 11M. In 96 losses would have been around 16M and the hedges worth 21M. As noted previously, the Nasdaq 100 puts got away from him and only offered about $6M in protection from a $20M loss.
Based on a 30% drop, the average upside of the put portfolio was about 17 times for each period (using the annual cost of options with < 1 year to go).
When volatility is at historically normal levels, using 1%-2% of your portfolio can provide a reasonable hedge against substantial market drops. Such an approach will reduce the volatility of your returns and provide cash to buy when others are selling. Klarman doesn't seem to be mechanical about his option buying but broadly stays within bounds of 1-2% of assets, a strike 10%-15% below market and a duration of about a year under normal (average) market conditions.
Wednesday, April 29, 2009
Demystifying PPIP (or Felix Salmon mystifying PPIP)
Felix Salmon writing for Reuters talks about a meeting with Mohamed El-Erian of PIMCO fame...
"On the subject of PPIP, though, I did ask El-Erian about how much value there is in clipping tails. If the government promises to absorb all losses beyond the first 15 cents on the dollar, how much does that raise the amount of money you’re willing to pay for any given asset? I was trying, in effect, to come at a value for the FDIC guarantee in the PPIP plan, but I didn’t get very far.
The answer, you see, is basically “it depends”. Every asset has a different probability distribution, and if you think that there’s a good chance the asset is actually worth 90, the tail-clipping at 85 is much more valuable than if you think the asset in reality is more likely to be worth 110. In short, it’s a long and laborious process of looking at every asset individually determining a probability distribution, and doing some math on it. How many good credit analysts are out there and capable of doing that kind of analysis? I think it’s not nearly enough, but El-Erian is a bit more bullish on that front: he thinks that if you create the right incentives, people will start to work this stuff out."
I've reproduced these paragraphs because Felix and El-Arian have taken something quite well known, put options, and made them sound mystical requiring some special kind of analysis. It doesn't! It requires the use of option pricing. The tail-clipping is simply a put sold by the government. That is why it's worth more the closer the intrinsic value is to your purchase price. Your purchase price minus 15% is the put's strike price. A put is obviously worth more the closer it is to being in the money.
The long laborious process of looking at every asset and determining its probability distribution translates to looking up historic volatility as an input to the options pricing model. In the absence of such data you could use a bottom up variance based on similar assets.
So putting this together, how does the government guarantee work. You believe a bond portfolio is worth 50c. You might bid 35c for the portfolio. Now if the government gives you a put 15% below your strike price you'll bid more because that put has value. Say the put is worth 4c. In that case you can bid 37c and you're still ahead by 2c.
The inputs to price the put are the strike price (15% below your purchase price), the current value (your estimate of intrinsic value), the volatility (calculated either bottom up or from trading data) and the time to expiry (however long the government guarantee runs for).
"On the subject of PPIP, though, I did ask El-Erian about how much value there is in clipping tails. If the government promises to absorb all losses beyond the first 15 cents on the dollar, how much does that raise the amount of money you’re willing to pay for any given asset? I was trying, in effect, to come at a value for the FDIC guarantee in the PPIP plan, but I didn’t get very far.
The answer, you see, is basically “it depends”. Every asset has a different probability distribution, and if you think that there’s a good chance the asset is actually worth 90, the tail-clipping at 85 is much more valuable than if you think the asset in reality is more likely to be worth 110. In short, it’s a long and laborious process of looking at every asset individually determining a probability distribution, and doing some math on it. How many good credit analysts are out there and capable of doing that kind of analysis? I think it’s not nearly enough, but El-Erian is a bit more bullish on that front: he thinks that if you create the right incentives, people will start to work this stuff out."
I've reproduced these paragraphs because Felix and El-Arian have taken something quite well known, put options, and made them sound mystical requiring some special kind of analysis. It doesn't! It requires the use of option pricing. The tail-clipping is simply a put sold by the government. That is why it's worth more the closer the intrinsic value is to your purchase price. Your purchase price minus 15% is the put's strike price. A put is obviously worth more the closer it is to being in the money.
The long laborious process of looking at every asset and determining its probability distribution translates to looking up historic volatility as an input to the options pricing model. In the absence of such data you could use a bottom up variance based on similar assets.
So putting this together, how does the government guarantee work. You believe a bond portfolio is worth 50c. You might bid 35c for the portfolio. Now if the government gives you a put 15% below your strike price you'll bid more because that put has value. Say the put is worth 4c. In that case you can bid 37c and you're still ahead by 2c.
The inputs to price the put are the strike price (15% below your purchase price), the current value (your estimate of intrinsic value), the volatility (calculated either bottom up or from trading data) and the time to expiry (however long the government guarantee runs for).
Monday, April 20, 2009
Opti Canada (OPC.to) - It's all in the risk
I wrote about Opti in November '08 here. Since then they have made some major changes to their capital structure. They sold 30% of their project equity to Nexen, their partner, for cash. This generated just enough cash to survive. If the whole company was purchased on the same terms, then there would be enough money to redeem the bonds at 80c on the dollar. Equity would be worthless.
The worry now, after the recapitalization, is whether or not they can meet their new covenants. It's relatively easy to analyse OPC's cash flows and it seems quite likely that they will meet the covenant in Q3 09. Failure to meet the covenant is not necessarily a death sentence. They can simply not draw against the revolving loan (in which case the covenants don't matter) or they could negotiate temporary relief. My analysis shows they will have about 100M drawn on the revolver by Q3, though they could manage this to a lower number. The covenant is the ratio of the drawn down revolver amount (first lien debt) to EBITDA with a maximum ratio of 2.5 to 1. The price of oil isn't terribly important due to OPTI's hedges. I have assumed a flat $45 for the year.
On this basis EBITDA will be around $44m annualized which provides a debt ceiling of around $110M. The January '10 quarter looks to be more of a problem. I expect annualized EBITDA of nearly 56M which provides a ceiling of $140m but I expect debt to be drawn down by about 146M. Again they can probably manage away $6m but it's quite tight. From Q2 2010 I expect OPTI to be well within this covenant.
The next interesting problem is their ability to participate in future phases of development. They expect 6 phases, with the current phase being phase 1. I don't expect they will be able to participate in phases 2 or 3 without substantial, additional financing. I have assumed they will not be able to secure such financing.
Assuming:
The fair value estimate is based on considerable risk. As they de-risk their business their value will increase substantially. At a fixed 10% discount rate (all the other assumptions remain constant except the 30% discount) OPC is worth $7.30.
The worry now, after the recapitalization, is whether or not they can meet their new covenants. It's relatively easy to analyse OPC's cash flows and it seems quite likely that they will meet the covenant in Q3 09. Failure to meet the covenant is not necessarily a death sentence. They can simply not draw against the revolving loan (in which case the covenants don't matter) or they could negotiate temporary relief. My analysis shows they will have about 100M drawn on the revolver by Q3, though they could manage this to a lower number. The covenant is the ratio of the drawn down revolver amount (first lien debt) to EBITDA with a maximum ratio of 2.5 to 1. The price of oil isn't terribly important due to OPTI's hedges. I have assumed a flat $45 for the year.
On this basis EBITDA will be around $44m annualized which provides a debt ceiling of around $110M. The January '10 quarter looks to be more of a problem. I expect annualized EBITDA of nearly 56M which provides a ceiling of $140m but I expect debt to be drawn down by about 146M. Again they can probably manage away $6m but it's quite tight. From Q2 2010 I expect OPTI to be well within this covenant.
The next interesting problem is their ability to participate in future phases of development. They expect 6 phases, with the current phase being phase 1. I don't expect they will be able to participate in phases 2 or 3 without substantial, additional financing. I have assumed they will not be able to secure such financing.
Assuming:
- No participation in phases 2 or 3
- Substantial repayment of debt, starting in 2011
- WTI of $60 in 2010 rising to $75 by 2013 and then rising by inflation
- A high risk period cost of equity of 22.6%
- A low risk period cost of equity of 10%
- A 30% discount based on chance of a B3 bond defaulting over the high risk period (if the bond defaults then equity is worthless)
The fair value estimate is based on considerable risk. As they de-risk their business their value will increase substantially. At a fixed 10% discount rate (all the other assumptions remain constant except the 30% discount) OPC is worth $7.30.
Nickel Stocks DCF (MCR.AX Mincor Panormaic Resources PAN.AX)
In January I completed discounted cash flow estimates for PAN and MCR. They are both up substantially since then. My fair value estimate for MCR is $2.27 and PAN $2.38.
In comaprison to the blended analyst estimates I have a higher value for Mincor and a lower value for Panoramic.
The model assumes a Nickel price of $7 by 2011 rising by inflation and a constant .65c AUD to USD exchange rate.
From today's price MCR (.96) has 137% upside and PAN (1.58) has 50%.
In comaprison to the blended analyst estimates I have a higher value for Mincor and a lower value for Panoramic.
The model assumes a Nickel price of $7 by 2011 rising by inflation and a constant .65c AUD to USD exchange rate.
From today's price MCR (.96) has 137% upside and PAN (1.58) has 50%.
Thursday, January 29, 2009
Nickel Stock Updates, Mincor, Panoramic (MCR MCR.AX PAN PAN.AX)
QUARTERLY RESULTS
Mincor and Panoramic Resources have just released their quarterly reports. Unfortunately, in Australia, quarterly reports do not have detailed financial data. However, there is a lot of good information. I've updated a number of metrics on both PAN and MCR since my last posts (prior PAN post, prior MCR post).
FINANCIAL METRICS
My buy price was loosely based on cash and cash equivalent backing net of liabilities. Roughly what Ben Graham called a net net or what Marty Whitman would call readily ascertainable net asset value.
In the case of Mincor this number has held quite steady at .52c per share down from .58c per share in the prior quarter. I don't believe that there is a particular trend downwards in these numbers. In the case of PAN, however, we are down to around .59c from .90c in early November; this is also the number used in my prior post.
The key financial metrics are presented in the table below. You may have to click on it to see all the figures.
VALUE AND TARGET PRICES
It's interesting to note that MCR has higher leverage to the price of Nickel but unfortunately also to the AUDUSD. Unfortunate, because I think the AUD will strengthen. MCR reports net working capital, PAN only reports net cash and receivables so I've estimated payables.
Since my prior posts I've also developed a long term Nickel price target. At US$7.75, It's lower than the one mentioned in my prior posts on PAN and MCR. I've gone back over analyst's reports from the prior 6 months and used that number to aggregate fair values.
I've then developed a blended fair value and compared the current price to it along with net current assets and book value.
By all of these metrics Mincor is the better buy. It has almost the same upside leverage, is much closer to net asset backing, has higher leverage to the Nickel price and is at a larger discount to book value. Mincor has managed their net current assets better than Panoramic and have a lower cash cost. Mincor seems like a slam dunk buy at .58c and a sell at $1.79. Panoramic would be a buy at .59c and a sell at $2.60 (though it would have 4 times upside from .59c). I also worry that PAN may be in a downtrend in terms of net current assets.
Mincor and Panoramic Resources have just released their quarterly reports. Unfortunately, in Australia, quarterly reports do not have detailed financial data. However, there is a lot of good information. I've updated a number of metrics on both PAN and MCR since my last posts (prior PAN post, prior MCR post).
FINANCIAL METRICS
My buy price was loosely based on cash and cash equivalent backing net of liabilities. Roughly what Ben Graham called a net net or what Marty Whitman would call readily ascertainable net asset value.
In the case of Mincor this number has held quite steady at .52c per share down from .58c per share in the prior quarter. I don't believe that there is a particular trend downwards in these numbers. In the case of PAN, however, we are down to around .59c from .90c in early November; this is also the number used in my prior post.
The key financial metrics are presented in the table below. You may have to click on it to see all the figures.
VALUE AND TARGET PRICES
It's interesting to note that MCR has higher leverage to the price of Nickel but unfortunately also to the AUDUSD. Unfortunate, because I think the AUD will strengthen. MCR reports net working capital, PAN only reports net cash and receivables so I've estimated payables.
Since my prior posts I've also developed a long term Nickel price target. At US$7.75, It's lower than the one mentioned in my prior posts on PAN and MCR. I've gone back over analyst's reports from the prior 6 months and used that number to aggregate fair values.
I've then developed a blended fair value and compared the current price to it along with net current assets and book value.
By all of these metrics Mincor is the better buy. It has almost the same upside leverage, is much closer to net asset backing, has higher leverage to the Nickel price and is at a larger discount to book value. Mincor has managed their net current assets better than Panoramic and have a lower cash cost. Mincor seems like a slam dunk buy at .58c and a sell at $1.79. Panoramic would be a buy at .59c and a sell at $2.60 (though it would have 4 times upside from .59c). I also worry that PAN may be in a downtrend in terms of net current assets.
Monday, January 26, 2009
Barron's Roundtable on Stealth Gas (GASS)
The quote below is from the Barron's 2009 Roundtable. Scott Black from Delphi talks about StealthGas (GASS). I have marked the offending portion in bold. He claims that their ships are worth $335M net of debt.
Aggresively they may be worth $30M as scrap and that's NOT net of debt. They have about 80k light displacement tons and each ton sells for between $205-$250USD in the scrap market.
This may or may not be a good buy but it's not "an asset play"!
__________________________________________________________
Barron's 2009 Roundtable:
"Black: My last pick is an asset play, atypical for Delphi. ROE is only 10%, but the stock, StealthGas, is cheap. The company owns tankers that transport liquefied petroleum gas, or LPG. It's based in Athens. The stock is 4.73, there are 22.3 million fully diluted shares, and a market cap of $105 million. It pays a 75-cent dividend, for a 15.8% yield, but they may not continue to pay it. Some shareholders think they should buy back shares or knock down debt instead
Schafer: What's the book value?
Black: Book is $14.23 a share and there is no goodwill, so price-to-book is 0.33. For 2008 I figure they earned $1.35 to $1.40 a share on revenue of $112 million. The company already has contracted for 67% of its voyage days for 2009 and 34% for 2010.
Schafer: How much stock does management own?
Black: About 6.5 million shares out of 22 million. The company has 39 boats. Day rates should come down a bit, to $7,000 from about $7,600. They get $21,000-$22,000 a day on three of their product carriers, so total 2009 revenue could be $124 million. Operating expenses will go up. We assume a 5% increase, to $5,760. They have $241 million of debt. Subtract about $94 million in expenses from $124 million in revenue, and you get estimated earnings of $30 million, or $1.35 a share. Street estimates are $1.42 to $1.45. Analysts have a higher revenue estimate. The stock sells for 3.5 times my earnings.
StealthGas specializes in short-haul, or feeder, boats. They come into a harbor in, say, Singapore or Thailand or the North Sea and offload their cargo. Four customers account for 60% of revenue: Shell, Statoil, Petredec and Vitol. Many contracts are for three or four years. The company's net debt-to-equity ratio is 0.71 to 1. Management says it has access to credit. Borrowing is done ship by ship.
Gabelli: What does a new ship cost?
Black: A new LPG tanker is about $18 million, and a product carrier is about $57 million. The fleet is only 10.8 years old. On a scrap-value basis the LPGs are worth about $500 million and the product tankers, $60 million. That's $560 million, less net debt of $225 million, for a total of $335 million or $15.09 a share, conservatively. After this year StealthGas will be cash-flow positive because it has finished building its fleet. That's it for me."
Aggresively they may be worth $30M as scrap and that's NOT net of debt. They have about 80k light displacement tons and each ton sells for between $205-$250USD in the scrap market.
This may or may not be a good buy but it's not "an asset play"!
__________________________________________________________
Barron's 2009 Roundtable:
"Black: My last pick is an asset play, atypical for Delphi. ROE is only 10%, but the stock, StealthGas, is cheap. The company owns tankers that transport liquefied petroleum gas, or LPG. It's based in Athens. The stock is 4.73, there are 22.3 million fully diluted shares, and a market cap of $105 million. It pays a 75-cent dividend, for a 15.8% yield, but they may not continue to pay it. Some shareholders think they should buy back shares or knock down debt instead
Schafer: What's the book value?
Black: Book is $14.23 a share and there is no goodwill, so price-to-book is 0.33. For 2008 I figure they earned $1.35 to $1.40 a share on revenue of $112 million. The company already has contracted for 67% of its voyage days for 2009 and 34% for 2010.
Schafer: How much stock does management own?
Black: About 6.5 million shares out of 22 million. The company has 39 boats. Day rates should come down a bit, to $7,000 from about $7,600. They get $21,000-$22,000 a day on three of their product carriers, so total 2009 revenue could be $124 million. Operating expenses will go up. We assume a 5% increase, to $5,760. They have $241 million of debt. Subtract about $94 million in expenses from $124 million in revenue, and you get estimated earnings of $30 million, or $1.35 a share. Street estimates are $1.42 to $1.45. Analysts have a higher revenue estimate. The stock sells for 3.5 times my earnings.
StealthGas specializes in short-haul, or feeder, boats. They come into a harbor in, say, Singapore or Thailand or the North Sea and offload their cargo. Four customers account for 60% of revenue: Shell, Statoil, Petredec and Vitol. Many contracts are for three or four years. The company's net debt-to-equity ratio is 0.71 to 1. Management says it has access to credit. Borrowing is done ship by ship.
Gabelli: What does a new ship cost?
Black: A new LPG tanker is about $18 million, and a product carrier is about $57 million. The fleet is only 10.8 years old. On a scrap-value basis the LPGs are worth about $500 million and the product tankers, $60 million. That's $560 million, less net debt of $225 million, for a total of $335 million or $15.09 a share, conservatively. After this year StealthGas will be cash-flow positive because it has finished building its fleet. That's it for me."
Fair Value for Crude Oil
A follow up to yesterday's post on incremental costs of various commodities. The chart below is from CIBC StrategEcon January 23, 2009 it shows that crude has rarely traded below the marginal cost of production and has always rapidly bounced back. Looking at the graph, it would seem to show that crude has traded about 25% above the marginal cost of production since the early 80's. CIBC claims that $90 a barrel is the marginal cost "for production from a new Canadian integrated oil sands mining and upgrading facility these days". That would indicate a price of about $112 as fair value for crude.
Saturday, January 24, 2009
Commodity Prices
I've been looking at long term commodity prices to develop an average price to use in valuation. Here are some long term averages for LME Nickel (click for larger image).
Here are averages for Australian Thermal Coal, Copper and Crude Oil (simple average of three spot prices; Dated Brent, West Texas Intermediate, and the Dubai Fateh).
There are lots of implications. These prices were higher than I expected for oil, lower than I expected for Nickel and about right for copper and coal.
It's worth mentioning the corresponding spot prices as of January 23rd (USD):
Looking at long term averages assumes that supply and demand are relatively constant over long periods of time. It is worth considering that China and India may have permanently increased the demand for these commodities at a given price. It is also worth considering that decades of underinvestment, depleting resources, political instability and environmental laws have shifted the supply curve such that there is now a lower supply at a given price.
I do believe that this is what's happened BUT most importantly I'm not investing on that basis. The key here is to invest in commodity companies that are valued based on commodities priced at or below the marginal cost of production and long term average prices.
When to sell
Given that buying is relatively easy, how do we decide when to sell. I'm going to choose price points for Nickel, Crude, Coal and Copper.
NICKEL
Nickel - $7.75 USD. Nickel can be replaced in Stainless Steel manufacturing by Nickel Pig Iron at about $8 USD for Nickel. The $7.75 is the 2000-2008 average. This is the number based on long term economics that draws the line between investment and speculation. I would expect to sell most of my Nickel stocks once they become priced based on $7.75 Nickel.
OIL
Oil - $85 USD. I need to keep an eye on the marginal cost of production and depletion rates. This article puts current marginal cost at closer to $85-90USD based on Goldman Sachs. I'm going to place my initial long term oil price at $85USD and I'll continue to monitor the situation. I would expect to sell some oil exposure once my oil stocks become based on that long term price.
COAL
Coal - $80 USD. Based on Credit Suisse's research, Thermal coal at $80USD and Coking coal $90USD (which is Russia's marginal cost versus Australia's at $100AUD) are good price points. Based on energy equivalence thermal coal would sell for around $130USD with oil at $85 USD. Thermal coal is very tightly tied to long term oil prices and energy demand. I will watch changes in oil prices and energy demand closely but I would expect to be reducing my coal exposure once long term thermal prices of $80USD are factored into coal equity prices.
COPPER
Copper - $1.80. I don't own any copper equities but it would seem that any companies reflecting $1.47 or worse copper would be a great buy right now. Once equities reflect $1.80 copper, it will be time to reduce positions.
Here are averages for Australian Thermal Coal, Copper and Crude Oil (simple average of three spot prices; Dated Brent, West Texas Intermediate, and the Dubai Fateh).
There are lots of implications. These prices were higher than I expected for oil, lower than I expected for Nickel and about right for copper and coal.
It's worth mentioning the corresponding spot prices as of January 23rd (USD):
- Nickel - 5.18
- Copper - 1.47
- Oil (sample average as above Brent, WTI & Dubai Fateh) - 46.17
- Australian Thermal Coal - $81.46
- Oil US offshore - $69.75, Average Western Hemisphere - $47.63
- Copper Marginal Cost - $1.8
- Australian Thermal Coal (based on Credit Suisse research) - $70-$80 AUD, $80 USD to meet project hurdle rates
- Nickel Marginal Cost - $6.8
- Nickel and Copper look to be the most undervalued against their average range and spot prices
- Crude oil is much lower than the marginal cost of production but is within it's long term average range.
- Australian coal is well above the long term average and fractionally above the marginal cost of production.
Looking at long term averages assumes that supply and demand are relatively constant over long periods of time. It is worth considering that China and India may have permanently increased the demand for these commodities at a given price. It is also worth considering that decades of underinvestment, depleting resources, political instability and environmental laws have shifted the supply curve such that there is now a lower supply at a given price.
I do believe that this is what's happened BUT most importantly I'm not investing on that basis. The key here is to invest in commodity companies that are valued based on commodities priced at or below the marginal cost of production and long term average prices.
When to sell
Given that buying is relatively easy, how do we decide when to sell. I'm going to choose price points for Nickel, Crude, Coal and Copper.
NICKEL
Nickel - $7.75 USD. Nickel can be replaced in Stainless Steel manufacturing by Nickel Pig Iron at about $8 USD for Nickel. The $7.75 is the 2000-2008 average. This is the number based on long term economics that draws the line between investment and speculation. I would expect to sell most of my Nickel stocks once they become priced based on $7.75 Nickel.
OIL
Oil - $85 USD. I need to keep an eye on the marginal cost of production and depletion rates. This article puts current marginal cost at closer to $85-90USD based on Goldman Sachs. I'm going to place my initial long term oil price at $85USD and I'll continue to monitor the situation. I would expect to sell some oil exposure once my oil stocks become based on that long term price.
COAL
Coal - $80 USD. Based on Credit Suisse's research, Thermal coal at $80USD and Coking coal $90USD (which is Russia's marginal cost versus Australia's at $100AUD) are good price points. Based on energy equivalence thermal coal would sell for around $130USD with oil at $85 USD. Thermal coal is very tightly tied to long term oil prices and energy demand. I will watch changes in oil prices and energy demand closely but I would expect to be reducing my coal exposure once long term thermal prices of $80USD are factored into coal equity prices.
COPPER
Copper - $1.80. I don't own any copper equities but it would seem that any companies reflecting $1.47 or worse copper would be a great buy right now. Once equities reflect $1.80 copper, it will be time to reduce positions.
Felix Buyout (Change of Control FLX FLX.ax)
The answer to what's going to happen with a buyout of Felix Resources is containted in an interview with Citigroup’s China analyst Huang Yiping.
"Number one is they certainly don’t want the Chinese companies to go out and invest prematurely. There was a concern last year, for instance, if the Chinese want to go invest overseas whether or not these investors understand the cycles of the market and there was a lot of discussion whether we have the international experiences for making a judgement on the current situation. "
"What they really want to avoid was making an investment where the asset price dropped significantly the next day. These kind of incidents already caused a lot of political pressure on investors as well as the government and so they're trying to discourage it a bit when people are not sure where is the bottom and so that's I think the first thing. They're probably trying to discourage investing over the near term a bit."
The Chinese government is going to make Chinese companies wait until there is a confirmed bottom before making any investments. As silly and un-Buffett like as that sounds, I'm sure it's the thinking of BHP etc as well.
This pretty much guarantees no transaction until FLX is trading above $14 or so for a number of months.
That's fine, I can wait.
"Number one is they certainly don’t want the Chinese companies to go out and invest prematurely. There was a concern last year, for instance, if the Chinese want to go invest overseas whether or not these investors understand the cycles of the market and there was a lot of discussion whether we have the international experiences for making a judgement on the current situation. "
"What they really want to avoid was making an investment where the asset price dropped significantly the next day. These kind of incidents already caused a lot of political pressure on investors as well as the government and so they're trying to discourage it a bit when people are not sure where is the bottom and so that's I think the first thing. They're probably trying to discourage investing over the near term a bit."
The Chinese government is going to make Chinese companies wait until there is a confirmed bottom before making any investments. As silly and un-Buffett like as that sounds, I'm sure it's the thinking of BHP etc as well.
This pretty much guarantees no transaction until FLX is trading above $14 or so for a number of months.
That's fine, I can wait.
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Disclaimer and Disclosure
Analyses are prepared from sources and data believed to be reliable, but no representation is made as to their accuracy or completeness. I am not paid by covered companies. Strategies or ideas are presented for informational purposes and should not be used as a basis for any financial decisions.
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