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Week 17 Portfolio Update: Of Two Minds

My portfolio was up rather substantially last week, along with the rest of the stock market.  To be honest, I would not have expected it to happen that way.

My portfolio is constructed against what I see as an eventual calamity in Europe, and my expectation that as the dominos begin to fall, perhaps extending as far as Japan, that investors will reconsider the grand 40 year experiment with fiat currency , and with that they will reconsider gold.

(I’m really starting to sound like a gold bug, aren’t I?)

The market, on the other hand, looked at the plan (or plan of a plan depending on how exact you want to be with your language) that the EU laid out on thursday and apparently began to wave the all clear flag.

So what happened?  How did gold rally at the same time as the broad markets?  Isn’t this a conflicting signal?

Well it is and it isn’t.  I think you have to look that the situation through two lenses to truly understand the response of gold, of the stock market and of the bond market.

The first lens is reality. This is what the bond market and the gold market are telling you, and it is all about the inadequacy of the bailout.

The WSJ laid out a fact based piece on the front page of the Saturday Journal.  Sometimes the facts are as damning as any commentary.  While the market rallied on Thursday, the bond market hardly budged.  Sometimes a chart is worth a thousand words.

Worse, on Friday Italy held an auction and was forced to issue 10 year bonds at above 6%.

In Friday’s bond auction, Italy was forced to pay more than 6% interest on its new 10-year debt, approaching levels that some analysts said the country can’t afford for long.

Its actually somewhat surprising that the market has so far shrugged this off.  First, it is a pretty scathing critique by bond investors.  One day after the grand plan announcement and Italy is paying higher rates than it was even a few months ago.

Moreover, as the above quote alludes to, this crisis began in August when Italian bonds rose from 5% to 6%.  The reason that this seemingly innocuous move up was met with such fear by the market is because Italy is basically on the precipice of falling off the cliff of solvency and 1% can throw them over the edge.  While Italian government revenues can withstand a 5% interest payment, they cannot withstand 6%.

That is how thin the thread is that Europe hangs to right now.  Italy owes $1.9t of debt.  When you owe that much debt, over the long run (as that debt comes due) whether you are solvent is more a question of perception than anything else.

Right now the perception isn’t so good.

And let’s look at little closer at some of the details of the plan.  First, the EFSF.  Do you really think that the EFSF, which according to the same WSJ article is expected to guarantee only the first 10% of Italian and Spanish debt after default (I thought this was supposed to be 20%?) is going to appease investors at future Italian and Spanish bond auctions who have just watched Greece take a 50%+ haircut?

And do you really think that Greece is going to be able to live up to the forecasts laid out in the plan?  The recap agreed to will lead to a Greek debt load that will peak at 186% in 2013 and that will fall to 120% by 2020.   That alone is worth reading twice.  But it gets better.  This will take place if you presume their growth scenario of 1 1/4% by 2013 and 2 1/4% by 2015. Seriously.

Given the scenes I’ve seen from Greece the last few days I wouldn’t be betting my pennies that the country will be growing at 1.25% in a little over a year.  It looks like a country in collapse mode.  As the WSJ points out in another article on Saturday:

Greece is the canary in the euro zone’s coal mine. The bloc’s prescription for a crisis spurred by overborrowing and overspending is a dose of radical fiscal rectitude, delivered fast. To regain the confidence of skittish investors, countries are being asked to rip up paternalistic policies that provided stability and comfort to legions of citizens but left the state reeling from the bill. The question is, can it be done without igniting society into revolt?

Greece has youth unemployment of 43%.  They have total unemployment of 16% and rising at a pace that is beginning to look parabolic.  And they haven’t even begun to fire the civil servants that they need to in order to meet the austerity measures they have agreed to.  The country is being ripped up at the roots and it is supposed to grow again in a year?

Moreover, the one mechanism that could make Greece competitive is off limits.  They are stuck with the Euro, which means they are stuck playing on a level currency field with Germany even when they are clearly world’s apart.

On final point.  The bailout, and future bailouts, are all going to have to be be paid for by someone.  Those someones are Germany and France.  Neither of these countries are a fortress of debt virtue.  Both have debt to GDP ratios of around 80%.  This point seems to get forgotten.  The bailout-ers are really not in that much better shape then the bailout-ees.

I could go on.  But you get the point.  This is not over by a long shot.

But, having given my critique, I did say that I was of two minds right now.   What is the other?

Well I was re-reading The Big Short this weekend for perspective.  By the summer of 2007, when the two Bear Sterns hedge funds collapsed, pretty much everybody that mattered knew that sub-prime was a big problem.  By February 2008, when Bear Stearns collapsed, you would have had to be in a bubble to manage money and still not know anything about subprime mortgages.  Yet the market plodded along, rallying at times, until the fall of 2008.  And it wasn’t until after the shit hit the fan, after Lehmans went belly up and credit essentially ceased to flow, that the stock market actually began to plummet.

I think that what has to be remembered is that most money managers investing in the stock market are not really being paid to quantify the scenarios in Europe.  Its out of scope to have to account for that sort of risk.  They probably just want it to go away so that they can return to what they are paid for and go home when they are supposed to.

This deal appears to give them the out, for a while, that lets them do that.  What this deal has done is stave off the final denouement for another few months.  Enough time that the market can perhaps gleefully rally and pretend again that all is well.

And who am I to argue with that logic?  I’m certainly not going to go out and buy bank stocks based on it, but if the market is going to tread water for a while longer, there are a number of stocks out there that could benefit.

With that in mind, I bought some stock this week.  The first is I bought back some Equal Energy on the news of their property disposition.  As I have already written this is a good deal because it is a deleveraging one.  And Equal remains extremely cheap by any metric.  There was a very good post on IV that pointed out that Equal’s Mississippian land in Oklahoma is worth $60M to $75M alone at the going rate of recent transactions.

I also opened a new position in Midway Energy.  Again pointing to a post on IV, Midway is trading very cheaply based on its current production and cashflow.  As teh excerpt below points out, you aren’t even fully paying for the Garrington assets, let alone the potential in the Beaverhill Lake.

With the stock only trading at $3.61/share we believe the stock is not even fully reflecting the value of the Garrington Cardium assets let alone any value for the Swan Hills Beaverhill Lake play. Our base valuation reflecting the 2012 cash flow is $3.00 and the Garrington upside potential adds another $2.50. We therefore believe that investors are getting a free ride on the 40 net sections of Beaverhill Lake rights at Swan Hills with their investment in MEL.

As well I have sold down the extra shares I bought of Jaguar when it got into the low $4 range, and replaced them with shares of Aurizon Mines in the mid $5 range.  Jaguar, which was up 35% this week, is an enigma.  There was no reason for it to fall as much as it did two weeks ago, and there is no reason it rose last week.  I think its pure manipulation.  I decided to lighten up before the manipulators changed their stripe.

Finally, one stock that I have not yet bought (back), but that I plan to is Gramercy Capital.  The company is cheap, and it probably is going to sell itself sooner or later.  I will be buying on any significant correction downward.

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