Skip to content

Archive for

Mr. Hyde Buys Barkville Gold Mines

I am two investors rolled up into a single portfolio.

On the one hand there is the meticulous researcher, searching out value that has been overlooked by the market.  This fellow is the investor that does most of the writing here, drawing logical conclusions from stepped out deductions and well thought out inferences.  We might call him Jekyll the Investor.

But there is another fellow that haunts these pages from time to time and who comes from a somewhat different place.  He likes to jump into more speculative positions, sometimes with no more reading then a news release, a quick scan of the company’s presentation and a few back of the napkin calculations.  While he still does more work than most do on the stocks he chooses, it is not with the same care as his counterpart.  Time is of the essence to him. He is especially attracted to gold and oil stocks that hold the opportunity of a big score, and you saw his work with the purchase of Gold Standard Ventures a couple of months ago or with the purchase of Mart Resources a couple of weeks ago (while he perhaps isn’t so thorough, he is still often quite lucrative).  We could call him Hyde the speculator.

Now to be fair, Hyde is not some sort of willy nilly gambler.  He has honed his craft with over 10 years of studying the business of getting commodities out of the ground.  The reason that he can take such quick action is because he has made enough moves, both good and bad, to develop an intuition about it.

Hyde begins to watch Barkerville Gold

I’ve had my eye on Barkerville Gold Mines (CA: BGM) for a month now.  It wasn’t a close eye, and I wasn’t really interested in buying stock in the company so much as I was curious about what they would do next.

I owned Barkerville 2 years ago for a brief one month stint when gold prices were going up and the best thing to buy was the cheapest junior with a story and a property.  I wrote about my purchase of the stock here, and then about my sale soon after here. I think I summed up my reason for being so quick to be in and then out quite well with this comment:

My experience is that you can make some money on juniors by projecting out cash flows based on a successful mine and then waiting for other people to make those same calculations.  But you are better off selling out before you test out the theory of whether those cash flows are realized.  

Mining is hard, and its pretty easy to screw up a mine and there seems to be just as many disasters as there are successes.  So unless you are willing to play this ‘greater fool’ game with your finger on the trigger, you’re probably better off in the long run with the big producer.

This is something I am trying to remember with these gold juniors we have been talking about lately.  The numbers we and the analysts are throwing about are legitimate for a trade, but don’t start believing them.

I added the bold and I think it is a sentence that shouldn’t be forgotten.  Even with mining stocks where I have the honest intention of holding through the duration of development (ala Atna), it is important to remember that numbers are just that, numbers, if things appear to be going wrong, it is always better to sell first and ask questions later.

Since that brief run I haven’t followed Barkerville very closely.  I took a quick look again about 6 months ago but was turned off by what looked like the high costs of maintaining a mill that couldn’t be delivered enough ore.   They seemed forever doomed to struggle with the high costs that come from a mill running at partial capacity.   Their eventual savior was another deposit that was unfortunately a number of miles away and that had some long-lead time permitting to be done before it could be brought to production.

I started following Barkerville again after beginning to lurk on a junior mining message board over on Silicon Investor called Microcap Kitchen Canadian Stocks.  What drew me to the board was that one of the posters, diddlysquatz, was listing companies that were trading at a price below or equal to their net cash position, and I’m always a sucker for cash on hand.

The folks on that board have been pointing to Barkerville for some time, and they have done an excellent job of picking out the run before it happened.  I saw the stock going up but I didn’t know why so I didn’t make any plunge myself.  But I was intrigued when I saw that Barkerville Gold was halted for trading Thursday morning.  I wondered if there might be some sort of merger, or maybe a drill hole, and the more cynical  part of me wondered if a diluted offering was in the works.

Well today at lunch I saw the stock trading up some 50% and it was pretty clear this wasn’t a dilutive offering.  I did a quick scan for news and almost didn’t believe what I saw.

The indicated resources, between the elevations 3,550 feet and 4,550 feet above sea level (town elevation 4,000 feet), estimated by Geoex for the Gold Quartz open pit model on Cow Mountain are 69,039,000 tons with an average grade of 0.154 ounces gold per ton (5.28 grams/T) and 10,626,100 ounces of contained gold as summarised in the following table.

In fact, I didn’t believe what I saw.  I wrote the following on twitter:

$BGM:CA Barkville resource at 10Moz? Is this for real? If it is the stock is suddenly very cheap

And while Jekyll has difficulty swallowing the thought of buying JC Penney up 2% on an up day, Hyde does not even consider that Barkerville Gold is up some 50% in the last hour when evaluating his potential purchase of the stock.  So I jumped in, albeit with a small position.

Honestly however, I’m still skeptical.  It just seems too good.  10Moz at over 5g/t of open-pittable indicated resource?  I put indicated in italics because this isn’t an inferred resource estimate.  Indicated ounces generally have some substance (I would ignore the geologic potential that the company provided, if anything it makes me wonder what they are doing here, building a resource or promoting a stock).   And at what looks like a strip ratio of a little over 1?  It seems extremely low for a pit that will contain 5 g/t gold.  I keep thinking I must be missing something, because even with the stock up some 50% on the day, it does not appear to be up nearly enough.

I took a quick look at the company that performed the resource estimate, Geoex Limited, and they aren’t some sort of one hit wonder.  They have produced estimates for Rubicon and San Gold in the past.

This is purely a speculation that there is not something here I am missing, and that the basic points of resource size, grade and strip are all legitimate estimates.  There’s no report available on Sedar yet, so I really can’t evaluate this on anything more than the numbers from the news release, which are the basic figures and not much more.  We’ll have to see what the stock does on Tuesday when it opens; if I am not missing anything, we should see it move higher.  If it doesn’t than I am probably best to assume someone knows something and that I would be better off leaving the speculation for someone else.

Nevertheless, Hyde felt it was worth a couple of bucks to speculate that the resource is indeed without a hitch.  If it is, then this stock is going much higher.

Week 51: A Couple of New Positions

Portfolio Performance

Portfolio Composition

Staying Smallish

I broke down and bought a position in MBIA at the end of the week last week.  I had mentioned in my post on the company last week on the company that I had planned to wait for lower prices.  I didn’t.  Over the past couple of weeks I have read through all the conference calls and the latest quarterly’s and the more I read about the court cases between MBIA and Bank of America, the more that I think that if I were Bank of America, I would be looking to settle before any further rulings come out.  With the first ruling (on the transformation of MBIA into two distinct entities that is being opposed by Bank of America and Societe Generale) due out in August I decided that I was willing to take the risk that the stock falls back to the $8-9 range in return for the potential reward if that settlement comes out.  I haven’t bought a lot of the stock, just enough to feel like I am participating. If it does fall back to $8 I would buy more.

I also started a very small position in JC Penney.  I could see it getting significantly larger.  I plan to put out a very detailed post at some point in the near future (probably next weekend) but to briefly summarize, I am fairly comfortable that the problems that JC Penney has will be worked through and that in time the stock will trade much higher.  What I am less comfortable with is whether the stock can trade much lower first.  I have been reading everything I can find about the company and I cannot believe how hated it, and its CEO Ron Johnson, have become.  Moreover, there seems to be a consensus that because the pricing strategy change that was announce in Q1 was not immediately successful, it should be concluded that the management team is a bunch of bumbling idiots who got lucky with Apple and will suffer a fate worse than death with JCP.  Yet as Johnson said on the first quarter conference call, they are trying to turn the titanic into a bunch of little speed boats, and that is going to take time.  The turnaround that Johnson is attempting will not miraculously happen in the next month or two, so there is room for further disappointing numbers.  I would love to see the stock fall to below $20, at which time I would load up.  I actually expect that it will, I mean there isn’t an immediate catalyst to the upside, and the negativity is so strong that its taking on a life of its own.

I haven’t added to my position in gold stocks, but I have changed it up a bit. Out is Canaco Resources, and lightened up on is Atna Resources.  In are Esperanza Resources and OceanaGold.

In the case of Esperanza, they are a company with a low cost development project (~$100M capex) and low expected operating costs (~$450-500/oz) that has been beaten up because they did a share offering that was over-subscribed and that diluted the share base.

I’m looking at the offering from the other side.  That is: they managed to do a share offering that was oversubscribed in this environment.  I think there are probably some games going on with the stock post-offering, and I suspect that is why we are able to get it as cheap as we are.  The only potential negative I have heard with Esperanza is that apparently because the offering was oversubscribed there were some unhappy subscribers who didn’t get all their shares.  Some have said that this could lead to lawsuits.  I admit I don’t fully understand the legal impacts of this, but it would seem to me that the ultimate responsibility would lie with the sponsoring bank and not Esperanza.

OceanaGold is a bit of a flyer.  I bought the stock at $1.80, I sold some, but not enough, at $2.15 to book some profits, and now its back to almost where I started at $1.90.  I placed this “bet” on OceanaGold based on the following expectations:

  1. The gold price is about to rise
  2. Didipio is going to be added into 2013 estimates shortly at which point the corporate cash costs of OGC will drop to sub $800 per ounce.
  3. The falling NZD and falling oil prices are going to start working in OGC’s favor rather than against it, as has bee the case for the last couple of years

The problem with OceanaGold is that it is a trading stock and trading stocks can go up and down like a yo-yo while you wait for what you think should happen to play out. Its excruciating and it’s a reason to only have a small amount of your overall capital invested in such names.  I have a small amount of capital invested in OceanaGold right now and I would be hesitant to add more.  We’ll see how it plays out.

Next week marks Week 52 since I started tracking my portfolio on-line. I will try to publish a short wrap-up of the year.

 

My Investigation into MBIA

How MGIC became MBIA

A couple of weeks ago I set out to learn more about MGIC (yes, MGIC not MBIA).  MGIC is a monoline insurer whose primary business is insuring residential mortgage bonds.   Needless to say, MGIC has had its troubles over the past few years and the stock price has been hammered down from over $70 in 2006 to a little over $2 right now.  I had spent some time investigating MGIC at Christmas and had gotten frustrated by the opaqueness of the company.  It was very difficult for me to determine true risk of default of the loans it had insured and I couldn’t figure out how I could invest in the company without getting a better handle on this.  I thought that in taking a second look at the company I might come to a better understanding of the business and whether it was about to go bust (which it is certainly priced for) or whether there is unrealized value.

What does this have to do with MBIA?

Well as it happens MGIC and MBIA have very similar names and they operate a similar business.  It’s quite understandable that someone may get the two companies mixed up.  And in fact someone did get the two companies mixed up and in the course of my research I ended up following a link to a message board that was purportedly a discussion of MGIC but was actually a discussion of MBIA.

It took reading only one message before I clued in that this was a different company than I had been researching before.  The discussion was focused around the separation of the structured finance insurance wing (not very different from the residential mortgage insurance provided by MGIC) and the municipal insurance wing (different from MGIC).

In retrospect I  was quite lucky that the message board began with what was an excellent synopsis of both of the businesses that MBIA is involved in, and a solid description of the investment case.  If it had been your typical message board, full of quips and rantings, I probably would have moved on without giving it a second thought. But instead I saw a company that sounded intriguing and potentially quite undervalued.

What’s the idea?

Below is a quote from Jay Brown, CEO of MBIA (taken from the Q4 2008 conference call transcript via Seeking Alpha):

“…are MBIA Corp and National separate with respect to the contributions that they make to enterprise value?  The answer to that is yes.  So to the extent that the value of one of them were to turn out to be zero, the remaining value of the consolidated firm [MBIA Inc] would be the value of the other.”

In 2008, when all hell was about to break loose in the financial markets, MBIA decided to split its two primary insurance businesses (a structured finance division (called MBIA Corp) which insures mortgage backed securities (MBS), collateralized debt obligations (CDOs) and some foreign government and corporate bonds, and a municipal insurance division (called National), which insures the debt of public municipalities and their infrastructure projects) into two separate holding companies.

The reason for the split was because the structured finance insurance business was looking tipsy, and this was impinging on the ability of MBIA to write municipal insurance.  The direct cause was downgrades to MBIA’s credit rating due to the uncertainty at the time with respect to all things structured finance.  At any rate, by splitting apart the municipal insurance business from the structured finance insurance business, the municipal business would have the strength to continue to underwrite municipal bonds.

The municipal insurance business was seen as an important business to preserve at the time, not only from the perspective of MBIA but from the perspective of the regulators and the government.  With the credit crisis reaching full bloom, it was necessary to insure that municipalities would be able to continue to raise funds and roll over expiring debt at reasonable rates.  Part of that depended on their ability to have their debt insured by a third party like MBIA.

The split was approved by the New York Insurance Department (NYID) in February 2009.

Why MBIA is a play on the outcome of court cases

Not everyone was happy about the split.  In particular, the banks that had originated the CDO’s and MBS that MBIA had insured did not like the idea of Structured Finance not having recourse to the parent or to Municipal.  Moreover, MBIA transferred $5B from the Structured Finance division to the Municipal division.  This transfer was done to shore up the capital requirements of the Municipal side, but of course it left the Structured Finance side with less capital at a time when the eventual capital requirements were very much in question.

There has been a lot written about the $5B  that MBIA transferred out of the structured and into municipal.  On the face of it, it seems a little strange that they were able to shuffle money out of one division and into another at the same time they were establishing walls on the recourse between these divisions.  However, after reading through some of the conference call transcripts I found this explanation in the Q4 2008 call.

All of the $5.2 billion invested assets transferred to National came from a portion of the accumulated retained earnings produced by the US public policy holders over the past 35 years and the remaining deferred revenue for the $553 billion in municipal finance net par that National assumed from MBI Corp.

It certainly sounds like the money transferred was earned by National and therefore is National’s to take.  The NYID seemed to agree, because they approved the transfer as part of the transformation of the company into separate non-recourse subsidiaries.

Because the transaction was approved by the regulators, the only legal recourse of the banks who don’t agree with the transaction is to claim that the NYID was negligent in their decision.

The case was taken to court in April, and it just finished wrapping up a couple of weeks ago.  The judge is expected to rule in the next couple of months and from there it will likely go to appeals.

Because of the almost certain appeal process, the case is likely to drag on quite a bit further before it is settled. Nevertheless the upcoming ruling will  be important to MBIA as it will be the first ruling on the matter, and because the judge residing over the case is not known to be overturned on appeal very often.

As I have said the banks only have recourse to annul the transformation by proving that the NYID acted in a manner that was negligent.  The terms that are used to describe the behavior that the banks must prove of the regulator are “arbitrary and capricious”.  These are strong terms.  Moreover, having to prove that the regulator acted with ill-intent a lot different than simply having to prove that MBIA acted in a manner that was improper or not in the best interests of all its policy holders.

Indeed, after having read through a number of the summaries of the court hearings, it appears that the Bank of America lawyers have consistently tried to change the frame of the trial to an evaluation of whether MBIA hid or misled information rather than whether the NYID acted reasonably in their decision.  I wonder if they are trying to redirect the issue because they know the real question before the courts will be difficult to prove.

As I mentioned, the pretrial was wrapping up at the beginning of June.  The judge (Judge Kapnick) is expected to rule on the case in the next couple of months, perhaps not until August.  The opinions of the trial that I have read (a good one’s are here and here) suggest that the odds favor that the ruling will be on the side of MBIA.

As I also have already mentioned, the odds are also that there will be an appeal and that this case will drag on in one form or another for some time yet.

More specifically, it is likely that the case will drag on until there is some sort of resolution between MBIA and Bank of America in all of their court disputes.  Because you can’t really understand what is going on between MBIA and Bank of America and the conflict over the transformation of MBIA without looking at the other disputes between the two parties.  The transformation case is really just one leg of what appears to be a high-stakes game of chicken between the two companies, with the other leg being the fraud case that MBIA has against Countrywide.

The other court case

The reason that Bank of America is so intent upon challenging MBIA and its split is not only (or likely even primarily) that they are concerned about their claims on MBS insured by MBIA.  It is instead because MBIA is litigating against Bank of America (more specifically litigating against Countrywide, of whose legal losses Bank of America would be responsible for) in a case concerning mortgages originated by  Countrywide, and insured by MBIA, that have since gone sour.  MBIA is trying to recoup claims it has had to pay out on Countrywide originations by claiming that there were misrepresentations and breaches of warranties in the insurance contracts (basically that the originators at Countrywide made up numbers, overstated  incomes, or lied about the employment status, net worth etc) that were signed.

The fact that the two court cases are linked is made pretty obvious by the history.  Originally the case against the MBIA transformation was being made by about a dozen banks and other entities.  Those numbers have been whittled down to two (Bank of America and Societe Generale).  In most instances where a bank dropped their case against MBIA’s transformation there was a concurrent resolution of the breaches of representations and warranties that MBIA was claiming against the bank.

I think that the reason Bank of America is one of the last to have not settled with MBIA is because the numbers involved are bigger.   In the suit against Bank of America for breaches, MBIA is looking to recover in the neighborhood of$3B, which it the amount they have paid to investors in claims on bonds backed by Countrywide mortgages.  MBIA has often said that most of its losses, and most of its recourse, has been aimed at three parties: Countrywide, ResCap, and IndyMac and that of those three, Countrywide was “by far” the largest.

This second court case is really the first court case.  By that I mean that it went to court first, and that it has already been ruled upon in some respects.  The case was heard in pre-trial towards the end of last year.  The hearing was aimed at resolving the burden of proof that MBIA had to meetto claim a breach of representation and warranties.  The judge (Judge Bransten) made a few significant rulings.  First, it was ruled that MBIA only had to prove that there was indeed a breach involved, but that MBIA did not have to prove that the breach was responsible for the eventual default.  Specifically, the judge concluded that MBIA and Syncora “need only show that Countrywide materially misled them at the time they agreed to write insurance on Countrywide mortgage-backed notes, not that the alleged misrepresentations led directly to MBS defaults and subsequent insurance payouts”.

That MBIA doesn’t have to prove the cause of the default is a big win.  In 2008 a lot of mortgages went bad, and trying to prove the exact cause of each default would have been a difficult and time consuming task.  The ruling should make it easier for MBIA to rescind insurance that they had written and recoup the losses.

Perhaps the only negative thus far is that the judge wouldn’t produce a summary judgment that if fraud could be proven on an individual loan, all mortgages within the MBS securitization of which that loan was a part of could be put-back to Countrywide.  While I’m a little fuzzy on why the ruling here would be different than the above described judgment, it apparently it has to do with the language of the insurance contract versus the language of the securitization.

This was aspect of the judgment was clearly in favor of Bank of America but it is less important to MBIA directly than it is as a weapon in the cat and mouse game taking place between the two companies.  If Judge Bransten would have assented to this summary judgment, it would have created, at least  based on my understanding, some big problems for Bank of America.  While the rulings in MBIA’s favor makes it easier for the insurers to get out of paying claims, the summary judgment on MBS as a whole could initiate a process that would eventually lead to the put-back of untold billions of mortgage backed securities by investors who could prove fraud.

How much is untold?  Numbers that I have read range from $22B to $35B .  The point here is not so much what the number is, but that it is big.

MBIA is not a direct investor in MBS securities, so from the perspective of direct exposure, this aspect of the ruling seems somewhat irrelevant to them.  But what makes it more relevant is that MBIA can pursue this aspect in order to keep the fear in the heart of Bank of America, giving them further enticement to settle the whole thing and be done with it.

Indeed, MBIA has appealed this aspect of the verdict, and that appeal sounds like it could have some legs.  Since the time of the verdict MBIA has dug up Countrywide’s internal fraud tracking database.  They also have a line of former Countrywide employees ready to give depositions about the fraud.

I have little doubt that there is much fraud to be found.  I’ve read a number of books on the housing crisis as I’ve struggled to learn how to best play its recovery, and more than one of those books has described in detail the shenanigans of Countrywide.  In particular. All the Devils are Here, written by Joe Nocura and Bethany Mclean, laid out a nice couple of chapters on how Countrywide went from a stand-up lender to out-and-out fraudulent behavior in its pursuit of market share and Angelo Mozilla’s obsession with being the biggest and best at whatever they did.  If the only question becomes whether fraud has occurred, I can’t see there being much doubt about the answer.

If MBIA can get the summary judgment on appeal, the result would be a big win for investors looking to recoup losses on Countrywide mortgages.  Until the matter is settled, it remains a big risk to Bank of America.

Bank of America should cave

This is strictly my semi-educated opinion on the subject, but I do not see why Bank of America continues to take the risk of letting this appeal against Countrywide, an appeal that could affect a lot of mortgages and result in a big loss for the bank, go to its final judgment.  The rulings against Countrywide on the issue of breach of representations and warranties have all gone against them.  If this appeal goes the same, it will not only be easy for MBIA and other insurers to rescind the insurance that it wrote for Countrywide, but it will be much easier for all investors of mortgage backed securities to do the same.

Why would Bank of America take that risk?

To up the ante just a little bit further, Bank of America has already reached an $8.5B settlement on much of their exposure to first lien mortgages.  I read a lot of commentary about the settlement, and more than some of it suggested that the deal was far below what had been expected.  The settlement, after all, reflects $106B in defaulted loans, meaning that it covers less than 10% of all defaults.

The settlement is already opposed by some of the smaller creditors and will be going to court to settle its validity.  Its been going through appeals to determine whether it should be settled in state court or federal court.

Remember that the summary judgment that MBIA has asked for is that if a single loan is in default in a MBS security, the entire security should be able to be put-back on Countrywide. If the judge agrees to the summary judgment on appeal, you are looking at put-backs of a substantial percentage of those $106B in defaults.  To take MBIA as a case study, in the Q2 2010 conference call, before the put-back litigation was announced and therefore at a time when MBIA was still speaking freely on the matter, the company said that “sometimes as low as 75% and some cases as high as 90% of the loans in the securitization are in violation of reps and warranties”.

The other point here is that by letting the put-back trial with MBIA progress through its discovery process, you are providing opportunity for MBIA to unearth more evidence and uncover more issues.  By doing so you are putting the much larger $8.5B settlement at risk.  Would it not be better to settle with MBIA and close the books on their investigation into Countrywide?

Bruce Berkowitz, of Fairholme Funds, was quoted as saying as much last year at a Morningstar Investment Conference:

While Fairholme’s stake in MBIA may seem schizophrenic given the latter’s legal dispute with Bank of America, Berkowitz thinks this a false problem. A win for MBIA, as he sees it, will mean little to Bank of America and a great deal to MBIA. The lawsuit’s unequal impact on the two parties, as well as the high likelihood of MBIA’s eventual triumph, has moved him to take a stake on both sides of the argument.

By continuing with the transformation case against MBIA, Bank of America seems to be betting it can do one of two things:

  1. It can win the case  and annul the split of the two businesses
  2. It can wait out MBIA until the middle of next year, at which time MBIA will run out of resources for claims and have to go into receivership

They may indeed be able to achieve one of these two ends.  But in the process they run the risk of opening up a far larger can of worms by putting in jeopardy their MBS settlements.

The Investment case for MBIA

Part of what makes MBIA a compelling investment idea right now is that these court cases are likely to come to resolution in the next 6-9 months.   The potential of the two above negative outcomes occurring seems to me to be outweighed by the potential negative (for BoA) consequences of the fraud case if Bank of America allows MBIA to move ahead with it.

The other part, of course, valuation. The value to be realized in MBIA seems to be enough to justify the risk.

On this write-up I hoped to focus on the court cases.  I am going to do another write-up that provides a more detailed run-through of the value of MBIA.   But for the purposes here, there are a number of analyses that have been done by others that can be leaned on to get a ballpark feel for the upside.

First of all, as I already alluded to, Bruce Berkowitz and Fairholme Funds own a large position in MBIA bonds and in their common stock.  In particular, the Fairholme Allocation Fund owns a little over 6 million shares of MBIA common stock, which makes up a rather enormous 25% of the assets in the fund.

Though written a couple of years ago, the following quote summarizes what Berkowitz thinks about MBIA:

“Once it becomes clear that National is walled-off, you have a tremendous amount of uncertainty gone,” Berkowitz said.

More recently, Fairholme gave investors a glimpse into the valuation range they saw.  In the 2011 annual report Fairholme said:

MBIA common stock is The Allocation Fund’s largest position. Recent legal settlements paid and reserves taken by defendants are convincing skeptics of the company’s ability to more than just survive. Following GAAP, the company reports a book value of about $12 per share. Following Statutory Accounting Principles (SAP) utilized by insurance regulators, book adjusts to $16. Assuming an orderly run-off, the company calculates an adjusted book value of $35. Each method has its strengths and weaknesses and does not include a value for new business.

Another value fund, Fernbank Partners, recently published their valuation range for MBIA here.  Fernbank puts the range at between $3.2B and $6B.  That is between a 50% and 200% appreciation from the current stock price.

BTIG initiated MBIA with a buy rating and a target price of $22 last November.  Perhaps worth pointing out is that the valuation BTIG came up with is based purely on the value of National (the municipal insurance business) less the holding company debt.  No value is attributed to the structured finance arm, and no value is attributed to the future business that National may be able to write once the lawsuits are settled.

Just like all of these folks, I think that the upside to a settlement with Bank of America is compelling.  The company trades at a fraction of adjusted book value, and the basic business of insuring municipal bonds looks to be worth at least double the current stock price in the event that the business can begin to write insurance again.  The structured finance division may be worth nothing, though that is very dependent on the size of the eventual settlement with Bank of America.  A full recovery of the amount that MBIA has booked ($3.2B) would give the structured finance division an adjusted book value of around $14 per share.  So it remains to be seen whether structured finance is a write-off.

I originally bought a small position in MBIA at $9.  But have since added to it in at $10.  I wish that MBIA had not risen so soon after I first discovered the idea.  I would have liked to have a larger position.  As it is, the stock accounts for about 4% of my portfolio.

Yamana take-over of Extorre Resources

I been working diligently on research of 3 companies this weekend: MBIA, OceanaGold and Esperanza Resources.  I haven’t anything to post yet on the 3, but I have bought decent positions in the latter two and am looking for an entry on MBIA.

I wanted to send out a quick update because of the news this morning that Yamana Gold entered into an arrangement to by Extorre Gold.   I looked at Extorre over the past couple of weeks and decided to go with Esperanza, which I chose because of its lower capital expenditures and that, being in Mexico rather than Argentina, Esperanza has less political risk.

Nevertheless, the move by Yamana just points to how cheap many of these gold junior companies are trading.  I expect there to be more of these sorts of transactions over the coming months, as majors pick up resources on the cheap.

Sold out of Equal Energy

I exited my position in Equal Energy last week.  I took the hit.

I had originally bought Equal at a little over $4.  I sold out the rest of what I owned last week at $2.85.

Why take the loss?

I decided that I would rather take the loss then wait for the outcome of the strategic alternatives process.  I’m worried about the repercussions if that process does not end well.  I’ve watched a few of these processes go badly in the last couple of months.  The result to the share price wasn’t pretty.  Take a look at Second Wave and Ithaca for a couple of examples.

In the Calgary Herald today there was an article on the struggling junior resource sector in the city.

There are 17 companies currently in strategic alternatives processes that are advertising and being broadly shopped. That’s about 65,000 boe/d,” he said. “And there are 35 asset packages, giving us another 76,000 boe/d.”

With this many companies on the selling block it is a buyers market out there.  That doesn’t bode well for Equal.

A second concern is the Hunton.  The Hunton is a solid producing asset when natural gas and natural gas liquids prices are decent.  It is not as solid when prices are as weak as they are now.   70% of the NGL production from the Hunton is ethane and propane.

I have written before about my concerns with respect to ethane and propane.  NGL’s are commonly talked about in the same breath as oil.   They are all “liquids”.  Except they aren’t; ethane and propane are not oil. They do not have the same end uses as oil and therefore can have a completely different supply/demand dynamic then oil.

Moreover, Conway propane prices, of which Equal has said the Hunton NGL pricing is based, have gone from bad to worse over the past couple of weeks.  You can access the Conway weekly pricing along with other marketing hub pricing here.  Some of the price decline at Conway has been due to short term bottlenecks that will go away, but not all of it.   If you look more broadly at propane prices across the west they show a broad based decline.

I could be totally wrong about my decision.  Equal could sell assets tomorrow, or even sell the whole company, and I would lose out for having sold.

The decision is really one based on risk and reward.  The risk is that if Equal announces that they are no longer pursuing strategic alternatives the stock could drop suddenly and I could be left holding the bad.  The concomitant risk is the ever present problems in Europe.  The reward of course is that with the right sale the stock could rise to $4, or maybe more.

In the current environment I have decided to not take the risk and instead forgo that potential reward in the name of capital preservation.

Week 49 Update: Hedged Bets

Portfolio Performance

Portfolio Composition

For the last two weeks of trades, click here.

With the news this weekend that Spain will receive E100B to help recapitalize its banks, one has to think that the markets will open higher on Monday.  However whether these gains can hold is an open question.  One hundred billion euros hardly fixes Spain.  It won’t bring down unemployment, or plug the budget deficit.   It will do nothing to help persuade the Greeks to stay in the EU.  All the problems that existed on Friday still exist.  But now the Spanish banks have more capital.

My strategy for almost a year now has been that with regards to the Eurozone, it is best to sell first and ask questions later.  What I realized from living through 2008 is that no one, or at least very few, can predict the consequences of a major shock to the financial system.  I come back to the point that I have made before that in 2008 it took  for two days after Lehman for the markets to begin to react to what the bankruptcy had unleashed.  It was not anticipated.  The consequences of systemic shocks are not at all clear beforehand.

Some would say  that I am fighting the last war with my fears.  They might be right.  But I have yet to hear a pervasive argument as to why what is happening in Europe will definitely not create a systemic shock at some point.  There are plenty of arguments as to why it should not.  Greece is too small.  Money managers and banks have known about it for a year.  The banks have been capitalized through the LTRO (and now the Spanish bailout).  The problem with these arguments is that they deal with the knowns, and the problem with a financial shock is with the unknowns.    Moreover, there are very intelligent people, like the Michael Novogratz interview I posted, that believe the consequence of a Greek departure is an open question.

Staying Small

My response to the uncertainty has been to  get smaller.  I was smaller throughout the second half of 2011.  When the LTRO led to a rally in stocks, I briefly got bigger again.  This was, perhaps, a mistake.  As I wrote in early January I didn’t believe that the effects of the LTRO would be much beyond the short term liquidity it provided.  Yet I got caught up in the mini-bull that occured from January to March and took on more risk.  The lastmonth and a half has been about taking that risk back off.

As an individual investor the primary advantage that I have is that there are no expectations of performance.  I do not have to outperform the benchmarks and no one will be taking away the money I manage or my job if I don’t.  The consequence is that the only thing keeping me from derisking in an uncertain environment is my own psychology.  If I can warm up to the perspective that it is ok for others to make money while I am not for a time then there is nothing to prevent me from getting out and waiting it out until a time when the game appears to be more clear.

Its that last point that can be tough to follow.  When markets are rallying and I am sitting in 30% cash, it can be difficult to swallow.  Monday will undoubtedly be frustrating. Stocks I have pared back on will rally, and stocks I have not bought yet will be bid up further.

There are a number of companies I have been looking seriously at in the last couple of weeks, but that I am waiting to pull the trigger on until at least the Greek election has past.  Xerox, AIG, MBIA are all companies I think will do well in the coming months.  I just want to buy them at a lower price.

Waiting for a lower price is perhaps the most difficult thing to do with investing.  But I don’t see the resolution in Spain as a lasting solution to the greater problems of either that country or of Europe as a whole.  It certainly does nothing to remove the risk of a Greece exit.  Until that risk begins to diminish, either from an exit or an integration, I am reluctant to take on too much risk myself.

And so it is that I plan to sit on my 30% cash position.  Staying small.

Comparing Gold Producers

Every quarter I spend an evening or two going through the reports of the 15 or so gold stocks that I follow and updating a spreadsheet that I use to track their progress and compare them against each other.

I do not use the spreadsheet in the way a strict value investor might.  I do not search out and buy the cheapest gold stock of the bunch on a cash flow metric or per ounce metric.  I do look for value, but I also look for growth.  The stock market tends  to treat gold producers in much the same way they treat any other business: stocks with superior growth potential get bid up to higher valuations.  On the other side of the coin, you can sit on what appears to be an undervalued producer for a long time if that producer has a poor pipeline of projects or has no prospects to produce near term incremental ounces.

I did exactly that recently with Aurizon Mines.  I was attracted to the value, it was cheap compared to its peers, it had a lot of cash on its balance sheet and no debt, and they have a well run and profitable operation at Casa Berardi.  Yet Aurizon does not have a strong growth pipelne.  Its closest to completion project is an open pit prospect called Joanna which, while it could one day produce a lot of gold, has been stuck in the feasibility stage for more than a few years and has the worry of requiring a large capital outlay out front.  When you add that to a number of fairly early stage exploration projects the result is a company without the near term potential to grow ounces significantly.  I sat on Aurizon for almost 6 months based on its value story and the stock went nowhere.

At the other end of the spectrum is a company like Argonaut Gold.  I owned Argonaut Gold for a while last fall but sold out way too soon.  I sold because I saw the stock was priced dearly compared to many of its peers.  However I failed to adequately account for the growth opportunities.  It was a silly oversight;  I had originally bought the stock because of the low capital cost heap leach projects that they could bring to market quickly.  Somehow though I forgot about this, got caught up in the valuation and that led me to sell too early.  The stock has since doubled to $10 before pulling back in the recent carnage that has brought all gold stocks to their knees.

When I was looking for gold producing companies a couple of weeks ago I was on the lookout for the next Argonaut Gold.  Unfortunately I have not been able to find them (if you have some ideas, please drop me a note).  In my opinion the closest comparison to Argonaut in terms of near term low capital cost growth potential is Atna Resources.  Atna has a legitimate chance of increasing their gold production from 40,000 to over 150,000 ounces in the next couple of years.  What makes Atna an imperfect comparison is that most of its projects hover around the cash cost level of $900 per oz, which is on the high side of the cash cost scale, whereas Argonaut has been able to achieve the double whammy of low cash cost low capital cost growth.

A second producer that I have bought (back) recently is OceanaGold.  I have had good luck with buying OceanaGold when the market hates them and selling when the market starts to show some love.  This time around I may hold on for a bit longer.  OceanaGold has typically been one of the cheapest gold stocks on cash flow metrics.  This is because, in part, they have struggled with costs and production at their existing mines. However, their soon to be producing mine in the Philippines (Didipio) will bring about some growth to the company, and perhaps more importantly, it will reduce the corporate cash flow numbers substantially.

One thing that got me interested in OceanaGold again was my research of Agnico-Eagle (which by the way is the third producer I own right now).  While Agnico-Eagle has had some difficulties with the closure of their GOldex mine, they remain one of the best growth stories in the industry and I believe the market will come around to forgetting about Goldex and recognizing this once again.  Agnico-Eagle owns 5 operating mines.  Of those five, one mine, Meadowbank, produces about 1/3 of the production.  At the corporate level, Agnico-Eagle has reasonably low cash costs.  They were $594 per oz in the first quarter.  However Meadowbank, the largest mine, has cash costs over $1000 per oz. On its own its a marginal mine that produces a large number of ounces.  Together with the other low cost assets that Agnico has, it receives a much higher valuation than it would on its own.

I liken this situation to the one at OceanaGold.  At OceanaGold, the corporate level cash costs should come down fairly substantially with the introduction of gold production from Didipio.  Didipio will produce a lot of copper in addition to its gold, and this will make the cash costs of the project appear to be quite low.  The cash costs of OceanaGold will not get down to the level of a company like Agnico-Eagle (the high cost mines at Oceana will continue to make up too much of the production) but I do not see it as unreasonable to think they will drop into the high $700 range.  My bet on OceanaGold is that when production begins at Didipio, analysts will begin to revalue the company on the basis of a mid-cost producer rather than a high cost one, and that should provide for some upside in the stock.

I updated the spreadsheet below over the weekend.  I did not update it during this week with stock prices for each stock tabled.  The prices are as of Friday’s close.  There has been so much movement in many of these gold names in the last couple days that the prices are already somewhat outdated.

My hope with gold and gold stocks is that this move is for real.  What I think we need to have for this move to be real is action out of Europe that brings gold back into the system.  I wrote this weekend about how, in general, the turmoil in Europe should cause weakness in paper currencies and lead to strength in gold.  On Sunday Donald Coxe was interviewed on King World News and decribed a scenario whereby gold would be used along with a value added tax as colateral for euro-bonds on ther periphery.  While I am a bit fuzzy on what  the details of such a bond might be, I believe that conceptually this is the sort of event that has the potential to create a great rally.  On the other hand my enthusiasm is tempered that if nothing is done in Europe, and if the Federal Reserve does indeed decide that QE is not working (I don’t think its nearly as clear as others do that the Fed will mindlessly embark on further quantitive easing.  The Fed is, after all, a data centric institution, and if it appears that the benefits of QE are not what was anticipated, and I believe that has been the case, they may decide that a third installment is not beneficial).

Below is my spreadsheet comparison.