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Jun 12

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.

Jun 10

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.

Jun 6

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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.

Jun 2

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On the trials and tribulations of owning gold stocks

About a month ago I wrote the following in an email to a friend:

I probably seem crazy to be chasing gold stocks in and out like I have. I’ve been wrong over and over. But I’m not losing much money doing it because I keep selling before it gets out of hand and I know from experience that when they move up they will move so fast and you have to be ready for it. What we saw in January was nothing, in the past I have had stocks triple in a month when they move. They can move so fast in such a short time its crazy.

At the time I was getting mucho frustrated and more than a little despondent about the reaction of the gold shares. Gold stocks were being sold indiscriminantly. Even though the price of gold was holding up rather well, the stocks of the companies that produced gold were being trashed. For those companies that only explore for gold, the thrashing was even worse.

I follow a few rules for investing. One of those rules is to never add to a losing position. Another rule is to scale out of stocks that are not doing what I think they should do. A third is to mind the intraday reversals. The consequence of following these rules with the gold stocks is that I have bought in and been bounced out of these companies a few times over the last couple of months. I have owned Aurizon Mines, Lydian International, Golden Minerals, Barrick Gold, Newmont Mining. I now own OceanaGold and Agnico Eagle in addition to a large position in Atna Resources and Gold Standard Ventures and (sigh) Canaco that I have held throughout.

While my furstration has left me tempted to walk away from gold completely, the reasons I didn’t give up was three-fold.

First, I just can’t get past the conclusion that the underlying condition of the world right now should be favourable to owning gold and gold stocks. World economies are weak and weakening, and along with it so are the inputs to gold mining. Interest rates are near zero, which means that alternative paper investments (bonds) do not have their usual yield advantage over gold. Central bankers have shown a bias towards printing money to avoid lengthy recessions and prevent a destabilizing banking crisis. Debt in the developed world is still high historically.

In this environment the perception of gold should be favorable, and its perceived value in units of paper currency should increase. The truth is that the price of gold is based on perception. I think that is why you have such wild fluctuations in both gold and gold stocks. Its because gold has no value apart from the value that man has historically perceived in it. And its difficult to nail that down. I am starting to get tired of the term, but to say that gold is the existential commodity is really not very far off.

Second, the gold stocks are cheap. They are trading at multiples that I didn’t think gold stocks would ever see. Newmont and Barrick have been down as low as 8x earnings.

As well, with economies slowing, I think we are finally going to see the benefit to gold mining from lower energy, labour and capital costs. It has become so common for a gold company to report escalating operating costs, or increase the estimate of capital costs to build a new mine, that it is now almost expected by the market. But these costs do not rise in a vacuum. They rise because energy, copper, steel and labor prices have been rising. As economies around the world slow, this effect is reversing. We should begin to see that effect in the second quarter numbers, where cash costs beging to show decline.

The third reason that I didn’t give up on gold stocks is because I know that when they turn, they turn hard. I have been on the outside looking in before when this turned happened. I have learned that it is extremely difficult to buy a stock when it has risen a significant amount in a short period of time. In the same manner that gold stocks have fallen day after day for months, with seemingly no support, they can also do the opposite, and rise very quickly and dramatically in a short period of time. The only way I have found to take advantage of this, given my own constitution, is to be in before the rise begins

In my update last weekend I noted that I had bought a position in OceanaGold and in Newmont. This week I added to OceanaGold and initiated a new position in Agnico Eagle:

I finally had timing on my side with these purchases. Yesterday gold and gold stocks took off after the dismal employment report. I was pleased that in my review of the carnage after the market closed, that because of the outperformance of the gold stocks, I was actually up a reasonable amount in my portfolio. This despite the fact that Newcastle and PHH got clocked pretty hard, and the oil stocks I own, Mart, Equal and Pan Orient succumbed to the pressure of falling oil prices and oil stock malaise.

Is what happened yesterday the sort of rise I have been waiting for? While it feels like it to me, its impossible to say. What I do know is that the underlying conditions in Europe have been supportive of a rising gold price for some time now. To say that gold must fall with Europe (presumably because of margin calls) can only be taken so far. There are only so many margin calls that can be made before no one is on margin any more.

I have listened to twice and would highly recommend this interview given by Donald Coxe on the James Pulplava Financial Sense news hour. He said the following:

With the great gold mines they have 20 or 30 or 40 years of reserves and you are getting it for free. Gold prices voer the longer term are bound to go up. You don’t have to pay via a call option to own gold in the future, you are getting it for free with these great gold companies. This is an amazing investment opportunity. All you have to say is, it won’t be an amazing investment opportunity if no governments are running deficits, if the money supply growth is not above 3.5%, in which case you should not own gold. If that is what you believe is likely then you should not own gold. On the other hand if you believe that is about as likely as an invasion of spaceships from some remote part of the milky way, which is my view, then you should be owning gold. And the best way to do that is by owning the gold mines.

Before today the concern about gold, I think, was that the American economy was on the cusp of a robust recovery and quite truthfully, if the US can grow sustainably, it can solve a lot of its problems. What the job report yesterday suggested was that the recovery is not robust. It needs to be understood that there is the possibility that the US just continues to muddle. The job report today does not mean that the US is collapsing, as the stock market and bond market seemed to suggest it was.

The bottom line, I think is that gold is an asset negatively correlated asset to paper currencies, and as paper currencies lose their perceived value, gold must benefit. Gold miners remain a very cheap way to take advantage of this idea.