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Week 65: Doing the work

Portfolio Performance

The turn in housing

– Michael Burry – Scion Capital

The housing market has turned.

Being that it is a huge, lumbering tanker, it takes a long time to slow down and redirect.  The changes happen slowly enough that you can miss them if you are focused on the wrong details (price increases and to a lessor degree sales increases) and not enough on the right one’s (inventory).  All that matters is that prices are cheap, rates are low, and inventory has come down to levels that leave many cities firmly entrenched as sellers markets. Once buyers stop seeing themselves in the drivers seat, their attitude changes from one of waiting for a better buy to that of getting in before its too late.  The vicious circle is replaced by a virtuous one, and sales and price increases will follow.  Nothing lasts forever, and the US housing collapse didn’t either.

Falling inventories had to lead the housing turnaround, and that is what we are seeing now.  Nationwide in August housing inventories fell from 8.2 months of supply a year ago to 6.1 last month.

The chart below is a little dated (its from June 2012) but it nevertheless shows the year over year declines that are happening across the US.

June 2012 Changes in Number of Single-Family Homes for Sale

Metropolitan Statistical Area # of Houses for Sale Yearly Change Monthly Change
Phoenix 15,415 -27.3% 6.6%
Inland Empire 9,674 -55.9% -20.4%
Los Angeles 15,043 -49.1% -15.1%
Sacramento 7,263 -36.2% -7.3%
San Diego 4,638 -52.5% -12.9%
San Francisco 4,212 -57.1% -13.4%
San Jose 1,456 -58.3% -8.3%
Ventura 1,225 -61.5% -12.4%
Denver 7,211 -40.0% -2.7%
Washington 11,825 -28.2% -5.5%
Chicago 37,246 0.0% 8.1%
Boston 16,578 9.0% 10.5%
Baltimore 7,496 -22.1% -2.8%
Las Vegas 15,042 -27.7% -4.6%
Long Island 16,715 -11.3% -1.0%
Portland 8,002 -25.9% -2.0%
Philadelphia 24,157 39.2% -2.7%
Austin 7,068 -23.1% 0.8%
Seattle 9,839 -40.9% -5.4%
National 220,105 -25.3% -2.4%

In my write-up of Sound Financial two weeks ago I talked about the Seattle housing market, and how I was shocked at how low inventory was there (it’s around 2 months of supply).  In Phoenix, inventory was as high as 55,000 units before the crisis hit but has recently fallen to 11,000.  In Sacramento, another hard hit area, inventory peaked at 19,000 in 2006 but has fallen to a rather astounding 2,013 as of last week.  Like Seattle, this is less than 2 months of supplyIn Los Angeles County  there are less than 2 months of inventory given the current sales rate.  In Chicago, inventory has fallen from its high of 70,000 to around 38,000 in September.  Months of inventory have gone from a high of 18 months in 2009 to 6 months this Sept.

I have had incredible success on real estate investments this year.  Nationstar is up over 150%.  Impac Mortgage has more than tripled from my first purchase.  PHH Corp is up 80%.  Radian Group is up 90%.

You might think that with these kind of results I would be readying myself to take money off the table.  Yet as I look across the landscape of investment alternatives, I remain of the mind that the best place to be going forward is invested in stocks that stand to benefit from the US housing turnaround.

In particular my current favorite is Impac Mortgage.  I did more work on the company this week. I keep looking for an ugly wart that will dissuade me.  I can’t find it.  If anything, the company appears to be stronger than its nominal financial results would suggest.  The true earnings are being obscured by the non-recourse investment trusts that the company has to consolidate.  I plan to do another write-up on Impac shortly.

I am also actively looking for community banks with strong mortgage lending arms.  I’ve found a couple so far: Monarch Financial Holding (MNRK) and First Mariner Bancorp (FMAR).  But I’m still looking.

Getting comfortable with the mortgage insurers

Another group that stands to benefit from the housing recovery are the mortgage insurers.  I have become much more comfortable with the mortgage insurers since completing the work I posted last week on Radian Group (RDN).  If you haven’t already read my analysis of Radian’s claim paying forecast, I would encourage it.  I know I made a lot of assumptions to come up with my results, and these assumptions could turn out to be off in some cases, but I think that to focus on the potential sources of error is to miss the forest through the trees.  The spirit of the analysis is the conclusion that absent another major leg down in the US economy and the housing market, the mortgage insurers (I am confident the same applies for MGIC (MTG), where there is probably more cushion in claim paying ability) will have more than enough liquidity to pay claims.

MGIC released news on Friday that they had reached a limited agreement in its dispute with Freddie Mac.  The two agreed that the MGIC holding company would downstream $100 million to its MGIC insurance subsidiary.  This was a compromise from the original $200 million that Freddie had demanded.  The other issues; the disputed $550 million in claims Freddie believe that MGIC owes them, and the requirement by Freddie that MGIC and regulators allow for capital from the MIC insurance subsidiary be available to the MGIC sub, remain unresolved.

If you look at the facts only, MGIC still has some major hurdles to clear.  But again, the spirit says otherwise.  The spirit of this latest move suggests that Freddie isn’t interested in sending MGIC into runoff, and if that’s the case then they will work something out eventually.  When I think this through, if I was Freddie and I was really planned on playing hardball, I wouldn’t be budging on the $200 million and extending the date. I’d put the screws to MGIC to see if they would crack.  But they didn’t do that.   It seems to me like what MGIC said on their second quarter conference call is turning out to be right; the initial letter from Freddie was an opening gambit for negotiations, and a compromise would be worked out from there.

I also have had it argued to me that its simply not in Freddie’s best interest to send MGIC into runoff or receivership.  MGIC is too important to Freddie’s own business.  They need to keep MGIC writing new business as much as anyone.

I expect that unless the stock opens significantly higher on Monday (say above $2) I will be adding back the half position that I sold.

The case being made by the natural gas bulls

Earlier this week I tweeted a number of links to comments made by a respected poster and expert on the natural gas market from (he goes by the moniker robry825).  Robry825 believes that the natural gas market is turning.  He made the comments  here and here.

…..Now, as I am more bullish on natgas than any analyst out there than I can think of (I can envision natgas flirting with par-value to WTI in 18 months… which is $15+ today and may be $20+ then) I am concerned. So concerned in fact that I sent off an email a couple weeks back to our local LDC (MICHCON) up here where I live. So far no reply from their public-relations folks. None!

……My thoughts on the extreme bullishness of natgas were laid out in yesterdays posts… to built on those thoughts, I want to emphasize that much of my expectations are predicated on the fact (as witnessed by the drilling stats) that natgas is out of favor relative to oil for the first time in decades… and that fact will trump all else as time unfolds (even if we have another mild winter). Only question is whether the bull charges winter-2013 (cold winter), spring-2013 (normal winter), or 2014 (mild winter).

(Note: if you don’t follow my tweets you can do so @LSigurd.  I am much quicker to update both changes to my portfolio or significant developments through twitter than on the blog).

And while I’m not yet convinced that he’s right, his comments certainly made me stand up and take notice.  What I do know is that the natural gas market has a  storage capacity that is small in comparison to supply and demand and natural gas wells tend to experience a steep decline in production in the first year.  These two effects have traditionally led to wild swings in prices.

Another excellent post on, this time by a poster that goes by the monikor charles_chessie, made the case that given the current rig count in the Haynesville, the number of wells in their first year of production and the inventory of wells waiting on completions, and if one recognizes that in the first year of production the typical Haynesville well will decline 60-75%, production in the Haynesville could decline 3Bcf/d over the next number of months.

3Bcf/d works out to about 1Tcf/y.  Total natural gas storage is about 4Tcf.  Keep in mind that we are only talking here about one field among many experiencing declines due simply to reduce drilling.

This is why the natural gas market can turn on a dime.

Robry suggested that natural gas could get as high as $15/mcf.  At first that may seem crazy (I mean gas prices are forever at $2 right?) but maybe its not and maybe Robry, who has built one of the best natural gas models out there, that has proven to consistently be more accurate in its predictions of weekly storage than any of the analysts, just knows the market well enough to see what’s coming before most others can (I wouldn’t bet against it).

And while I don’t know the natural gas market nearly as well as Robry does, I do understand the factors of its supply and of demand, and I do have a pretty good imagination for envisioning how things of this sort might play out.  I can quite easily imagine a scenario developing where production is declining at the same time demand is rising and we reach gas prices that right now would seem impossible.

I am actively looking for natural gas stocks.  I have a few names that I have begun to look closer at, though I don’t think there is any rush to jump into them just yet (one company that I did buy that does have natural gas exposure is Equal Energy, though I can’t attribute my reasons there to a renaissance in natural gas).

Portfolio Composition

Note: I have begun to add all new US holdings in US dollars. This will make it easier to distinguish between US dollar and CDN dollar holdings. However, I cannot move currencies for existing stocks and preserve gains so existing US stocks in the portfolio will continue to show up in the CDN Holdings portfolio

Click here for the last two weeks of trades.

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