For most of the selloff and recovery, I have mentioned that my favorite market analogy to our current situation has been 1973-74, which had a 55% collapse and 74% snapback rally.
However, as this market has continued to power higher, it has left 1973 behind, and is looking more and more like the Great Panic of 1907:
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All charts courtesy of The Chart Store
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Best Buy has fallen 8.9% this year, and Einhorn, who established his position at an average price of $33.33, is in the red on this bet. Still, he makes a compelling argument for the down-but-not-out security. Of note: Greenlight's long-run annualized return since 1996 is close to 25%. It ranks as one of the best-performing U.S. hedge funds, despite a focus on mainly domestic equities. Also, unlike its peers, Greenlight has a small staff and rarely trades. Its operations are focused on researching and then owning, or shorting, stocks, not vacillating on its investments, as many firms do.
In his quarterly letter, Einhorn stressed that investors are far too concerned that Best Buy has reached its growth limit and will suffer declining sales in the future. In particular, he views Best Buy's holiday dip as a fleeting issue rather than a signal of looming obsolescence. In essence, Einhorn is making a bet against online shopping for electronics. He sees Best Buy offering customer value through "store help, merchandising, service and being able to walk out of the store with your purchase." The challenge of seeking a refund or repair for an Internet-purchased high-ticket item, such as a 3D television, illustrates Einhorn's point. Internet shopping may dominate for low-ticket, easily replaceable items, but brick-and-mortar will likey retain a lock on expensive goods.
Despite such security, Best Buy will face indisputable headwinds as its U.S. business matures in coming years and it fine-tunes its combination sales strategy, offering products through both its Web site and retail outlets. Einhorn concedes that square footage will drop by a couple percent a year. Still, he is encouraged by the Best Buy Mobile concept. Though rarely discussed, Best Buy is among the world's largest retailers of cellular phones, offering models from all major carriers, at stores and stand-alone mall kiosks. It was the first third-party retailer to start selling the Apple(AAPL) iPhone and iPad. Einhorn is also optimistic about Best Buy's international prospects, going forward.
In fiscal 2011, Best Buy generated 26% of its revenue from outside the U.S. However, the vast majority came from similarly developed markets, with 11% in Canada and 11% in Europe. China accounted for 3.9% of sales, presenting an expansion opportunity. Furthermore, with $3.1 billion of share repurchases [10% of the current float] slated for this fiscal year, Einhorn sees an upside catalyst for the stock, which, to be expected, is trading at a discount multiple. It sells for just 8-times Einhorn's 2012 earnings projection and offers an estimated annual free-cash-flow yield of 20%, assuming efficiency is achieved. The balance sheet is clean.
With $1.7 billion of cash and $1.7 billion of debt, Best Buy has a less-than-ideal quick ratio of 0.5, but a modest debt-to-equity ratio of 0.3. Quarterly return on equity, at 20%, and return on assets, at 7.2%, illustrate solid profitability. In Einhorn's camp isCredit Suisse, the most bullish global investment bank on Best Buy, ranking its stock "outperform" with a $42 target, suggesting a gain of 35%. Credit Suisse, encouraged by Best Buy's April analysts meeting, has a contrarian view on the company, whose stock receives positive reviews from an unimpressive 42% of researchers. Citigroup ranks it "sell" and expects a drop of 15% to $27 within the next 12 months.
Credit Suisse says the roadmap laid out by management is both credible and underappreciated. While guidance remained steady at the recent analyst meeting, management provided "a strategy for each segment of the business, from big screens to tablets, and a plan to improve return on invested capital through those actions, lower capital expenditure and higher share buybacks." Despite optimism, Credit Suisse expects Best Buy's stock to stay in a trading range until later this year, as a stabilization in comparable-store sales, expansion of share repurchases and success in mobile will attract investors. Valuation is the bank's sticking point.
The stock is at the very bottom of its 10-year range of earnings multiples, with a reduction in the float looming. Thus, Best Buy is historically cheap. The PEG ratio, a valuation metric that discounts predicted earnings growth, at 0.8, suggests that Best Buy's stock is selling 20% below fair value. In a market that is rife with froth, ranging from commodity plays like Freeport McMoRan(FCX) to cloud-computing darlings like Salesforce(CRM), Best Buy ranks as one of the few compelling value ideas. Other potential stock catalysts include: driving a higher penetration in appliances, pending Tablet Central segments in each store and improved margin negotiation with vendors.
Best Buy's gross margin widened from 25% to 26% in its fiscal fourth quarter, though the operating margin declined from 7.8% to 7.6%. Although Credit Suisse believes Best Buy's Internet business "is well below that of its competitors," it expects increased investment in that segment. The company's online order, in-store pickup strategy will likely have relevance, offering a way to expand store efficiency and boost sales without capital expenditure. Credit Suisse would like to see a more aggressive store-closure strategy, but doesn't feel it's yet a pressing issue, given initiatives. Best Buy announces fiscal first-quarter results June 14.
Wall Street forecasts a 9% drop in adjusted earnings to 33 cents and a 1% dip in sales to less than $11 billion. Although Credit Suisse's and Einhorn's respective bullish theses may not play out perfectly during 2011, both make compelling arguments for considering the stock at its current valuation. Individual investors should investigate Best Buy.
By John Gittelsohn
Bloomberg
May 9, 2011
More than 28 percent of U.S. homeowners owed more than their properties were worth in the first quarter as values fell the most since 2008, Zillow Inc. said today.
Homeowners with negative equity increased from 22 percent a year earlier as home prices slumped 8.2 percent over the past 12 months, the Seattle-based company said. About 27 percent of homes were “underwater” in the fourth quarter, according to Zillow, which runs a website with property-value estimates and real-estate listings.
Home prices fell 3 percent in the first quarter and will drop as much as 9 percent this year as foreclosures spread and unemployment remains high, Zillow Chief Economist Stan Humphries said. Prices won’t find a floor until 2012, he said.
“We get tired of telling such a grim story, but unfortunately this is the story that needs to be told,” Humphries said in a telephone interview. “Demand is still quite anemic due to unemployment and the fact that home values are still falling. And that tends to make people more cautious about buying.”
The U.S. unemployment rate rose to 9 percent in April, up from 8.8 percent in March, the Department of Labor reported May 6. Home prices have fallen almost 30 percent from their June 2006 peak, wiping out more than $10 trillion in equity, including $667.5 billion in the first quarter, Humphries said.
Dropping Home Values
Other analysts also expect homes to continue losing value this year. Oliver Chang of Morgan Stanley expects prices to fall as much as 11 percent, according to an April 25 report. Prices may fall “another 5 or 10 percent,” Robert Shiller, an economics professor at Yale University, said April 26 on Fox Business News. Home prices were 33 percent below the July 2006 peak in February, according to the S&P/Case-Shiller Composite 20-City Home Price Index, co-created by Shiller.
Prices will continue falling as more houses are lost to foreclosure, flooding the market with distressed properties, Humphries said.
Foreclosures fell to the lowest level in three years in the first quarter as lenders worked through a backlog of flawed paperwork, according to RealtyTrac Inc., an Irvine, California- based real estate information service. Foreclosure filings are likely to jump 20 percent this year, reaching a peak for the housing crisis, RealtyTrac predicted in January.
Las Vegas Highest
In Las Vegas, 85 percent of homes with mortgages were underwater, the most of any city tracked by Zillow. Other metropolitan areas in the top five were Reno, Nevada, at 73 percent; Phoenix at 68 percent; and Modesto, California, and Tampa, Florida, both at 60 percent. Zillow has tracked negative equity since the first quarter of 2009, when more than 22 percent of homes were underwater.
Property values rose in only three of the 132 regions tracked by Zillow: Fort Myers, Florida, where they gained 2.4 percent; Champaign-Urbana, Illinois, up 0.8 percent; and Honolulu, up 0.3 percent. Fort Myers prices increased after falling more than 60 percent from their 2006 peak because they “over-corrected,” Humphries said.
The first quarter’s U.S. home price decline was the steepest since the fourth quarter of 2008, when prices fell 3.9 percent, according to Zillow data. Values dropped almost 13 percent over the course of that year.
“It’s not going to be as bad as 2008,” Humphries said. “But it’s going to be worse than we thought it was going to be.”
‘Stealing Demand’
Prices were propped up in 2009 and early 2010 by federal stimulus programs, such as tax credits worth up to $8,000 for first-time homebuyers, Humphries said. That program “was stealing demand from the future,” weakening shoppers’ appetites now even as housing affordability is at its three-decade high, he said.
“In the past, people felt more bullish in a post-recession recovery,” he said. “They’d go out and spend more on homes and that would ignite hiring in construction and the mortgage industry. And they’d start to get the flywheel moving more quickly. Unfortunately, now, that flywheel is broken.”
30 years ago, Bunker Hunt, while trying to demand delivery for virtually every single silver bar in existence, and getting caught in the middle of a series of margin hikes (sound familiar), accused the Comex (as well as the CFTC and the CBOT) of changing the rules in the middle of the game (and was not too happy about it). Whether or not this allegation is valid is open to debate. We do know that "testimony would reveal that nine of the 23 Comex board members held short contracts on 38,000,000 ounces of silver. With their 1.88 billion dollar collective interest in having the price go down, it is easy to see why Bunker did not view them as objective." One wonders how many short positions current Comex board members have on now. Yet by dint of being a monopoly, the Comex had and has free reign to do as it pleases: after all, where can futures investors go? Nowhere... at least until now. In precisely 9 days, on May 18, the Hong Kong Mercantile exchange will finally offer an alternative to the Comex and its alleged attempts at perpetual precious metals manipulation.
From Commodity Online:
The Hong Kong Mercantile Exchange (HKMEx) has received authorisation from the Securities and Futures Commission and will make its trading debut on May 18, 2011 with the 1-kilo gold futures contract offered in US dollars with physical delivery in Hong Kong.
The ATS authorisation grants HKMEx the right to offer market participants, through its member firms, the use of its state-of-the-art electronic platform to trade commodities. The Exchange will begin trading with at least 16 members including some of the world’s largest financial institutions as well as several well-established brokerages in Hong Kong.
“We are very excited about this historic day. It allows us to establish a liquid and vibrant international commodities exchange based in Hong Kong, linking China with the rest of Asia and the world,” said Barry Cheung, chairman of HKMEx. “Global demand for core commodities has in recent years been driven by Asia, especially China and India. However, market participants in the region have had to rely on Western exchanges for price discovery, bearing the basis risk exposure in the process. Our new platform will offer Asia a bigger say in setting global commodity prices. It will also enable market participants to more actively manage their risk exposures, using products tailored to Asian market needs.”
HKMEx’s broking members at launch include BOCI Securities Ltd, Celestial Commodities Ltd, CES Capital International Co. Ltd, Chief Commodities Ltd, ICBC International Futures Ltd, Interactive Brokers LLC, KGI Futures (Hong Kong) Ltd, MF Global Hong Kong Ltd, Morgan Stanley Hong Kong Securities Ltd, OSK Futures Hong Kong Ltd, Phillip Commodities (HK) Ltd, Tanrich Futures Ltd and TG Securities Ltd. Its three clearing members are Interactive Brokers (UK) Ltd, MF Global UK Ltd and Morgan Stanley & Co International Plc.
And while the Chinese market is far more bubbly when it comes to gold and silver purchases, it remains to be seen just how happy a gambling addicted Chinese population will take to spurious and conveniently timed margin hikes that take the air out of the next parabolic move up in gold and silver (our guess is not very).
Far more importantly, the Comex monopoly appears to be over, and going forward the exchange will have to be far more sensitive about angering broad swaths of the population using 5 consecutive margin hikes in 9 days. The new exchange will also make the now traditional "banging the close" operation (or "banging the whatever" as the May 1 15% drop from $49 to $42 in minutes demonstrated) obsolete, as traders will have options of where to route orders from the hours of 0800 HKT to 2300 HKT.
Bottom line: if Chinese demand for gold and silver is as strong as it was a week ago, and it is, the recent Comex-directed plunge in precious metals is about to the BTFDed.
From the HKMex:
HKMEx is introducing a 32 troy ounce gold futures contract useable by a wide range of market participants to execute hedging, arbitrage and other investing strategies. Moreover, the HKMEx gold futures contract has the following important characteristics designed to meet the needs of a marketplace which lacks an international price-setting mechanism in the Asian time zone:
* Secure physical delivery in Hong Kong meeting international standards
* Trading execution on an advanced and robust electronic platform
* World-class clearing functionality
* Extended Asian day trading hours to tap into global market liquidity
* Contract specifications tailored to market participants in Asia
Gold is one of the world’s most important and actively traded commodities. Demand for the metal is driven by three main factors: the jewellery market, industrial manufacturing and financial investment. In addition, gold is relatively unique in that it is used as both a commodity and a monetary asset.
Although gold has a long trading history in Asia, the majority of price formation for gold is today concentrated in the North American and European markets. In recent years, the introduction of gold futures trading in Asia has tapped into latent trading demand that is primarily driven by strong economic development in China and India.
Hong Kong is historically one of the world’s leading gold centres and has a natural geographical advantage in Asia. Hong Kong’s vibrant financial infrastructure ensures access to leading market participants and deep regional and international pools of liquidity.
Trading hours for the HKMEx gold contract will extend from 0800 HKT to 2300 HKT, opening with TOCOM in Japan and encompassing the London Bullion Market Association AM Fixing, the opening of COMEX, and the LBMA PM Fixing. The HKMEx opening auction will run from 0730 to 0800.
While gold futures trading on Asian exchanges has demonstrated significant growth, there is currently no contract that is or will likely become a regional benchmark contract for gold pricing. Without a regional benchmark, true price discovery for gold is either confined to the local in-country market or must depend on the European or North American markets. In-country markets generally restrict foreign participation and often subject it to adverse currency restrictions or tax treatment. Meanwhile, global benchmark pricing from the western hemisphere provides imperfect hedging for Asia’s trading community.
HKMEx is well positioned to address the demand of Asia’s trading community for the establishment of a gold futures contract as the regional benchmark.
When you look at the profusion of new ETF’s being launched today, you find that they almost always correspond with market tops. The higher the market, the greater the demand for the underlying, and the more leverage traders bay for it. The resulting returns for investors are disastrous.
But occasionally a blind squirrel finds an acorn, and if you fire buckshot long enough, you hit a barn. That was the case a year ago when the corn ETF was launched (CORN), after five months of stagnant performance by the grain. I smelled a bargain for my readers, piled them into the ETF the day it launched, and caught a quick double in six weeks, just as the Russian fires were igniting.
I think that we are about to see a replay with the new ProShares Short High Yield ETF (SJB). After riding the bull move in junk all the way up with (JNK), I have recently turned negative on the sector. Junk bonds have moved too far too fast. Current spreads for junk paper are now only 400 basis points over equivalent term Treasury bonds, and investors at these levels are in no way being compensated for their risk.
If the stock market starts to roll over this summer, as I expect, then the junk bond market will follow it in the elevator going to down to the ladies underwear department in the basement. Keep in mind that when shorting the junk market, you run into the same problem you have with the (TBT), a leveraged short ETF for the Treasury bond market. Buy the (SJB) and you are short an 8% coupon, which works out to a monthly costs of 75 basis points. That is a big nut to cover. So timing for entry into this fund will be crucial.
By. Mad Hedge Fund Trader
John Thomas, The Mad Hedge Fund Trader is one of today's most successful Hedge Fund Managers and a 40 year veteran of the financial markets. He has one of the best performing newsletters and has just launched a new investment service for Investors and Traders.
A recent Q&A with Mark Mobius, Templeton Asset Management’s emerging markets guru, follows below, courtesy of the company’s monthly newsletter.
What are frontier markets?
Frontier markets are commonly used to describe a subset of emerging markets which have lower market capitalization and liquidity than the more developed emerging markets. More importantly they are markets that have not yet been “discovered” by the majority of investors. They are markets where there is limited research available to investors.
Frontier markets may generally be smaller and less developed than emerging markets, but they continue to experience strong economic growth and maintain a low debt-to-GDP ratio. They are where many emerging markets were 20 years ago. In the future, we expect these markets – at least some of them – to become quite important and to eventually become full-fledged emerging markets.
What is your rationale for investing in them and what’s the essence of your investment strategy?
Economic growth in many frontier market countries remains high and is even faster than some emerging markets and exceeds the growth in developed markets by a wide margin. The growth is not only economic growth but also growth in capital markets. Some of these markets are moving from small and illiquid status to large and liquid.
Many frontier countries are also leading producers of oil, gas and precious metals, and they are well positioned to benefit from the high global demand for these resources. Additionally, as the economies of frontier market countries expand, they continue to increase investments in infrastructure, offering valuable opportunities in the construction, transportation, banking and finance and telecommunications industries. Rising consumption provides these economies with strong purchasing power and the ability to spend their way into growth. Moreover, frontier market countries have been, and continue to be, positively impacted by the substantial investments made by large emerging market countries such as China, India, Russia and Brazil.
The economic drivers across frontier markets are diverse. For example, Botswana, one of the world’s largest diamond exporters, is introducing call and data processing centers. On the other hand, Kazakhstan, a country rich in oil and other natural resources, is seeing significant investments in infrastructure development. These varied economic themes across frontier markets ensure a diversified portfolio.
And why should investors care about frontier markets? Aren’t emerging markets already “risky” enough?
Frontier markets are actually not more risky than emerging markets or developed markets. Although there are a lot of uncertainties because of the general lack of knowledge among investors who don’t have the resources to study those markets, the actual risks are not significantly different from other markets. Although individual markets can be volatile, combined in a diversified portfolio they could be less volatile than a portfolio of developed market stocks.
How does the disaster in Japan (and potential slower growth from Japan), as well as the turmoil in Middle East, factor in one’s analysis of frontier markets?
The Japan and Middle East situations are not having any more impact on frontier markets than any other markets around the world. Of course, in the case of some of the Middle East markets there has been some volatility. However, the wide range of frontier markets going from places like Nigeria, to Vietnam and Ukraine means that events in, say, Egypt, will not have much impact on the other markets.
In fact, we continue to invest in Middle East companies that we believe will survive the current turmoil and prosper over the next five years. Generally speaking the “information revolution” where people of all walks of live and in every economic status can communicate quickly and efficiently with cell phone and through the internet means that it will be more and more difficult for corrupt and dictatorial regimes to survive. This is quite beneficial for the development of capital markets and particularly stock markets so we are quite optimistic regarding the Middle East. Emerging markets growth rates and per capita income are moving up at a rapid pace. As foreign reserves in these countries reach sky-high levels, and their safety profile continues to improve, perceptions about emerging markets also continue to improve. People are beginning to realize they’re not as risky as they seem. Moreover, there’s quite a lot of value in emerging markets, because earnings growth is keeping up at a rapid pace, so we still are finding opportunities.
Do events such as the instability in the MENA region make “investing” during these volatile times more attractive? Or simply more dangerous?
If you have good research on the frontier market companies, volatility can be very good since with panic selling prices can come down temporarily to very low levels enabling the patient and knowledgeable investors buy stocks cheaply.
What are the challenges of investing in frontier markets and how do you try to circumvent them?
While frontier markets offer a potentially attractive investment opportunity, an array of challenges also exists. Examples include poor information flow, illiquid stocks and sudden government policy changes. Frontier markets are subject to additional, heightened risks due to a lack of established legal, political, business and social frameworks to support securities markets. Relying on seasoned international fund managers who have demonstrated knowledge in navigating through these relatively new and volatile markets is essential.
Our emerging markets team has over 40 investment professionals working from offices in 17 locations. In employing Templeton’s ground-up investment approach, our local analysts are able to address such issues because they not only understand the local languages and culture, but they get to know the companies and the market environment by meeting with company management teams, understanding the impact of local regulations, and talking with local customers and competitors. Frontier market investing often requires additional time and due diligence to assess the quality of the management team including more frequent on site visits to evaluate the business effectively.
Which countries and sectors in frontier markets look interesting?
We do not favor any particular market but select stocks which are the most attractive across all markets. A look at the breakdown of our frontier market funds country investments will show where we are finding the most bargains at this stage. Currently, our largest exposures are to Nigeria, Saudi Arabia, Egypt, Vietnam, Kazakhstan, Qatar, Ukraine and Argentina. Liquidity is the key concern for most investors, so markets that are the most liquid could attract greater investment flows.
In terms of sectors, our focus has been on what we refer to as the two ‘Cs’: consumers and commodities. Middle class expansion and the deceleration of population growth has triggered rising per capita income and increasing demand for consumer products. This in turn has led to positive earnings growth outlook for consumer-related companies. We look for opportunities not only in areas related to consumer products, such as automobiles and retailing, but also consider services such as finance, banking and telecommunications. Commodities can offer another way to access the high growth trajectory of nations like China and India and take advantage of greater demand. We are look for companies that are strong producers of commodities such as oil, iron ore, aluminum, copper, nickel and platinum. While infrastructure development in emerging markets has led to continued demand for hard commodities, demand for soft commodities such as sugar, cocoa and select grains has also increased. Resource-rich countries in Latin America, too, are benefiting from increasing global demand.
How can investors get exposure frontier markets?
The best way for retail investors to get exposure to frontier markets is to purchase a frontier markets fund. We have two major frontier markets funds. The total assets in our frontier markets funds has grown to about US$1.5 billion, probably making us the largest frontier markets investor. Trying to invest directly for an individual market is simply not practical since access too many of the markets is complex and expensive for the individual.
Some brilliant Chicago-based exchange apparatchik just ask himself this simple question: "If it worked so well with silver, why not do it with crude?" The answer is here: the CME, as we predicted last week, just hiked initial and maintenance margins on Crude and Brent by 25%, as well as FX, and other petrochemicals. And, oh yes, this is prudent risk management, because while the CME kept margins flat when WTI was at $115, the massive spike from $97 to $102 is unbearably destabilizing. At this point one can only stand back and watch as the CME proceeds with hike after hike, in an absolute vacuum from the administration, which certainly had nothing to do with this decision. And really who cares: free capital markets died on March 18, 2009.
Some oil fields never die. In fact, some just get better with age.
Alberta's Duvernay shale may just be the best example yet.
It all has to do with the "shale revolution,” and how it's dramatically altering the energy landscape.
To be sure, large volumes of natural gas are being found in the least likely of places: Quebec, Michigan, even countries like Poland and Latvia.
That’s all well and good -- the world is finally cueing into the fact that cheap abundant natural gas will drive the global economy for decades to come.
Alberta has been a latecomer to the shale gas game, but that's about to change in a big way -- thanks to the emergence of the liquids-rich Duvernay play.
For weeks, speculation has been building that unknown buyers have been staking out a new shale play in Wild Rose Country, driving land prices at Crown mineral auctions to new heights. In fact the Alberta government took in $2.6 billion in the fiscal year ended March 31, which was an all-time high (but still far short of liquor, tobacco and video lottery).
Since last summer unknown bidders have paid as much as $35,000 a hectare for land (2.5 acres=1 hectare) in an area called Kaybob that normally sells for only a tenth as much. At an Alberta land sale in March unknown buyers put up the ridiculous sum of $107 million for a single parcel near Fox Creek, 260 km northwest of Edmonton, a sure sign that something is afoot in the hinterland.
This is Montney country, yes. But the sheer scale of the bids was enough to turn heads and set tongues wagging in the high skyscrapers of downtown Calgary. All that money for deeper rights down to the Devonian -- it could only be the Duvernay.
The Duvernay is noteworthy because it's the source rock for the original Leduc oil discovery in 1947. It's also a high-quality source rock for most of the crown jewel oil discoveries in Alberta over the decades, from the Swan Hills to the Keg River reefs.
It's the same rock that built an industry... a gift that keeps giving to this day.
The Duvernay is a spot-on, perfect example of a well-known play that could never be developed without the technologies we have today: the dynamic duo of hydraulic fracturing and horizontal drilling.
On April 19, Trilogy Energy Corp. (TSX-TET), along with partners Celtic Exploration Ltd. (TSX-CLT) and Yoho Resources Inc. (TSX-YO) announced test results from their second Duvernay joint venture well.
The results were quite strong -- 7.5 million cubic feet per day of gas. More important, the well yielded 75 barrels of liquid condensates and 56-degree API oil for every million cubic feet of gas, for some 1,250 barrels of oil equivalent per day.
If the crew at Canadian brokerage firm Peters & Co. was disappointed with the cost of the well -- $17.5 million including the fracs -- it was clearly impressed with the production numbers, especially the liquids content which amounts to more than 500 barrels a day alone (Do the match by multiplying by $100 a barrel). Peters thinks there are cost savings to be realized with full scale development, which is usually the case with these early stage plays.
In some ways, it could be the most important well drilled in Western Canada since the first Leduc discovery well in 1947. That's because the liquids, which are priced on an oil equivalent basis, are more than enough to make up for the relatively weak gas price.
Wellington West Capital Markets reports that the addition of those liquids effectively pushes the realized gas price up to $8 per mcf equivalent (mcfe), which is not bad at all, especially in the current market.
These are the kinds of numbers that draw attention of major players.
So it was hardly a surprise that Encana Corp. (TSX-ECA) came out the very next day and revealed itself as the mystery buyer of all those Duvernay rights, spending $300 million on land acquisition in the first quarter alone.
For a company like Encana -- North America's second-largest gas producer, the shift into liquids is a no-brainer after the haircut they took in the first quarter. As one of the most gas-levered companies on the planet, they have to do something.
And one look at the company's first quarter results tells the story: it barely broke even in the first three months of the year (thanks to effective hedging) compared to a $1.5 billion profit in the same period a year ago.
They're basically giving the gas away for free.
Encana CEO Randy Eresman practically said so much at the company's annual meeting in Calgary last week when he suggested the company could give away the gas and still make money on the liquids.
In that sense Duvernay is manna from heaven, and some serious good fortune for a trouble gas sector.
Plus, Alberta has a ready-made market for those liquids, which are used to dilute bitumen and heavy oil and make it flow through pipelines like the Keystone XL to the U.S. Those liquids have been in short supply in recent years, and there was even talk of importing them from offshore for use in the oil sands.
As I said, Encana shelled out $300 million on land acquisition, just in the first quarter.
It’s a big number considering there are only two published drill holes into the Duvernay – and neither one belongs to Encana.
The Duvernay is the hot new stealth play in western Canada.
Yes, it’s early stage, but Encana’s big purchase shows they believe it will be a highly profitable play – so profitable in fact, the big dog of Canadian gas could become a take-over target itself. As I mentioned, the Duvernay is the “source rock” where much of the oil in the Western Canadian Sedimentary Basin was formed – and then migrated upwards into the pools and traps that have been the discovered since the first Leduc well in Alberta in 1947.
Ironically, Encana quoted Trilogy’s test numbers as a benchmark of success even though it hasn’t drilled a single horizontal well into the play. In fact, it only has one vertical penetration to date, which it described as “encouraging.” Assuming of course, a company like Encana has enough clout to create “the economies of scale” needed to drive down costs. Indeed, it has shown it has plenty of muscle, even in a weak gas price environment, to do just that.
On a conference call to discuss its disappointing first quarter results, company officials raved that the Duvernay has the potential to be a “top quartile” shale play in North America.
Confidence or cockiness? Given Encana’s reputation as a low cost producer that has become a victim of its own success by unlocking tens of trillions of cubic feet of reserves, we’re going to say both. Let’s face it, they ARE a big part of the reason there’s so much gas around these days.
But what happens next is an investor’s dream. This could be a HUGE new play, like the Horn River in remote northeast B.C., but on a larger scale.
Except Duvernay isn’t northeast B.C. In the Duvernay area, we’re talking about good roads capable of carrying good crews and equipment to work each day. You can even get a good cup of coffee on the way there, and drive back home at night – no camps with extended absences from family. It’s a virtuous circle.
So here's the full tally:
• The Duvernay has an abundant and highly profitable natural gas liquids, to the point where Encana says it can give the regular dry gas away for free and still make money.
• There is lots of infrastructure in the area – pipelines, gas processing centres, and so forth.
• Several junior and intermediate producers already own dozens of sections each of Duvernay rights that haven’t been priced into their stocks yet (this is exactly what happened in the Cardium play in late 2009 and Alberta Bakken plays in mid-late 2010).
So which companies/stocks will likely benefit the most from the emerging Duvernay play?
Companies like Trilogy have been playing Kaybob and another area called Simonette for almost two decades. Almost by accident, it’s now the largest Duvernay land holder after Encana.
Trilogy is either going to become a big fish in a small pond or its going to get swallowed fast. Ditto for Celtic and Yoho, which might as well hang out the for sale sign and get it over with.
Other junior companies that could be ripe for the picking include Donnybrook Energy (DEI-TSXv) and Cequence Energy (CQE-TSX). Both juniors own more than three dozen net sections near where Encana bought a large acreage position for the Duvernay – Donnybrook is on both sides of Encana’s new package – Simonette to the west and BigStone to the east.
Even Encana has been rumored to be a takeover target for a super major like Shell, and its shares must look pretty cheap right at $30 or so, especially if it’s sitting on another Marcellus or Eagleford. Unlike Exxon, Shell has been sitting on the shale gas sidelines and it could be looking to make a move. Taking out Encana would probably be a $40-billion bite and undoubtedly one of the biggest corporate deals in Canadian history (hypothetically speaking, of course).
But it’s not just producers that stand to gain from a big shale discovery in Alberta. Considering this first well cost nearly $18 million to drill and complete, it’s a trickle down economy with all the attendant drilling, completion and transportation stocks having nowhere to go but up.
Even if producers can get the all-in well cost down to $15 million or even $10 million, all your favorite drilling stocks, Precision Drilling Corp. (TSX-PD), Trinidad Drilling (TSX-TDG), and Ensign Energy Services (TSX-TSI), are going to reap the benefits of this next drilling boom.
Along with all your pressure pumpers and frack masters, the Calfracs (TSX-CFW) and Flints (TSX-FES) of the world, whose pumper trucks are the key to making unconventional gas a viable proposition.
And unlike Quebec or New York, even the politicos will get on board this train.
Given that the Alberta government had the scare of its life when its ill-conceived royalty changes just about scared every rig out of the province three years ago, it isn’t eager to make the same mistake twice. The bean counters in Edmonton are probably toasting their good luck about the Duvernay now, because this is the kind of tide that raises all boats, including theirs.
The Duvernay is the gift that keeps on giving. Only now, it’s going to be giving directly to investor’s wallets.
By. Keith Schaefer
Unless you have been hiding under a rock, you probably know that silver has had a major correction over the past week. The precious metal plummeted about 30% from a high of almost $50 an ounce to less than $35 yesterday. This six-day drop is one of the largest since 1983.
Silver has given back just about all of its gains for the past month and some traders are thinking it might be time to get long. But before you run and buy silver, there are a couple things to consider.
There are many theories on why this sell-off is happening. Obviously, any real strength or even support in the U.S. dollar will generally be bearish for precious metals like gold and silver. This is mostly because the U.S. holds the largest stockpiles of these metals and they are traded in U.S. dollars globally. Even though gold is more of a recognized currency, they both have sensitivity to changes in the U.S. dollar's value.
The falling U.S. dollar has recently leveled out. That means we've seen a small correction in dollar-denominated commodities and metals overall. Earlier this week, the European and London central banks held their rates steady. The ECB also hinted that they may not raise their rates next month either. This is good news for the U.S. dollar.
The U.S. dollar traded higher late in the day yesterday and sent other dollar-sensitive commodities like oil and even stocks much lower on the day. Oil had its largest percentage drop in three years. If you don't believe that the dollar is in control here, think again...
For now, it seems that the U.S. dollar will continue to be relatively weak. The rally seems more like a short-term bump rather than a long-term trend. Current Federal Reserve policy puts general downward pressure on the U.S. dollar.
Then there is the historical ratio between gold and silver. A good "average" ratio of gold to silver is about 55, according to many experts. That means 1 oz. of gold should buy 55 oz. of silver. The gold premium is because there is much more silver on this Earth than gold. Even though silver has industrial uses beyond gold, there is a global desire, respect and currency reserve with gold that silver just does not have.
If that ratio gets extremely high, like 100, that means that silver is cheap relative to gold and may be a good value. If the number is low, silver may be getting overly expensive.
On April 28, the gold-silver ratio was about 30, relatively low. Now the ratio is back up around 43, still low, but not extreme. I'd like to see that ratio above 48 if I were thinking of buying.
Using current gold prices of $1,494, that means a drop in silver prices to $31.12 an ounce. Remember, though, that ratios are a two-way street. That means gold prices can climb, too, putting the ratio closer to its "good average."
(Sign up for Smart Investing Daily and let me and fellow editor Sara Nunnally simplify the market for you with our easy-to-understand articles.)
Technical formations also play an important role in finding buy and sell points. Looking at iShares Silver Trust (SLV:NYSE), you can see the sharp sell-off on the right side of the chart. In my opinion, it seems that we are nearing a short-term bottom. The lower Bollinger band (gray area) was just broken yesterday, as prices dipped below the lowest level of the band. This is generally an indicator of an oversold condition just before a bounce.
I also would look to the 50% Fibonacci retracement line (dotted) of about $33 for support. (For more info on Fibonacci retracement lines, read this Smart Investing Daily article.) The danger here is the fact that we have broken below the 50-day moving average, which is not good for the bulls. To solidify a strong trend, I would like to see the price of SLV get above that 50-day moving average, at about $38.
You can't simply view the charts in a vacuum. There are other things "manipulating" the market.
The manipulation here is the recent 500% jump in margin requirements for silver futures. When you buy a futures contract on silver (one futures contract is for 5,000 ounces of silver), you are required to put up a deposit called "margin." That initial cost has risen tremendously as of late. They have also raised the amount of margin you have to pay once you are already in the trade and it starts to go against you.
If traders cannot meet the new margin requirements, they are forced to sell their contracts. This new rule will deter new buyers.
It's like someone raising your rent from $1,000 to $5,000 in a month. Higher margin requirements can also make a sell-off worse, as contracts are sold to cover losing positions. These requirements affect everyone from individual traders to hedge funds. This is one of the main reasons why silver is making 10% moves daily.
Now in all fairness, the dollar cost of margin will rise as the price of silver rises, but the CME (COMEX) has increased the margin requirements abnormally in the past week and will raise them again Monday.
May traders are selling ahead of this hike.
ETFs like the SLV hold actual silver and futures contracts. At present there are about 600 million ounces of silver held by ETFs. When traders begin to sell shares of an ETF like SLV, the ETF may sell silver futures to keep everything in balance. About 6 million ounces of silver have exited ETFs in the past week.
ETFs can also add to the domino effect, both long and short. But remember that stocks usually take the escalator up and the elevator down!
Once the hype settles down and the CME completes its margin increase on Monday, we should see silver prices stabilize. From my perspective, I see $33 as a level I may cautiously begin to buy. If silver breaks below that level, I think support will be around $29 until the Fed decides it's time to cool inflation.
I am sure that Ben B. was feeling quite happy with the corrections in gold, oil and silver this week. Perhaps Americans will feel some reprieve as well...
Editor's Note: Silver ETFs may be taking a big hit with these margin increases, but they're not the only way to play silver right now. Michael Robinson, editor of 180 Trader, has been riding the silver bull, and this most recent drop might give his subscribers another great opportunity. For more information on silver and the companies Michael's been recommending, check out 180 Trader.
