Tag Archives: alternative

NYSE Crackdown On… You

Summary The NYSE thinks it knows what is good for you. It is going to ban a number of current trades. Some I like and others I don’t, but none should be banned. The NYSE vs. Traders The New York Stock Exchange (NYSE: ICE ) did not like what you did in August. There was all kinds of nonsense what with the buying and selling and prices going this way and that the exchange plans on cracking down early next year. Specifically, it is concerned with “price swings”. It is not taking it any more. To that end, the exchange is banning a number of popular trading tactics starting early next year. Scapegoat #1: Stop Orders On August 24, 2015, there were some such price swings in securities including JPMorgan (NYSE: JPM ) and General Electric (NYSE: GE ). One of the first scapegoats was the “stop-loss order”. A stop order is an order to place a market order once a given price is reached. For example, someone could buy a share of GE at a $30 per share with the instruction to sell it at whatever price one can get if it first goes beneath $25. While fewer than 0.3% of NYSE trades are such orders, they were thought to compound the problems in August generally and the 24th in particular. I have never made a stop order. I am certain that I never will. If I want to sell something at $25 that currently costs $30 I would not buy it at $30. That ends my interest in making such orders. But I am delighted if other people want to. In fact, many of the things that would drive a given price down to people’s stop-losses are what might interest me in buying. My colleague Andrew Walker says that he looks for opportunities, “where no one else is looking or where everyone else is panicking”. If people want to sell because a price is lower, that is fine with me. I am grateful for the liquidity in just such circumstances. In short, I try to avoid panicking, but I am staunchly pro-panic. Scapegoat #2: Good Till Canceled Orders The NYSE’s second boogeyman is the good till canceled order. Unlike stop-losses which I never use, I always use good till canceled. The distinction of one trading day versus another is wholly arbitrary to me. Essentially, I am completely price-sensitive but time-insensitive. If I find something that is meaningfully undervalued, then I want to buy it and I will still want to buy it on Tuesday. Yes, I could keep re-typing the same offer each morning at 9:30 AM, but why? If your investing philosophy is as antithetical to mine on GTC orders as it is on stop-losses, then you should be delighted with my participation in the market. I am a liquidity provider to price-insensitive/time-sensitive traders who want to exploit momentum or candlesticks or whatever. The Real Solution You might be a fan or foe of these tactics (I use one of the two). But that is not the important point. If you don’t like using them, then don’t. If you think that someone using one or the other puts himself at a disadvantage, than take the other side of the trade. But what should the exchange do if they want rational, transparent, undistorted pricing? Nothing. Get out of the way. The best, fairest, fastest solution to getting good prices is allowing for bad prices. If a share trades of JPM or GE at $0.01 per share or $1,000,000 per share, then let the trade go through. Enforce all private contracts as they are, not as the probably should be. In the Great Depression, Herbert Hoover recalled Andrew Mellon’s advice, liquidate labor, liquidate stocks, liquidate farmers, liquidate real estate… it will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up from less competent people. In short, the solution to a high price is a high price and the solution to a low price is a low price. The worse thing that a government or exchange can do is to interfere with the market’s functioning so that prices are distorted. If they see an “unfair” price that is, to them, too high or too low and put a stop to it to protect one or the other party to the transaction, then they will discourage future market participants from correcting such anomalies. As for me, I buy or sell only when there is a price that is “wrong” and even “unfair”. My entire business is built around exploiting anomalies in the price system. Why would anyone ever want to pay a “right” or “fair” price? The provision of liquidity to the capital market requires the active participation of such exploitative characters. Is this selfish or unsavory? No. It is what allows people to rush out of the market if they are in a rush. It is what allows others to avoid risks that they are ill-suited to judge. It is what allows foundations and pensions and other important investors to provide for their beneficiaries when they need to. What is selfish and unsavory is when market participants demand a bailout. What they mean is that they want a do over at a price that they can live with. If they want a bailout, I am more than happy to offer a bailout as a market participant at a market price. I particularly like bailing out counterparties during maximum chaos and uncertainty. There is a perfectly functional, liquid market. Of course that is not what they mean. They do not necessarily like my price but instead want more money for themselves because they, er, um, just really want it. How is that not selfish? The market itself is the world’s fastest, most efficient and even ruthless regulator. People selling JPM or GE for $0.01 will have a whole lot less influence on markets in the subsequent days. People diligent enough to scour the markets for opportunities to buy during such opportunities will be enriched. They will increase their subsequent influence over the markets. They will motivate themselves and others to correct such mispricing in the future. The bureaucrats in the NYSE are too far away from the floor to realize that they are looking at a problem that is its own solution. Prices are supposed to swing. If you don’t like it, just let them swing and wait. If you do not distort the markets, they will swing back. Stability is a side effect of a freely functioning market, not something that can be achieved by artificial manipulation.

Dollar/Yen As A Hedge To Oil Investments

Summary Oil and oil companies seem like attractive bets, however there are many near term risks. In an environment of persistent low oil prices, the BOJ has assured continued QE or increases in QE. The dollar has an inverse correlation to oil, therefore a dollar hedge allows for a pure supply/demand bet on oil. The case for being long oil (NYSEARCA: OIL ) has been made numerous times on this website and others, but I will recap a few of the salient points here for completeness. Oil may be attractive from a supply point of view. Most of the new supply that led to the recent glut came from shale oil wells in the United States. In fact, oil production from other sources of world oil actually declined during the period from 2012 to 2014. Source: Resilience.org Shale oil wells have rapid decline curves compared to conventional wells. Source: oilprice.com As shown above, the production rate is a small fraction of the initial production by years 2-3. Therefore, we ought to expect that roughly two years after oil rig counts began to decline, the supplies of crude oil ought to begin to fall rapidly. However, the timetable for this recovery in oil price has been delayed due to the fact that several E&P companies were slow to stop drilling. In a last ditch effort to produce cash flows from their land, many companies continued to drill even at unfavorable prices. Source: marketrealist.com Though crude began to fall in July of 2014, companies didn’t start reducing rig count until many months later, and rig counts didn’t reach the current lower range until the spring of this year. This led to a situation where US supply didn’t start to roll over until the beginning of this year. Despite the drop in rig counts, the supply coming out of US shale is still higher than it was at the start of the crash in oil prices: Source: QuintoCapital.com This makes for an interesting situation of time arbitrage. The sharp decline in shale wells, combined with a lack of new drilling in the U.S., means that by 2017 (2 years from the peak shale oil supply seen in the above chart) the U.S. supply should be low enough to begin to positively affect oil prices. Investors who are convinced of the above argument may take a long position either in the commodity (via futures) or in specific, cash-rich E&P names that are unlikely to go bankrupt, and wait out the supply-demand imbalance. However, there is a danger in catching a falling knife – commodity speculators are currently riding the trend for lower prices, and stock traders are following suit with oil stocks. In addition, there is a risk that the oil supply/demand mismatch may worsen when Iran brings new production online. A long position in oil or oil stocks could pay off eventually, but lead to disastrous portfolio results in the meantime. Therefore, it is desirable to hedge such a position. The Case for Shorting the Yen ( YCS ) Japan’s central bank, unlike the Federal Reserve, uses a measure of inflation that includes the cost of energy. Thus, the fall in oil prices has set back its goal of ending deflation. Though Haruhiko Kuroda has been insisting that this is a temporary setback, one must consider what would have to happen for an investment in a cash-rich E&P firm to go poorly – namely, we would have to see much lower oil prices before the supply glut ends. Take a look at comments Kuroda made earlier this year (emphasis added): “…however, based on the assumption that crude oil prices are expected to rise moderately from the recent level , the CPI is likely to reach 2 percent in or around fiscal 2015. Needless to say, the Bank maintains its policy stance that it will make adjustments as necessary without hesitation, when there are changes in trend inflation, in order to achieve the price stability target at the earliest possible time. The Bank will not respond to developments in crude oil prices themselves, but in conducting monetary policy, it will closely monitor how they affect inflation expectations — or, in other words, whether conversion of the deflationary mindset will nevertheless proceed.” And, more recently, “The timing of reaching the inflation target depends on oil, he told reporters in Tokyo. Kuroda, 71, reiterated that the BOJ won’t hesitate to adjust policy if necessary.” And “Kuroda said he didn’t see limits to further policy steps, amid concern among private analysts that the BOJ’s campaign — mainly purchases of Japanese government bonds, or JGBs — is running up against constraints. He didn’t think a limit on buying JGBs would come soon.” The latest inflation numbers for September showed inflation at -.1% , a far cry from the 2% goal. While Kuroda stated that the BOJ will not specifically respond to oil prices, lower oil prices are bound to continue to bring down inflation expectations. I take the above comments as basically an assurance that as long as oil prices stay low, the BOJ will continue its QE program, and if oil prices fall further, there is a high likelihood that the BOJ will ramp up its QE program yet again. The Case for Being Long The U.S. Dollar There has been a strong inverse relationship between the dollar (NYSEARCA: UUP ) and oil: Source: quintocapital.com This correlation makes sense: because oil is priced in dollars, the strong dollar has contributed to the fall in oil prices. While Japan has been concentrated on stepping up its QE program, the US Federal Reserve has basically told market participants that it plans to raise rates in December. This divergence in policies is driving the USD/JPY higher, and the oil price lower. So going long the dollar in addition to being long oil provides investors a way to play oil purely for its supply-demand characteristics, rather than its aspect as an alternative currency. A word about China There has been a perception that the crash in Chinese stock prices will lead, or already has led, to weakening oil demand. However, the opposite is actually true – Chinese oil demand is actually up 9.2% year-over-year , as lower prices have stimulated demand. As Stanley Druckenmiller said earlier this year , the cure for high prices is high prices, and the cure for low prices is low prices. Putting it together I think there’s a strong case out there for being long oil right now. However, there is always a risk that the fall in oil could become overdone, and we could see oil prices that are in the $20-$30 range before we see prices in the $60-70 range. In order to hedge this volatility, I think there’s a good case for being long the US dollar, specifically against the yen, which will devalue further if oil either stays low or drops further. Any thoughts are always appreciated.

TransCanada – It’s Not The End Of The World, Rather A Buying Opportunity

The president has finally rejected TransCanada’s Keystone XL pipeline. The decision seems more political than economical, but it is bad for TransCanada which has already spent $2.4 billion on the project. Although the market has been focusing on the future of Keystone XL, TransCanada has other projects in its pipeline that could fuel its growth in the coming years. Energy East could be the biggest growth driver in the long term, but the management has laid emphasis on a number of small projects. Earlier this month, the Obama administration finally rejected TransCanada Corp. (NYSE: TRP )’s Keystone XL pipeline on the grounds that the project was not in U.S. national interest and could reflect poorly on the country’s global leadership in protecting the environment. The decision, which was widely anticipated, finally concludes TransCanada’s seven-year efforts in getting an approval for the 830,000 barrels a day pipeline from the current administration. The decision seems more political than economical. It is difficult to imagine how a 1,179-mile pipeline spread over six states which would have mostly carried crude from Canada’s oil sands, but also up to 100,000 barrels a day of North Dakota oil, to Gulf Coast refineries would not lead towards meaningful economic benefits for the U.S. and Canada. Besides, the State Department’s environmental review , released in Jan. 2014, had already stated that the construction of the pipeline will not have any substantial negative impact on the climate. On the contrary, the rejection could increase the Canadian oil sands producers’ reliance on rail for delivering the crude to the U.S., which is far more carbon-intensive than the pipeline. Nonetheless, the decision is bad for TransCanada which has already spent C$2.4 billion on the project. A significant chunk of the expenditure could be written off as non-cash pretax charges in the coming quarters. The investment which related to the physical pipeline and equipment, however, can be utilized on other projects. As I have discussed previously , TransCanada has several options on its table following the rejection. The company can seek remedies under the energy chapter of the North American Free Trade Agreement, construct a rail loop that would connect U.S. and Canadian pipelines, or simply wait until a new U.S. president arrives in 2017 and then file another application. However, it is also important to note that the rejection is not the end of the world for TransCanada. Although the company’s stock declined 5.2% on the day of the rejection and has failed to completely recover completely since, I believe this could be an interesting buying opportunity. Although Mr. Market has been largely focusing on the future of Keystone XL, TransCanada has several other projects in its pipeline that could fuel earnings and cash flow growth in the coming years. This includes the giant Energy East pipeline which is bigger than Keystone XL in terms of investment, capacity and impact on the bottom line. Energy East, which comes with a price tag of more than C$12 billion as opposed to Keystone XL’s C$8 billion, will be able to ship up to 1.1 million barrels of crude per day from Alberta to Eastern Canada. Once Energy East becomes fully operational by 2020, it can lift TransCanada’s annual earnings (EBITDA) by C$1.8 billion. Keystone XL, on the other hand, was supposed to generate annual earnings of C$1 billion. Overall, excluding Energy East and Keystone XL, TransCanada has a backlog of C$15 billion of commercially secured major projects that can lift its annual earnings by more than C$1 billion in the long-term, according to my rough estimate. Energy East pipeline What’s even more interesting is that during the recently held investor day (Nov. 17), TransCanada emphasized that in addition to the major projects, it also has a C$13 billion backlog of eleven smaller projects, none of which require investment of more than C$1.4 billion, which will drive its growth over the next two years. Some of these projects, such as the Houston lateral and terminal, Topolobampo, Mazatlan and Canadian Mainline, will begin to contribute to earnings in 2016 while some of the bigger ones with capital cost of at least C$1 billion each, such as the liquids pipelines Grand Rapids and Northern Courier, will fuel earnings growth beyond 2016. Overall, the small and large projects are forecasted to drive 8% to 14% increase in annual earnings through the end of the decade. This will lead towards an average of 8% to 10% increase in dividends in each year through 2020. That’s higher than the CAGR of around 7% witnessed over the last fifteen years. Thanks to the recent drop following Keystone XL’s rejection, the stock is already offering an attractive yield of around 5%, which is higher than the industry’s average of 3.2%, according to data from Thomson Reuters. I believe the recent weakness could be an opportunity to buy this pipeline stock and earn strong returns in the long-run.