Monday, June 24, 2013

If I was a millionaire I’ll be buying…

Not much. Barenaked Ladies may know how to write cute songs, but during these days of low interest, a million doesn't buy you a lot, unless you like Macaroni and artificial Cheese. So say you are one-and-a-half millionaire. Say you are a retiree with a paid off $500,000 house and a $1 million dollar RRSP which you have in a 1% savings account.

Oh my God, the rich guy makes an incredible $10,000 per year. That is not enough to live off! Oh, and to top it off if you take it out of the RRSP you have to pay income taxes on it. Thank G that you have a personal deduction of $17,000 but... oops, there is also inflation of 1.5%.
Well, at least the retiree has a home to live in with only $3000 per year in property taxes not to mention maintenance costs of another $2000 to $3000. This is in a nut shell the dilemma many retirees face. They saved during their younger days like Dagobert Duck. However today, they don't make enough to take a bath in the vault.
Blame the central banker who has ‘rescued’ the economic system and Wall Street Bonuses at the expense of these ‘rich’ retirees. To make matters worse, the younger generation blames these 'retirees' because the Canada Pension coffers are near empty and the youngsters feel that they have pulled the short straw in that Ponzi scheme. Even worse, because those old fogies can’t afford to retire, they keep jobs from younger people and don’t even have the decency to die and take off to heaven! There is health care in action for you!
Then you have all those seniors that didn’t even come close to saving a million for their retirement! Yes, I am talking about the parents of you youngsters! Those same ones who took you on vacation as kids; who bought you your first computer with Reader Rabbit and Treasure Mountain. Who fed you and helped you through university and through life in general. You call that fair?
In the meantime, fat cat central bankers like Bernanke and their cronies at Goldman Sachs or in the Whitehouse are telling everyone that they should save more and buy & hold while recommending to 'tax the rich'. Then when a factory collapses in India, the customers at Wall Mart are the guilty ones. Strange world we’re living in!
So, you may be afraid of inflation, but why? Some inflation is part of a better economy; finally, we’re losing our artificially low interest rate environment. Yes your dividend paying stocks may decrease in value, however, I think that it is very unlikely that Coca Cola, Johnson & Johnson, or the Royal Bank (to name a few) will stay down for long.  When the economy is picking up enough so that interest rates will normalize, chances are that we will be drinking more coke, buy more baby shampoo and we’re putting more money into GICs so that banks can sell even more mortgages. Chances are that corporate earnings will outpace or at least keep up with rising interest costs and so will dividends.
Really, it is about time that interest rates normalize and that we get returns exceeding inflation on our GICs and other fixed instruments. Yes, long duration bond holders will suffer, but don’t tell me they haven’t been warned for the last four or five years that we’re at the very top of the bond cycle. The real miracle is that it took so long for yields to go up. If you still own long term bonds sell them because there is only one long term trend: down!
For the near term stay in cash and sell your riskier, uncertain stocks. Hold on to your dividend aristocrats. In 3 to six months, you can start buying short term fixed income and possibly variable rate GICs or 1 year GICs with a yield of 2 to 3%. Then keep on turning them over upon expiry and you may out do inflation. Remember though the tax man, do this within your RRSP or your tax free savings account. We had a 30 year bull market in bonds but now we’ll be starting a long term bear market. So stick only to short term (less than a year) fixed income. Hopefully that 1 million will make $30,000 per year or better in the near future.

At least silver is used for something else than just looking pretty.


What’s going on with this market?  Are we already in a bear market? Is the market finally realizing the enormous debt levels of many governments and is it throwing in the towel? What about the collapsing gold prices?
Well….  I don’t know. I have a suspicion that things are really not that bad. After 5 years of excessive stimulation and artificially low interest rates, central bankers are finally considering that the economy is getting strong enough to take the foot a bit of the gas pedal and maybe, maybe, they're even considering reducing the bond buybacks, Awful!  Terrible! Sell, sell, sell!… Really, are we’re that addicted to whining and to rock bottom interest rates?  
Well, maybe. I have been selling some stocks, but not because we’re reaching yet another 'end of the world'. There are many who still think that all that government debt can only result in one thing: the collapse of fiat money and an explosion in the value of gold. In particular the skyrocketing of physical gold prices as opposed to ETF (paper) gold.
True, the ETF story is scary, but Ladies & Gentlemen, gold prices have collapsed to nearly $1200 where is the inflation? Hmmm... must be reflected in the price of oil then! What about the U.S. dollar which has been on a tear? That is not exactly the result of the collapse of fiat money. Oh yes! Of course!  All other currencies are collapsing that is why you don’t see the effect right away.  Yes?  To be honest, that makes no sense to me.
My guess, is that we’re suffering from artificially low interest withdrawal in an increasingly stronger economy and in the U.S., Central bankers are finally starting to timidly take away excessive stimulus; something the gold bugs wanted for years if not all the way back to the 1970s. Now that they get what they said they wanted, they’re not happy because their gold price is collapsing. This gold stuff is worse than tulip bulbs – those can at least be used to grow more tulip bulbs. He! Did you ever see a gold nugget grow gold dust?
So the economy is strengthening, although China is having some domestic trouble. Irony over irony, maybe China’s banking system is not as safe as you might assume in a country that is the largest U.S. creditor nation. Is China the real bubble as suspected on this blog in earlier postings? May I be so bold as asking whether the Chinese government will survive an economic set back?
With energy supply so abundant and secure in North America are we seeing a revival in our manufacturing sector? How does the productivity of a North American worker compare to that of an Chinese worker? Does that combined with higher transportation costs, lack of resources, less transparent accounting, hidden leverage, hidden state subsidies and overcapitalization offset the Chinese advantage of lower labor costs? How long can the world’s third largest economy (after Western Europe and the U.S.) keep on growing at absurdly high rates? Something must give… and right now China is giving a bit.
That the North American economy is improving is good for us. We now have affordable energy, in particular natural gas, less dependency on OPEC oil, a recovering housing market and high tech and pharmaceutical industries that are finally freed from the excesses of the late 1990s. My guess: North America is about to take off with a roughly shaken Europe not far behind.
Yes I sold shares during this correction, so that I have cash for the bargains. BTW, I wouldn’t be so hasty selling off those dividend growers; because they often are solid companies that also grow at a respectable clip in a higher interest environment. Do you really think that TransCanada pipelines will become less profitable when North America is screaming for pipeline capacity?  Do you really think that shopping mall values (RioCan) will decline in the face of a healthier economy and some inflation? What about insurance companies; don’t they get their float for free and make more money when interest rates rise?
What about all those pensioners who will be able to make some real returns on their cash? Did you think it was so easy for them during the years of zero interest rates?  Yes, the economic winds are about to change direction again but not necessarily for the worst as the markets lately seem to think. Even gold and other commodities that have so severely deflated over the last couple of years are likely not far from a comeback. So hold on to your seats.  BTW, I prefer silver over gold. At least silver is used for something else than just looking pretty.

Sunday, June 16, 2013

What's happened with Peak Oil - evolution of an idea!


Peak Oil is not a lie, but it is an idea attempting to describe how things are. The idea of peak oil has evolved. It is true that the world is not likely to run out of energy any time soon. Heck, the energy revolution of multistage fracking in horizontal wells has ensured that. But at what price?
Financial forecasters and newsletter writers tell us that the U.S. may become self-sufficient in oil supply. Wouldn’t that be wonderful! No more worrying about Middle Eastern instability; no longer will the U.S. need to support dictatorships; more control regarding the environment and… a significant reduction of the U.S. trade deficit and possibly even its debt.
The land locked position of this new oil and natural gas will also help to keep prices down, because pipeline capacity and limited refining capacity will force those greedy produces into low-profitable oil sales. Right?  Maybe… but what about frac-spreads for refineries and government taxes? Did you notice that gasoline prices haven’t really moved down?
I work in the oil industry, I am a professional geologist. So let me tell you that the oil patch is exceedingly complex with numerous sources of supply, ways of transportation and even more ways to consume oil. It is very difficult to get a proper view on the natural gas and oil situation and it is extremely difficult to forecast and survive this capital intensive, hyper-competitive industry. Anyone who is telling you that oil and gas prices are fixed by big fat nasty oil barons should think twice before actual believing this nonsense.
Anyone who truly believes that the U.S. will become self-sufficient in its hydrocarbon supply should ask themselves critically whether they’re serious in that believe. Because if so, then why has the price of oil not crashed during these so-called weak economic times?
Yes, today, new horizontal wells have increased North American oil production to close to all-time highs. The question is for how long and how expensive? You see those new oil wells start production fabulously. A single well may produce 30,000 barrels in a year – nearly 50% of what older vertical wells produced over their 40 year or longer productive life.   But most of that production comes only from the first 3 to 6 months. A year later, production has fallen from initially 300 barrels or so per day to barely 10 barrels. The technical lingo states that these wells have a high decline rate. Yeah, Duuh! These horizontal wells may decline nearly 90% in production rate over the first year and if the capital invested has not been earned back over that first year, the company that owns the well may never make a profit on its investment.
Thus, say in year 1, a company drills 100 wells and sees its production skyrocket by 300x100 = 30,000 barrels a day. It must replace 90% of that 'new' production in year 2. With a 90% decline rate, the company has to drill the following year 90 similar wells, just to keep production constant. If it wants to grow production by another 30,000 barrels it will not only have to drill 90 wells; instead it must drill 190 wells. Considering that each well costs approximately $3 million to drill, complete and tie-into the pipeline system, the company needs to invest close to $600 million dollars in that 2nd year. Do the math for year three if you want to experience shock! You think that can be done at an oil price of $40 per barrel?
Just think, after operating costs and royalties in Alberta of $15 to $20, each barrel brings in $20 to $25 dollars in cash (called net-back). How many barrels do we have to produce to pay for a well costing $3 million? Right: 120,000 barrels – oh but the well does only 30,000 barrels in the first year. So at what oil price do we break-even, let alone make profit? $90?
Let’s see: Royalties go up with the oil price. So at $90, our operating costs (including royalties) is $40 per barrel and net-back is thus $50. To make back our $3 million, we have to produce: 3 million divided by 50 equals 60,000 barrels in one year! These are just rough numbers but I am sure that have gotten the idea.
Peak Oil may not be correctly describing current production, but if oil prices would fall below $70 per barrel, we would not have many companies drilling in what is euphemistically called the ‘oil resource plays’ of the Bakken and Cardium in Alberta or, for that matter, in the resource plays of North Dakota or Texas.
Multistage fracking and horizontal well technology give us economically viable projects in reservoirs that are literally as porous as concrete. Such reservoir rocks have the capability to flow oil to a nearby wellbore that is less than the aforementioned concrete. The old conventional pools are no more. If you want to see such a pool close-up then go to the outcrops along Grassi Lakes in Canmore, Alberta where the rocks have holes (pores) so large that you can put a fist in it. That is what the first wells in Alberta’s 1947 LeDuc were like. Today, in resource plays the size of a pore is typically 0.5 micrometers (that is one half of 1/1000 millimeters) in diameter.
Only today’s oil pricing and technology allow the oil industry to keep our car tanks filled and our houses heated, and our factories running. Next time, you step in your car; think about this new reality and about what your lifestyle costs in terms of environment. Maybe don’t blame the oil companies that try to keep on providing energy at the most competitive prices so that you can keep forgetting to turn the lights off in your house.

Jim Rogers versus the Man-With-Bread

It is August 2017, after having overcome yet another major financial crisis and having survived another devastating bird flu epidemic, Jim Rogers flies first class across the ocean in a sparkling NetJets’ plane chartered from his buddy WB. Suddenly a small explosion and the GE turbine on the jet failed. The plane crashed into the tropical ocean. Jim grabs a gold bar and efficiently abandons the plane. No panic, he has meticulously examined the flight path and knows that he is within 100m from an uninhabited island.

Competently Jim with his gold bar reaches the pristine shores of the island where he finds a fellow survivor who had grabbed a bread prior to his escape from the crashed jet. Jim says, "I am hungry, here take my gold bar, the universal currency of the world, in exchange for your bread."
The Man-With-Bread laughs and says ‘No Way, I cannot live of gold, but I can eat bread and survive a bit longer. Hahaha, what is your gold worth now?” Jim Rogers picks up his gold bar and bashes the head of the Man-With-Bread until the sucker is dead. “Hahaha… “ , says Jim, “Now I own the gold and the bread! That is at least a 100% ROI!”
A week later, after consuming the last bread crumb, Jim dies from thirst and starvation. He lost 45 pounds during those last 7 days and was considering selling his new Jim Roger’s diet for a healthy profit. But alas! Now even Jim is gone.
At that moment a mud crab crawls onto  the beach and starts to nibble on Jim’s left toe. The crab smiles and says to itself: “Hahaha. I am the richest crab around here”. But you and I know that crabs cannot really talk nor think – they have no brains after all!. Shhhh… don’t crush the crab’s self-esteem!
At that very moment a Japanese fishing trailer comes by and scoops up the mud crab in its fishing nets. The Japanese empress who owns the trailer mutters to herself, “Hahaha, who is now the richest nation in the world? BTW there’s oil below this island and we’re going to use it to fuel our society’s economy.”
“Not so”, say the Germans, "We need that oil to transport our Mercedes to China." They launch a nuclear war against Japan. Who supported by the U.S. retaliates. Next the Russians and Chinese react and 10 minutes later after a war of deterrence the world is flattened…
Except for North Korea; Kim Jong-un’s nuclear missiles failed to launch. Besides, the other countries of the world were all too busy to retaliate against each other. The radio is silent in Kim Jong-un’s office. Despite the fact that he is now the richest and most powerful man on the planet, he can no longer listen to radio broadcasts about his favorite baseball player, Dennis Rodman. The latter did not survive the nukes launched against the almighty U.S.
Just at that moment the radio comes to life: “We are the Borg, resistance is futile!” While Kim Jong-un’s last hair is being assimilated the radio comes back to life one more time. Amidst static noise it can be barely heard: “We are Wall Street Bankers. Do you pay annual performance bonuses? By the way, we recommend buying gold.”

Saturday, June 8, 2013

I have too many investment ideas!

People are afraid of missing out on the new big bull market – forgetting that they have been missing out since the bottom of March 2009. But then, what if the current correction turns out to be the beginning of the end of the world? After all, with the collapse of Japan’s bond market that end can’t be far off!  So maybe we should sell everything we own right now!

And then there are the long term interest rates that are on the rise in North America and the ‘tapering off strategy’ of Bernanke’s Central Bank because the economy is doing too well! So should we buy or sell? Should we buy real estate with the Canadian Real Estate markets about to collapse as we’re reading every day in the newspapers? You’re damned if you do and stupid if you don’t and afterwards every guru claims that he or she saw the ‘disaster coming’ way before their buddies.

If you know that you’re hearing garbage, treat it as such. Don't alter your investment strategy with each change in the direction of hot economic air. Just buy a quality business, enjoy cash flow from its appreciation and/or from its dividends. Yes, dividend paying stocks like BCE or Pembina Pipelines are expensive, but if you own them already you will receive their growing dividends year after year. So, yes they may fall from their current high stock market prices, but they are sound businesses that will keep on growing and keep on churning out more and more dividends over the long haul. If you calculate your dividend yield based on your purchase price rather than on the current high stock price then you may realize that you still make fabulous profits. 
As said many times on this blog, we don’t care about schizophrenic emotional stock market pricing. We only care about owning good investment businesses that we buy at good prices. You’re not quitting your job every time the stock price of your employer is down! In fact you’re buying more through your employee stock savings plan. Of course, a business can truly turn sour, even the one you chose to work for. But what are your employer’s assets worth? A poor manager can be replaced. Poor cash flow or high debt can be overcome – although with pain. But good assets are irreplaceable.If you researched your employer you may have chosen it because you could buy your employer's assets through your savings plan at 40, 30, or 50 cents on the dollar and augmented by your employer’s savings plan contribution, which often equals 100 to 150% of your own contribution. Your savings plan holdings likely become one day extremely profitable. So, you wait it out and accumulate. Yes things may go wrong, but chances are good that you’ll make an enormous profit.
The same with your other stock market investments and… with your real estate. Always buy investment that are self-sustaining, that is: once you’ve made your investment, other than giving back a bit of cash flow from time to time, your investment should not require new funding. That way you can wait and hold on to it until the cows come home.
If you look around, you will see good businesses everywhere and you can select from these only the very best. You don’t need many. Who needs to own more than 30 companies to get rich? Who needs more than a dozen or so properties to build up a sizeable cash flow stream for retirement?  If you think about it, there are plenty of great investments around and you will have plenty of time to get familiar with them so that you can make well informed investment choices. There is no pressure to buy nor sell right now. Once you realize that you are not in a hurry to buy or sell, you will make better decisions.

Every time you have an investment that becomes too expensive or if you feel that you made a lot of insane profits, you will have to ask yourself these questions:
1.       If I now sell, I’ll lose my interest free government loan in the form of capital gains taxes which will come due upon sale. So without the ‘tax leverage’ will my ROI be just as good when I buy this stock back after it falls and recovers?

2.       Have I made now so much profits that this is a once in a lifetime opportunity and that I will never again make significantly more profits by holding on to this investment?
 
With this approach, you will build up cash while approaching the next market peak and then you can use this cash to buy more brilliant investments following the unavoidable downturn. Also, you will find that you’re never running out of investment ideas. There are always many more investment ideas than you have money to invest.