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ARCHIVED COMMENTARY
[current commentary at link above for LSGI Fund investors]
July 21 – Wednesday The Edison Electric Institute notes that U.S. electrical power consumption is up 3.6% year to date versus year ago levels. Some of this gain is due to the heat we have seen in the Midwest and East and need for air conditioning—but some of the demand is also from the economic recovery. Electricity usage is a very good indicator of economic activity.
Tudor Pickering Holt had his note yesterday on LSGI holding KWK:
· KWK takeout…seems unlikely ($12.83 – B) – Nice ~15% stock pop yesterday on takeout rumblings, but we think our $20 NAV is ballpark for management’s minimum takeout price (they own ~30% outstanding shares). That’s a 55% premium and way at upper end of premiums for corporate deals. So focus naturally shifts to accelerating drilling/value via joint venture in Horn River Basin. Our math says KWK selling 50% wi for $500mm (25% cash, 75% carry) is non-dilutive to our NAV (equates to $7,800/acre). Stay tuned.
While KWK may not be a takeout candidate several other firms in our portfolio are in our opinion at current prices
July 20 – Tuesday China has passed the U.S. to become the world's biggest energy consumer according to new data from the International Energy Agency. Already this year, China has sped past the United States as the largest auto market on the planet and moved ahead of Germany as the world's No. 1 exporter
In June, China posted record crude oil imports of 5.4 million barrels per day, meaning that more than 50 per cent of the country's oil consumption is now being supplied by foreign sources. So far this year, China's crude oil imports are running at an average 4.77 million barrels per day, up a massive 30.2 per cent year over year. Total crude oil consumption was 8.71 million barrels per day on average, up 18.6 per cent year over year.
China is expected to maintain a voracious appetite for energy and energy products as its economy shifts towards more consumer driven demand. China's ascent marks "a new age in the history of energy," IEA chief economist Fatih Birol said in an interview. Its continued growth stands to have long term implications for global energy prices and security.
The IEA said China consumed 2.252 billion tons of oil equivalent last year, about 4% more than the U.S. The oil-equivalent metric represents all forms of energy consumed, including crude oil, nuclear power, coal, natural gas and renewable sources such as hydropower.
The U.S. had been the globe's biggest overall energy user since the early 1900’s. China overtook it at breakneck pace. China's total energy consumption was just half that of the U.S. 10 years ago, but in many of the years since, China saw annual double-digit growth rates. It had been expected to pass the U.S. about five years from now, but took the top position earlier because the global recession hit the U.S. more severely, slowing American industrial activity and energy use.
China's economic rise has required enormous amounts of energy—especially since much of the past decade's growth was fueled not by consumer demand, as in the U.S., but from energy-intense heavy industry and infrastructure building. The U.S. still uses more crude oil than China. On a per capita basis the U.S. uses around five times as much crude oil as China, but including coal and other fuels China has now surpassed total U.S. demand.
Long term this is positive for energy stocks and markets. EPM’s joint venture to further develop the Giddings Field mentioned in the note below involves a maximum of five horizontal wells that they will operate. The fact EPM retained operations is significant. Also significant is the fact that the wells will be drilled from an inventory of 21 proved locations and 2 probable locations. Using outside capital on a promoted basis, retaining the majority share of the proved locations, retaining operational control, all while reducing risk—a smart move in our opinion by management.
July 19 – Monday James Stack of InvesTech noted that in a July 7th poll conducted by the American Association of Individual Investors the number of bears outnumbered bulls by a ratio of almost 3-to-1. The 17 times that has occurred since 1988, stocks were up 15 times both three and six months later according to Stack.
Don Hays of Hays Advisors notes that all four composite indicators they follow—psychology, monetary, valuation, and market trend (technical analysis) remain bullish as of this morning. On the other hand Richard Russell of the Dow Theory Letter remains bearish using his technical analysis. Donald Coxe also thinks that the markets face headwinds into the fall with lower tax revenues and employment cutbacks at the state and local levels which will increase unemployment to over 10% in his opinion, with higher taxes imposed.
Several interesting developments were announced by LSGI Fund holdings. The first by Evolution Petroleum (EPM) was that they will develop their holdings in the Giddings Field on a promoted basis over the next 6 months. The prospect is mainly crude oil and liquids, with roughly 33% natural gas. The promoted basis will reduce risk while maintaining substantial upside potential. The company has a discounted present value (PV10) well above current market rates—and the July 1st PV10 determination will be released in a SEC filing in the near future. We really like the low risk/high reward strategy used by EPM management to enhance shareholder value.
Quicksilver Resources (KWK) announced that Reliance Industries may partner or take a stake in the company, and has an interest in the firm’s production in British Columbia. Last week a Canadian paper noted that KWK is in the process of drilling an initial horizontal well to an oil formation above their huge natural gas field that has already been developed. The CEO of KWK noted that as they develop the technology the amount of oil that might be produced from the field could be substantial. Best, the leases are held by production by the natural gas development.
Arts Way Manufacturing (ARTW) held their earnings conference call last week. Among other comments, the Chairman noted that up until now the firm had expected revenues to equal those of last fiscal year—but recent developments and sales have changed the outlook so they expect sales to grow, a positive development since revenues over the first six months are down 10.7% year over year. So to increase revenues this year we should see substantial revenue gains year over year in the last two quarters which should drive the earnings per share upward. The backlog is also up year over year by roughly 30% (13.6 million versus 10.5 million a year ago).
The Scientific Lab Division of ARTW has roughly 190 bids outstanding for a total of $67 million in potential projects. The Vessels Division has done much better year over year, with repeat orders from clients in the water treatment sector. Employment is up 22 from year earlier levels, and the agricultural equipment line acquisitions are beginning to pay dividends.
Note the Wall Street Journal had an article this weekend on how agribusiness might be the ‘hot new sector’ of the 21st century — article:
With an estimated 9.2 billion mouths to feed by 2050, up from 6.8 billion now, and growing demand from wealthier emerging-market consumers for a high-protein diet, the challenge of feeding the world looks daunting. In theory, that should provide a huge secular boost to agribusiness stocks over the coming years. But it will still require investors to have an appetite for risk.
July 15 – Thursday The following is a summary of the IEA monthly report to be made public shortly:
The IEA’s monthly report issued earlier this week contains a trove of interesting new information and projections as the Agency attempts to grapple with rates of economic growth, oil depletion, investment, deepwater moratoriums and new regulation, and a host of other factors that impinge on the world’s oil markets.
The full report, which will not be made public for another two weeks, is said by those with access to estimate a drop in global oil production of 255,000 b/d in June. This comes on top of a drop in global production of 575,000 b/d in May, no growth in April, and a 220,000 b/d drop in March. February was the last month to show substantial growth.
The Agency is still estimating that 2010 demand will average 86.5 million b/d or an increase of 1.8 million b/d over 2009. In its first projections for 2011, the IEA has consumption rising by another 1.3 million b/d to 87.8 million. Most of the increased consumption naturally will come from Asia as OECD consumption is forecast to drop a bit.
Apparently, amidst all this growth in demand and what sort of looks like falling world production, we do not have to worry about higher prices as the Agency assures us that OPEC will continue to have 5.5 to 6 million b/d of spare capacity that could be brought into production to meet any emergency.
The Agency expects that Chinese oil demand will rise just 4.8 percent next year to 9.5 million b/d as compared with this year’s growth of 9.1 percent.
There is obviously a lot that does not add up in this mélange of lower real production, rapid growth in Asia, steady prices, lower and less-productive investment and a variety of serious deepwater production problems. Matters may be coming to some kind of a head over the next 18 months, in alignment with IEA warnings in 2007 of an oil crunch by 2012. . .
July 14 – Wednesday Hays Analytics announced that their Psychology Indicator went to “P1” last week—the most positive and bullish reading possible, and very rare. We will see if the indicator has the forecasting accuracy that it has had in the past. The problem with some of these indicators is that in a leveraged debt-driven global recession some of the monetary tools are not as effective in rebooting the economy—and the historical indicators have not been as effective in forecasting future trends.
The Wall Street Journal had an article on the leveraged commercial real estate sector last week, and how banks are restructuring the loans so that they stay ‘current’ by extending them or reducing the interest rates. Otherwise the banks might have to write off the loan, which would impact their regulatory capital levels.
The concern we have is that bad loans are being extended to avoid a capital call—but in the meantime the bank will be in no condition to extend new credit to viable new ventures or expanding companies that might hire additional employees. The end result might be a Japan style stagnation in both business, employment, and economic growth. The best alternative for the economy would be to write off the bad loans, instead of keeping institutions in sick bay for a decade as they deal with past mistakes. Loans made several years ago might not be collateralized to the extent they should be due to property price declines and office vacancies.
July 13 – Tuesday The Lloyd’s study mentioned yesterday included a forecast that most analysts think that crude oil prices will trend upward over the short and longer term. The most dramatic forecast mentioned is from Professor Stevens:
Supply constraints will drive up the price of oil “A supply crunch appears likely around 2013…given recent price experience, a spike in excess of $200 per barrel is not infeasible” - Professor Paul Stevens, Chatham House
We think this forecast is a bit too dire—but $80 to $100 a barrel oil would not surprise us. Keep in mind demand for crude oil from developed countries has not recovered from 2007 levels. Most of the incremental demand is from rapidly developing countries.
Last week China, the world’s second-biggest oil consumer, announced record crude-oil imports in June. Purchases climbed to 22.14 million metric tons, or about 5.39 million barrels a day, from 17.65 million tons a month earlier. This was more than the previous record of 20.98 million tons set in April. Most striking, purchases of crude oil in the first half rose 30 percent from year earlier levels.
China will increase imports the second half of the year for stockpiling in their expanding strategic oil reserve according to some analysts, although auto sales are growing at a slowing rate (but still growing) than year earlier levels.
July 12 – Monday Lloyds of London has a new report out on the energy sector. They summarize:
Modern society has been built on the back of access to relatively cheap, combustible, carbon-based energy sources. Three factors render that model outdated: surging energy consumption in emerging economies, multiple constraints on conventional fuel production and international recognition that continuing to release carbon dioxide into the atmosphere will cause climate chaos. . .
Energy markets will continue to be volatile as traditional mechanisms for balancing supply and price lose their power. International oil prices are likely to rise in the short to mid-term due to the costs of producing additional barrels from difficult environments, such as deep offshore fields and tar sands.
An oil supply crunch in the medium term is likely to be due to a combination of insufficient investment in upstream oil and efficiency over the last two decades and rebounding demand following the global recession. This would create a price spike prompting drastic national measures to cut oil dependency
The entire report can be accessed at the following link: Lloyds report
July 11 – Sunday The Fed apparently has investigated the impact of a bankruptcy of BP on the global markets. Due to the size of the firm, and the fact that it is highly interconnected in the financial sector with loans, swaps, derivatives, and is a counter party to many derivative contracts, it raises the issue that if the firm files bankruptcy will it shock the system like the Lehman Brothers failure.
Publically the Fed has no comment on the results of their investigation, and BP also has no comment. Some analysts have noted the impact it might have on the financial sector. Some banks have limited the nature of contracts they will enter with BP, limiting the term to a one year period to limit risk.
The bottom line in the BP incident is that offshore deep water exploration is much more expensive and risky than expected—which will make onshore fields and production in politically secure areas more valuable in the future. Firms like GEOI, EPM and CXPO should benefit from this trend.
Last week Saudi Arabia's King Abdullah has ordered a halt to oil exploration operations to save the hydrocarbon wealth in the world's top crude exporting nation for future generations, the official Saudi Press Agency reported. Speculation as to why this was imposed, and what it means for the global energy sector, has analysts analyzing the announcement.
This announcement from the King comes 8 months after the following announcement:
Halliburton Co. said Friday it received a contract to drill and complete oil wells in Saudi Arabia's Ghawar field. The five year project would involve work in Uthmaniyah, Haradh, Hawiyah and Shedgum. The project is expected to use three to four rigs, and involve between 153 and 185 oil production, water injection and evaluation wells, Halliburton said.
The contract is an important part of Saudi Aramco's plan to explore new avenues of collaboration with major oil-field services providers. Halliburton said it has worked previously with the petroleum company, which is owned by the Saudi Arabian government. The Ghawar field contract can be renewed for an additional five years.
Saudi Arabia has the expertise to drill and complete oil wells. The speculation is that Halliburton was needed to deal with Ghawar depletion issues—and to keep the decline curve in the field as low as possible.
Last, a delegation of Saudi Arabian investment experts has met with BP about taking a position in the company for the Kingdom. If the Saudi government knows that oil production in their fields has peaked—or is stagnating—oil prices could be higher, which might make the investment very profitable.
July 9 – Friday In Canada the insurance sector is the focus of regulators who are conducting ‘stress tests’ to see the impact of a major pandemic or another stock market crash. The insurance sector in that country has underperformed as one of their main asset classes—stocks—have performed very poorly. It is interesting that the regulators are focusing on a pandemic—a risk that Professor Smil has identified as a major long term risk (see note on June 28th). Apparently Bill Gate’s foundation uses Dr. Smil’s works in making allocation decisions with regard to their grants and projects.
Over the last eleven years the S&P 500 index, including dividends, declined 0.8% per year. The Nasdaq Composite Index, including dividends, declined 2.2% per year – some of the worst performances since the Great Depression. One thousand dollars invested in the S&P 500 index on July 1, 1999 would have fallen to $915, including dividends, as of July 1st - eleven years without a positive return. One thousand dollars invested in the Nasdaq Composite Index would have fallen to $783.
Meanwhile, the S&P 500 index in the first six months of 2010 is off to its worst start since 2002 with a loss of 7.6% as of July 1st. The ‘lost decade’ for equities appears to continue. The poor performance, and contingent obligations of the insurance industry, raises the issue of whether they have the assets to meet obligations. We have not seen a similar stress test proposed for U.S. insurance companies.
The fact that the market performance over the last 11 years is some of the worst since the Great Depression, while a concern for the insurance industry, from an investor standpoint may be an indication that the risks of continued decline over the next decade are lower than many expect. Investors over the last few years, and the last two months, have been redeeming massive amounts of equity mutual funds and moving their money into cash equivalents or bond funds. Longer term returns generally tend to revert to the mean, which for large cap stocks is a return of roughly 7% to 9% per year. So over the last decade the major stocks underperformed the long term average by 10% per year or more.
Some of the valuation and return models we follow (Hays or the Value Line models) reflect the fact that stocks should outperform historical averages over the next 3-5 years. The performance should revert to the mean according to the models.
With regard to agriculture, adverse weather in Canada, Europe and Russia has pushed the price of wheat sharply higher in the past week, as the once high-flying commodity rallies from recent depressed lows. The Economist had a detailed article on UG99, wheat rust, and the threat it is creating in the global wheat market. Apparently the strain remains one that is very difficult to control, and one that continues to spread across the globe. To date the strain has not invaded a major wheat producing country, but the risk is rising.
Farm equipment retailer Tractor Supply Co. (TSCO) announced sales are above expectations. The company boosted its earnings forecast yesterday for the full year, saying that the earnings per share will be $4 to $4.10. That beats the average analyst estimate of $3.73—by quite a lot. If retailers like TSCO are finding increased demand for farm equipment it should bode well for manufactures of farm equipment like LSGI Fund holding ARTW.
July 8 – Thursday The Financial Times yesterday had a story on how badly the net worth of some of the very wealthy have been impacted by the financial crisis. They note the founders of Kohlberg Kravis Roberts were going to take their firm public in 2007. Estimated firm value then was $26 billion. The firm did not go public and has re-filed to go public this year—and the estimated valuation of the firm is $6.4 billion today. Two of the founders ‘lost’ around $2.5 billion in value over the three year period due to the reduced valuation of the enterprise.
GEOI issued an update on their drilling activity yesterday. It was very positive. The firm is focusing on crude oil, mostly in the North Dakota Bakken/Three Forks play. GEOI both operates and is a partner in the development of the prospects in the area. After the update was issued a firm that followed the company reaffirmed their ‘buy’ rating.
With regard to the economy, many are concerned about the slow-down in activity. What is interesting that if the economy continues to grow at a very slow pace and does not add jobs as many forecast, firms that are growing should demand a premium valuation in the market. The median growth rate for revenues in the LSGI portfolio from analysts that cover our firms is 33.2% next year—a blistering growth rate. Many larger firms consider a low double digit revenue growth rate as the ultimate accomplishment.
We talked with the IR person at ARTW about earnings, and due to delays in CPA reviews of the financials the earnings release will be much later this year than last—most likely near the 15th. Apparently the timing is all driven by the availability of the accountants to review the numbers. Due to an unexpected emergency unrelated to the firm one or more of the accountants were not available to review ARTW’s financials. We expect the firm will be profitable and revenues will be near to what they were last year, with slightly better margins this year.
July 7 – Wednesday USA Today noted today that we are back in a bear market, at least technically:
“The Russell 2000, a key measure of small-company stocks, on Tuesday fell 1.5%, leaving it 20.5% below its recent high in April. While Tuesday's drop was minor, a decline of 20% or more is an attention grabber because it meets the unofficial definition of a bear market. Seeing small stocks stumble so much could be bad news for investors at large because those were the leaders in the market's big run-up from its 2009 low. And while mainstream market measures, such as the Standard & Poor's 500 index and Dow Jones industrial average, have fared relatively better, they've been on a steady slide and appear at risk of a bear market, too. The Dow, for instance, on Tuesday broke a seven-session losing streak that was one of its worst stretches in more than a year.” On the positive side Bloomberg noted that analysts are raising earnings estimates for U.S. companies at the fastest rate in some time. Earnings for the Standard & Poor’s 500 Index companies will jump 34 percent in 2010, compared with a projected gain of 27 percent on March 29, according to more than 8,000 estimates compiled by Bloomberg. The revision, the most during any quarter in at least six years
We are finishing the LSGI Fund Report and investor statemetns for July and will have them mailed out shortly.
July 5 – Monday SmartTrend had the following comment on LSGI holding ARTW last week:
Below are the top five companies in the Construction & Farm Machinery industry as measured by the price to cash flow ratio. Often companies with the lowest ratio present the greatest value to investors. Supreme Industries has a price to free cash flow ratio of 5.5x based on a current price of $2.25 and a free cash flow per share of $0.41. Art's-Way Manufacturing (NASDAQ:ARTW) has a price to free cash flow ratio of 6.4x based on a current price of $5.48 and a free cash flow per share of $0.85. . . .
SmarTrend is bullish on shares of ARTW and our subscribers were alerted to Buy on February 23, 2010 at $4.63. The stock has risen 18.4% since the alert was issued.
Don Coxe issued his latest Basic Points last week. Among other points he makes:
We believe well-chosen commodity stocks will solidly outperform the traditional commodity funds—most importantly and obviously—as long as contangos are in force for key commodities such as oil. When one owns the shares of well-managed commodity producers with unhedged reserves in the ground in politically-secure areas of the world, one benefits more from a sustained commodity price increase thanpassive owners of that commodity. . . .
Remain heavily overweight oil compared with natgas. Gas prices have climbed because of the cutoff of expected production from the Gulf, but this should be only a temporary price boost. As Macondo has tragically demonstrated, finding big oil deposits is a high-cost, high-risk business. Finding gigantic natgas deposits is a low-cost, low-risk business
Coxe reduced recommended pension funds reduce their exposure to equities a small amount in his report. Basic Points—Coxe
June 30 – Wednesday Alex became the first June hurricane in the Atlantic since 1995 as oil companies evacuated workers in the Gulf of Mexico and girded for a storm surge that may affect production and refineries in the region. The hurricane has halted about 25 percent of crude production in the Gulf of Mexico and 9 percent of natural-gas output, the U.S. government said. The next advisory is due at 11 a.m. EST. Alex is a category one storm, the weakest on the hurricane scale. Three rigs and 28 platforms have been evacuated because of the storm, the Bureau of Ocean Energy Management, Regulation and Enforcement said in a statement on its website. Almost 396,000 barrels of daily oil output were shut-in, along with 600 million cubic feet of gas.
The Gulf Coast is home to 43 percent of operable U.S. refining capacity and about 30 percent of U.S. crude oil, 12 percent of its natural gas production, and seven of the 10 busiest U.S. ports.
June 28 – Monday Tidal waves, tsunami, volcanoes, earthquakes, global heating, global cooling, meteor or asteroid collision, war, terrorism and pandemics. Over the next 50 years which of these has a nearly 100% chance of impacting global conditions, causing millions of deaths, and adversely affecting the global economy and social structure?
Professor Vaclay Smil addresses these issues in his recent book ‘Global Catastrophes and Trends: The Next Fifty Years’ as he examines studies of future trends and developments that might impact the global economy. We ran across his study from an article that noted that Bill Gates follows Dr. Smil’s works and thinks very highly of his research. The professor apparently has written dozens of books on different scientific issues and studies that have addressed these problems—including books on energy, agriculture, and the global economy and political structure.
The answer to the question above is that in his opinion we have almost a 100% chance of experiencing a pandemic of a flu or a contagious disease in the next 50 years that could kill millions globally—and the event will adversely impact the global economy and social structure. He cites studies of the 1918 pandemic, the modern swine flu, drug resistance, and related studies and modern trends in travel and global interaction to reach the conclusion. It is an interesting conclusion, especially in light of other recent books that have been published that detail how certain microbes are becoming resistant to antibiotics making the management of certain diseases more difficult.
The book also discusses trends in the global energy sector. Dr. Smil concludes that hydrocarbons will not be replaced soon by alternative fuels, and that price signals will allow global economies to develop more efficient and ultimately alternative means to produce needed goods or services. He does not accept the ‘peak oil’ theory, claiming higher prices will reduce demand and allow alternative technologies to advance well before we face physical limitations on supplies.
June 27 – Sunday The number of millionaire households, defined as those with at least $1 million in investable assets excluding primary residences, expanded to 10 million from 8.6 million a year earlier Capgemini SA and Merrill Lynch & Co said in their 14th annual World Wealth Report published last week. Keep in mind ‘investable assets’ and ‘net worth’ are not identical measures of wealth.
North America had a 17 percent increase from the year earlier level, with the U.S. having 2.9 millionaire households. Assuming 115 million households in North America this would equate to around 2.5% of households having $1 million or more in investable assets excluding primary residences. This percentage seems high. Possibly the measure is excluding certain household debt obligations.
Studies have shown most U.S. households have a majority of their wealth invested in the real estate sector in their house or other property—and few areas have seen these prices increase in the last few years. Mortgage debt levels have tended to remain relatively constant, so the net worth after debt of many has for the most part not seen positive changes. We would expect the number of U.S. households with a ‘net worth’ above $1 million to be quite a bit lower than the Merrill Lynch ‘investable asset’ figures. The study is not readily available to the public so some of the methodology details are not clear from the press releases and articles.
Merrill attributed the gains to the recovery of the global stock markets and the fact that high net worth individuals tend to hold a lot of stocks versus other asset classes.
A similar study released by the Boston Consulting Group claimed there were 11.2 million ‘millionaire househoulds’ worldwide, using the same definition as Merrill used. The Boston Consulting Group found that the U.S. had 4.7 million millionaire households—much higher than the 2.9 found by Merrill’s study. The Boston Consulting Group study is also not available to the public without purchase.
We assume some of the discrepancy between the studies is a result of the way wealth levels were measured. In any event both studies indicated wealth levels in high worth households, as defined in their studies, was recovering from depressed 2008 levels.
June 26 – Saturday Donald Coxe in his institutional conference call yesterday remains concerned about European banks and the financial sector. He claims European banks are less capitalized than U.S. banks, which could create issues due to European sovereign debt levels which might be difficult to manage for some countries and institutions. One positive is the TED spread—a measure of risk in the financial sector—fell last week from 50 to 40, a positive sign.
Richard Russell of the Dow Theory Letters issued a total sell recommendation to his subscribers, forecasting a crash in the market. Apparently he is writing his notes from the hospital—they did not say what his health issue was but he is well into his 80’s as we recall. Russell uses the Dow Theory for his signals. Another Dow Theory adherent was on Bloomberg last week and was bullish, taking the position this was a time to buy stocks. Same model, two interpretations. We remain cautious—it appears quite a few issues need to be worked out globally, especially with regard to sovereign debt issues.
The storm in the Gulf of Mexico has evolved into a tropical storm named Alex as of 5 am EST, with winds of 40 mph. It is unclear what path it will take in the Gulf, or how strong it might get. Oil prices jumped $2.50 a barrel on Friday.
The LSGI Fund is up slightly this month, but remains volatile. We have sold two of our positions in companies we felt had not performed as expected and have added no new companies to the portfolio.
June 23 – Wednesday The first storm of the Atlantic hurricane season may enter the Gulf of Mexico as soon as next week according to the weather experts. Chances are favorable for the current system of thunderstorms to intensify, although the chances of becoming a tropical storm remain low.
Meanwhile a judge overturned the six month drilling moratorium imposed by the Obama Administration in the Gulf. The Administration has said they will appeal the order and will issue new regulations prohibiting drilling activities. In the end, between the appeals and the new regulations, in our opinion it will be at least six months before the order is lifted.
The interesting point is that the Administration’s order will have a very negative impact on the economies of the Gulf coast—something that is not needed at this time of high and persistent unemployment. In the end, politically, the temporary cessation of activity will be very damaging. As of yesterday 8 of the 32 deep water rigs impacted by the deep water drilling moratorium had left U.S. waters to drill elsewhere. It will be years before these rigs return. In addition regulatory stability—the ability for firms to calculate regulatory risks—is very low. Regulatory costs and delays now have to be considered much higher than a year ago. Longer term, this does not bode well for Gulf of Mexico production levels.
The EIA issued a mid-term report this week, forecasting global demand for crude oil at around 91 millin barrels per day by 2015 –by far a record level of consumption. The EIA forecasts that supply will meet demand—but with issues in the capital markets, political risk, regulatory risk, and the like supply growth may not be as robust as many expect.
June 22 – Tuesday For the third time in 18 months the video card or motherboard on the Dell computer we used has failed—so we have not posted in a few weeks as the machine gets repaired. We would guess that the heat from the machine might be the cause of the circuit issues, but in any case the machine is under warranty. The file transfer software on the machine makes it easy to upload commentary, and we do not have that software on the backup computers.
Several interesting things to note over the last few weeks. First, the Gulf of Mexico water temperatures are heating up, making storms more likely. The Browning newsletter forecasts as follows with regard to tropical storms or hurricanes:
“Expect at least 3 landfalls in the Gulf oil and gas regions. Unfortunately this means a good probability of a storm hitting the oil spill region. . . . With the elimination of any storm suppressing El Nino winds the probability of hurricanes and intense hurricanes increases. Expect at least 9 or more hurricanes and 4 intense ones. . . .”
Their analysis is in line with other private and government forecasting models—and should these forecasts prove accurate it will impact the energy sector since roughly 20% of U.S. oil and gas production is in the Gulf or along the shoreline. A neat map to track storms is at the following link: Stormpulse (in the upper right hand corner turn the Forecast Models to ‘on’ to see the computer model forecasted storm paths).
Insurance in the Gulf of Mexico has increased by 50% or more since the BP spill, and the Obama Administration 6 month moratorium on drilling remains in place. While some have argued for a reduction in the length of the moratorium it appears that the head of the commission in charge of the Administration‘s review expects the process to take at least six months—so their report and drilling would not resume until 2011. A judge is examining the drilling ban and is expected to rule Wednesday as to whether it can be legally imposed. The moratorium will have a major adverse economic impact if it is not lifted, and regardless production from the Gulf will be adversely impacted from recent events.
Meanwhile the International Energy Agency last week raised its forecast for global oil demand this year. Worldwide oil use will rise by 1.7 million barrels a day, or 2 percent, in 2010 to a record 86.4 million barrels, the Paris-based agency said in its monthly market report. The increase of 60,000 barrels from last month’s estimate is driven by an acceleration in North American demand.
China's oil demand continued its 2010 climb at a steady clip from a year ago to reach about 8.6 million barrels per day (b/d) in May according to a Platts report issued yesterday. That is 9.8% higher than the corresponding month of 2009.
The Rural Mainstreet Index survey by Creighton University released yesterday indicated farm equipment sales continue to increase as the equipment sales index rose to 53.1 in June from May’s 50.9. Any number over 50 indicates expansion. Economist Ernie Goss noted “In addition to an expanding rural economy, we are tracking significant improvements in farm and ranch land prices and farm equipment sales. I expect both of these factors to remain healthy in the months ahead.” Good news for agricultural equipment maker Art’s Way Manufacturing. Art’s Way also recently added another line of equipment, and they expect the acquisition to be accretive.
Don Coxe in his latest Basic Points, published in the last week, is bullish on gold and the Canadian dollar. He has concerns about the dip in the Baltic Shipping index and the TED spread, two of our concerns also. Coxe is worried about the exposure of European banks to Greek debt, and the implications it might have on economic activity in that part of the world. His report can be accessed at:
http://www.zerohedge.com/sites/default/files/BMO_NB_Basic_Points_June_2010.pdf
We have added no new positions to the Fund and have sold down a few of the existing positions. Our net asset value is right on the long term moving average—not a sell signal but not a buy signal either. We added to our position in EBIX and EPM in the last month.
June 7 – Monday The U.S. government issued their official hurricane forecast late last month. They predict an extremely active storm season, which corresponds to what other official forecasters have predicted. In addition to these forecasts an interesting study was released last week on the correlation between sunspots and hurricane frequency. The researchers found that periods of very low sunspot activity increased the odds of an active hurricane season.
In the current solar cycle we should be observing dozens of sunspost by now. In actuality it has been a very quiet sun as can be seen on this site: Sunspots Robert Hodges and Jim Elsner of Florida State University found the probability of three or more hurricanes hitting the USA goes up drastically during low points of the 11-year sunspot cycle, as is now the case. The research is preliminary, but is interesting, especially with 20% of oil and natural gas production coming from the Gulf of Mexico: sunspot research.
The flight to safety continues, with money flooding from equities into Treasury bonds, as discussed in a recent New York Times column: flight to safety The volatility, and continued economic and regulatory issues, mean that the average investor probably will not come rushing back to the stock market in the short term—leaving a massive amount of assets in accounts earning very little return. We discuss this and other issues, and review the seven largest positions in the portfolio and why we find them attractive, in the LSGI Fund Report just issued — June 5, 2010
June 3 – Thursday The EIA oil inventory report was issued today, and continues to show that demand for all oil products is accelerating:
Total products supplied over the last four-week period has averaged 19.7 million barrels per day, up by 8.1 percent compared to the similar period last year. Over the last four weeks, motor gasoline demand has averaged 9.1 million barrels per day, up by 0.5 percent from the same period last year. Distillate fuel demand has averaged 4.0 million barrels per day over the last four weeks, up by 17.1 percent from the same period last year. Jet fuel demand is 8.1 percent higher over the last four weeks compared to the same four-week period last year.
Note that last week Royal Dutch Shell paid $4.7-billion cash to buy privately held East Resources Inc., giving it substantially more exposure to crucial shale gas plays in North America. So while current natural gas prices are low, the acquisition market for shale prospects remains active. Which should help support corporate valuations in the sector.
May 28 – Friday Another agricultural equipment dealer, Rocky Mountain Dealerships Inc., saw sales and earnings jump in the first quarter. The company sees continued sales growth in the agricultural sector:
The North American agricultural industry continued to see strong sales in high horsepower tractors and combines through the first quarter of 2010. Our market, which is focused on small grain and oilseed farming, was no exception with increased sales of combines and tractors over 140 horsepower. Market share gains and a strong market resulted in an increase in volume in our agriculture equipment locations.
We anticipate stabilized commodity prices and favorable weather conditions for seeding in western Canada will result in strong crop receipts for farmers in 2010. With reductions in commodity prices since 2008, farmers are looking for advanced technology to lower input costs and increase yields. This drives sales and product support revenues in our dealerships. With global grain “stocks to use” ratios at historic low levels we expect farm commodity prices to maintain a level that will keep the farmers balance sheets strong for the coming years.
May 27 – Thursday Agricultural equipment maker John Deere increased their guidance for the sale of agricultural equipment in the U.S. and Canada in their conference call last week:
Slide 19 highlights our 2010 industry outlook. Sales of agricultural equipment in the US and Canada are now forecasted to be up 5% to 10%. That's quite a change from our February forecast of comparable to 2009 and our November 2009 forecast of down about 10%. We continue to see our order book strengthen, especially for large Ag equipment. Remember the Combine Early Order Program ended in January was a significantly higher than expected response rate. Demand for large tractors has been higher than expected as well. The new 8R Series Tractor has been very well received in the marketplace. We have continued to add schedules throughout the first half of the year and effective availability is November 2010. Effective availability for the 9000 Series Tractors is September 2010.
This confirms the Creighton University comment that agricultural equipment sales is ‘soaring’ in their latest economic study. If the trend holds across all equipment classes this should benefit Art’s Way Manufacturing (ARTW). We have been told that ARTW is hiring at both their Armstrong, Iowa, location as well as at their new West Union, Iowa plant.
May 26 – Wednesday We reviewed an analyst report for EPM yesterday that an analyst was kind enough to forward to us. They have a buy rating on the stock with a target price of $8.50 (market price is $5.15). The report calculates the assets of the firm have a discounted asset value of $8.63, a figure we find reasonable. Commentary includes the following:
The Delhi Field began responding to CO2 flooding in mid-March with production averaging 243 Bopd, a mere four months after injections commenced. Typical of CO2 recovery projects, once the rock begins to respond to injection production tends to ramp up quickly. April production averaged north of 880 Bopd gross or 65 Bopd net to Evolution’s 7.4% over riding royalty interest. Previously, we assumed a conservative 9% recovery factor given Denbury’s (DNR) average CO2 recovery programs have recovered 17% to date. Given the early response, we are comfortable with increasing our recovery factor estimate to 14% resulting in the Delhi’s gross EUR increasing from 35 Mmbo to 47 Mmbo, which is consistent with the company’s third party reservoir engineers. We anticipate that Evolution will be able to book approximately 75% of its net reserves associated with the Delhi field in this fiscal yearend of June 30, 2010. This will move probable reserves to the proven category for Delhi for the first time, which should continue to increase investor confidence in the project and inherent value that has been created. We value Evolution’s net interest in the Delhi Field at $6.27 per share.
May 25 – Tuesday Agricultural equipment sales are growing according to recent data—a reading above 50 means sales are expanding:
The farm equipment sales index soared to 57.2 from March’s 41.4 and February’s 42.4. Prior to February of this year, both farmland price growth and farm equipment sales had been slipping. “We are tracking significant improvements in farm and ranch land prices and farm equipment sales. I expect both these factors to remain healthy in the months ahead,” said [economist] Goss.
Chart and details at the Creighton University newsletter
We have been told that agricultural manufacturer Art’s Way Manufacturing is hiring at their Armstrong manufacturing plant, as well at their new plant in West Union, Iowa. Good omens for the company, longer term.
May 24 – Monday We had listened to the Ebix Inc. conference call last week and were impressed. Over the weekend we ordered a transcript and reviewed the details again—the firm reported record revenues of $32 million last quarter, the first quarter of 2010. The company expects to grow revenues and maintain margins in the insurance software sector—but how aggressive the growth will be was somewhat of a surprise on reviewing the transcript. The CEO mentioned that by the fourth quarter of 2011—seven quarters from now—the firm’s goal is to have annual revenue run rate of $200 million.
EBIX has emerged as the largest on-demand insurance exchange in the world. The number of transactions and participants are expected to ramp up quite impressively in the next year, which should benefit both the participants as well as EBIX. The firm will enter the property and casualty insurance exchange market in the near future, and may also examine exchanges that may be required under the new healthcare legislation.
Creighton University in Omaha issued a monthly report on the economy, and their indicators of farm equipment sales are moving upward according to the May 2010 report. Farm land valuations are also increasing. Farm equipment sales according to the index were over 50—indicating expansion—for the first time in over a year. We requested the underlying data from the publisher, we would like to run regressions on the data. This is a positive indicator for firms like Art’s Way Manufacturing, a manufacturer of farm equipment.
May 22 – Saturday Month to date the Russell 2000 Small Cap Index is down 9.7%. The LSGI portfolio is down a similar percentage. Concerns about high frequency traders, market instability, Greece, Euro zone economic crisis, government debts, lack of employment opportunities in recovering economies, Iran and North Korea, as well as other issues have been blamed for the decline.
Richard Russell of the Dow Theory Letters forecasts a major market crash and advises investors to liquidate to gold and to cash. Other Dow Theory proponents interviewed on Bloomberg radio have reached the opposite conclusion, advising investors to add to their stock holdings on weakness. Technical and quantitative analysts like Don Hays remain bullish, with all four of his major indicators in bullish territory.
The volatility was enhanced by investors who have triggered major outflows in equity mutual funds in the last few weeks. Outflows from equity mutual funds increased to $12.3 billion versus an outflow of $1.2 billion the week before, and an inflow of $1.9 billion three weeks ago. A massive amount of assets remain in money market or similar funds, earning very meager returns. The volatility, and perceived risk to the economy and markets, probably mean that the funds will not enter the stock market any time soon.
While high frequency traders constitute around 50% of the volume on the New York Stock Exchange they focus on larger cap, liquid firms, so by design do not target small cap stocks. Market movements caused by such traders will impact the small cap sector however, as seen in the recent flash decline. Dallas investor Mark Cuban notes that Wall Street is now composed of traders and mathematicians, and claims the financial sector has lost sight of their initial mission of providing funding for interesting business seeking to grow or expand.
From our standpoint, in this environment an investor’s job is to identify a good business, figure out what it’s worth, then buy a position in the firm when someone sells it for less than it’s worth. Emotion is driving prices in some cases well below where they should be using an economic analysis, not reason. In theory this is a very simple approach to investing, but that is not to say it is easy. Volatility in some of these stock prices is something to be exploited, an inefficiency, not to be feared. As investor Shelby Davis noted years ago investors can get rich during recessions, they just do not recognize it until much later.
Ben Graham in his investment text was an early advocate of the following insight: The best way to make money in the stock market over the long run is to (mostly) ignore the stock market. Identify a good business. Figure out what it’s worth, then wait until someone hits the panic button and will sell it for less than that – at which point you take them up on the offer. Most pricing inefficiencies—and potential for gains—historically have existed in the small company sector. Repeat until market value is realized. In volatile times, the market allows you to do this, because – and this is by far the most important thing one can take away from Messrs. Graham and Buffett – stock prices fluctuate far more than real business values do.
May 20 – Thursday The Globe & Mail mentioned the following yesterday in a bullish article on the energy markets:
Ninety per cent of every new barrel of oil produced in the world gets burned as transport fuel. If you compare China’s auto sales with America’s sales, it’s not hard to predict where tomorrow’s oil supply will be headed. China’s oil consumption has grown from just over two million barrels per day in the early 1980s to an estimated nine million barrels per day this year. And at the rate that its vehicle market is growing, the country could double its oil consumption over the next decade or so.
May 19 – Wednesday GeoResources presented to institutional investors yesterday in London. They note they have 49,000 acres in Williams County, North Dakota, and will drill three wells in the area by year end. If results are positive they plan on running two rigs full time next year. It is expected that spacing will either be one well per 640 acres or one well per 1,280 acres.
The Williams County prospect targets the Bakken Shale for crude oil production, and other operators have announced very positive results in the county in the last several months (see May 17 note). Lease rates have increased to $4,000 per acre, well above GEOI leasehold costs due to the fact GEOI was one of the early movers. GEOI will operate these wells, will have roughly 47% working interest, and has promoted out the remaining interest to several partners in a joint venture.
With regard to GEOI’s joint venture with Slawson Exploration in the adjoining county, a well has been drilled to the Three Forks formation and is awaiting completion. The Three Forks formation is below the Bakken, and could add additional value to the play. GEOI generally has a 10% to 15% working interest in the Slawson wells.
Using PV10 for proved reserves and adding the value of leasehold and other assets, less debt, leaves a value of roughly $22 per share. The stock is selling at $15.00, so a substantial margin of safety exists for shareholders. The company expects the gains in both crude oil and natural gas production and reserves will continue moving forward.
GEOI online presentation: London
May 17 – Monday After last week’s earnings call Evolution Petroleum’s target price was raised to $8.50 from $5.00 at Global Hunter Securities. The firm reiterated a buy rating on the stock.
In the GeoResources call one of the analysts was asking about GEOI’s drilling plan in their new Williams County, North Dakota, prospect. The company will begin drilling late this summer, and will drill three or more wells by year end. One of the recent wells completed in the county, and the initial test results (the wells are mainly oil wells), was referenced in the call:
Sundance Energy (ASX: SEA) has reported that American Oil & Gas Inc.'s (NYSE, AMEX: AEZ) Ron Viall 1-25H well produced 2,844 barrels of oil equivalent (1,981 barrels of oil and 5,179 Mcf of natural gas) from the Bakken formation during an early 24 hour flow back period. The well is located in T156NR98W Sections 24 and 25 in the Goliath prospect of Williams County, North Dakota. The 9,223 foot lateral in the Bakken formation was fracture stimulated with 30 stages.
GeoResources was also highlighted in the Investor Business Daily ‘New America’ series today. The article does a good job summarizing the firm’s strategy and management philosophy. We find GEOI very attractive and have taken a large position in the Fund. IBD Article
May 16 – Sunday Lowry’s issued a short term buy signal on May 10th, and their buying power measure increased last week ten points to 228 while selling pressure stayed even at 706.
Don Hays of Hays Advisors also issued a buy signal last week. He remains bullish with all four of their macro indicators now in bullish territory. Statistically, he claims the probabilities based on historical data are high that investors will obtain excess returns in this market.
That said the TED spread (a measure of banking health) is widening—and several commentators (including Don Coxe last Friday) noted that if the European issues degenerate into a situation where the credit markets freeze it will have an impact on the banking system and ultimately the economy and stock markets. He is concerned, but thought that problems will be contained. Similar comments were made in the Financial Times this weekend, as well as the Wall Street Journal.
The difficulty is predicting with any degree of accuracy where the European issues will lead, and how they will be resolved, or if the infection will spread elsewhere. As forecast by Harvard’s Dr. Rogoff in his studies of historical financial crisis, tax revenues generated after a financial crisis are much impaired which results in massive deficits. Nations across the globe, and in the U.S. state and local governments, are facing the revenue shortfall issue. Tax receipts in April were down from last year for several states according to an article in the Wall Street Journal last week—and April is the month with the largest tax inflow due to personal income taxes. So budgets will have to be cut again in some states as well as at the local level, or additional federal aid will be needed.
If the manufacturing indexes are accurate in their forecast of an expanding manufacturing sector in the U.S. the price of metals should increase with demand. We found a very small scrap recycling company that has made some impressive gains in volume and revenues over the last year and added it to our portfolio. We generally do not invest in these firms due to the cyclical nature of metals prices, scrap prices, and the fact that many serve relatively local markets due to the nature of the materials—but in this case we took a small position after speaking with the CEO and discussing the outlook for his firm and the recycling sector for the remainder of the year.
May 14 – Friday Crimson Resources (CXPO) held a conference call yesterday outlining first quarter results. Production was down to 31,600 Mcf/day from 47,900 Mcf/day in the year earlier quarter. The decline was due to a lack of drilling for development in response to the recession and commodity prices. The company remains highly focused on natural gas with around 75% of the reserves classified as natural gas.
CXPO indicated that their Grizzly well was at total depth. It is located in the East Texas area near the Kardell well. They will most likely horizontally drill and complete in the Bossier formation—the Kardell was completed in the Haynesville formation. The company will use much larger volumes of frac fluid to fracture the formation, which should improve total reserve recovery. The Kardell well is producing around 2.5 million cubic feet a day and has cumulative production of around 1.2 Bcf, a disappointment after the well had record initial test results. Grizzly results are expected to be released in mid to late July.
The company has one rig working in East Texas and one rig working in South Texas and expects production to begin to ramp up again this year with the activity. For the year they expect production to average 35,000 to 39,000 Mcf/day with an exit rate for the year around 45,000 Mcf/day—substantial increases from the 31,600 Mcf/day average rate seen in the first quarter.
In the East Texas prospect they expect three formations to add value—the Haynesville, the Bossier, and the James Lime. Testing the Bossier formation in the Grizzly well will help the firm analyze the value of the leasehold assets in this area, and the behind pipe potential in other wells that do not initially complete in every zone.
Two wells are currently being completed in South Texas, and management expects they will be online and producing in the current quarter, which will help stabilize and grow production volumes. In addition, recompletion projects are underway that payout quickly and increase production volumes.
The company intends to maintain capital expenditures within their cash flow levels. From a recent IPAA presentation the PV10 of their proven reserves is about equal to the stock price. The possible and probable reserves—which are substantial here due to the lack of development in the East Texas and some of the South Texas areas—are essentially free to the shareholder.
If we had a bit more clarity on the natural gas market we would feel comfortable adding to our position at these price levels. The problem CXPO faces is that larger operators such as Devon, XTO, and Chesapeake are drilling to preserve leases even as the price of natural gas languishes around $4 mcf—a level that is very difficult to obtain a reasonable rate of return. We think firms with substantial crude oil and natural gas production and reserves, like GEOI and EPM, are much lower risk due to the production diversification between commodities.
We also listened to the EBIX call and are impressed with the growth strategy and positioning of the company going forward. EBIX is one of the larger positions in our portfolio. Balchem’s (BCPC) conference call also went well, the replay is unavailable but we obtained a transcript. The company has several interesting products in niche growth sectors.
May 13 – Thursday Evolution Petroleum (EPM) in their conference call yesterday noted they were ‘very pleased with the response’ of the wells in the Delhi field to the carbon dioxide flood. The flood began several months ago and the reservoir response was not expected until early this summer. In April the three producing wells averaged 886 gross barrels per day, of which Evolution gets 65 barrels as a cost free royalty.
The operator intends to have 200 wells in the field when the project is complete, with production ramping up between now and 2015. PV10 at $66, with no increase in future price or allowance for a royalty holiday for EPM’s interest pursuant to Louisiana law, is $6 per share. The stock sells at $5.80. The company has other assets in Texas in Oklahoma. PV10 for all their assets was roughly $7.50 a share according to a recent presentation last July—we expect it will be higher when the valuation is recalculated at fiscal year end this year (July 1, 2010).
Once crude oil production maximizes in the Delhi field in 2015 the decline will be very slight compared to the Barnett or Haynesville shale—maybe 8-10% per year, so this is a long term asset play on the value of crude oil. Valuation is very sensitive to the future price of crude oil, so if oil prices rise above $66 used in the last PV10 the value per share of this asset to the company could increase substantially.
Crimson Exploration also reported, we participated in the EPM conference call instead of the CXPO call. CXPO is natural gas oriented, EPM crude oil focused, and we think short term the crude oil market is more attractive.
Harbin Electric (HBRN) also reported earnings earlier this week. They reported record quarterly earnings, up 69% year over year to $0.66 per share, with strong revenue growth. We remain impressed with this firm. Harbin makes electric motors in China.
EBIX also reported earnings in the last week. The reported record revenues, up 58% year over year, and earnings per share were up 38%. We think the firm is well positioned in the insurance software sector.
May 12 – Wednesday The upcoming hurricane season could be a top 10 active year, a stark contrast from the relatively calm 2009 season according to AccuWeather Chief Hurricane Meteorologist Joe Bastardi. He predicts a total of 16-18 storms this season. To put that in perspective, only eight years in the 160 years of records have had 16 or more storms in a season. The season should start early with one or two threats by early July, and stay late with additional threats extending well into October. The Gulf of Mexico accounts for 30% of U.S. crude oil production, and around 18% of the natural gas production. Around one-third of the country’s refining capacity is also on the coast. Bloomberg also reported that Michael Economides, professor at the University of Houston, commented on the supply and demand for oil at an International Association of Independent Tanker Owners conference in London. Venezuela, Nigeria and Iraq are under-producing, he said. “There are problems out there for the production of oil. China has gone berserk. There’s no other country in the history of mankind that increases consumption by 20 percent a year. I’m personally surprised that the price of oil hasn’t already hit $100 a barrel. . . I think $100 is around the corner. There are no alternatives to hydrocarbon energy sources in the near future.” He continued, noting China is “going to show us in the west the reality of the importance of energy in the modern world.”
May 11—Tuesday The EIA projects that world oil consumption will grow by 1.6 million barrels per day (bbl/d) in 2010, slightly higher than in last month's Outlook, and will also grow by 1.6 million bbl/d in 2011. The growth in oil consumption is expected to be largely concentrated in the Asia-Pacific and Middle East regions.
GEOI announced impressive first quarter results this morning. Barrels of energy equivalent increased 60% year over year, with revenues increasing to $26.6 million from $14.6 million a year ago. Earnings per share increased to $0.30 per share from $0.03 per share a year ago. Production and reserves have tripled in the last three years. Management noted that they expect this growth to continue.
May 9—Sunday Regulators still cannot figure out why the market dipped last Thursday, another blow to investor confidence. The Wall Street Journal noted yesterday that many small investors who had placed ‘stop loss’ orders were hurt by the dip. The article went on to discuss examples—including insurance software firm EBIX Inc., a company in our LSGI portfolio. Selling at around $16 at day start, in the dip the stock fell to $0.75—and the stop loss orders were executed for a number of investors. The stock ended the day back near $16 a share—so the volatility removed a number of investors at a major loss, on no new information.
EBIX is a fantastic company, with a fantastic niche, and we have added to our position over the last few months—but unfortunately were unable to buy more shares at $0.75 last Thursday. The company is our fifth largest position. The stop loss issue is another example of how difficult it is to implement strategies to reduce volatility risks in the microcap sector—and how volatility may not be a measure of risk as some academic models have suggested.
The business model and outlook for EBIX was worth $500 million at day start on Thursday as measured by market capitalization, was $25 million briefly during the market dip, then finished the day at $500 million. Efficiency was not an attribute of this market, or sector (although to be fair even mega cap firms like Procter & Gamble also lost and gained massive valuations during the market event).
We don’t use stop loss orders in the LSGI portfolio due to the intraday volatility of companies in the microcap sector—and the problems with execution seen with EBIX. We will sell down our losing positions, when necessary, depending market liquidity and company fundamentals.
In the energy sector, Jim Puplava has a couple of experts discuss industry studies on trends in supply and deman in crude oil. Both studies see higher crude oil prices in the near future. Interview in fourth hour: Puplava
On the energy front, BP’s ‘cone’ to capture the crude oil has encountered difficulties. As we noted in our commentary in the latest LSGI Fund Report the spill will have a long lasting impact on the energy sector. LSGI Report [company positions are set out in the report mailed to investors, they have been deleted for the online version].
We remain very positive on the outlook for GEOI and EPM. Portfolio holding ARD has an outstanding offer for the firm, so is fully priced in our opinion. CXPO has an earnings call and annual meeting in Houston this month. We may attend the annual meeting, depending on our schedule.
May 7—Friday The May LSGI Report was mailed yesterday to our investors. We added Green Plains Renewable Energy (GPRE) to our portfolio, an ethanol, grain, and agriculture produce supplier. The company is the fourth largest ethanol producer in the U.S.
In the last few days the TED spread, a measure of the health of the banking sector, has jumped upward. The ‘TED spread’ is the yield differential between the 90-day T-Bill and Eurodollar contracts. It is a real money gauge that measures the risk within the global banking system. Eurodollars are the primary instrument of inter-bank lending—unregulated and uninsured dollars. When the banking or credit markets are stressed money flows into T-Bills while Eurodollar funds become more expensive, hence the divergence or spread in rates.
Investors and bankers are concerned about the Greece restructuring, and related impact in other European countries. Further upward movement of the TED spread is not a good sign for future economic activity—it indicates the credit market and banking sectors may be falling back into a state of disorganization or disrepair. Worst case we may see another global credit freeze.
Liquidity driven portions of the markets, like the microcap sector, will be most impacted by any banking or credit meltdown—but keep in mind share prices in these situations do not necessarily reflect the long term value of the underlying business enterprise.
April 27—Tuesday Donald Coxe in his latest conference call noted that he does not agree with Henry Groppe’s bullish view on natural gas. He recommends focusing on crude oil. Coxe also said that corn and grain prices most likely will remain depressed due to the size of the expected crop, and he said the recent volcano will not impact global weather patterns. Long term grains are attractive however.
With regard to ethanol he noted as follows in his most recent Basic Points:
The ethanol story, which has long been a colorful tale of politics, mendacity and greed, has recently taken a new twist. Look, Ma, it’s for real! Ethanol’s profitability depends on the spread between gasoline prices—which are driven by oil prices, and the cost of corn and natural gas. . . . low corn and natural gas prices now combine with high oil prices to create a market for ethanol that is at least partly based on honest economics—a remarkable novelty for ethanol. So we have made an investment for the Fund in a large ethanol producer.
He fails to mention the upcoming EPA determination on “E15” - a ruling that could substantially increase the demand for ethanol. Currently “E10” is the maximum blend—10% ethanol. Odds are that the EPA will approve the 15% blend limit.
April 26—Monday While the Burlington Northern is the most recent railroad purchase by Warren Buffett it is not the first time he has looked at the industry. When he was around 30 years old he tried to force the Copper Range railroad to pay out some of the cash they held to parties who held preferred stock to him and his wife Susan, and looked at potentially purchasing the entire line. A typical value play, the stock was trading at a severe discount, hauling mostly mine rock in Upper Michigan’s copper mining district.
He used an attorney that was a classmate of his to negotiate with the Copper Range. Apparently the company did not relent on Buffett’s demands. In a recent email from Mr. Buffett he noted he could not recall many of the details of his interest in the company, but said his classmate/attorney died at an unexpected young age.
We make a presentation last week to undergraduate finance students at Michigan Tech on investment managers who have delivered excess returns in the past—and their investment strategies: STRATEGIES USED BY WARREN BUFFET, CHARLES MUNGER, AND SHELBY DAVIS TO OUTPERFORM THE MARKET
April 20—Tuesday Someone highlighted the points made in the Art’s Way Manufacturing (ARTW) conference call last weekend. As noted last week the results were in line with what we expected. Highlights of the first quarter call, from the online posting, include:
1. The Company lost 13 days worth of production in Iowa due to snow, plus the Company had to pay plowing costs
2. Beet harvester orders were up significantly
3. Sales for this quarter will be the same as last year, but with better margins.
4. Sales of beet harvesters are up 60-70%. Could add another $1.5M in sales this year.
5. Backlog is up 35% from year earlier levels
6. Farmers are in very good financial condition, and have been buying equipment
7. The Company has a new building in South Dakota for auger manufacturing,
8. The backlog for augers is way up
9. The Company has a new building in West Union, Iowa, for Miller Pro line and equipment storage
10. Vessels division is moving in the right direction, sales are up
11. The Obama stimulus funds for the most part have not been released for laboratory construction yet. The Company says it would have been better if the stimulus was not passed, it has just stalled all bidding activity for laboratories and upgrades while we wait on the agencies to decide how to award the grants
12. The Company is looking to keep adding to their existing equipment lines
13. Q1 is usually the worst of the year due to cyclicality
14. Q2 and Q3 are usually the best of the year for the Company
15. The Company also had downtime in Q1 to re-organize the Armstrong manufacturing plant line to optimize production of the existing as well as new product lines, and to install additional computerized fabrication equipment.
As noted in our SEC filing, as of the filing date the LSGI Fund and related parties owned around 6.8% of the Company. We think ARTW is headed in the right direction, is gaining momentum as they expand their operations and equipment line, and is well managed. Manufacturing indexes have been indicating expansion in the sector for a number of months now. The next two quarters have historically been the Company’s best—the firm is somewhat cyclical and remains so.
From a statistical standpoint, James O’Shaughnessy in his analysis of 42 years of historical data (published in “What Works on Wall Street”) notes that the following three factors substantially increase the statistical chance a company’s share price will appreciate: (1) a small market capitalization, (2) a low price/sales ratio, and (3) stock price momentum (relative strength). Dr. Benson Durham at the Federal Reserve System studied 37 years of data and published a research paper entitled ”The Extreme Bounds of the Cross-Section of Expected Stock Returns” and found the same factors significantly increased the chances a company’s stock will outperform.
Applying these factors to ARTW we find: (1) with a market capitalization of only $24 million the Company qualifies as a small microcap firm—it would have to get at least 10 times larger to be considered by some as a ’small cap’ and around 25 times as large to be an average sized company in the Russell 2000 small cap index; (2) the Company has a price/sales ratio of 0.97 versus the S&P 500 average of 2.2, on the low end of the range; (3) the Company’s trailing 6 month relative strength is 90—meaning it outperformed 90% of the stocks in our database in the last 6 months, and the Company’s 12 month relative strength is 61—meaning the Company stock outperformed 61% of the firms in our database over the last year.
Statistically, these factors look very promising. Add in the increased backlog, increased margins, new products, customer interest, and expansion and this year could be very interesting for ARTW—and for us.
April 19—Monday The Globe & Mail had an interesting article online yesterday on the massive increase in debt levels seen in both Canada and the U.S.:
Canadians used to be big savers and cautious borrowers. In 1982, Canadians socked away 20 per cent of their disposable income and per capita debt stood at about $5,500, according to Statistics Canada. By contrast, Americans were saving just 7.5 per cent of their disposable income at that time and borrowed $6,500 per capita.
Savings and borrowing soon went in opposite directions in both countries and by 2002 debt levels surpassed disposable income for the first time. In 2005, the savings rate in Canada fell to 1.2 per cent, about the same as in the U.S. Meanwhile, per capital borrowing jumped to $28,390 in Canada and $48,700 in the U.S. . . .
•147%: Debt-to-income ratio in Canada, a record high •157%: Debt-to-income ratio in the United States
Unless unemployment begins to improve, and wages begin to increase, it is hard to see a massive amount of consumer spending to drive the economy when debt levels have risen so high. Especially if interest rates begin to increase. On the other hand debt has been increasing for decades, so the consumer may surprise.
While stock prices have improved significantly over the last year, most of the equities are held by households in the top 10% - and the assets held by middle class households (real estate mainly) have seen little improvement in market valuation, with many households having little equity in their homes at current depressed prices. Employment still lags, and long term unemployment is a major economic and political issue, which further raises the risk that the middle class will not recover as quickly as expected.
The Economist magazine noted this weekend that the discrepancy between those households who hold equities and those who hold real estate is creating a widening wealth gap in the U.S.—and while this gap has been tolerated in the past if unemployment and under-employment persist the political winds may change: article
With regard to real estate we were lucky in Texas to the extent regulations restricted second mortgages and the ability to use home equity as a credit line, which has helped prevent foreclosures in the economic downturn and has to some extent maintained property values.
April 18—Sunday With the Goldman Sachs SEC allegations released Friday, and the recent SEC charges against fund managers for allegations of insider trading, an interesting commentary was published recently that discussed the difficulty that active fund managers have in generating ‘alpha’ - excess returns for their investors.
The goal of investment managers is to develop an edge for their investment portfolio. Because there are so few truly inefficient markets that larger money managers can exploit without insider tips or manipulating the investor’s risk/reward playing field, the incentive for these managers is to ‘push the gray boundaries of legal information flow’. Firms that manage hundreds of millions of dollars for institutional investors face tremendous pressure to deliver excess returns, or face institutional redemptions – and possibly the failure of the asset management firm.
The commentary by author Alice Schroeder (“The Snowball: Warren Buffett”) notes:
They have another, bigger problem, the same one faced by the large institutions. There is only so much alpha to be had in the market, and they are chasing it along with everybody else. The aggregate number of people trying to carve fees out of investor returns simply overwhelms the potential gains for stockholders. It is this oversupply of overhead that creates so much pressure to cross the legal line.
Victims of their own success, the banks have severely aggravated this situation by going public, then taking on too many masters to “diversify” earnings: institutional money managers, retail investors, investment-banking clients, prime brokerage clients, “financial sponsors” (private-equity and buyout funds), their own asset-management arms, and proprietary traders. It is all but impossible for people at investment banks to serve all these clients -- whose interests conflict -- while doing their real job: to satisfy the quarterly earnings expectations of the banks’ investors.
One area these large managers cannot exploit—and one that is very inefficient—is the micro and small cap market for public stocks. The amount of money most of these asset managers handle, and the fact that many of these small firms are relatively illiquid, makes investing in small firms for their clients all but impossible.
Highly complex automated computer trading, ‘quants’, flash trading, derivatives, future, and complex financial instruments are the result of this push to find alpha in an environment where it is tougher and tougher to generate these excess returns (note the hundreds of millions spent on asset management, research, models, and the education of some of these managers, all in pursuit of the big payout).
We continue to take the position that it is very difficult for the average manager to generate excess returns. The more assets one manages the larger the challenge. The large cap stock market is relatively efficient due to the amount of resources that focus on companies that sector. Few mainstream asset managers will generate excess returns over time, unless they find a niche outside the large cap sector.
Even with the recent market and economic meltdown we take the position that the public stock market for small companies is very inefficient and many mis-pricings occur relatively regularly and can be exploited—although the volatility is also much higher reflecting the lack of liquidity. Active managers in the small company sector should have greater than average odds of generating market beating returns over time.
The entire Bloomberg column is at the following link, it raises some interesting points: Wall Street
April 17—Saturday Veteran energy analyst Henry Groppe was interviewed yesterday on the energy sector—and repeated his bullish long term call on the sector, including a bullish view for natural gas. He claims only a small part of the domestic natural gas is being produced from unconventional shale formations and production from the largest of these fields—the Barnett field here in North Texas—has peaked and is now declining.
Groppe said that natural gas is at a point where it is ‘greatly undervalued’ considering the fundamentals. He claims shale gas is only 13% of supply, and 60% of that is Barnett shale gas and that field is in serious decline. The market has misinterpreted the role shale gas has played in the market, and the future production levels and capacity.
Groppe claims that conventional natural gas wells are declining substantially, and that shale gas will not replace these declines. Power generation, and the fact that natural gas at current price is now competitive with coal for electrical generation, means natural gas demand should increase. Groppe sees the price of natural gas doubling as it reflects the supply and demand trends.
Groppe sees a peaking of global crude oil production claiming we are entering a new era. Higher prices will ration oil supplies, and he thinks the oil sands will provide incremental gains—one of the few areas that will be able to increase production in a world of declining oil production capacity. He thinks many of the Canadian tar sand producers will be purchased as investors will have no-where else to go for reserves, and China is aggressively purchasing reserves and will continue. Groppe sees tight supply conditions during which many acquisitions will be made over the next five to ten years.
Groppe claims that the major risk to investing in natural gas is timing. The fundamentals are so strong in his opinion that long term investors should face few risks, with timing moved few months one way or another based on fundamentals. He claims natural gas is the best one of long term investment thesis that he knows. Energy is capital intensive business, technology is very complex, and Canadian producers are very attractive in his opinion.
The comments are worth listening to, Groppe is well respected: http://watch.bnn.ca/#clip290075
Bill Powers of the Powers Energy Letter is also bullish on natural gas, in fact he is on the same page as Henry Groppe. Production of natural gas continues to decline from conventional wells according to Powers and the shale gas reserves have a tendency to decline quickly. So while it appears the natural gas market is well supplied in reality the declines will insure that new production does to overwhelm the supply and demand balance. Powers also notes how poor the federal government natural gas reporting data has been—state records are much more accurate he claims.
The Colorado State hurricane forecast was released recenly. Dr. Gray predicts an above average season starting July 1st. His forecast is in line with AccuWeather’s earlier forecast. Due to the amount of oil and natural gas production in the Gulf of Mexico and along the shoreline these forecasts raise the risk of a supply interruption this summer. Even a storm threat causes platforms and pipelines to shut in production for safety and environmental reasons.
Don Coxe discussed how strong the Canadian dollar might become, and the difficulties that might create for the Canadian economy. He also mentioned that his monthly report, Basic Points, will discuss the global manufacturing recovery. With the financial crash inventories were liquidated quickly to raise funds, and with demand increasing manufacturers have to ramp up quickly. Coxe also expects commodities prices to continue to increase with manufacturing activity. A level of confidence can be found in raw material stocks and stocks tied to industry.
Coxe is confident that China is not in a bubble, that the country is huge and the economic growth is directed at developing infrastructure versus speculation in financial instruments. He sees more and more pressure on the prices of raw materials, and sees very positive action by commodity stocks. He thinks China will raise the value of their currency to help control the inflation of commodity prices.
The Iceland volcano is not a major concern weather wise, at least yet, according to Coxe, and probably will not impact agriculture. The volcano is a relatively small eruption in the scheme of things, and is producing ash and not sulfuric acid as has been emitted in earlier major eruptions. Sulfuric acid reduces global temperature, ash should increase global temperatures. Ash is toxic however, and disruptive to airline schedules.
Art’s Way Manufacturing held their first quarter conference call yesterday. We think the firm is on the correct path from a business strategy standpoint. They have acquired two new buildings for manufacturing, one in South Dakota for augers and one in West Union, Iowa, for the Miller Pro line of products. Backlogs are up 35% from the year earlier levels. Orders for new laboratories from the stimulus plan are still on hold—only 20% of the stimulus funds expected to be distributed for new facilities has been awarded, the number of applications for funds and the awarding of projects has been much slower than expected.
We had lunch with a founder of a small company that was sold a couple years ago for around $50 million, and he noted that after all the cuts and cost controls you implement during a recession when the recession finally ends the company will generally become very profitable coming out of a recession. He said that his company made the most money ever when just exiting recession, and he expects to see something similar with firms like Art’s Way Manufacturing. He wanted to take a position in the firm.
April 16—Friday Last weekend the Dallas Morning News published the following article on toxic air emissions from natural gas wells in North Texas. While the wells might not violate regulations keep in mind that common law liability could arise – potential negligence, nuisance, trespass, unreasonable use of the surface causes of action come to mind: *********************************** Most Barnett Shale facilities release emissions09:48 AM CDT on Sunday, April 11, 2010, Dallas Morning NewsPlumes of toxic, smog-causing chemicals from Barnett Shale natural-gas operations are so common that inspectors find them nearly every time they look, a Dallas Morning News examination of government records shows.
What's more, the inspectors have rarely looked.
Hundreds of pages of documents obtained by The News under federal and state open-records laws, plus other reports and studies, reveal a pattern of emissions of toxic compounds, often including cancer-causing benzene, from Barnett Shale facilities . . . .
[link to rest of article] -
********************************* We were interviewed on several studies forecasting a global shortfall of crude oil supplies in the near future last weekend by Jim Puplava:
http://www.lsgifund.com/CPS/Puplava.4.2010.wmv
April 15—Thursday The drought in southwestern China which began last fall continues to intensify and may be starting to impact world energy prices. So far as many as 25 million people, 20 million acres of crops, and 12 million head of livestock have been affected.
The drought stricken area is the watershed for the bulk of China’s hydro-electric generating capacity, which in turn provides a substantial share of the power for the industrial plants along the southeast coast. Press reports speak of hydro power output falling from 70 to 90 percent in some regions. Officials note that unless heavy rains come in the next month, many reservoirs will be empty and power stations will have to close down. For a country attempting to grow its GDP by 11 percent this year, electricity shortages that could run to 10 of 15 percent of national production could be a disaster.
To make up the shortfall temporary diesel or gasoline powered generators may be employed at some facilities, although they will not make up for the entire power shortfall expected without heavy rain. The demand for these crude oil products would increase during the period of hydropower shortage. Coal imports might also increase, although many coal plants have been running at near capacity.
Apache announced that they bought energy producer Mariner this morning for $2.7 billion, another in a series of mergers in the sector. We continue to note that these acquisitions will put a floor under stock prices of many companies in the sector.
April 14—Wednesday A Chinese refining company bought an interest in the Canadian tar sands last week. The amount they paid for their 12% interest in the project was just stunning according to many analysts. After running the numbers, with an 8.5 per cent tax discount rate, Greg Pardy of RBC Dominion Securities concluded the $4.65-billion price tag on this deal implies a long-term oil price of $95 a barrel. At Peters & Co., analyst Jeff Martin concluded the Sinopec purchase is based on a $106-a-barrel expectation on oil.
In general, when buying oil reserves the buyer pays a discount to the current market price. The tar sands also require a large amount of capital expenditures needed to mine and process the bitumen to make it a feedstock for the typical oil refinery, and to ship it to market by pipeline. The valuation on this deal shows China’s largest refiner has a bullish long-term view on energy prices, and the potential of the oil sands
GFRE, a Chinese producer of bromide for industrial uses, announced new guidance this morning—increasing revenue and earnings guidance by 20-25% due to strong prices for their products. We continue to find this firm attractive.
April 13—Tuesday The U.S. Joint Operating Forces Command report issued last month noted that "by 2012, surplus oil production capacity could entirely disappear, and as early as 2015, the shortfall in output could reach nearly 10 million barrels per day." If correct, a shortage of 10 million barrels per day would be a massive shortfall—current global demand is roughly 85 million barrels per day. In such a situation the price of crude oil would be much higher than $100 a barrel.
A report by the IEA issued this week estimated global demand in 2010 would rise to 86.6 million barrels a day in 2010. Demand for 2009 was revised down by 70,000 barrels to 84.9 million. Gain year over year would be 1.7 million barrels a day or 2%.
GEOI provided operational updates recently. It has healthy crude oil reserves, and the operational update was very positive. The company has a great niche in the crude oil sector. Note all the recent acquisitions and mergers in the energy sector recently, which sets a floor under the valuation of these companies.
ARTW announced earnings that were in line with what we expected. The equipment manufacturing facility had the equipment lines completely reconfigured last quarter which reduced output for the quarter but makes it more efficient to produce the current product lines and boosts capacity and throughput. The quarter is historically the weakest quarter of the year for the company.
We recently reviewed a report by the Michigan Tech Applied Portfolio Management team on GFRE they were presenting to an investor—they had a target price on the company of $32. GFRE is trading for roughly $11 per share. The company is in our portfolio.
April 12—Monday This weekend it was announced that China, the world’s second-biggest energy consumer, increased March crude oil imports by 29 percent from a year earlier. It remains a net importer of fuel. Crude imports reached 4.98 million barrels a day, preliminary data released by the General Administration of Customs showed. Demand a year ago was roughly 3.9 million barrels per day—a huge increase in a global marketplace where demand is around 85 million barrels per day.
In the U.S. the alternative fuel market in the form of ethanol production continues to expand. As the amount of corn used for ethanol increases each year corn could get more expensive according to a recent study unless supplies can expand to meet the incremental demand.
From 2005 to present the amount of corn production used for ethanol has increased from 9.5 percent to 22 percent. With the 2007 Renewable Fuels Standard Program in place that percentage will continue to rise. If severe weather limits corn supply, and on any given year there is a 10% chance of this occurring, ethanol could use as much as 40 percent of corn produced this year—and prices could double according to a recent study.
Currently the blend limit is set at 10% ethanol to gasoline—but the EPA will issue a ruling on an application to increase that blend percentage to 15% in the near future (such a ruling is expected by July). If the EPA increases the blend limits this could increase ethanol demand quite significantly this summer. Several groups who are concerned about engine damage from higher ethanol levels are opposing the increased ethanol use.
With relatively low corn prices and low natural gas prices, the two major cost inputs to ethanol, and high crude oil prices going into refined products such as gasoline, ethanol is much more competitive from an economic standpoint than it was a year ago. Long term ethanol is not a great plan for energy independence for several reasons (one of which is that it takes almost as much energy to make a gallon of ethanol as is recovered when it is burned), but short term it might be an interesting sector to watch.
April 9—Friday Donald Coxe in his conference call today discussed gold, currency, and commodities. Reviewing a gold chart he noted that gold may have begun to break out to the upside with a pennant or flag, which might indicate a change in the perception of paper money versus commodities. A lot of chartists claim that gold will test new highs, probably soon.
This is unusual since the dollar has also been strong. But the dollar is strong only because the euro and yen are so weak. The Greek breakdown has illustrated how fragile the euro is as a currency. The euro is a currency that was established by committee, not a usual structure to create a strong currency.
Up until the Greek crisis many investors saw the euro as a good diversification to the dollar, especially with the budget adopted by the current U.S. Administration. The dollars is now looked as the ’least bad’ of the three major currencies. The overall effect is the Obama Administration has been given a giant gift from Greece, as the dollar is the only strong currency that is liquid enough to handle the global capital flows.
In this environment many are beginning to realize that maybe gold is a good alternative, as well as oil. Back in the 1970’s this also occurred, with money flowing into crude oil and gold, so history may be repeating. Coxe claims that maybe the higher oil prices we see are a sign of inflation, or maybe it is a sign that investors see oil as a good alternative to paper currency. Inflation may not be an issue now due to the futures curve for oil.
Israel might also be a factor in the higher current prices for oil, since there is a threat that the country might act on the threat from Iran. This probability of some type of military action probably has increased due to the deterioration of U.S. and Israel relations according to Coxe.
Coxe says one can take the view that industrial commodities are getting stronger by the week as the economy is recovering. The commodity story can exist for awhile without large jumps in inflation. The price of scrap steel has gone up to an extent so quickly that Coxe claims he has never seen such a jump in his career.
Coxe notes that he finds interesting in the ‘big performance’ in the farm machinery stocks. He says equipment might give farmers a fast payback, which has caused an ‘upside breakout’ in some agricultural sector stocks. And the industrial sector is also strong, which is driving demand. Fertilizer sales have recovered also from last year. Coxe remains enthusiastic for the agriculture sector as an investment theme.
Note one of our agricultural plays, ARTW, will announce earnings in the next week or so. The annual meeting will be held in three weeks in Iowa. We will attend.
April 8—Thursday Tudor Pickering issued the following note today:
· 2010 hurricane forecast update ($4/mcf) – Never too early to stock up (batteries, water, beer and bean-dip). Colorado State storm swamis expecting active 2010 season (usually starts June 1st). Last year was duster (only 3 hurricanes w/ 2 major storms), but this year looking for 8 hurricanes, 4 intense (category 3 or higher) and 35 hurricane days. All these above 50-year averages. ~70% probability of intense hurricane hitting entire U.S. East Coast (52% norm for past century). At miserable $4/mcf pricing, more weather is better weather for nat gas. Next update from CSU June 2nd.
As we noted several weeks back Accuweather concurs on this long term forecast.
April 7—Wednesday The Bush Institute 'Natural Gas Nation' symposium last week at SMU painted a very positive picture for domestic natural gas production and markets. One concern that could be a major hurdle for companies developing this resource is the danger to the environment from these 'hydraulic fracing' operations.
PBS had a short interview with the producer of "Gasland" last week - an award winning short film on the environmental issues relating to natural gas shale formation development - and the conflict between economic benefits of development and the offsetting pollution concerns:
http://www.pbs.org/now/shows/613/index.html
March 30—Tuesday Tudor Pickering Holt issued the following note on the natural gas storage situation:
Gas Storage…winter summary ($3.98/mcf)
· Summary – Winter is almost over, so we wanted to summarize what we’ve seen from storage injection performance. Remember, we view storage as best real-time indicator of supply/demand balance. Good news: storage says the weather-normalized gas market is tighter than a year-ago and was close to “normal”. The not so good news: the market was not as tight as we predicted it would be (based on our supply study) and the storage data showed a degree of weather sensitivity that raises the potential for larger than normal shoulder period injections.
· How did we fare this winter? Gas draw so far this winter (from early Nov) has been 2,205bcf compared to 1,840bcf last year (a delta of 366bcf), 2,021bcf for the 10-yr norm and 2,015bcf for the 5-yr norm. For comparisons with last year, this winter has been 1% warmer y/y (and 3.5% colder than the 10-yr normal). Adjusting for a slightly warmer winter vs. y-ago, the 366bcf larger draw becomes ~430bcf. Over the 20 weeks of winter, this is 3/bcf/day tighter than y-ago. Over the past 4 weeks, the data is showing a market that is only ~2bcf/day tighter y/y – implying the rapid uptick in drilling off the 2009 trough is starting to be felt. While the market is clearly better y/y, it is nowhere close to as tight as we anticipated (which is why we lowered our $7.50/mcf 2010 gas price call and why the market is so darn bearish).
· Weather sensitivity? One aspect of the gas storage draws that is troubling/confusing is the apparent weather sensitivity in this winter’s storage draws. For the 10 weeks when heating degree days were >200 (i.e, cold), the weather normalized storage data outperformed (larger draws than predicted) by ~1bcf/day. In contrast, the 10 weeks with HDD<200 (i.e., milder weather) underperformed by ~2bcf/day (smaller draws than expected…). We are not sure what to attribute this trend. Initially thought it was caused by more residential and commercial demand as % of total demand but would not explain overall bullish data when weather is cold or could be location of cold weather this winter (focused in southeast/Texas)…or maybe something else?. Regardless of the reason, apparent weather sensitivity has potential implications for upcoming shoulder period injections when we experience very mild weather. In other words, if this trend continues, storage injections in late April and May could be significantly larger than normal (high 70’s to mid-90’s bcf per week injections). Ugh.
· Shoulder Period injections. Obviously, hot (or not) weather and the presence/absence of meaningful tropical activity influence summer storage injections. However, the amount of gas injected during mid/late April thru late May have also historically correlated strongly with overall summer injection volumes. In other words, if there is a lot of gas available for injection during the shoulder period then underlying supply and demand fundamentals are weakish and, all else being equal, above average amounts of gas will be injected during the summer. The converse is also true…small shoulder period injections suggest tight market and the potential for below average summer injections. As you might guess, we’re closely watching the 5 to 6 week period from April 15 thru end of May!
March 28—Sunday Investors Intelligence Analysis issues period technical ‘signals’ for select stocks. On March 24th the daily report noted in the “P&F Breakouts” section of the report that a bull signal had been issued on ARTW, with a target price of $11. We are always skeptical of technical analysis signals, but we were pleased with the recent announcement by ARTW with regard to a potential new facility in Iowa and their new equipment line. We expect more acquisitions, and growth, going forward.
John Dizard had another article on shale gas in the Financial Times yesterday. His comments are as follows:
Normal, non-obsessive, readers may want to see the end of my shale gas scepticism, but there was, according to my mail, one big question left unanswered by my comments on the industry's economics: What could take the price back up to the $10 per 1,000 cu ft that I and others believe the industry needs to make money?
Liquid natural gas import facilities in the US cannot yet offset a significant decline in North American production. That would already have happened if we did not have the supply from the new shale gas wells. The recession-induced fall in electricity demand also cushioned the effect of conventional gas production weakness. That's why we have $4 gas. To get to $10 we need a large increase in gas demand, or decline in supply. Either will do, and we will probably get both.
Prospective laws and regulations restricting coal-fired generation are likely to have a startling effect on gas prices. The coal industry says that even without any taxes or caps on carbon dioxide emissions, proposed limits on sulphur and nitrous oxides, along with mercury, would make at least 15 per cent of coal fired capacity uneconomic.
Even if only a tenth of coal power is shut down, that would require a shift of 5 percentage points of US power supply to gas or renewables, which would also need substantial gas-fired backup. Since gas now generates about 20 per cent of electricity, that is a large increase in demand and could lead to electricity price rises of a quarter to a third.
What about a decline in supply? Low gas prices will do that. Not even the shale gas evangelists will be able to keep up the financing needed to pay for today's level of drilling. The huge initial production, and rapid decline, of shale wells mean more drilling is needed just to stay even.
Then, of course, there's the possibility of a war in the Middle East, which could drag up gas as well as oil prices. No doubt, though, the US influence over Israel is so strong that a strike on Iran can be ruled out. Or maybe not.
In his earlier column on shale economics Dizard mentioned the work of Ben Dell at Bernstein Research. For his modeling estimates Dell uses a price of $8.50 a mcf for natural gas (versus a spot price of $4.00 today) and an oil price of $102.60 in 2011 (versus a spot price of $80 today). In 2012 he uses $9.18 mcf for natural gas and $110.81 for crude oil. Bullish numbers, perhaps too bullish in our book, but we think he is directionally correct.
March 27—Saturday Lowry’s buying power continued to advance last week, from 208 to 222. Selling power remained constant, which is a bullish sign for the market. We have added two companies this month to our portfolio and sold down our exposure in several existing portfolio positions.
The LSGI Fund net asset value continues to trade above the trailing 200 day moving average, a positive signal. We use the 200 day moving average as a signal to determine if we should be fully invested or if we should be raising cash. Mark Hulbert had an interesting column last month on how the 200 day moving average is an excellent tool—or at least as good as any other technical indicator—for portfolio managers. He noted:
Compared to almost all other market timing systems I monitor, this one was the simplest. And yet, it also turned out to perform quite well: For the decade of the 1980s, for example, it was the very best performer of any tracked by the Hulbert Financial Digest.
Hulbert’s entire discussion can be found at the following link: column
March 26—Friday We attended the first Bush Institute symposium on energy at SMU this week. The program focused on the potential for natural gas to meet our domestic energy needs. The speakers were well received and interesting, however they provided no materials for participants and in our opinion were biased to the optimistic side with regard to the amount of natural gas that can be recovered using hydraulic fracturing and downplayed environmental, regulatory, and technical issues in such development.
Another organization has issued a report on the impact of stabilization and potential decline of global crude oil production on the economy and global trade: Tipping point study
March 22—Monday The following materials were sent to Oil & Gas Law students at SMU. Some of the materials have both legal and financial implications:
Several recent environmental developments that you should be aware of:
1. As we discussed in class horizontal drilling and hydraulic fracturing processes create unique environmental issues that the industry and regulators have not faced before. Last week the EPA announced they would examine the hydraulic fracturing process to assess the impact on water quality and human health:
http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aPhkIp7oziGk
2. As we discussed in class some cities have adopted ordinances to restrict drilling activities. After a recent spill of hydraulic fracturing fluid several council members in Flower Mound want to adopt a six month drilling moratorium:
http://lewisvilleblog.dallasnews.com/archives/2010/03/flower-mound-2-councilmen-want.html
Because oil and gas leases have a term clause during which a well must be drilled or the lease will expire, and because some of the lease bonuses have been $20,000 per acre lease, do you think an operator could have any claims for damages if their leases expired due to a city imposed drilling ban?
Also, with regard to the spill, do you think the landowner can sue on a negligence theory? Negligence per se under Railroad Commission Rule 8? A strict liability theory? Nuisance theory?
3. As we discussed in class, there is some debate as to how prolific the horizontally drilled wells are when drilled into shale formations such as the Barnett Shale (Fort Worth) or Haynesville Shale (East Texas) or Eagle Ford Shale (South Texas). You would think it would be simple for the operators to determine if these wells are profitable or not – but it is more difficult than you would expect.
One view claims that with the new fracturing and drilling technology we now have access to a century worth of natural gas reserves that we can recover at incredibly low prices with almost no impact on the environment. We could significantly reduce the level of crude oil imports and our reliance on Middle Eastern countries for our energy supplies. I call this the “Wall Street promoter” view.
Another view claims that the horizontal shale wells deplete very quickly, are very costly to drill, and have many hidden environmental impacts so that they will not be economically viable unless natural gas prices are roughly twice the current spot price. In addition these advocates claim that the shale basins will not add anywhere near the reserves to our energy inventory that proponents are claiming – and in fact production from the Barnett Shale basin is in steep decline and the Haynesville Shale production has peaked – only three years after the field was discovered! I call this the “Engineer/Small oilfield operator” viewpoint.
Regardless of who is correct, it is a great debate – and the country’s energy policy and outlook, as well as the price of the fuel, will be heavily influenced by who is correct:
http://www.lsgifund.com/SMU/research/shale.doc
http://www.financialsense.com/fsu/editorials/dancy/2009/1201b.html
4. If the global economic recovery continues the trends in demand and supply for crude oil and natural gas could result in higher prices for both those commodities. As prices move higher the general rule is that energy projects with more intensive environmental impacts become more viable (think additional development of old marginal fields, oil shale mining, oil sands development, etc.).
I wrote a brief note on trends in crude oil and natural gas demand and supply recently. Many well known energy analysts are forecasting much higher crude oil and gasoline prices over the next few years due to supply constraints and the booming demand for crude oil in China:
http://www.financialsense.com/fsu/editorials/dancy/2010/0316.html
5. The U.S. Joint Forces Command issued their Joint Operating Environment (JOE) report for 2010 last month. They maintain:
A severe energy crunch is inevitable without a massive expansion of production and refining capacity. While it is difficult to predict precisely what economic, political, and strategic effects such a shortfall might produce, it surely would reduce the prospects for growth in both the developing and developed worlds. Such an economic slowdown would exacerbate other unresolved tensions, push fragile and failing states further down the path toward collapse, and perhaps have serious economic impact on both China and India. At best, it would lead to periods of harsh economic adjustment.
The report notes that by 2012 excess global crude oil productive capacity may disappear, which could result in wildly volatile and higher crude oil prices! Exciting and frightening all at the same time. The entire report is at the following link, with energy discussed on pages 24 to 29:
http://www.jfcom.mil/newslink/storyarchive/2010/JOE_2010_o.pdf
March 21—Sunday The International Energy Agency noted last week it is worried about underinvestment on finding oil and developing reserves. Global capital spending on those activities -- including spending on maintaining or increasing production from existing fields -- fell $90 billion, or 19%, in 2009. That decline, the IEA reports, was the first in a decade. Three trends make this decline particularly troubling to the IEA:
First, Western oil companies are increasingly excluded from the most promising areas for exploration and development. National oil companies control access to many of the attractive basins. It is estimated that 85% of oil reserves are controlled by national oil companies. Governments don’t have the same incentives to develop some of these fields as a private firm may have.
Second, as fields are found in more challenging environments the cost of finding oil continues to rise. Western oil majors have recently reported a rise in the drilling failure rate and in the cost of drilling and completion.
Third, the IEA estimates that output from existing fields will drop by almost two-thirds by 2030 due to resource depletion. Decline rates range from 5-8% per year on average, but some fields decline much slower and some much higher.
A drought in Venezuela may effectively shut down or severely reduce refining and crude oil production activities in that country within the next three months. Two-thirds of the country’s electrical power is generated from a major dam that is nearing minimal water levels. Power cutbacks are already in effect, but the availability of electricity may become more severe unless the country experiences a massive amount of rain the next few months.
Last, a study out of Kuwait was released last week that predicts that crude oil production will peak globally in 2014. The research team examined oil production trends in 47 major oil-producing countries which supply most of the world's crude oil. Some of the countries have already hit their peak. Canada, the U.S., Mexico, Russia, Norway, the U.K., China, Iran, and Indonesia have all peaked, according to the researchers' calculations.
There were many countries which are expected to peak after 2014, most notably OPEC member countries, which are expected to peak in 2026. Non-OPEC countries included in the study peaked in 2006. It was also noteworthy that the study found the world's oil reserves are being depleted at a rate of 2.1 percent per year, while the U.S. crude oil reserves are being depleted at three times the world rate (6.3 percent annually).
Meanwhile China’s crude oil demand is set to grow by 900,000 barrels a day in the next two years. Chinese oil consumption reached 8.5 million barrels a day last year, compared with 4.8 million in 2000. The country will account for a third of the world’s total consumption growth this year.
While China is by far the fastest-growing oil market in the world, the United States is still the top consumer: despite the slump, Americans consumed 18.5 million barrels a day in 2009. That amounts to 22 barrels of oil a year for each American, compared with 2.4 barrels for each Chinese.
March 20—Saturday The U.S. Joint Forces Command issued their Joint Operating Environment (JOE) report for 2010. They maintain:
A severe energy crunch is inevitable without a massive expansion of production and refining capacity. While it is difficult to predict precisely what economic, political, and strategic effects such a shortfall might produce, it surely would reduce the prospects for growth in both the developing and developed worlds.
Such an economic slowdown would exacerbate other unresolved tensions, push fragile and failing states further down the path toward collapse, and perhaps have serious economic impact on both China and India. At best, it would lead to periods of harsh economic adjustment.
To what extent conservation measures, investments in alternative energy production, and efforts to expand petroleum production from tar sands and shale would mitigate such a period of adjustment is difficult to predict. One should not forget that the Great Depression spawned a number of totalitarian regimes that sought economic prosperity for their nations by ruthless conquest.
The report notes that by 2012 excess global productive capacity to produce crude oil may disappear, which could result in wildly volatile crude oil prices. The entire report is at the following link with energy discussed on pages 24 to 29: JOE2010
In the LSGI portfolio we are trying to focus on companies with more crude oil reserves and production versus natural gas, based on the fact that crude oil is a global market and demand is increasing. Natural gas markets are more local, pipeline constrained, and natural gas prices have been weak due to supply and demand issues. The rig count for horizontal drilling has recovered strongly even in the weak pricing environment, and horizontal wells in some of the shale plays have exhibited tremendous productive capacity.
Over time we think natural gas prices will firm, but short term we have few catalysts to move prices much over the $4.20 mcf front month prices. The heating season is nearing an end, so demand for natural gas should decrease into spring. Keep in mind that at the current price natural gas is becoming competitive with coal to generate power, so incremental demand for natural gas may increase during the summer months as peaker plants are put online. And the hurricane season and potential interruptions in supply is months away.
March 19—Friday Dow Theory, a forecasting system devised more than 100 years ago by Wall Street Journal editor Charles Dow, is back in the bullish camp according to experts. The theory is a trend following strategy that tracks the levels of Dow Jones Industrials and Dow Jones Transportation index, and highs in one index need to be confirmed by highs in the other index.
A weakness of Dow Theory is that its followers can miss out on big gains, because by the time the market sends a clear signal that the trend has changed from down to up, the market has already posted sizable gains. Regardless, it is a positive sign for the markets.
Richard Russell of the Dow Theory Letter notes as follows:
. . Turning to the nearer term, ironically, the stock market issued a "triple bull signal" yesterday. And I'll be really fascinated to see how the year 2010 turns out. I have the feeling that there are going to be a lot of major surprises this year. I'm guessing that the year 2010 is going to be a very tricky and difficult year.
The reason I say that is that so much of the bullishness of 2010 was manufactured by the Fed and the Treasury and with the help of the greatest addition of debt in the history of the US or any other nation. Everything in life and in finance is a trade-off. And I wonder what the trade-off will be from the US taking on trillions in debt to defeat the Great Recession. For the time being, the market is saying that "everything's OK." For the time being, that is.
March 18—Thursday Official forecasts may be underestimating the future demand for oil by a substantial amount according to a research paper by Joyce Dargay of the University of Leeds and Dermot Gately of New York University. If so, the ‘next oil crisis is going to be a whopper’ according to commentary on the study.
Dargay and Gately base their logic on the observation that the demand for oil no longer appears to respond to price. While price increases in the 1970s hammered worldwide demand for the fuel, the heftier oil prices we’ve witnessed over the past decade had no such effect. Instead, worldwide demand for oil increased by 4% during that time.
The professors say the 1970s fall in demand was the result of taking advantage of simple economies like moving away from using oil to generate power. But they caution that those successes can’t be repeated—and transportation is very inelastic to oil prices, especially in developing countries. Dr. Gately emailed a copy of the study for us to review. It can be accessed at the following link: study
The World Bank has raised its growth forecast for China this year to 9.5 percent from the 8.7 percent it had forecast in November. The bank also expects that growth will fall to 8.7 percent in 2012. While expressing some concern about inflation, the housing bubble, and local government finances, the bank said that all these problems are manageable and that it does not expect serious economic difficulties.
March 16—Tuesday Richard Russell of the Dow Theory Letter noted the following in yesterday’s comment:
The Leuthold Group published a most interesting study of returns during various ten-year periods. I'm showing the annualized total returns below, and I consider this study significant.
1930 to 1939 ..... Annualized return for the S&P 500..... +0.0% 1940 to 1949 ..... +9.2% 1950 to 1959 .......+19.4% 1960 to 1969..... +7.8% 1970 to 1979 .....+ 5.9% 1980 to 1989.....+ 17.5% 1990 to 1999......+18.2% 2000 to 2009.... -0.9%
What's this, the decade of 2000 to 2009 was the worst in history including the decade that included the Great Depression? And it's the only decade that ended up on the minus side. Is the stock market, in its wisdom, trying to tell us something? I think it is. I think the stock market by its negative performance during 2000 to 2009 was preparing us for hard times, a period ahead where we will have to deal with the results of years of Fed-created inflation, towering debt, and phony fiat currency.
March 14—Sunday Tudor Pickering reports that hydroelectric generation in the Western U.S. will be down this year due to low reservoir levels and the lack of precipitation. The benchmark Dalles Dam water flow is forecast currently at 65% of normal, which would be the third driest year over the last 50 years (1977 and 2001 were drier). Lost hydro power is generally replaced by natural gas powered generation. If flow is as low as expected natural gas demand could increase this summer by 1.5 to 3.0 Bcf/day. Along with the summer hurricane forecast, these trends would be positive for natural gas pricing.
Due to the amount of snow that has fallen this winter there is a high level of concern about spring flooding in the agricultural states in the Midwest and Plains areas. Also of concern is the fact that wet conditions might delay spring planting, which might impact corn and soybean prices.
March 13—Saturday Richard Dixon of Lowry’s Research was interviewed at length on Bloomberg Radio yesterday. He noted that the intensity of the “Buying Power” - the demand for stocks—is growing. Buying power increased to 214 from 192. And “Selling Power” - the supply of stock—continues to fall with the index falling from 677 to 655. As a result they think any pullback in the market “will not be substantial.” In fact he noted that these trends were very bullish longer term—”blowing the trumpet” or “beating the drum” for a bull market.
Dixon also noted that investors are starting to move into mid and small cap firms—investors are willing to take on a bit more risk than in the last year. The last cycle where small caps outperformed peaked in 1999 according to Dixon, and this move could be the start of another cycle where smaller firms outperform.
Don Hays also published a new study on stock valuations as well as a weekly report on his indicators. For the first time in a couple of years his timing model is fully bullish, not just bullish for a trading period but bullish for long term investors. His valuation model, back-tested against the S&P 500, places stocks into 5 different quintiles as to valuation.
Right now stocks are as undervalued as they have been in decades, in quintile ‘one’ - most undervalued, according to Hays. When this reading has occurred in the past the S&P on average has gained 21.8% over the following 12 months. We expect that small cap stocks, since they are more volatile, would have performed better than the S&P 500 index during these time periods.
Don Coxe discussed the changes in royalty rates in the Alberta oil sands this week. Apparently the government has lowered royalties in an attempt to increase developmental activity. Even with a stronger dollar he sees global demand for commodities supporting higher commodity prices and higher prices for commodity-related stocks. He points out that China and India continue to grow.
Jim Puplava has a number of charts that track indicators on his site this week. Like the charts we track in the monthly LSGI Report most of the charts he follows are very positive for the economy—and the markets: charts
March 12—Friday Emerging markets are driving unexpectedly strong growth of world oil demand this year with a big boost from China, despite a fall in advanced economies, the International Energy Agency said in a report issued this morning. The IEA warned that demand for oil, a strong indicator of economic activity, would not recover in advanced economies overall this year, but was signalling an "astonishing" growth trend of 28 percent in China. It raised its forecast for global demand in 2010 to 86.6 million barrels per day (mbd) from its projection last month of 86.5 mbd -- a 1.8-percent increase from 2009 demand levels.
The IEA said that demand in the area covered by the Organization for Economic Cooperation and Development (OECD) remained "persistently weak", and would fall by 0.3 percent this year. The OECD groups 30 developed economies including Britain, France, Germany, Japan and the United States, which account for by far the major part of global economic output.
China is currently expected to account for almost a third of global oil demand growth in 2010.
HiTech Pharma (HITK) reported earnings yesterday. They exceeded expectations, and the company conference call went well.
March 11—Thursday AccuWeather foresees 16 to 18 named hurricanes/tropical storms forming in the Atlantic Ocean in the upcoming hurricane season starting July 1st. Five will become hurricanes and two or three of them going ashore in the U.S. as major systems. In all, 15 storms probably will be in the western Atlantic or the Gulf of Mexico, and seven may make landfall in the U.S., said Joe Bastardi, chief long-range and hurricane forecaster. The Gulf of Mexico is home about 27 percent of U.S. oil and 15 percent of U.S. natural gas production, according to the Department of Energy.
Only nine named storms formed during the 2009 season, the fewest in 12 years, and three of them became hurricanes. Last year was the first time since 2006 that no hurricane hit the U.S. mainland. In 2008, there were 16 named storms, and eight of them were hurricanes. The historical average is for 11 named storms, with six of them becoming hurricanes, two of them major.
March 10—Wednesday The U.S. Energy Department increased its crude oil price forecast for 2010 to an average $80.06 a barrel from $79.78 yesterday. The department bolstered its outlook for global oil consumption this year to 85.51 million barrels a day from 85.3
Meanwhile China's passenger car sales climbed 55 percent from a year earlier in February, despite a long national holiday, on strong demand for smaller cars and sport utility vehicles, an industry group reported. Sales of cars, commercial vehicles and SUVs rose to 942,900 units, while sales of all vehicles including trucks and buses rose 46 percent year-on-year to 1.21 million, according to the government-affiliated China Association of Automobile Manufacturers.
Tudor Pickering Holt reduced their natural gas pricing forecasts yesterday to $6.20 mcf in 2010. Natural gas on the futures market is at roughly $4.50 a mcf for the front month. Their crude oil price forecast remains constant. They cite the increase in drilling activity, the number of horizontal rigs, and EIA data that seems somewhat ambiguous with regard to the decline rate for shale formations.
Even at $6.20 that still means a substantial gain for natural gas pricing. The discounted present value of natural gas production from reserves skyrockets in most cases much moreso than the price of the natural gas (reserve valuation is leveraged to the price of natural gas). For example, a 33% gain in the price of natural gas to $5.85 per mcf might mean a doubling or tripling of the discounted present value of production (valuation depends on production characteristics and costs).
So natural gas producers might be much more attractive than most realize, assuming Tudor Pickering Holt’s pricing estimates are somewhat accurate.
March 9—Tuesday A very interesting debate has arisen with regard to the accuracy of some of the natural gas data released by the Energy Information Administration. The EIA releases weekly natural gas storage figures as well as a monthly report on production and consumption. The data is compiled from industry surveys, which does not in most cases cover 100% of the universe of companies.
A component of the monthly report is a ‘balancing factor’ - a plug the EIA uses to compensate for the discrepancies between supply and demand data. This year the balancing factor is much larger than it has been historically. From what the experts claim either the EIA is (1) under-estimating the demand for natural gas or (2) over-estimating production of natural gas. Or possibly it is a combination of the two. In either event, it is bullish for natural gas prices.
Also, it is interesting to note that Gulf of Mexico drilling rig count has fallen to decades-long low. The Gulf supplies 18% of the natural gas used in the U.S. Meanwhile the number of onshore directional drilling rigs in operation has reached record, or near record, levels. The rig count illustrates the shift to the development of onshore shale fields from more expensive Gulf operations.
Another firm issued a long-term forecast for the hurricane season (starting July 1st). Like Joe Bastardi of Accuweather the firm saw a season with above-average activity. Hurricanes can impact offshore oil and natural gas production, as well as onshore facilities and refineries in coastal areas.
EBIX announced quarterly earnings yesterday. Like so many firms that have reported in the last month from our portfolio, the company set records for quarterly revenue and earnings per share. In fact, the results as measured by revenues and earnings per share were the best in the 34 year history of the company. We expect revenues and earnings per share should rise by at least 20% next year.
Longer term earnings per share drive share prices higher or lower. We are very pleased with the earnings reported by LSGI portfolio firms in the last month or so. Net asset value per unit of the LSGI Fund should follow earnings and revenue trends of companies in our portfolio if historical trends repeat.
March 8—Monday Our LSGI Report was mailed to investors this weekend. It includes our portfolio and additions/changes to the fund. The articles in the Report are at the following link: research
Probably the most interesting finding was the correlation between the microcap Berkshire Hathaway stock price in the 1968 to 1976 time period and the value of the LSGI Fund from 2002 to 2010. Statistically the stock of Berkshire Hathaway ‘explained’ 79% of the movement of the LSGI Fund using the coefficient of determination (’R-squared’). We conclude recession induced volatility had the same impact on microcaps in the 1970’s as it did in 2009.
March 7—Sunday Late last week the press noted that several countries, including Singapore, were increasing security due to terrorism threats to oil tankers in the Malacca Strait. Eighty percent of China’s oil imports pass through this area and 30% of its’ iron ore pass through the Strait. Any disruption of shipping activity could have a large impact on global trade, at least temporarily. We are somewhat surprised that crude oil tankers have not been the focus of pirate attacks over the last several years versus other types of vessels.
Northern Trust published another note that mentioned the energy sector late last week:
Supply and demand for oil should tighten as the global economy grows. Incited by the mid-January tightening of monetary conditions in China, commodities have shown their stripes as a leveraged play on the global economy. . . . Demand for energy commodities, particularly oil, should rebound with the global economy, but there remain few signs of new supply on the way. Big historical producers, such as Mexico, Venezuela and Russia, appear to have seen their best days, while new supply from Brazil and Iraq looks slow to appear. The long-term bias in oil prices, like many other commodities, appears to remain to the upside. . . .
Donald Coxe in his weekly conference call last week discussed the mining sector. He was at the BMO Mining Conference in Florida and remains bullish on the mining sector. There are few viable small cap mining plays, at least none that make our quantitative screens.
March 6—Saturday The head of the IEA warned last month that countries must brace for a return of wild crude oil price swings as the global economy recovers. He noted "the cheap energy age is over, and we have to prepare for that in the government and private sector."
IEA officials claim that "the market could easily become again more volatile once the world economy grows again and the supply tightens." They urged governments to open access to energy reserves, and said "encouraging investment on the production side could lessen volatility."
On a like note Bank of America and Barclays Capital, two leading oil traders, have told clients to brace for crude above $100 a barrel by next year, before it pushes higher over the decade. This would be in stark contrast from recessions in the 1980s and 1990s, when it took years to work off excess production capacity built in the boom.
The EIA released natural gas production data on Friday in their EIA 914 report. Lower 48 States natural gas production decreased by 0.7 percent in December. While production declined it has not declined to the extent many predicted due to the sharp decline in drilling activity. Some say that the decline will occur, it is just temporarily suspended while wells that have been drilled are completed. Others say the new economics of the shale formations mean that fewer wells can produce much more natural gas. Time will tell who is correct.
The weekly draw reports were announced Friday also and were bullish with a 172 bcf draw versus a ‘normal’ draw for that week of 141 bcf. Interestingly the current storage level is below last year at this time, and below the five year average storage level. Longer term the declines in storage could place a floor under the price of natural gas. It appears that if current trends continue the amount of natural gas in storage could fall to levels near the low of the 5 year averages—although much of the draw will depend on weather conditions and heating loads.
February 26—Friday Joe Bastardi issued his long term hurricane forecast for 2010—the season that starts July 1st. Unlike most of the other forecasters last year who predicted a very busy year (it was not) Bastardi predicted a quiet hurricane season in 2009, an accurate forecast. Using his long term models, databases, and analysis his forecast for the upcoming season is for a very busy hurricane season with a number of storms to make landfall in the U.S. The fact that 20% of natural gas production and 25% of crude oil production in the Gulf of Mexico any disruptions would be bullish for energy prices, especially the natural gas market: forecast
ARTW held a conference call on their latest earnings report which closed out fiscal year 2009. The outlook for the Scientific and Manufacturing Divisions is very positive for 2010, it appears it will be a better year than 2009 sales wise—and we expect earnings per share will improve also.
******************************* Chris Martenson has some interesting presentations at the following links:
Global energy production trends: http://www.chrismartenson.com/peak_oil Energy yield and alternative fuels: http://www.chrismartenson.com/peak-oil-b Energy and the economy—is energy really money?: http://www.chrismartenson.com/peak-oil-c Energy, mining, and mineral economics: http://www.chrismartenson.com/environmental_data |
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LSGI COMMENTARY
The most recent commentary on our portfolio, the energy, agriculture, and stock markets, as well as the economy can be accessed at the following link:
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