Category Archives: Interesting Reading

Bitumen Bubble… WTIC vs. WCS

Recently our Premier went on TV to warn the public of a “Bitumen Bubble” here. Essentially Alberta’s oil is landlocked. With limited pipeline capacity and increased  American oil production (primarily in the Bakken) the prices of Western Canadian Select has decreased relative to the more traditional Texas Crude.

You can see from the video that the Albertan government was caught flat footed. They push blame to the Canadian government for poor forecasting. To me that’s like myself passing blame to an analyst for me losing money on an investment.

The Edmonton Journal does a good job visualizing the situation here.

Aside from that, the government was not alone in being caught off guard. Yours truly wasn’t paying enough attention to the potential impacts for my investments and (more importantly) career. Many companies have been cutting spending which has led to lay-offs. My company alone let go of 15% of the workforce. If you consider what the expectations were at the start of 2012, we are talking closer to 25% less staff then expected. It’s huge.

Many Albertans are still ignorant to the effects. It is actually quite amazing how little we know about what drives our economy.

Here in Alberta it is nothing new to have the price of Western Canadian Select differ slightly from West Texas Crude, but recently things have been quite interesting. Alberta production has finally started to climb and many (if not all) projects need to produce to lower the overall cost of production, even at $50. Here is a look at Alberta production courtesy of ERCB. Shown are the barrels per day.

Alberta_Oil_Production

Unless a pipeline (or even a massive rail line) is built then this phenomenon is likely to continue. The longer it continues, the further down the economy will go. The other concern is how much of Alberta’s seemingly cheap Residential Real Estate market is because it is being propped up by high wage earners in the oil sands. The potential for a domino effect is scary.

There are several ways to play this from an investing (more like speculating) standpoint. Many companies are heavily exposed to drilling activity here in Alberta. The easiest picks would be producers, but with high debt loads you would have to be very precise on timing in order for them not to do damage to the balance sheet and for earnings to rebound.

An alternative would be the drilling and service companies. This would be my preference. Many have stronger balance sheets, though some are very levered. To be clear, I do think that the only competitive advantage any have would be those that are run conservatively. Most (if not all) drillers and service companies have been increasing the amount of capital expenditures and now (for the first time since the recession) there is likely more supply than demand. This is pushing down gross margins.

The final alternative would be companies that provide some sort of service or product beyond the obvious, like mobile trailers to drilling sites or catering services to camp sites.

I don’t have an idea why so many of these debt heavy cyclicals pay dividends, I am a little perplexed. Many could continue though I think they shouldn’t. Maybe the nadir for the sector would be the cut in dividends. I don’t know how much of that is priced in at this point, but it would likely lead to some large institutional selling.

The last type of company to purchase would be one that will benefit from new pipeline development directly. I don’t have any names, but I am looking. Please send some names if you have them.

Potential Investments

I lay out the case to not immediately buy, but to scale into names when we get an announcement on pipeline or some sort of solution that oil from the WCSB will no longer be landlocked. Many have little or no analyst following, which tends to lead to a sleepy Mr. Market. I have intentionally picked more conservative companies for extra margin of safety. They may or may not rise as fast as their peers in an oil price spike. All names are Canadian listed. Many have exposure outside the WCSB as well.

Here you can find daily quotes for WCS from Suncor. Or here at the CME site.

Drillers: AKT.A, XDC, CDI

Traditional Service: SDY, SVY, NWE, FRC

Unique Service: HNL, WTA, BRY

Something I wanted to point out was the fact that I didn’t rant about our elected officials and how dumb it is to rely on oil and gas resources to be our main value proposition to the world. You’re welcome.

Dean

Disclosure: No position in anything mentioned.

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Look Ma…I’m Famous!!

Well not quite.

I was recently interviewed by Globe and Mail. It is quite a revealing interview and at least puts a face to the name Petty Cash.

Check it out here.

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Canada Housing Reality Check…insert scary charts.

There is no shortage of great blogs posts on the Canadian residential real estate market. Garth Turner is an excellent writer who has been the canary in the coal mine for quite some time now. Ben Rabidoux also has stated how the real estate market is overvalued. Saj Karsen and Hardcore Value mention it as well. Yours truly even took a stab at it.

After reading Demographia international housing, I needed to see for myself. It seemed like Edmonton wasn’t as overpriced as I had once thought. For the record, I don’t remember who gave me the report.

I have compiled some data in regards to Edmonton specifically. I wanted to see where we are if I looked at the Edmonton market historically. Just like equities I needed some sort of valuation measurements to see “fair value” and make any necessary decisions.

Full disclosure, I bought my house in 2004. It wasn’t a function of what I thought the real estate market would do, it just made sense at the time relative to renting. It is a really small 50+ year old house. Being as debt adverse as I am, I put 25% down and made it my goal to pay it off by the time I am 30. Since then I have rethought that approach and have focused on paying off the mortgage and saving for my retirement through the purchase of public companies in tax sheltered accounts.

Here is a price chart for average residential real estate price since 1962. I pulled the data from this site.

This doesn’t say too much other than prices go up over a long time. The chart below shows inflation adjusted prices. I grabbed the CPI numbers from the government of Canada website. The numbers in the 60s are for Canada as a whole, after that I have Alberta specific numbers.

You can see a wicked run unlike anything seen in the last 50 years starting in 2005. I also put in a price channel to show what happens in oil country when we have an oil boom. You can see that during the last oil boom we had a big run in prices as well. The most recent run has eclipsed the last. In order to get back to the top of the channel prices have to fall 24%. To get to the bottom its 42%. If you look closely you can see that in real terms if you bought at the previous high, it took you 20 years to make a profit from price appreciation.

Here I took the data and added in a range of 30% above and below the average price. Why 30%? I needed a wide enough variance to account for cyclical peaks and troughs. 30% seemed like a decent number. The inflation adjusted price spends 68% of its time within the 30% +/- range, so it seems like a decent valuation measurement.

In order to get to the top of the range prices have to fall 24%. To get to average they have to fall 40%. To get to the bottom they have to fall almost 60%.

So by measure of historical value we are at best overvalued by 25%.

Moving to price to personal income. I feel the best measurement would have been price to household income after debt service costs. I used personal income from the government of Canada. The numbers were calculated a little different over the periods so I have to blend some together which is likely leading to a distortion.

Pretty much the same story as before. You can see the big run of the last 5-7 years followed by a period of stability. I also added at 30% range like before.

It’s interesting to note that at the previous peak in the late 70s early 80s, the price/income stopped at the 30% range. It is only now that prices have made a new channel, although likely temporarily. This time we spend 80% within the range.

To get to the top of the channel prices need to drop 7%. To get to average prices need to drop 27%. To get to the bottom of the channel prices need to drop 45%.

I like this measurement best, but it can be distorted.  Things like more income earners per house over the last 50 years could play a factor. More importantly is  the cost of borrowing.

Last go around we had falling interest rates to act as a cushion. Top that off with record personal debt levels in Canada means there is a strong chance of mean reversion.

Some scuttlebutt

Here are some quotes from people that I have asked about the residential real estate market in Canada.

“Can’t go wrong owning property. I don’t know why you waste your time on stocks when you can just buy property and forget about it.”

-Real estate “investor” who owns 4 rental properties

“You should absolutely consider your home as part of your net worth. Even if you never plan to sell it or earn income from it.”

-Financial Planner at the local bank

“Sure prices have moved quite a bit in the last 10 years, but that doesn’t mean that they will fall.”

-Real estate agent advertising in the community newsletter

“We’ll see who’s smarter in 10 years… me or you.”

-My neighbour

What does it all mean?

Expect some sort of mean reversion in the Canadian housing market. Vancouver and Toronto are the most exposed, while this phenomenon is almost nationwide. The CMHC is encouraging this behaviour which it kind of scary and upsetting at the same time.

The only thing that has me doubting myself on this one is the fact that so many people are sounding the alarm bells on this. Maybe it’s just the internet allowing us to connect in ways that we never have before.

I won’t try to time it, but I have made some steps to minimize the impact. I will write another post to share what I think is best for me and my family.

Dean

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Buying in China

Fear not everyone, I am still here. I have a couple of posts ready as soon as my positions have been filled.

I wanted to take a minute to post about some of the news regarding Chinese stocks, particularly reverse mergers that are fraudulent. As an investor in a couple of Chinese companies (MGO and ZUN), I have been following some of the better articles. Some of the better bloggers have been very helpful in educating a layman like myself. Others have already made their positions and are blogging to either encourage movement in share price or help encourage feedback. I have provided some of the better links that I have read. There is even more in-depth research out there, but there are only so many hours in a day. You can really see how short sellers have played a big role in uncovering some of the names.

I don’t think that either of my two Chinese companies are frauds. I am comfortable with the accounting firms and the disclosure that both have. That doesn’t mean that they don’t have any issues.

Geoff Gannon

Jae Jun

News article from Bloomberg

Bronte Capital

Feel free to roam the internet looking for more information on Chinese frauds. Put the coffee on first as there is a huge amount of material. If you are already familiar, feel free to post a link to some more interesting sites.

Dean

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