Blue Moat

For any new readers, the Deep Moat Quote, is supposed to be a timely prediction as well as an informative quote for a certain trend or industry.  This is the 25th, and it’s about batteries.

“The existing global rechargeable-battery business is about $40 billion. Lead still owns almost half of this market and continues to grow… …But the lithium share is expected to nearly double to $6 billion by 2012″ - Mark P. Mills, physicist and a co-founding partner in Digital Power Capital, an energy-tech venture fund as well as co-author of three books on Energy.

Forbes

I got blasted, no - torn apart, over at seekingalpha, by perma-bull-gold-bugs (aka the most depressing people in the world), when I wrote that I was getting out of leveraged gold, back as gold was moving up towards the $950 zone. I’ve never had an “I told you so” feel better, I mean people were personally attacking me. I’ll admit here, the call was a little lucky, but to your face I’ll say it was 100% skill This was after this note to readers, to buy Yamana warrants when they hit $2.25. 13 days later, they hit $4.60. (I didn’t know the call I made was going to be that good) I took some amazing profits, and closed everything in the $4 - $4.60 range. Unfortunately, I didn’t foresee how violent the pull-back in Yamana was going to be, and didn’t really call that. As it has now pulled back significantly from it’s all time highs, it’s obviously due to the pull-back in gold, plus Yamana, has had some problems themselves. I have never been long the stock, but some clients (who have less risk tolerance than I) have been long and have been holding along the ride up, and now the ride down to a break-even point. I did get a 21% gain for one client, honestly only by accident, because we wrote nearly at the money calls, and the stock got called away. But, what am I getting at? What I’m trying to say is, listen to me and feel free to disagree with this next statement: Yamana is going to be okay - because none of the problems in the US that made gold go up in the first place have changed. All of those predictions for the +$1000 mark by the end of ‘08 - still have merit, but nobody remembers because it, because everybody got tired of listening to every one else screaming it 4 months ago. Thus, it’s time to buy again. The warrants are getting closer and closer to expiry, so are higher and higher risk, but I think are on the order of “cheap” again, and so is the stock.

By the way, this blog is going to change, it’s going to become more personal, because, well, I’m not a journalist. I’m an investor and generally just get high off of helping people invest. Playing journalist is fun, but readership statistics have fallen off since Sandvine has became nearly a penny stock. So, I’m caring less and less, and want to gain from my readers, I want the discussion, not asynchronous opinion. And, even I want to puke, after reading the nauseating “I told you so’s” like I wrote above, but that comes after I get comments to historic posts I made like this. Seriously, Bob Newhart, how productive is that comment? I’ve had bad calls, and I’ve had good ones. Get over it. No one is perfect. Oh, short note on crocs, you’ll be glad to know, I’ve come to my senses and am now out, at $12. That was of course after the management announced they were full of shit. Before they turned out to be liars, they claimed they were going to see $0.45 in a quarter, I figured they wouldn’t hit that, but I also figured they would come in near $0.22. I was wrong, they came in at a loss of $0.05, I was floored at this, as my thesis for it being “just a undervalued shoe company” no longer held. So, I took my losses. I’m so glad I didn’t get any clients tangled up in that mess, because I was smart enough to know, it was very high risk. I still contest, it could have gone the other-way, had the fad lasted into this year even at all - the stock would have hit the moon. And, please remember folks, I did make money on the way up, I was shorting puts from $43 to $69. I’ll add, for the guys over at full-disclosure, because of the Buy-Write strategy I was employing on CROX, my losses were reduced by almost 75%, although still substantial.

Update: First bolded sentence, was grammatically and fundamentally incorrect, it’s fixed now.

I am really late to this party. I’m not informed enough, but I think the equilibrium that will likely be found is worth investigating and learning from.

For those under a rock, there’s a food crisis happening around the world and hitting North America. The world’s Rice futures have almost doubled since the first of the year. It’s the economic fruition of what the price of Monsanto (MON) foreshadowed. Is it too late to profit from this, no. The market will find an equilibrium, as the world will create more rice fields. And, those current and newly created rice fields will yield more rice per acre than they do now. Since 1977, yield per acreage has almost doubled. Right now, my bet is that countries all over the world will be creating rice fields until the parabolic rise of rice starts to flatten out and pull back. Even after that, the return on a rice crop is now much higher than other crops, so crops will be converted. For instance, how will this affect peanut crops (will it even at all)? The price of peanut runners are down ~20% ytd to $0.195 / lb.

I’m looking for international companies that build silos, are involved in crop dusting, or other yield enhancing technology. Any choice must be well positioned in international markets. Just like developing countries end up buying phones, developing countries will end up spending to increase yields on rice crops. Crop dusting is my (extremely uninformed) bet as to where they will spend.

I’m also looking at how to profit from the fact that rice producing real-estate is going to (likely already did somewhat) climb.

Like I said, if I find anything, I’ll have to question if the party is already over.

I couldn’t resist sharing this link, for the folks still (unfortunately) holding Sandvine.  The trend I’ve been preaching as the driving factor for the 10 year story for the Waterloo founded start-up, is time lined, and predicted more and more by articles like this.  If you’re going to read it, you have to read past the in my opinion, likely overly “extrapolated trend line” like prediction:

“In three years’ time, 20 typical households will generate more traffic than the entire Internet today.”

That’s ridiculous, and i’ll believe it when I see it.  In December 2007, 1.3B people were ‘connected’.  Let’s estimate (with extreme conservatism) that even if they all on average use just 10 Mb per person per month, that’s 13 Billion Mb per month of usage, today.  With this (likely extremely low number), in the future, those 20 households would have to have all consume 650,000,000 Mb per month each.  In other words, even if everybody switches to the new 50+ Gb HD movie file format, they would have to download 13,000 movies per month. It’s obvious the average household will increase their bandwidth, through better quality everything (TV, phone, music, social networking, etc.), but in 3 years - to the extent of 20 average households consuming the bandwidth of the entire Internet? I just don’t see it.

The rest of the article’s numbers seem appropriate, at first glance.

Long Sandvine.

It was extremely obvious to me, so likely it was to the entire market, that Canada’s short-term future depends greatly on how much of a slow-down the US has.  Between rising oil, the falling US dollar, still unaccounted write-offs potentially looming, and a host of other problems, the US, and thus Canada, is in an uncertain period of history in the making.  The Bank of Canada re-iterated our reliance on our neighbor, and cut rates by 50 bp down to 3% because of it. Except, with the exception of our dependence on the US, Canada actually has been doing fairly well over recent history and trends project positively for Canada.  It is one of the strongest positioned nations to deal with the global slow down.  Unlike the States. Our real-estate market hasn’t fallen off a cliff, and is actually just now showing signs of a (local) peak.  We’re creating jobs. We’re diversifying who we trade with and increasing our exports. Our fiscal policy has kept us in a surplus since 1996, although we could be facing the first year of deficit.  Now, a deficit isn’t particularly a bad thing, it’s by no means anywhere near an unsustainable point.  There are many possibilities for many resource exploits coming online for Canada. For example, take a look at the oil fields which are getting more and more efficient as oil moves up. One specific area I’ve began reading on is the, extremely overly optimistic expectations from, the Bakken Oil Fields.   Inflation is concern, but it is not running rampant like it is in other countries.  I think we, as a nation, we will pull through any trouble our neighbor to the south is faced with.  As a result I will be looking for more exposure to Canada in my portfolio as I see the problem of our dependence on the US, as a temporary one (as in, on a time scale measured in decades).  Either the US will bounce back with new leadership next year, or Canada will trade more and more with other nations, or both.

I can’t say “Go Long Canada” without giving you a way to do it. Here’s you’re answer: The Horizon’s BetaPro Bull Plus ETF HXU, it’s double long the daily return of the S&P/TSX 60 less inefficiencies due to how they run the ETF and 1.15% in fees. By the way, HXU trades some very (illiquid) derivatives over at the Montreal Options Exchange. Oh, and in the event you disagree with me, you can check out HXD (I didn’t like on purpose) it’s the double-short version.

There is extensive trading terminology surrounding using derivatives. As a result, there tends to be some nomenclature and slang issues along the learning curve. This post is intended for people learning, and with less experience. I’d say this is written for anybody who has been trading for less than 2 months, but has at some point or another traded options at least once. It’s dedicated to the readers, and authors over at full disclosure finance. The following discussion all pertain to the American options, European options work slightly differently.

Anybody learning to trade options, needs to understand some basic definitions. These concepts are key to understanding the ‘talk’. If you don’t understand the following concepts, Google them with the word ‘options’ along side. The (BASIC) concepts include:

nouns : call option, put option, margin, leverage, a hedge, a combination leg, strike, expiration, underlying
verbs: To hedge, To go short, to go long, to write, to cover (not to be confused with the state of being ‘covered’)

the states of being: bullish, bearish, covered, naked/uncovered, long, short, out-of/in the-money

These things seem simple, individually, but the “I taught myself crowd” might not realize what it means to cover one’s covered calls (”buy them back”), or what it means to be bullish by going short a derivative, while using a covered hedge at the same time to reduce risk.

When a derivative contract is created, there are two parties involved, and each have certain obligations and rights granted and demanded by the terms of the contract. There is a creator (also referred to as the author or writer) of a particular contract. On the other side of the trade there is the purchaser/buyer of the contract (be it a put or call). The author is giving up rights in exchange for cash today, while the buyer is gladly paying to delay a decision into the future. The author is going short the option while the buyer is going long (In either case, put or call). [Note: This shouldn’t be confused with ‘taking a short/long position in XYZ’ by buying a put/call.] The author is bound to deliver on the expiration date either cash or securities - depending on the contract, it is the buyers choice, should they so choose to force the author to deliver good on the terms (they paid for) of the contract. The option clearing corporation essentially makes this decision automatic, as $0.05 in the money options are exercised (as what buyer wouldn’t want to harvest the value, should there be any, on expiration?).

If the author is writing (initialization and selling) a contract to a buyer, and the author owns the underlying securities, which he can deliver, if on expiration the options are in the money, his short option ‘leg’ of stock XYZ is covered by his ownership of the underlying. That is to say, if the underlying goes up too fast, he’s “covered” by the appreciation (or depreciation) of the underlying. If the author doesn’t own the underlying, and he writes options, he is said to be naked or uncovered. Aka, he is uncovered against potential appreciation (or depreciation) of the underlying.

If one writes a call, and upon expiration, if it’s in the money, the stock is ‘called away’ and the buyer of the option must deliver cash in exchange, if he should choose to exercise the contract . If the author was long the underlying, (aka covered) prior to expiration, he is left with no position and cash in exchange. If the author was not long the underlying (aka uncovered, or naked) he essentially opens a short position. The buyer is left with a long position.

If one writes a put, and upon expiration, if it’s in the money, the stock is ‘put onto’ the author, as the buyer of the option forces his shares onto the author, in exchange for cash. If the author was short the underlying, (aka covered) prior to expiration, he is left with no position. If the author was not short the underlying (aka uncovered, or naked) he opens a long position.

Now these contracts, once created, can be traded between two people. Neither must be the original authors. They can do this, at any time, at market-value, before expiry. In the same way that some one can open a position by going long an option, and close the position by selling it to somebody else, an author can create a contract by writing (shorting) it, then close the leg, by covering. If you own the stock, and sell calls, this is referred to as a “buy-write” (buy stock, write calls) strategy. You can create (sell) a contract at any time, and take profit when/if the call option falls in value, else, it expires worthless or your stock gets called away. When you write calls, you’re shorting calls. It’s a hedge that turns your entire position into a little less bullish because shorting calls is a bearish leg. You can “buy them back” which directly translates into “pay cash to cover the short option leg” or put differently “exchange cash with the market, in order to buy back the option, to reclaim the right to decide when/if to sell at what price”.

All of the terms, generally work well, if one truly understands the definition of an ‘option’ - as in, a choice to be made. A corollary to this is, if a person owns shares, he should also consider how the ownership of stock (or generally any worldly possession) inherently comes with the option to choose when to sell the stock and at what price. He can sell that option, he inherently bought along with the stock, anytime he chooses. He can do so by creating a contract. He can buy that option back, anytime he wants, provided he is willing to pay the price to own the option again. The aforementioned is the metaphoric ownership of stock, and thus a call. A corollary to this is, if one is short stock, the option one writes is a put. The same way a call goes up as a long position in the underlying appreciates, a put goes up as a short position in the underlying appreciates.

In context of options, it also helps to disconnect the idea of bullish & bearishness from long & short. One can be bearish, and naked short sell calls. But one is bullish, if they, naked short sell puts. One can create a covered bearish strategy made up of short sold calls, by going long a call option of a different strike OR he can choose to cover the short, and close the position, by buying back the option that was previously shorted. Do you see how one use of the word cover is different than the other. One is a state, and one is the act. The act to cover can, in certain context, lead to the state of being covered, or it can close a short position. The state of being covered refers to the existence of an upper-bound to the downside risk. It helps to re-think the definition of short and tie it to the sayings such as “I’m short on time” or “I’m short a buck”. It’s funny how one can “cover you, by lending you a dollar, if you are short a buck”. It means, to have an absence of something. In market speak, an investor who sells anything, who intends to buy it back later is short that “thing”. Instead of buying low selling high, one shorts high and covers low. The later half refers to stocks and options alike, it’s obvious for stocks, but confusing for a first time call shorter/writer.

If I was unclear of something, please, leave a question in the comments. I’ve been actively using derivatives for 3 years, it’s a little hard to get back to basics sometimes.

Disclaimer: It’s 2 AM. The information above is very easy to miss-write, and therefore may contain mistakes, use at your own risk. Options involve risk, you should consult a licensed financial adviser who is fully awake. You should go to http://www.888options.com for more information.

A timely quote surrounding food prices, also giving a prediction for the market.

“the food scare of 2008, severe as it is, is only a symptom of a broader problem. The surge in food prices has ended 30 years in which food was cheap, farming was subsidised in rich countries and international food markets were wildly distorted. Eventually, no doubt, farmers will respond to higher prices by growing more and a new equilibrium will be established. If all goes well, food will be affordable again without the subsidies, dumping and distortions of the earlier period. But at the moment, agriculture has been caught in limbo. The era of cheap food is over.”

The Economist

I encourage you to click through, and read the entire article.  Remember, markets over react in both directions.

Since I nailed the last one, I figure, hey - why not try another lame round of predictions. Careful, lighting rarely strikes twice.

Google announces tonight, after the bell, and is going to come in with numbers pointing to slowing growth. Lots of people may refer to this as a “miss”. Of course, the only thing they can really miss is the analysts’ consensus. The economy is suffering and google’s growth is going to suffer along with it, it’s just a question of how much. Inevitable for a company like the great Google. But the drops in click data have been brutal so the street may have the downside all priced in. I’m optimistic the downside is priced in, after the release, a little uncertainty will clear up, and the stock will move north. Something to think about, which keeps me both optimistic, and an investor in Google is 44% of revenue comes from overseas.

It’s these facts combined as to why no matter how the stock reacts, nobody (not even me) can say - “I told you so”, as to the direction the stock moves this quarter. If they do, call them lame, to their face. Nobody (in a situation like this) can accurately account for the causality built into a stock price. Everybody (including myself) tries, every 12 weeks, but it’s all lame and fun. Half the people will be “wrong”, the loud ones will have been “right”.

Long GOOG - for the long haul.

Update (After the release)

Well, it never fails, when everybody is sure that a stock is going to miss, the bad news is more than priced in. It definitely was, and a beat was so unexpected the stock is now sailing north. Glad I stayed optimistic, and glad I get to be one of the loud ones tomorrow - even if I totally didn’t expect a beat.

Predictions are lame, but I can’t resist, because they are also fun.

Johnson Controls, JCI, announces Q2 for 2008 this Wednesday, April 16th.  For more reasons than I have time to blog, I am going to predict they announce in-line, and either re-iterate or up guidance (and if they do beat or up guidance, it will be marginal).  I think the last quarter, they were being conservative with numbers because of fears in the economy that they couldn’t control - despite them verbally saying otherwise. In the last CC, they said something to the effect of ”We don’t see the extreme downside that economists are pointing to and other companies are foreshadowing/blaming” (I paraphrased that quote).  The street didn’t get the raised guidance it was expecting, nor like that stance.  That could mean two things - 1. They are dumb, and things slowed down, so they will miss. I’m more optimistic and to lean towards 2. They are smart, the market didn’t believe them, and since they are an international brand and well diversified with a very long term backlog, things will be okay for them.  My conclusion is their conservatism combined with the economy not slowing as much as the stock priced in, could give the shares a boost this week.

They recently announced that they are going to be one of the 12 suppliers of an expected $10B contract, spread over 5 years.  That can hypothetically add a number somewhere around $166M per year in revenue.  This is nearly negligible, to JCI’s revenue, however I’m hoping JCI is going to supply more than one twelfth of the work.  The $166M figure comes from the math that $10B / (5 years x 12 companies) = $166M. 

Some recent analyst commentary contained negative things regarding the outlook for 2009.  That’s too far away to accurately predict right now.  A very respected economist I know personally, said recently “We have never been in more economically uncertain times”.  Seriously - the fed cuts vs not cuts - Fed lends vs not lends - china’s growth slows fast vs slows slowly - India ramps up the army of engineers faster or slower - all these things can swing the story of 2009.  I leave 2009 in the hands of the capable management at Johnson Controls, who by the way have an extremely great track-record of delivering. 

I stay optimistic, and side with Robert Baird.  Then again, I’m crossing my fingers they have an off quarter and I get to load up on shares under $30 - for the long haul.

By: Blue Moat

Long JCI and short puts for 2009.

In case you’ve been living under a rock - for the last three years, it has been an awful market to participate in real-estate, in the great United States of America. Of course, with the exception of some niche markets, apparently Hawaii and Pheonix have been doing great - up until recently. I am fortunate enough to not be American. Well, today, I’m reflecting on the differences between the two markets as a personal deal just fell through. I’m trying to sell a ~$200K home, I’ve used it for rental income. It generates $23K+ per year in revenue. I was asking $199,900 last Wednesday, and within the first 24 hours of listing it - I had two bids. They started a bidding war with each other, the prices both climbed up and over my ask. But here’s the kicker, the buyer I signed with, came in at $206K, but couldn’t get financing. Due to the bidding, I got to meet the buyers. Two people, married, both ~26 years old, had 20% down, both employed (with good jobs). They were dealing with a local broker and the appraisal came in higher than $200K. I heard that, and I figured all systems were a go. Problem came in, the bank didn’t like the fact that they could potentially rent to students. I was disappointed, but it’s almost as if the banks don’t want the business. The fact that they couldn’t get financing makes me feel safe, to keep participating in the Canadian Real-Estate market. If these people couldn’t get financing then that means that people in worse situations then them can’t get financing. And so, we should never experience (the magnitude) of a downward spiral experienced in the states. Add on top of that, the fact that Canada operates under some strict lending practices, known as the Canadian Lending Act, forcing would be poor buyers to use CMHC, and you have the ingredients for a market that should a) never sky-rocket irrationally (since banks are cautious lenders here) and b) never fall off a cliff like down in Florida (since only people that can afford the housing, actually can buy).

Update: FYI, the home is in Waterloo, Ontario.