Elon Musk, Tesla, and electric cars are the talk of the town these days. But what few, if any, investors seem to be asking themselves is how are they going to build all these cars? It’s a question we delve into in this week’s Insider Weekly.
Welcome!
For newer members, a quick and dirty.
Each week, Insider Weekly provides concepts and theses worth considering, some trade ideas, and a short (ok, not always) synopsis of things we’re looking at here. Trade ideas – if they spring to mind – are included but not considered alerts.
Additionally, I love sunsets. And so each week I share one with you from your fellow members. As such, please share with me at [email protected]. My kids have a blast selecting one for publication. The world is better with beauty, let’s share it.
Last week, you received an update on the earnings report for Mongolian Mining Corporation, so I think it appropriate to share this one fresh from Crazystan Mongolia (Orkhon Suom). Thanks this week go to your fellow Insider member Dylan.
Musings for this week:
- Rare earth metals: How are they to build all these electric cars?
- Areva nationalized? Damn! Well, at least we get our capital back.
- Strong markets worrying investors: When are we going to see a repeat of the late 1990s?
- Indexing euphoria: A side effect to capitalize on.
- Hedge funds: Too popular and too mainstream. Where are the secretive funds lurking?
- Noble Group (Singapore): Another contrary bullish sign for commodities
- North Korea
- Traditional retail: Beware the popular narrative!
- Oilers: The average oiler is trading at GFC levels. Can I tempt you to go short and hold that short for 5 years?
- The Big Five (Ok, 6): Golden Ocean Shipping, Oestjydsk Bank, Austin Engineering, Stone Energy, MBIA, and Ageon.
Digging Deeper Into Rare Earths
No two ways about it: Electric vehicles, like hair in communal showers, are only going to proliferate. To get straight to the point – where are all the resources going to come from to produce these electric cars, wind turbines etc?
Take a look at growth projections of electric vehicles (EVs). I included this in last week’s Weekly as well:
There hasn’t (yet) been a big ramp up in development/production of the materials that will prove vital in the production of all these electric chariots. Let’s not forget the impact of the commodity “super cycle” crash from 2011 – 2015. It’s still a hated sector. Joy!
As an introduction, these are the rare earths that go into making an electric car:
Think about what it will take from a raw input perspective to produce these EVs. The requirements for producing all the electric motors, magnets, etc. require rare earth metals, which – while not actually particularly rare – are subject to our typical commodity supply and demand dynamics. And you don’t need me to tell you that rare earths have been treated like a redheaded stepchild. Joy!
Take a look at the two charts below which one of my team here showed me. To kick things off, Lynas is the only company outside of China dedicated to producing just rare earths (genuine rare earths like neodymium and praseodymium). The other company producing rare earths was Molycorp, which in 2015 handed out pink slips and retired to play golf and sudoku (incidentally, this signalled the bottom of the market for rare earth metals).
But what about the likes of Hastings, Avalon, Arafura, Alkane and Scandium? These are all companies with rare earths under development (i.e. no production yet). More on that later.
So if electric vehicles grow as anticipated, by 2024 we will need to see production increase by the full amount of Lynas’s Mt. Weld mine, which took about 5 years to bring on stream. Hmmm… more joy!
We can look at it another way. To keep up with anticipated demand, even by 2019 demand will rise by about 50% of Lynas’ current 12-month production.
But Lynas is the only real producer of rare earths neodymium and praseodymium. How long will it take to bring other mines on stream, and then on top of that, who is going to process the stuff?
Separating the rare earth element from its ore body is a tricky process that involves a lot of cost if you want to inhibit environmental pollution.
Unless I’m missing something, there seems to be a big deficit of rare earths on its way. And given that China controls 90% of the world’s rare earth production, there is always the possibility that protectionism raises its ugly head. Certainly, as I’ve mentioned many times before, we’ve moved rapidly into an environment of “strong” political leadership. “Strong” could quite easily be redefined as “not bright” in this context.
This seems to fit well with what we’re seeing in the chart patterns in Lynas and the miners developing REM resources like Arafura.
I guess the question is how aggressive to get? That is a debate for a different day and has to take into account lots of factors. But in the meantime, it seems that a small exposure to these rare earth miners isn’t the dumbest idea I’ve ever had.
I think the bigger issue will be when to take profits. A nice problem to have!
I’m intrigued by the long-term setups in Lynas and Arafura, both with very defined trading ranges with Lynas now breaking to the upside:
Arafura hasn’t broken out yet but look at how long it has been in that trading range:
As I have said many times before: I know of no other long-term technical setup that is this powerful and reliable. The stock is subject to a prolonged bear market where it loses 80% or more of its market cap and then trades in a sideways fashion for at least a couple of years. When breakouts come to the upside, the move surprises everyone and you get not 20% moves, or even 100% moves, but typically hundreds of percent or more.
Asymmetry is, of course, a two sided coin, and so let me ask you this question: How much lower do you think this sector goes after being down over 80% and having traded sideways for a few years? Certainly it’s less risky than the market is pricing it at.
Areva Nationalized. Bastards! Well, at Least We Get Our Money Back!
In December, we put out a trade alert on uranium. As part of that alert was French nuclear giant (well, at least from days gone by). This went into the Insider Portfolio at €4.50. Well, as “luck” would have it, the French are nationalizing it (taking it private). So at least you get your money back (less a bit of brokerage).
We bought Areva as an “extreme” contrarian play. Essentially, we were betting that the French government wouldn’t let Areva go bust due to its vital strategic importance. Well, we were right. They didn’t let it go bust, but we weren’t figuring on them taking 100% ownership and returning our capital.
We’re closing this position (obviously) and moving on.
One Mighty Strange Market!
Take a look at this WSJ headline:
I recall back to the late 1990s when everyone was doing cartwheels on the NYSE as the Dow broke through 10,000 – a time when every second man on the street had taken to day trading. I remember also back to 2006 and 2007 when every trader wanted to become a hedge fund manager or proprietary trader. Taking risk was looked upon as a virtue and the guys who shunned leverage were treated like they had a bad case of halitosis.
And yet here and now we have the Dow & Co. making new highs and we are treated to repeated “boo hoo” on Wall Street.
Yes, I know there are many screaming for a crash. A recession? Sure. A correction of, say, 20%? No problem. But crashes rarely take place with such market structure. I may be wrong but I don’t think so.
I think everyone underestimates the psychological trauma that the GFC has had on investors. Let’s not forget that the global financial system froze up in 2008 so much so that governments had to guarantee bank accounts.
They say time heals the wounded. Well, the length of time depends on how deep the wounds were in the first place.
Considering it was the biggest financial crisis since the Great Depression I’m guessing that we have a few more years before those wounds heal (or at least investors forget about the GFC), and then we’ll have the ability to have euphoria and a massive crash.
While there is this disbelief in the health or sustainability of the bull market in equities the probabilities actually favour them moving higher.
But I am not here to trade major market indices. I’m here to discover deep value situations which are likely to have little to do with the general direction of the market. One day, these deep value situations will dry up, and then I will know the market is fully valued. I think we are some way off that at this stage.
Indexing
The consequence of this move to indexing is a massive divide between valuations of stocks within markets. Contrary to popular opinion it is good news for stock pickers or those who fancy their chances of outperforming the market.
The following CNBC article about sums it up:
Side effect of index investing boom:
In some ways, the focus on companies with no analyst coverage is an unintended consequence of the index investing boom. Approximately 42 percent of all assets in stock funds are now in passive funds that track indexes, up from 24 percent in 2010, according to the Investment Company Institute.
With fewer investors buying and selling individual stocks, brokerage firms have been forced to cut research staffs, which had long supplied information about small companies in hopes of generating trading commissions.
Over the last 12 months, brokers such as BB&T, Nomura, and Avondale have shut down whole research divisions, leaving a hole in information that is unlikely to be filled quickly. BCA Research, an independent Montreal-based firm, estimates the total number of analyst reports being produced will fall by at least 20 percent as investment banks reshape operations to adapt to the popularity of indexing.
There will always be inefficiencies in markets. This is one area today where it stands out like a teenager without their head buried in a smartphone.
So moral of the story: Keep looking for value in areas that aren’t covered by index tracking funds and have little or no analyst coverage. This is where your big payoff trades are likely to lurk.
So perhaps there is even more reason to look at the toxic waste/unwanted dogs that we look at.
Hedge Funds are Too Popular
I couldn’t help but notice Paul Singer having a good whinge:
I was brought up in an era when hedge funds were these secretive beasts where no one wanted to talk about what they were doing for fear of others finding out… and where only a relative few could invest their money.
The reason why folks are shunning hedge funds is because, as a group, their performance isn’t great. Their performance isn’t great because they are too popular and they are chasing the same crowded trades. Their proliferation has led to index managers index hugging. Subscribers who are fund managers yourself will know this.
We know the model, ladies and gents. If we don’t knock out quarterlies above the index, redemptions follow… even where the strategies are not correlated to quarterly time horizons. It’s a reason we don’t take capital from just anyone and we want permanent capital. It’s a tough one but if you’re not an fund manager, this isn’t an issue for you. Realise, however, that this is an advantage for you. Your time horizon is your own and your decisions need not be made based on an ADHD market.
Think about it: When was the last time you heard a hedge fund manager buying a stock because he/she believed it would be materially higher 5 years from now? Never!
You know who does? Buffet.
Why? Because he self finances through an insurance company. Permanent capital.
Can you beat Buffet? I don’t know but to start with, permanent capital is important.
Noble Group’s Impending Bankruptcy
Couldn’t happen to a more deserving company but for us it’s a contrary sign. I’m watching commodity trading group Noble (of Singapore) head closer and closer to zero. This, my friends, is another contrary sign of a bottoming in the commodity super-cycle bust. High profile bankruptcies generally occur at or near the bottom in the market.
Noble was a classic case of a company getting too carried away with debt when the going was good. In fact, there was/are all sorts of shenanigans going on with their accounting so watching them die will be purging the system of bad actors. Karma? C’est la vie!
If my short 20 years in the markets has taught me any lesson, it is that the best time to buy is when everyone else is being forced out due to high debt loads and when many players are being forced to sell.
I remember that Anglo American (of South Africa) were famous for this. They used to “lighten up” or exit businesses when the going was good and then when everyone was offloading “non-core” assets (typically when those businesses were at the bottom of a cycle), they would come in and buy those assets at cents on the dollar.
Clearly, that’s easier said than done, otherwise there’d be more Anglo Americans out there.
Traditional Retail is Dead
I’ve lost track of how many times have I been handsomely rewarded for taking the opposite side of a popular narrative.
If you wait for “extremes” in popular thought, then go against that narrative and give yourself enough time, it is actually quite hard to go wrong. The only hard thing is dealing with what sits between your own two ears. Obviously there’s more to it than that but if I was asked the question of how to keep it really really simple, not even focus on earnings, studying cycles, behavioural psychology, technicals, and so forth, then I think that is it.
On that note: Over the last month or so I have been increasingly drawn to all this banter about how traditional retail is dead and Amazon is going to take over the world.
Now, here is the thing about the future: The more you look at it the more it changes because you looked at it. That is an opening quote from the film “Next” with Nicolas Cage.
Think about it. If everyone is saying that traditional retail is dead, what are traditional retailers going to do? Well, they aren’t going to sit back and do nothing and let death creep up on them. They will change and adapt… or at least have a good go at it.
Yes, change tends to happen in the face of adversity, not when everything is going well.
I think this is what is happening at many of the big US retail chains.
The other thing is this: Far too much retail got built in the US. That needs absorbing, and a bunch of it is going to be bulldozed or turned into squatter camps for opioid users. But well located retail is still full. People still go out to shop even though the Amazon app sits on their smartphone.
There’s something else, too. When everyone thinks the worst (or some variation of it), people overreact and lower the bar of expectations, which means it is easier for companies to outperform. I’ve been watching this space for some time and now this is exactly what has been happening as of late. Take a look at Macy’s, for example:
But still the stock was slammed for 10%! Now take a closer look at Macy’s ROE 14%, forward P/E 7.5x, P/Book 1.47x, dividend yield 7.3%… and down 70% from its highs! We’re getting there friends. Probably a little early but keep your eyes open.
Seems to me that the market continues to price Macy’s (and its siblings) as if they won’t be around a couple of years from now. If you think that Macy’s will survive and still be profitable in 5 years from now, then this is the time to step up to that contrarian batting plate.
North Korea: Who Can Afford a Conflict?
I’ll keep this short.
Glass is what you get when you heat rock up to extreme temperatures. If Kim pushes that button and hits land somewhere other than North Korea, or certainly Guam as intimated, then most of North Korea will be turned into glass.
It’s possible, though not probable, that Kim is insane. In the event he is insane, it’s a fair assumption to make that his generals are not. They must know this reality and one would think would keep the kid from pushing that button because it would mean their progeny have a high probability of growing another head and genitalia which would frighten Rambo.
There is absolutely no upside to them in “opening the batting”. There is actually extraordinary upside to having the world’s super powers rallying around to pay attention to you when you’re a leader of an impoverished nation experiencing domestic political pressures and this is, I believe, why we’re hearing so much bluster.
It does seem that the US is preparing for war. After all, what’s another to add to the list? Actually, it really doesn’t matter what you or I think of all of this. What matters is what does actually happen and how we position – literally and with our capital – for any such event.
And so a common question I’m asked is: What about gold?
If you want to buy gold then do it for long-term fundamental, not geopolitical reasons. I don’t have any radically strong views on gold right now but if you forced me to take a position, it would be to the long side of gold via gold miners. That would be consistent with my general bullish view on commodities in general.
I think gold will have its day but gold DOES NOT move on inflation as the gold bugs will have you believe. If you doubt me then just go pull the charts on it. Gold will move when we have loss of faith in currency.
Before I sign off on this North Korean topic, let me just say that if you were worrying about a bear market or significant downside in the major market indices, then you will probably be waiting a “whee while” longer. Bear markets typically start for “structural fundamental” reasons, not geopolitical ones.
Remember: Bear markets are few and far between, but geopolitical events are a dime a dozen.
Japan 4% Growth?
Don’t fall off your chair.
Implications? Well, think about it: Everything in Japan (from a financial market valuation perspective) is prefabricated on the belief that Japan will be mired in deflation and low/no growth for decades to come. But what if that reverses?
Well, not to hard to figure out that one. Japan’s bond market sells off and so with it goes the JPY and folks will run into the “safety” of equities as an inflation/currency hedge, only to find that the BOJ’s equity ETF buying antics has sucked liquidity out of the market and an equity bidding war ensues.
Every Dog Has Its Day
I haven’t given up on the idea that significant value lurks within the oil and gas sector, which, incidentally, has been the worst performer this year off all S&P sectors!
Below is SPDR S&P Oil & Gas Exploration & Production ETF (XOP) which gives you exposure to the average oil and gas stock in the US. There are some 60 stocks in the ETF and they are more or less equally weighted, which gives you exposure to the “average oil and gas exploration and production company”:
What I find very interesting is that the “average oiler” is trading more or less where it was during the height of the GFC:
And even if you start the time series from mid-2014, the average oiler is down some 60%:
Let’s play a game.
Say you were about to head off to a Seychelles or Maldives for the next 5 years and you’ll be cut off from the markets with no ability to monitor or track any investments. Would you buy SPDR S&P Oil & Gas Exploration & Production ETF or FANGs?
How about another game? Would you be prepared to go short SPDR S&P Oil & Gas Exploration & Production ETF and hold that short for the next 5 years?
I’d suspect the latter would end in tears, and indeed, being long XOP for the next 5 years wouldn’t be the daftest idea you’ve ever had.
The Big Five
Five stocks (or a few more for good measure) that have been crushed within the last 10 years but are breaking out of a long-term bottoming phase (at least two years of sideways trading range). It is highly likely that these offer huge fundamental value and we’re putting momentum on our side.
As per usual, this isn’t an in-depth trade alert but rather an invitation to take a closer look as it appears something is “up” with these markets.
This week we have the following line up of “toxic dogs” showing signs of life:
- Golden Ocean Shipping: Dry shipping (US)
- Aegon: Life insurance (Netherlands)
- MBIA: Property and casualty insurance (US)
- Stone Energy: Oiler (US)
- Austin Engineering: Mining services (Aussie)
- Oestjydsk Bank: Banking (Denmark)
Golden Ocean Shipping, a dry shipper. Also take a closer look at Genco (GNK). A number of shippers are displaying “textbook” long-term bullish setups. After having lost some 90%+ of their market caps over the last 10 years, they have traded sideways in extremely tight trading ranges since the start of last year and are now breaking to the upside.
It should be noted that many shippers have also been recapitalized over the last two years, bringing debt levels down by 75% in many cases. Many shippers are way more financially robust than they have been since well before the GFC.
Indexed to 100 as of 2007 – so down some 94% since then! Joy.
And from April 2014… still down 88%:
Aegon. Dutch insurer Aegon (the owner of Transamerica in the US), has held my interest for a long time now.
It remains at the same level as it did during the GFC, which means that it is probably being priced for a reasonable chance of bankruptcy… or at least a huge write down of its book value.
However, the company is profitable, it is on an actual P/E of 15x and forward of 10x, P/Book 0.4x, and has a dividend yield of some 5%.
Aegon had issues with its capital adequacy which they have made progress in raising.
Anyway, this isn’t the place to get too caught up with “details”. Yet another long-term trading range and it is still down some 60% from its pre-GFC level.
What we love about Aegon is the ultra long-term options that trade in Amsterdam and Frankfurt. They go out to December 2021 and have very tight bid offer spreads.
As an idea: You can do a December 2021 6/8 bull call spread for 0.24, which it if gets to 8 or above come December 2021, then it will be a 700% return. Joy!
MBIA. A poster child for the GFC disaster. As with Aegon, MBIA is trading at the same level as it was at the height of the GFC and has traded in a very tight trading range since. I note that not even the Puerto Rico disaster, which cost MBIA just over $1bn, hardly made a blip on the stock price. Rock bottom comes to mind.
Stone Energy. I have discussed Stone Energy before. They operate in the Gulf of Mexico and to cut a long story short came out of bankruptcy in March together with a new look balance sheet (debt holders became equity holders, etc).
The two graphs below are indexed to 100 as of the start of the time period. Yes, it is more or less trading where it was during the height of the GFC. Hated!
Now getting out the magnifying glass, note how Stone Energy has been trading sideways in a very tight trading range ever since it came out of bankruptcy in March/April.
This isn’t so weird in itself but if you put it up against the behavior of other oilers who have been smashed March, then this behavior becomes “freaky”.
Seems that there is a very strong bid under Stone Energy and if it hasn’t made new lows now, then the next big move is to the upside.
Stone is particularly interesting to me as it had some obscure long-term (2021) call warrants that trade on it, and they are very cheap.
Austin Engineering. An Aussie mining services company manufacturing anything from dump truck trays, excavator buckets, equipment repair and maintenance, specialized fabrication, specialized machining, etc. Down by 90% from 2012.
But look at that 18 month old trading range and the break to the upside:
Oestjydsk Bank. Don’t even try to ask me to pronounce it! Oestjydsk is a regional bank in Denmark. Let the charts do the talking:
Looking back on things, these banks were just an accident waiting to happen. The “unbridled” growth in the stock prices up to 2007 eventually caught the attention of Mr. Mean Reversion.
But the bank is showing all the signs of hammering out an ultra long-term bottom… and it still trades on a P/Book of 0.5x.
As per usual, take any one of these companies, and I wouldn’t fancy my chances. But take all five, go short in equal dollar amounts and hold those short positions for 5 years. Good luck on not losing the shirt on your back and a “little” more!
Their time is likely coming.
Sincerely,
Chris MacIntosh
Founder & Editor In Chief, Capitalist Exploits Independent Investment Research
Founder & Managing Partner, Asymmetric Opportunities Fund
Article by Capitalist Exploits
