CANADIAN
LEVERAGE WITHOUT MARGIN
by Jim Willie CB
May 1, 2006
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Jim Willie CB is the editor of the “HAT TRICK LETTER” For specific detailed analysis of the Gold, USDollar, Treasury bonds, and inter-market dynamics with the US Economy and Fed monetary policy, see instructions for subscription to my newsletter research reports, which include stock recommendations positioned to rise in the commodity bull market. Let this essay be more on a personal nature. In my writings, I have refrained in diction from using the word “I” throughout. On a couple occasions, descriptions of certain family background facts have been provided, things like that. I try to be cold and objective, well, at least objective since my disdain and disgust for mismanaged economic policy and outright blatant deception comes across vividly and with visceral sentiment more than clear. My homeland, the nation I have lived in for five decades has a deserved worldwide reputation as a place with dishonest financial everything, soup to nuts. It bothers me immensely. When I go abroad, like to Europe and elsewhere, I must field questions about that dishonesty and whether it is institutionalized or isolated. I also field unusual questions about whether our leaders are really as stupid as they seem. With a straightforward reply, I tell them that dishonesty is not uniform in business or in government, but when it comes to financials and economic reporting, yes, the corruption in the accounting is highly motivated in order to sell our debts and paint a picture of reduced inflation. Distortion is blatant, uniform, consistent, and shocking with the USGovt. In fact, as distress persists, widens, and worsens, even more dishonesty at a national level should be expected in the future. The corruption becomes a problem for investors when they expect a return to normalcy and a return to natural equilibrium forces. The Plunge Protection Team (aka Working Group for Financial Markets), US Federal Reserve, Dept of Treasury, various ministries, and sordid seamy relationships (like among the Gold Cartel with central banks, Wall Street big banks, brokerage houses) make for a very risky environment for investors. A lot of chicanery can hurt an investment stock account. When someone tells me of a nifty promising US stock story, I look immediately for a parallel story in Canada. The chosen topic inspires me to make this essay personal, since a few personal friends have suffered setbacks in the midst of a gigantic bull market. We are moving quickly to a very dangerous place, for our nation, for our national security, for your family, and for your personal financial security. Grand changes are in progress, which in my opinion will result in pronounced political systemic change in due time. This is no time to take huge risks with minimal protection. On occasion big entities target our profits sitting on the table and our invested capital put at risk generally. Too many sinister forces are out there. In 2002, I decided to enter the Canadian realm. Its mining stocks offered tremendous leverage on the gold price. Later I took advantage of leverage on the silver price, the crude oil price, the natural gas price. Later still, the leverage from the copper price and uranium price was exploited. Sure, these Canadian stocks contain their own vagaries and unique risks, which will be covered in the ensuing sections. Nothing of value comes without risk. DRAWBACKS OF FUTURES CONTRACTS The commodities futures market is a place for professionals to place their bets, and for companies to properly hedge as they neutralize risk. When at Staples, I had my first venture into the futures arena. The company had several million dollars worth of Japanese production supply in the pipeline for office products, mainly the devices and gadgets. We had two periods of time with strong sales of key business tools as well as the fancy gizmos and elaborate toys. Many were integral parts to home based businesses, things like cell phones and handheld devices. The “Dad’s & Grads” was the time of Father’s Day and school graduation. The Christmas holiday also was such a time. Anyway, an obscure group appealed to our Forecasting Analysis group where I worked, and asked for time to set up a risk reduction via Japanese Yen futures contracts, in order to neutralize over a two-month period the inventory flow in progress. The opposite side of the table has gamblers who crave the leverage, risk, and reward. They seek “juice” and win less often typically than lose. To place a bet in these financial trading exchanges requires in no way an economic justification from a business standpoint. If you wish to put a $20 thousand bet on natural gas in November, you can do so, whether you are operating a trading desk in your home or working for a small production company in the Gulf of Mexico. A quick review of hedge risk on the sane side of the ledger might be helpful. If XYZ Corp commits to buying a large quantity of natural gas next June, like $50 million worth from a production supplier output, they are at risk. That is because the final price cannot be determined and fixed. It will be set at delivery time by the supplier, which has its own commitments from customers, fixed prices, other suppliers, and employee costs, not to mention overhead costs. They run off a business model. Without a hedge in place, if natural gas in June rises 10% or 20% in price, they might be hard pressed to honor the contract commitment. They might lose big money. They might lose enough money to knock them out of business. So they hedge to reduce the risk. They purchase an equivalent of natural gas futures contracts, going long, a commitment to purchase the commodity, with a June expiration contract. So, if the natgas price rises, they will pay more than expected, in excess of the expected $50 million, but that extra costs is covered dollar for dollar by the long natgas futures contracts used to match the business contract commitment. The commodity futures contract industry was born when farmers decided to manage their sale of harvest output in future months, balanced against their own seed costs, fuel costs, labor costs, and overhead costs. Business needs reduced risk. They want little part in becoming experts in commodity pricing and their associated markets. The alternative hedge comes from producers like Phelps Dodge (PD), which is in the news. They recently failed to benefit from the huge runup in the copper price. They sold forward future production output, and did so apparently at $1.50 per lb. Given the actual locked price, Phelps Dodge must have locked their hedged contracts last summer, see COPPER CHART. They hedged against a possible decline in the copper price, and thus missed out on a hefty rise in its price. They booked a hedged loss. How well do they comprehend the entire Chinse industrial expansion story? One must ask. Investors who bought PD shares in anticipation of a leveraged gain in Phelps Dodge profits from a higher copper price were disappointed. Such is the plight of hedged producers. Phelps Dodge did not sell more than forward production, like many gold cartel shady financial manipulator rogues. They simply failed to exploit a higher copper price, and denied their investors their expected capital gain profits. A friend of mine lost a ton of money this winter investing in natural gas futures contracts. He lost over $100 thousand, expecting a normal winter, colder weather, and a bounce back over $10 in the natgas price. It did not happen. He has experience with these leveraged dynamic risky financial vehicles, but lost anyway. Such is the fallout from global warming. Despite the warming trend, he expected some bounce after some cold snaps. Natgas was driven down below the $7 mark, much to the shock of many observers. Another friend gambled that the silver price would hit $10 and come down sharply on a selloff, in part from the psychological effect of the “10” level. He expected the gold and silver cartel to slam the market in yet another ambush, as they are wont to do. It did not happen, as the silver exchange traded fund was soon to launch. He lost over $70 thousand, going short on silver futures. Another friend used state commemorative quarters (uncirculated US minted coins) to go long on silver. He won out, but now is unsure when to bag his profits and end the risky game. Coins represent a safer longterm investment, held for years. I personally hold a collection of Morgan silver dollars, even the trio New Orleans Morgans, the complete Franklin half dollar set, the complete Mercury dime set, and more. They have more than tripled in value in the last few years. And then there is Frank Veneroso who shorted copper at $1.0 per lb way back in late 2003. He is long copper mining stocks and short copper futures, but this is a fool’s unprofitable game. Veneroso doubts the entire China story, follows its industrial progress, its banking mess, and decided to use copper as his vehicle to short China. Does it matter how smart he is, or how deep his experience is with central bankers in the Western world? People are rarely smarter than the market. A huge and growing national Chinese reserve account can cover a multitude of errors. It in unclear how he will extract himself from the losing bets. Futures contracts are inherently loaded with risk. You can be right three months down the road, or two years down the road. But in the meantime, you might be bankrupted from riding on such vehicles. Nothing more painful in my memory was when margin calls were handed to me on underwater futures contracts in soybeans and gold back in 1995, which ruined all the profits from my futures contracts in Japanese yen and corn. This forced liquidation locked in huge losses. Bonds removed a leg of mine during those days during a whipsaw. I turned to the yen currency since my economics background aided nicely. The summer drought whacked corn, and suddenly I fashioned myself a weather expert. Chalk it up to a learning experience. For those with some desire for dampening the extreme volatility and risk in futures contracts, one can dabble with futures options, whose underlying securities are futures contracts. Some people every September buy heating oil futures contract options with March expiration, with a steady record of profits. Oy oy oy, include me out. My financial security has been greatly enhanced by means of Canadian mining and energy stocks. I am grateful to Canada. BENEFITS OF CANADIAN STOCKS For the many junior Canadian stocks in the mining and energy sector, tremendous leverage affords the potential for wonderful gains. While leverage is big, margin calls are nonexistent, as is forced liquidation. Like any other stock, the potential capital gain extends from the leveraged profit of revenues over costs. If a company’s gold or copper or natgas or oil output comes in six weeks or six months late, you can ride it out. The leverage will eventually deliver you the big bonanza capital gain, provided the company is successful in its discovery, and prudently makes the next steps toward production or acquisition by a producer. They must adeptly manage their finance deals, secure competent partners, hire reputable drillers, employ experience skilled geologists, and so on. This is no slam dunk easy task. With a handful of silver explorers with or without some production involved, you can invest in silver and put big leverage to work, but with no margin call risk. Ditto with gold or natural gas. Plenty can go wrong, to be sure. Delays in drilling can happen. Bad partners on financial deals might sell all their stock when shares become free trading, only to deliver a powerful down draft. Permits can be refused by state or provincial or national governments. Management might pay more attention to their share price and news releases, thereby denying proper attention to fundamental operations. Inexperienced investor relations officers might attract poor quality investors. Acquired property might be low quality. Management might have overpaid for their property, or under-estimated deep underground mine costs. Drillers might encounter dry holes from poor geologist consulting. Local problems might crop up from environmental concerns, water runoff pollution. If not connected, management might sit last in line for access to drill equipment. The risk can be managed and minimized. One key method is to go with mining executives with a strong track record. Some of these guys are habitual winners, with both a nose for discoveries, and a knack to build good relationships. Not only is no margin call in store for investors of Canadian stocks, but no margin is even available for buying most stock issues. In the Toronto Stock Exchange, only after a stock price exceeds the C$3 mark can it be bought on margin. Only then will commodity funds show interest. With US equivalents, it is up to the discretion of the brokerage house as to whether a stock over US$5 in price can be bought on margin. If a Canadian stock has a trading symbol on AMEX or NYSE, then surely it can be bought on margin above the US$5 price. Personally, I have employed margin for only three months since 2002 on Canadian stocks in my portfolio. It actually feels good, fostering peace of mind, that a delay of a month with a minor setback is no big deal. When these stocks move, THEY MOVE. Margin extra power is not needed. This atmosphere is a far cry from the frothy memories of 1999 during the tech/telecom boom & bust. BOAST ON PORTFOLIO The three biggest gainers in the Hat Trick Letter portfolio are silver miners. Thanks to Greg M and Doug B for bringing them to my attention. They each rose over 500% since last September for incredible gains. These gains are of the type one sees with futures contracts. When the silver price fell by 20% from its $15 top, two of these silver miners barely budged, not even by 10%. They sense the grand uptrend. They see future ore body extensions. They know of the physical shortage. They smell the Silver ETF effect. One such winner went into a hibernation of sorts for several months, only to handsomely reward its share holders when they closed the purchase of a key property. They might rise 500% from here in the next couple years, as production gets underway, and costs are amortized rather than immediately expensed. My favorite method is to find a mothballed miner whose output became economical only recently, now that the silver price has risen. Their stock zooms like a combination phoenix from the ashes and Lazarus from the dead. Uranium does not offer a futures contract. The HTL portfolio has two strong gainers in the uranium space. If you have a strong feeling about the future of energy, obstacles in geopolitics behind crude oil in the Middle East, a change in US domestic energy policy, then the Canadian uranium miners are perfect. Buy two or three of them, sit back, don’t worry about the little swings, and look for at least one to hit a nice deposit in Canada, Mongoli, or Australia. Utah is a bit tapped out in the lower 48 states. Look north. THE CANADIAN DOLLAR My first tough call on the forecasting arena was to claim the Canadian Dollar would rise in a grand bull market toward parity with the USDollar. In 2002 and 2003, this was not a uniformly accepted concept and position to take. I stood in direct opposition to at least one widely read analyst, without names to protect the guilty. He thought the Can$ would suffer a decline toward 50 cents, since tied so tightly in commerce to the USEconomy. I disagreed, expecting a resurgent bull market in commodities generally, in crude oil and Alberta specifically. I expected distress to Canada’s real economy, with some suffering within their manufacturing and tangible industries, without doubt just like in the United States. However, I also expected dynamic economic growth in the western Canadian provinces, which eventually would lead to political conflict between east and west, the “haves” and “have nots” involved. We are beginning to see that now. Will additional taxes be levied against thriving western developers in order to finance support for crumbling eastern industries? Who knows? A separate challenge for the Canadian government is to what extent they should sterilize oil surplus revenues into USTBonds, so as to prevent even more rapidly rising Canadian Dollar exchange rate. The rise in the Can$ has come from the 62 cent level when I began this Great White North approach, to almost 90 cents today. The eventual eclipse of the USDollar, going past parity, is written in stone for some day in the future, probably this calendar year. Canada is so rich in oil, natural gas, precious metals, industrial metals, uranium, and more. The bull market in Alberta energy lands is well along, with a 400% rise in property value. The Chinese and Japanese are competing with the Americans. It was estimated that in 2003, fully $23 billion (with “b” as in “boy”) in investments were made by US corporations. The world is recognizing what I saw in 2002 and 2003, that Alberta is our regional Saudi Arabia, without the political maze and net, but also without the ultra low costs either. The most expensive crude oil out there might be in the Athabasca oil sands territory. Some analysts used to poopoo Athabasca, calling that oil locked up. Thanks to engineering advancements, the technology is there to release the oil. However, the rub is that the process uses natural gas in large quantities.
If you as a US investor owned a Canadian stock in 2002, and endured a big fat nothing in capital gain, no change in its share price on the listed Toronto Stock Exchange price, and you continue to hold it now, then you have over a 40% gain during that time JUST FROM THE RISE IN THE LOONEY, THE WONDERFUL CANADIAN DOLLAR. That surpasses the Dow Jones Industrials and the S&P500 with room to spare. I call it the “Canadian vig” for US investors. I count on further Can$ vig. COMMODITY & OIL PLAY One the most versatile and relatively safe investment approaches to play on the bull market in commodities generally, and crude oil specifically, is the Canadian Dollar. It continues to track the CRB index and the crude oil price (West Texas Intermediate Crude). See for yourself. My personal investment strategy will continue to focus upon the Canadian mining and energy sector. I hope that the United States does not annex Canada, a process which might occur in the distant future. Until then, the strategy will thrive. The added bonus is that I get to meet wonderful influential people in Vancouver (land of beautiful women, including Miranda B who is also smart), in Toronto (home of key contacts like Doug B and Keith L), and in Calgary (whose April bright sun is like nothing I have ever witnessed in the natural world). In early 2006, I am on record saying that the Wall Street goombas got the oil price wrong in 2005 for weather reasons, but in 2006 they will get it wrong for geopolitical reasons. Their biased and compromised clowns trumpeted nonsensical oil price forecasts last January for a retreat to $50 per barrel. We are seeing a frenzy of conflict in Iraq, Iran, Nigeria, and even Russia. Got that right, and gonna get worse before the next snows arrive next winter. You should note that the Wall Street clowns do almost no investment banking for energy companies. Enough said.
Needless to say, the trend is up up up for both the CRB and WTIC crude oil. In the past, I have maintained that the uptrend in the CRB and the US trade deficit explain the rise in the Dow Transportation index. This idea has caught the attention of the venerable Richard Russell. So the Canadian Dollar might be part of a confusing mix which has put the Dow Theory to test.
©
2006 Jim Willie, CB
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Jim
Willie CB is a statistical analyst in marketing research and retail
forecasting.