Profiting from the Inevitable Oil Rebound

The price of oil is down, way down.  Last June’s $142/bl has been below $35/bl.  Now may be a very good time to invest in oil stocks.  On the other hand, prices still seems to be heading south.  You have the “falling knife” risk.  Yet, how low can it go?  Unlike derivatives we are talking real assets here.  At a certain point, pumping won’t pay. And, of course, low prices stoke demand.  It is not a matter of if oil prices will rebound, it is a matter of when and to what extent.  There is also the geopolitical risk and the “Peak Oil” scenario.  Events in the Middle East can flare oil prices up on a moments notice.
Calling a bottom is risky.  Hedging is one way to minimize risk.  Thanks to easily bought and sold Exchange Traded Funds (ETFs) or Exchange Trade Notes (ETNs) you can hedge against price declines  without actually shorting stocks.  ETFs mostly eliminate the “corporate risk” as they often represent a “basket” of companies.  ETNs are riskier as they are derivatives and are only as good as the provider.
Cash is a good place to be in today’s market.  You could “hedge” against lower oil prices by holding cash in reserve.   Another conservative hedge might be buying the US dollar, using the ETF UUP.  The dollar and oil prices are  inversely correlated to some extent.  Holding UUP may be a good hedging strategy.
Using ultrashort ETFs as hedges is powerful,  but risky.  Things aren’t always what they seem.   Often these instruments are trading tools not hedges.  There have been several recent articles on the risks of ultrashort industry segment ETFs such as finance, real estate and oil.
For a more aggressive hedge you can use commodity and currency ETFs and ETNs.   I compared the performance of the ultrashort oil exchange traded fund DUG, the exchange traded note DTO and the exchange traded fund SCO during 2008 using Yahoo Finance charts.  See the chart here.  Remember oil peaked in late June and has since declined 74% .   The comparison is quite informative.   You would not want to be an owner of DUG for the last three months despite its name and the rapid decline in oil prices.  DTO performed very well, but  carries the risk of an ETN (see above).  SCO is a new ETF but seemed to have mirrored DTO’s performance over its short lifespan.  Maybe SCO would be the best aggressive ETF hedge against lower oil prices.
Of course “Past results are not indicative of future performance” and I have a notoriously spotty record of timing, so you should do your own research.  This article only gives you a “heads up” of where you might wish to start.
Disclosures: Long UUP

Wild Oil Prices

The wild swings in the price of oil are truly baffling.  Early July last summer saw prices above $140/barrel.  Now, only 5 months later, the price is below $40/ barrel.   Demand is down some 5-10%.  So why a 70% price drop in oil?
First, a very brief  oil primer.  When oil and gas is pumped out of the ground you usually get a  “witches brew” of compounds, from heavy tar like liquids to methane gas and a lot of stuff in between.   “Sweet” oil is low in sulfur.   West Texas Light/Intermediate (WTI) is light and low in sulfur high grade of oil.  The tar sands of Canada hold lots of oil but it tends to be heavy and high in sulfur requiring more refining.  One of the problems we have is that the easy to get light oils are in decline so more and more we need to tap the heavy, more costly oils.
What is usually called the “price of petroleum” is the spot (payment and delivery now) price of WTI/Light crude as delivered to the large storage facilities near Cushing, Oklahoma.  Sometimes, it may also refer to the price of Brent as traded on the Intercontinental Exchange (ICE) in Scotland.  Lower in quality grades sell for less.  Iran has a lot of oil but it is of a heavier grade so costs less.
Now, back to the price fluctuations.  It seems that even professionals have a hard time predicting these.  Back in July, practically no one expected the high prices to last, even the most bearish predicted a price of around $80/barrel.  Yet, today it is around $40/barrel.  Why?  Some obvious factors are speculation and the faltering economy.  However, it is still perplexing.
Where things go from here is hard to say.  Some say prices will go down to $25/barrel, while others say we will be bottoming soon.  No one disputes the following however.

• The price of oil has not broken out of its downward trend yet
• The price is probably now well below average “production price” (maybe $45-50/barrel)
• Give the above, at some time in the future, prices will again rise, possibly drastically.

Working at the Dump

Signs of the times, as seen in the St. Petersburg Times.
On December 18, the St Petersburg Times ran an article about three recent job openings at the City Dump.  The openings attracted over 130  applicants.   Some of the applicants apparently were on their knees begging for the job.  The pay?  $9.50 an hour.  I’ve been to dumps; lots of flies, birds, noise and all kinds of unpleasant smells.  Can you imagine?   Working outside, at the dump, it must be brutal in the Florida summer heat.  I heard they supply gloves.
Also, on December 20 the Times‘ Hernando Section (Hernando County is about 30 miles north of Tampa) had an article on the Hernando Builders Association postponing their annual March Parade of Homes show because of the area’s “large inventory of unsold and foreclosed homes”.  Only a couple years ago thousands attended.  However, in March of 2008 attendance was “disappointing”.   Since the outlook for March 2009 is “dismal” the show was postponed.  No new date has been set.

SunTrust, Business as Usual

SunTrust (STI) is a major Mid-Atlantic and Southeastern regional bank.  The company has $175 billion in assets with a large residential and commercial real estate involvement.  There are close to 1,700 retail branches throughout 9 states.  The bank has significant holdings in Coca Cola (KO), which along with SunTrust is based in Atlanta.
I deal frequently with SunTrust.  We have had accounts with them for several years.  The company prides itself on excellent customer service.  It is our experience that they do that very well.  Personnel are unfailingly helpful and courteous.
Like any well run business SunTrust has kept a positive and upbeat attitude in the current crisis.    In our community north of Tampa real estate has dropped up to 35% in value over the last year or so.   Since SunTrust is a major lender in the area and throughout Florida this has to have an effect.  So far, however, they project a “business as usual” image.  Our home equity credit limits have not been frozen or reduced.  We still get regular mailings from them about refinancing and other services.
Recently, branches have begun prominently displaying signs stressing how “solid” and “reliable” the bank is.  The  FDIC’s decision to increase deposit insurance from $100,000 to $250,000 is also mentioned.  Their website, www.suntrust.com, has similar messages.
Suntrust, of course, is not immune to the economic climate.  The stock is down some 60% from its 52 week high.  Write-downs are increasing.  Perhaps more ominously, they have twice tapped TARP funds, once in early November for $3.5 billion and then again in early December for $1.4 billion.  With the dividend yield over 7% you have to wonder how safe it is.
Last Tuesday night we went to the new Shops at Wiregrass mall north of Tampa for some Christmas shopping.  Large crowds, however, seemed mostly interested in watching the free Christmas tree light show.  The numerous specialty shops were largely empty with bored clerks hanging around large red 50% off signs.   With several mall owners like General Growth Properties (GGP) near bankruptcy, this does not bode well for banks heavily into commercial lending such as SunTrust.   TheStreet.com in their “Banks and Thrift Screener” gives SunTrust a C- (Fair) rating.  You won’t find any mention of that at the branches.

Deflation has Arrived

Not too long ago (three months) everyone was worried about inflation.  The price of gasoline was skyrocketing and food prices were increasing.  As the financial crisis took a major turn for the worse in mid September things have changed big time.  Look at the following trends.  Even more ominously, as of the date of this post, these trends show no sign of reversal despite bailout after bailout.

• Housing prices continue to decline
• Gasoline prices are declining
• Even food prices are declining
• The stock market is declining
• Employment is declining
• All basic commodities, lumber, steel, precious metals, grains are declining.
  

Folks, this is deflation, a whole new ball game.    At first you may be tempted to think this is good.  It does feel great to fill your gas tank for under $20.  However, if you lost, or are in danger of losing, your job things don’t look rosy at all.

End Game For General Motors and Chrysler

At the time of this post GM and Chrysler are still optimistic that Bush and the Treasury Department will bail them out.  I’m going out on a limb here maybe, but I think it is too late.
Hardly anyone is buying from these companies now due to all the negative publicity.  The massive outflows of money continue with almost nothing coming in.  A bailout will only create more scraps to fight over at tax payer expense.  Consider:

• Potential customers will wonder how long their warranties would be good
• What about resale value?
• How will the cars be serviced with dealerships closing?
• Most importantly, even the best car companies, such as Toyota and Honda, are suffering severe sales declines.   The recession is forecast to last at least through 2009

Ford might make it, they wisely said they don’t need money, yet.  That makes them look good.
I take no pleasure in this.  I own property in Michigan.  It is unfortunate that both management and unions were blind to the gathering storm,  now the wolf is at the door.

How I Learned to Stop Worrying and Love ATPG

Dr. Strangelove himself couldn’t have contrived a more diabolical plot than my tango with ATP Oil and Gas (ATPG).
Way back in September (Was it that long ago?) I ran across an article touting ATPG as a potential 200% gainer.  I have always been partial to oil and gas companies — good liquid assets you know. So, I took a gamble, buying shares at 22.  However, I was foolish enough to not use a stop-loss.  By October 10 my ATPG was down 40%.
Wow, I thought, surely now this has to be an outstanding value!  Obviously Mr. Market is making a big mistake here and things will only improve.  A little mental math now showed a potential 400% gain, Oh Boy!  Other investors will soon become as enlightened as I am, and we will all be rich.  So I did it, I bought more.  What do they call that? “doubling down” or is it “dumbing down”?  You see, I hadn’t read about that “falling knife” stuff yet.
On November 20, minus several fingers, I was mournfully watching my ATPG ticking south of 4, an 82% loss in little over a month, bleep bleep bleep!   In my darker moments I ‘m thinking of flying to New York to look for the guy who wrote the original article.  Rather difficult, however, as I: couldn’t remember his name, couldn’t find the article and now didn’t have the money for a plane ticket - even if I sold my ATPG.
Misery always love company so I decided the check ATPG’s message board on Yahoo Finance.  Yep, my misery found plenty of company.  The general consensus was that the dropping price had something to do with hedge fund selling.  Perhaps I could out wait those hedge funds fellows.  Sure enough, on November 26, things got much better,  ATPG was up 50 % to over 7.  I was ecstatic, never mind the fact that I was still down 70% from the original purchase.  Then another drop.  On December 9, more signs of life, up 20%, December 10 up 12% more.
Lessons learned?  Like the naive investor I was, I didn’t use a stop-loss so had a wild ride down, hoping and wishing for recovery.  I am now wiser.  I learned that “hoping and wishing” doesn’t work in markets, neither does believing everything you read.  Maybe, though, patience does.
From this point forward, my plan is clear.  I am going to buy one of those ultra short ETFs and the next time the market plunges sell and plow all the proceeds into more ATPG  Maybe, just maybe, all my money and then some will come back when all Paulson’s dollars find a home in real assets.  With the money the government is pumping into the economy we should soon have hyper-inflation and all “real” assets such as oil (and ATPG) will sky rocket.  Seriously, I  really do plan on doing this, and then I will finally love ATPG
Maybe next I should write about how one can make 200% on ATPG.  It gets even better, though.  Here is an article claiming ATPG may have more than $15 billion oil and gas reserves and could be a takeover target for Exxon.  December 9’s market cap is $255 million.  So, you see, I really do love ATPG.  Thank you Dr. Strangelove! … err, I mean Mr. Paulson!
Disclosure:  Long ATPG

Watch the Treasury Long Bond

TLT the exchange traded fund (etf ) that tracks the treasury long bond has been displaying some unusual movement lately.  TLT has been one of the few ways to make money in the market over the last year.
The upward trend has accelerated over the last couple of weeks, tracking up 20% since November 17.   The reason is fear, fear of deflation and depression, almost panic buying.  In a deflationary environment this long term treasury will rise while its yield will decrease.  See the chart to the left for the 1 year trend.
Be very careful here though.  There are a lot of reasons why inflation may make a come back in the long, if not short term.  Reasons include, all the stimulus  and bailout programs, less buying of treasuries by foreign governments among others.  If (when?) inflation comes back TLT will drop like a rock.

Why Housing Crashed

St. Petersburg Times, November 30, 2008. The Headlines on the front page tell about a house, in a run down area of Tampa.  A tattoo parlor owner bought it for a $100 deed, then sold three months later for $300,000, with the help of a zero down loan from a subsidiary of Washington Mutual.
Isolated example?  No, far from it!  The tatoo parlor owner did  some 90 deals like this during the housing boom.
Two questions immediately come to mind: 1)  Who would pay $300,000 for this run down house?  2)  How in the heck did loan ever get approved?  The article provided answers.
Sellers, buyers,  and brokerage offices were often in collusion on the deal.  Everyone got a piece of the loan proceeds.  Buyers were often drug dealers said the article,  who (surprise) don’t really care about their credit being tarnished when they default.
Perhaps even more importantly:  Why were these loans approved?  The article says fraud was often involved.  Banks were after the fees and  totally dropped the ball in checking on loan details and property specifics.   Since the loans were bundled as Mortgage Backed Securities (MBSs) and sold, everyone made out like bandits except the purchasers of the MBSs.   Now that we, the taxpayers, are bailing out the MBS holders (banks and financial firms) we are the ones left holding the bag.