By Rok Spruk, on March 16th, 2010
Here’s a list of interesting readings for this week.
In NY Times, Paul Krugman discussed (link) the painfulness of financial crisis in Ireland and the U.S and suggesting what we should learn from banking regulation in Canada to prevent future crises of similar proportions.
In Waging War on Black Teens, Richard W. Rahn and Izzy Santa wrote (link) about the high unemployment rate among young African Americans. Furthermore, they suggest that minimum wage mandate is the main cause of steep unemployment rise thereupon.
The Economist (link) summarized the estimated total cost of reconstruction after the earthquake in Chile at $20-30 billion (13-19 percent of the GDP). Chile’s sovereign wealth fund has just over $11 billion saved during the pre-crisis period of high copper prices which, at that time, stood at record levels.
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By Rok Spruk, on November 24th, 2009
A study by June O’Neill and Dave M. O’Neill (link) suggests that the U.S health care system provides more choice, efficiency, better delivery and capacity than the Canadian system:
“Does Canada’s publicly funded, single payer health care system deliver better health outcomes and distribute health resources more equitably than the multi-payer heavily private U.S. system? We show that the efficacy of health care systems cannot be usefully evaluated by comparisons of infant mortality and life expectancy. We analyze several alternative measures of health status using JCUSH (The Joint Canada/U.S. Survey of Health) and other surveys. We find a somewhat higher incidence of chronic health conditions in the U.S. than in Canada but somewhat greater U.S. access to treatment for these conditions. Moreover, a significantly higher percentage of U.S. women and men are screened for major forms of cancer. Although health status, measured in various ways is similar in both countries, mortality/incidence ratios for various cancers tend to be higher in Canada. The need to ration resources in Canada, where care is delivered “free”, ultimately leads to long waits. In the U.S., costs are more often a source of unmet needs. We also find that Canada has no more abolished the tendency for health status to improve with income than have other countries. Indeed, the health-income gradient is slightly steeper in Canada than it is in the U.S.”
By Trace Mayer, on October 26th, 2009
On 22 October 2009 Reuters reported that Korea National Energy Corporation will purchase Harvest for C$1.8B or C$10 per unit. On 12 December 2008 I wrote, “For these reasons Harvest appears to be fairly cheap and a good opportunity.” This article will examine the anatomy of the trade and opportunities for redeployment of capital.
PEAK OIL
One of the underlying themes for my investment philosophy is Peak Oil. Many major oil producing countries have already passed their peak oil production; Germany in 1966, the United States in 1970 and shortly before the Nixon shock when he unilaterally defaulted on international gold obligations, Iran in 1974, France in 1988, in 1999 Argentina and the United Kingdom around the time Gordon Brown sold massive amounts of England’s gold, Mexico in 2004 and Kuwait is expected to peak in 2013, Saudi Arabia in 2014 and Iraq in 2018.
The prescient oil specialist and investment banker Matt Simmons, author or Twilight In The Desert, thinks OPEC has almost no spare capacity. The role of the monetary metals, particularly gold, is to perform mental calculations of value; pricing. The sooner you begin to calculate value in terms of real things the sooner you will be able to understand the relationship between gold, oil and your stomach. Provident living principles include having excess energy; a monkey that gets margin called starves to death.
The United States, consuming 400% more than it produces, needs a reliable source to feed its addiction and Canada is the perfect candidate.
CANADIAN ENERGY TRUSTS
The Canadian energy trusts are generally high-yield going concerns that pay out distributions based on cash flow. Generally, under Canadian tax law they receive preferential treatment so long as the pay out ratio is above 50%. This special treatment will change in 2012 but many trusts have significant tax pools to shield income like Harvest with $3B.
When I recommended Harvest its price was FRN$8.68 per unit or about 0.33 grams of gold. The unit price of the Canadian energy trusts were decimated with the fall in oil and Harvest was no exception. For example, it fell to a low of $3, or about 0.10 grams of gold, on 9 March 2009.
HEDGE STRATEGY
The role Harvest played in my portfolio had to do with passive income according to provident living principles. Accordingly I followed my own suggestions I wrote in my article.
Worst case scenario oil prices continue to fall and the Federal Reserve Note Dollar continues to strengthen which will weaken Harvest’s extremely attractive yield from the current approximately 30% (depends on your tax situation). Long term put options can easily be purchased to preserve capital investment.
Despite the volatility in price I maintained significant monthly cash flow, a 30% cash-on-cash yield will do that, and actually significantly increased my position by purchasing additional units with the proceeds from the put options. Consequently, the new problem is to figure out where to deploy this capital so that the portfolio balance and lifestyle are not disrupted.
PENN WEST ENERGY
A comparable company to Harvest is Penn West Energy (PWE) although they produce over three times as much oil and gas, do not have a refinery and are not burdened with as much debt. At $17.67 per unit with a C$.15 per month distribution it currently yields cash-on-cash about .78% or 9.3% annually.
Like Harvest it implements a prudent hedging strategy that minimizes the impact of volatile commodity prices. Even with weak commodity prices in Q2 2009 they achieved $25.64 netback per barrel of equivalent which included a realized hedging gain of $5.46.
But Penn West has risen about 35% in the past two months. The goal is to buy low and sell high. While I think Penn West will make a good dairy cow for my herd it does seem a little expensive at the current price. Consequently, the open strategy will need to be a little more complex than a market order.
SELL STAGGERED PUTS
For a time horizon of a few years, which includes the tax pool advantages, Penn West appears a decent purchase around $16 per unit. It may even be worth paying a little extra in order to reduce US$ exposure with the cash balance.
A naked put, also called an uncovered put, is a put option whose writer (the seller) does not have a position in the underlying stock or other instrument. This strategy is best used by investors who want to accumulate a position in the underlying stock but only if the price is low enough. If the buyer fails to sell the shares then the seller keeps the option premium for bearing the risk.
Selling naked put options does entail significant risk. The maximum value at risk would be the strike price minus the premium received and would materialize in a bankruptcy that I would consider a black swan. A more likely risk would be a significant decline in the unit price like what happened with Harvest in March 2009. This risk has a higher probability because of the recent run up in price and coming seasonal weakness for energy commodities.
But I need a new dairy cow for my herd and am not very fond of my unemployed cash in this zero interest rate environment where the Federal Reserve will fail with quantitative easing. Consequently, I think opening some uncovered put positions on Penn West around the $15 and $12.50 strike prices for December 2009 and March 2010 will be a good use of the excess liquidity that has resulted from KNOC’s tender offer.
If Penn West floats around its current price then the options will not exercise and I keep the premiums. For the March 2010 $15 puts that amounts to $65 per contract and depending on the margin requirements will take about $500-1,200 of excess liquidity for a very flexible stress test. Of course, raising the bid to $.85 or higher, in a measured and staggered fashion, will help increase the return. Remember, you make money when you open the position not when you close it.
Thus, this strategy will be able to replace the lost passive income from Harvest. Excess capital can be used to reduce risk and expand one’s wealth foundation by moving a significant portion of the unused capital into cash positions holding physical gold, silver or platinum bullion via GoldMoney.
CONCLUSION
The world has a very serious problem with its energy sources and consumption habits. While nations may do incredibly stupid things, like the Nixon shock or Brown’s blunder, individuals can take calculated risk to protect, preserve and grow their capital according to provident living principles.
But even after acquiring good assets the markets can turn and therefore it is important to implement a good hedging strategy to preserve capital. Sometimes against your wishes the market will take your dairy cow to market and turn it into hamburger in which case it will be time to find a new dairy cow.
But there is a wide variety of investments available and sufficient tools to take measured risk. In this case, Penn West appears to be a slightly expensive replacement for Harvest and with an uncovered put strategy the acquisition of units will be at a better value than the current market price.
DISCLOSURES: Long HTE, physical gold, silver and platinum with no position in the problematic GLD or SLV ETFs and short put options on Penn West.
By Bron Suchecki, on June 8th, 2009
In the past week it has been reported that the Royal Canadian Mint (RCM) has “lost gold”. The reports contain statements that to the lay reader may seem unremarkable, but which to me give an indication of what is really going on.
It is also a story of particular interest to me not just because I work in a Mint, but because one job (of the many) I held at the Perth Mint was that of Metal Accountant. The Mint is so obsessive about metal control that it developed four parallel metal general ledgers (au, ag, pt, & pd) and employs a Metal Account full time on ensuring debits equal credits down to one thousandth of an ounce.
My experience in this area is also why I get annoyed at the Jason Hommels who make unsubstantiated claims that the Perth Mint is short gold and/or runs a fractional Depository – for many years it was my job to make sure metal liabilities were backed by metal assets. Anyway, enough of my gripes. For those who haven’t seen the reports, below are the key “facts”, with each number hyperlinked backed to the source of the quote.
1. a significant quantity of gold, silver and other precious metals is unaccounted for.
2. The Royal Canadian Mint is withholding employee bonus pay as special auditors enter a fourth month hunting for unaccounted gold insiders say could be worth as much as several million dollars.
3. In recent years, the mint has become a rich source of cash for the government, generating net income of $21.6 million in 2007 on record revenue of $632 million.
4. external auditors have been working since early March to reconcile the precious metals discrepancy, apparently without success. Even retired mint staff have been quietly brought into the Sussex Drive plant on weekends to try solve the discrepancy, according to a source.
5. external auditors are investigating a discrepancy between the mint’s 2008 financial accounting of its precious metals holdings and the physical stockpile.
6. possibilities from sloppy bookkeeping to a gold heist.
7. “An unprecedented demand in gold in 2008 has led to an unreconciled difference between the mint’s financial statements and the physical count of precious metals. There’s a difference there that we’re looking into.”
8. Officials will only say the discrepancy may be related to an unprecedented demand for gold in 2008, including a 352-per-cent surge in production of its popular Gold Maple Leaf coins.
9. She said an unprecedented demand for gold in 2008 put pressure on the mint’s internal control systems, which led to the “unreconciled difference” between the gold on hand and the value recorded in the mint’s books.
10. “includes the analysis of precious metal by-products and financial data”
11. “We’re looking at many different angles right now,”
12. would not say whether the gold and other metals in question were part of the refinery and bullion operation or one of the mint’s three other business lines.
13. It’s not known when or what triggered the audit review or what external auditor is conducting the review.
14. The corporation’s fiscal 2008 runs from Jan. 1 to Dec. 31 and its normal external auditor is the Auditor General of Canada, who is required to audit the mint’s year-end consolidated financial statements.
15. “Doing business with the mint is still safe and this review will likely give us some suggestions on how to improve our processes.”
16. Notably absent, however, is any expression of optimism the affair will turn out to be a case of sloppy bookkeeping or another accounting mix-up. Asked this week to acknowledge the mint is fairly confident the unaccounted for gold has not been stolen, Aquino replied: “We really want to wait for the review before we make any conclusions. We don’t want to come to any conclusion until then.”
17. police have not been called into what mint officials considered an internal matter.
Firstly, exactly how many millions is “significant”? External auditors have a lot of things to check when reviewing accounting records, so they focus on those that will have a material effect. Accounting standards say that if an item will affect profit by 10% then it is clearly material, with 5% a sort of bottom cut off. If RCM made $21m in 2007, and had a 352% increase in Maple sales, then I think conservatively we could assume they will make $40m this year. This means that the “discrepancy” must be at least $2m, if not $4m. That’s a fair amount of gold, or silver.
The second thing of interest is that the external auditors have been working on the problem since early March. What is interesting about this statement is that if the RCM had process problems (#15) and pressure on their internal controls (#9) as a result of increases in volumes (#8), then discrepancies would have starting being evident during 2008. I find it hard to believe they would just have found out about it at the 31 Dec stocktake.
The Perth Mint, for example, performs quarterly physical stocktakes and metal reconciliations. If there were process/control problems, abnormal variations would show up well before year end, prompting investigations. That is the point of doing it quarterly, so there are no surprises come year end.
I suspect that they only started reconciling book records to the stocktake result mid Jan (holidays etc), I can that taking a month or so. Come late Feb they realise they have a problem, do some more work on it but the external auditors are around then doing their usual stuff and they can’t resolve it so mid-Mar the auditors become aware of the problem. It would also not surprise me that considering the size of the problem, one response would be to question the stocktake result, leading to another stocktake at the end of March.
Why one could question a stocktake (if your inventory records say 10 widgets in stock then you either have 10 or not, don’t you?), how one would not know for certain if gold had been stolen, how one could have a “discrepancy”, why the need for retired workers and what would they have to offer, and why it would take so long to solve the problem requires us to delve into the esoteric world of precious metal manufacture, by-products, and giveaway. In short, stocktaking precious metals is not a straightforward counting of gold widgets – it involves estimations, hence the potential for accounting process stuffups. This I will discuss in my next blog.
By Cheryl Grey, on October 13th, 2008
The trade relationship between the U.S. and Canada is globally unique and intensively intertwined. As the United States’ most significant trading partner, 80% of all Canada’s exports are shipped south (and 21.4% of America’s travel north). In 2007, more goods passed back and forth across just one U.S.-Canadian border crossing—the Ambassador Bridge between Detroit and Windsor—than the U.S. sent to the entire nation of Japan.
The first U.S.-Canadian Free Trade Agreement went into effect in 1989; between 1990 and 2005, Canadian GDP expanded 51.1%.
The Motion
The downside to this extraordinary exchange is that a lot of Canada’s economic eggs are in one basket.
Gross domestic product (GDP) is the measure of all goods and services produced and it’s the universal economic scorecard. With exports supplying approximately one-third of Canadian GDP and exports specifically to the U.S. dominating that contribution, whenever the U.S. economy slows down, historically, Canada has not been far behind. During the current volatile year, as U.S. consumer demand weakened and market after market imploded, economists watched and waited for Canada’s economy to tank.
But like the commercial with the toy bunny that just keeps going, Canada’s economy has proven incredibly resilient. While it’s true that, in the first quarter of 2008, Canadian GDP shrank by 0.8% and in the second quarter it expanded merely by 0.3%, after that point the economy seemed to catch a second wind. In July, the most recent for which data is available, Canada astonished financial markets by a 0.7% surge over June’s performance. Considering the global financial climate, that’s pretty impressive.
The Canadian labor market remains remarkably tight, with the unemployment rate steady at 6.1% in September and jobs continuing to be created even in this climate. In stark contrast, the U.S. job market has declined for nine consecutive months through September, and no one seriously expects that to quit before at least the end of the year.
The Battery
So what’s sustaining the Canadian economy?
Despite opinions to the contrary, NAFTA was never about jobs but all about oil. The greatest percentage of U.S. crude oil imports, around 18% annually, are extracted from Canadian soil, in comparison to 11% each from Mexico and Saudi Arabia. With 99% of all Canada’s crude oil exports flowing south in a steady stream, well, what are a few jobs between friends?
Petroleum cash poured into Canada. The U.S. trade deficit with much of the world is shrinking, mainly due to the recent low value of the greenback and reduced domestic demand for imported products. But in August, the trade deficit with Canada expanded by $200,000,000.
In Alberta, the Texas of Canada, the average annual after-tax family income is $12,000 higher than the average of the other nine provinces.
As the price of oil ballooned through 2007 and the first half of 2008, the value of Canadian exports and, therefore, the Canadian dollar (CAD) surged to follow, climbing 17% against the U.S. dollar (USD) on international foreign exchange markets. Because it then required more USD to purchase Canadian crude, this surge in CAD contributed to the hike in oil prices that climaxed on July 11 at $147.27.
But that weekend, IndyMac was seized by the FDIC and global financial markets turned skittish. Investors backed out of riskier investments and ran for the safety of Treasury notes. Rising demand for USD increased its perceived value, contributing to the popping of commodities prices and the resultant deleveraging.
With the shift in relative values between the two currencies, the flow of funds into Canada began to weaken although the flow of crude into the U.S. barely slowed. When Lehman Brothers fell, the skittishness became panic, and on October 10, the Canadian dollar collapsed against the greenback, along with most other major currencies around the world, as investors exited markets en masse and ran for shelter.
The chart above tracks the depreciation of USD against CAD, beginning in March 2007 at the upper horizontal red line, dropping to an historic low in November 2007 and re-appreciating strongly since the fall of Lehman Brothers.
As long as the U.S. needs crude oil, the Canadian economy will be in no danger of collapsing, although the standard of living in Alberta might not be sustained. Meanwhile, in the U.S., there’s panic over the possible self-destruction of the entire financial system; in Canada the budget may run a deficit for the first time in 11 years.
By Stephan Zimmermann, on October 6th, 2008
Several questions during the last few days pointed out the obvious: lost in the media coverage of the American financial crisis and the tail end of the presidential election seems to be the fact that there really is news beyond Wall Street and Main Street.
I could not agree more.
For example, how much attention has been paid to the fact that our closest neighbor, Canada, is having its 40th parliamentary election on October 14?
Neither the Liberal nor Conservative Party has a majority in the parliamentary system.
The economy, of course, is topmost on the agenda.
In the Toronto Star, the paper raised the question whether Canada is likely to experience similar problems in its housing boom. The upsurge in housing lasted for more than ten years, although it has somewhat cooled off even before the Bearn Stearns, Merrill Lynch, Lehman Brothers, and AIG debacles.
According to Jim Adair of Realty Times,
Tighter lending guidelines for developers and a lower level of investor participation have reinforced a more cautious approach among home builders. …Households, for their part, are not over leveraged. Home equity as a share of real estate assets has been steadily building this decade, as price appreciation outpaces the rise in mortgage obligations. Canadian households also have little direct exposure to sub-prime lending, which has accounted for only about five per cent of domestic mortgages in recent years, compared to over 20 per cent in the United States. (www.realitytimes.com)
Reflecting the fears and uncertainties of Wall Street, however, the Toronto stock exchange (TSX) on October 2 saw a fall of more than 800 points, following on the events of Monday, September 29.
Further adding to market malaise,
On October 1, 2008, the United States Securities and Exchange Commission issued Release No. 58703 announcing the extension of the temporary easing of restrictions on issuers repurchasing their securities. Issuers listed on a U.S. national securities exchange (U.S. Exchange) are temporarily exempt from the application of certain share repurchase rules under the Exchange Act Rule 10b-18. TSX has granted and is extending similar temporary relief to TSX listed issuers that are also listed on a U.S. Exchange. (www.tsx.com)
That SEC rule extension virtually encourages Canadian companies to repatriate subsidiaries with U.S. exposure.
Other key items on Canada’s election agenda include the environment, the arts, infrastructure, and the nation’s role in Afghanistan.
Unlike the United States with it two-party political system, Canada’ multi-party parliamentary structure assures that dissident or minority parties’ concerns are widely aired. The dual-language nation also airs its major parties in both French and English debates. Interestingly, while some 30% of Canadians didn’t plan to listen to either the Canadian or the American vice-presidential debates, more than 60% of those polled had planned to watch both. The debates were both aired on October 2.
Stephan is a former department chair for economics and taught at various colleges and universities at both graduate and undergraduate levels. If you would like Stephan to answer your economics-related questions, read his post “Got an Economics Question?” and submit your questions in the comments area there.
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