Using Oil & Gas Trusts to Beat Inflation
by Mike Stathis, Managing Principle, Apex Venture Advisors
According to Washington, the official inflation rate is around 4.1%. At this point, I think it’s obvious most consumers know this data is wrong. Of course some people accept anything Washington reports, especially the agenda-driven “experts” on television who bring in media hams as cheerleaders to spread the ludicrous propaganda of a strong economy.
You don’t need a Ph.D in economics or finance to know that inflation is approaching levels similar to those seen in the 1970s. In fact, those who have been formally trained in these disciplines are more likely to miss what is really going on because they’ve been programmed to think that fancy math is always superior to common sense. But they often neglect to consider the fact that new standards are continuously being devised to hide the real data - from inflation and unemployment numbers to GDP and poverty statistics.
Understand that most economists are in some way connected to the government. Economists in private industry often sit on Washington committees. Most academic economists too are pressured to accept government methods of data analysis without question, or else they risk losing federal grants, government consulting projects, or being appointed to sit on government committees.
Important Considerations
14% returns are much better than the market’s historical average of around 8%. So what’s the catch? Well, we obviously need to consider the risks before we make any decisions. In the end, you should understand your risk tolerance and investment horizon. After considering the risks, you will be able to determine a risk-reward profile for these investments. This is the general method to determine suitability for all investments. Let’s take a look at some of the more important variables to consider.
Oil Demand
Oil demand is obviously a very important consideration one must make. Some of the questions you might pose are:
Is demand growth accelerating?
What are the reasons for this acceleration and what are the risks for it to end?
What impact will alternative energy have on oil demand and when might a real effect be seen?
While America is the clear leader in annual oil consumption, China leads the world in oil growth demand. In other words, China is accelerating is demand for oil more so than any other nation. This is expected to continue for many years, with all of Asia on a similar course. Unlike America, where oil demand will always (until alternative and renewable energy sources are mature) be quite high due its extensive reach within the economy, China’s demand is primarily the result of its export trade commerce. As corporate America continues to enrich the living standards of China, we will soon see very strong Chinese consumers who, from auto ownership alone will create huge demands for oil. While it should be quite clear that America faces a continued weak economy for at least the next two to three years, it is unknown to what extent these effects will spill over to the rest of the globe. I would estimate that we will see a global recession. Thus, demand from China is likely to stall at some point. But going forward thereafter, you should expect China’s demand for fossil fuels to continue its long-term trajectory.
While there is certainly much noise over alternative energy, the fact is that it will take many years before it makes a dent in the global oil demand. And it will come gradually, allowing OPEC and non-OPEC producing nations to gradually adjust output and resources so that they are able to control demand-supply and thus pricing. Even when alternative energy becomes highly competitive with oil and other fossil fuels (which might not be before 2020), keep in mind that we will always need crude for basic materials. It is a building block for many products.
Oil Prices
Without a doubt, crude is priced way ahead of itself. And while prices could easily correct downward by 30 to 40% over as little as a two-month period, you should understand a few things before you get spooked. As we have seen, oil demand does not necessarily have a high correlation with oil prices in the short-term. Although there is certainly a correlation, OPEC agendas, military conflicts, speculation and momentum-driven trading often causes huge swings in price.
Many independent oil experts believe the long-term price trend for oil is headed much higher. So while a price of $140 per barrel might be a couple of years ahead of itself, even with a 40% correction in the near-term, it is very likely that the fair value trading price of oil will back at this level if not higher over the next two years anyway.
Many of the oil trusts were trading near or above current levels when oil was below $100 just a few months ago. So if oil does correct, this does not mean the price of these trusts will decline proportionately. As I will discuss below, these companies lock in oil prices so they can provide consistent dividends. Therefore, the trading price of these trusts is not likely to collapse with a large oil correction, as long as management is able to lock in prices. However, investors ultimately determine prices of securities so we never know. And price volatility is a reality of investing. What we really need to focus on is the dividend. Therefore we should ask whether a large correction in price will affect the forward dividends. For reasons I will get to shortly, I feel the dividends for at least my favorite two Canadian oil sands trusts (PGH and PWE) are fairly safe.
Finally, understand that many Canadian oil trusts typically hedge or lock in oil prices at certain rates so as to ensure consistent dividends for investors.
Hedging Success and Strategies
When looking at the dividend payouts of these trusts, you might wonder why in the case of Penn Growth for instance, the dividend has remained fairly constant for several months even when oil was well under the $80 mark. Rather than gamble that oil will remain at $140 per barrel, management uses oil futures contracts to lock in what it feels are reasonable prices for oil. If you examine some of the previous statements and headlines for Penn Growth, you will see the company reported losses based on futures contracts. The reason was most likely because management bet against oil going up. They did this because they wanted to play it safe. While we can never be sure whether they will continue this strategy, I would expect them to because it is the most prudent way to deliver a consistent earnings stream to investors while minimizing the downside. Thus, it would seem reasonable to conclude that even a large correction in crude of say 30% over a one or two month period would not alter the dividend by much. In fact, if traders think otherwise, these trusts could sell off as they have recently, thereby increasing the dividend yield, assuming the future dividends remain fairly consistent.
Tax Changes
As a way to encourage investment capital into the new Alberta sands region, the oil trusts were exempt from corporate taxation. Since that time, billions of dollars from all over the world have flooded into the region and now the government wants a piece of the action. A couple of years ago the Canadian government announced that the tax treatment for its trusts would be changed starting in 2011. This caused these trusts to sell off in panic. However, I would not anticipate the dividends to be effected by much. The good thing is that this news is already known and factored into the price of these trusts. But that does not mean there won’t be another correction just before 2011.
Management
The ability of each management team to run these companies with prudence is always a risk we take as investors.
Risk Comparison
When we compare the risk of oil trusts, we should look at asset classes with similar rates of return. The first type of asset class that comes to mind is REITs. After all that has happened to the real estate market, I do not think I need to discuss the risk level here. On average, the Canadian oil trusts I have mentioned are yielding around 14% annually. The only other major asset class that even comes close to this is small cap stocks. However, you should note that even small caps only return around 11% on average, and that is over a long period, such as 20 or 30 years. As well, the volatility is higher and there are some small caps that go bankrupt. I certainly wouldn’t want to be in small caps during this market.
Even if you are willing to assume the risk of small caps given current market conditions, you would most likely need to actively trade these stocks in order to secure any chance of annual double digit returns over say a 5-year horizon. Otherwise, you could end up flat or even down over that period. In contrast, the oil sands pay monthly dividends. That’s money that comes every month; money that can help neutralize the declining purchasing power of the dollar. In conclusion, whether you want to go Canadian or American, oil trusts offer an excellent solution to counter the effects of high inflation. And during this period of economic uncertainty, perhaps one of the few things we can be certain of is that oil will remain high for many years.
Conclusions
Remember, before you can justify investing in oil trusts, the oil story is something you have to fully believe in because these securities are volatile. While trading opportunities are definitely available, you should be willing to hold them for several years. In fact, at current prices and assuming historical dividend payouts to continue, your cost basis (before taxes) would approach zero if you bought and held Baytex, Paramount, Bonavista, Arc, Advantage, Crescent Point, Enerplus, Freehold or Penn West over the next eight years.
Showing posts with label Penn West. Show all posts
Showing posts with label Penn West. Show all posts
Tuesday, July 15, 2008
Friday, February 29, 2008
Why I Think You Got to Look at Natural Gas (Again)
Don Coxe on Natural Gas in his February 21, 2008 Conference Call
Another commodity that we have not had good things to say about for a long, long time - natural gas - is one I want you to start looking at. And I want you to pull up a long term chart on natgas and what you'll see is this is a long term base pattern after the panic associated with Katrina when we told you to get out of the natural gas stocks and switch to metals.
It's a long sideways move. But the reason why I think you got to look at natural gas, again, is that it looks like it's about to break out of its base on the upside. And if it does, the natural gas, which is a short reserve life index fuel in the US, is now a situation where massive amounts of capital are being committed by the big oil companies led by ExxonMobil on pulling out tight gas from formations where in the past they couldn't possibly extract the gas. They're using new technology. This is expensive gas.
We're going to get a new floor price for gas set by this. In the case of ExxonMobil they're reason for doing it is primarily to protect their reserve life index. They've had to cut it by three full years, this year, because of what's been happening to them on oil from political risk. And, because of this magic that you can use six units of natural gas to equal a barrel of oil then ExxonMobil by developing reserves of natural gas, high-priced gas, can protect its reserve life index on this barrel of energy equivalent.
ExxonMobil is a brilliantly run company. They're going to do what they can to preserve their reserve life index. But another big company is involved in this because you've got General Electric promoting, once again, the sale of gas turbines for electricity. And with oil prices staying high and if you look…if you take the price of oil as far ahead as 2010 - December oil is now at 92.34, which means that for users of residual, what they can't see is any relief in the future. And natural gas, of course, also wins on the basis of environmentally-sound fuel because of small amounts of air pollution.
So I think you're going to have major companies out there with big followings. They're going to be promoting this. And what they can't do is rely on LNG for the reasons we've discussed on so many calls, particularly terror risk, but in addition the fact that the LNG suppliers out there, so much of it is from places in the world that have definite levels of political risk in them. That was going to be the saviour.
And as I told you before, six years ago I attended a meeting of the partners in the natural gas industry in the Chicago Land, which was both the users of natural gas and the major pipelines that delivered gas. And at that time I watched as the head of Marathon Oil's operations for natural gas in North America covered a wall with a chart of all the natural gas fields with their reserve life indices. And he pointed out that by the end of this decade, we were going to be facing a full-blown crisis in this country for natgas, but it was going to be solved by a pipeline that was going to bring it in from Canada.
And I got up at the meeting, spoke after him and said first of all he also said that LNG was going to come in big and I said I don't believe all those LNG projects are going to go forward because of 9/11. And the guy from Marathon jumped up and said “Who invited him to the meeting? We checked out our approvals for these projects with the FBI and they've all been approved as being safe. and I said, "Have you talked to them since 9/11?" and he said "No, we didn't have to. We've got approvals." And then I said, "As for the pipeline in Canada, that's not going to go forward in this decade. Not a chance." Once again he jumped up and said, "We have all the arrangements in place. We've got an agreement from the federal government in Ottawa that it's going forward," and I said, "You haven't got an agreement from the native peoples." Well the meeting became very difficult at that stage because once again he said I didn't know what I was talking about and there weren't going to be a few native tribes holding back a project like this. I tell you that only because it illustrates that the industry collectively had a comfort level on gas, which wasn't vindicated.
So we could get yet another energy surprise coming. And that's not just because we've
had such a cold winter because, of course, nobody out there who could be intellectually respected thought we could have cold winters. But, because it illustrates that the supply side response that you would have ordinarily expected, has been constrained by conditions they can't control.
So I think you have got to start looking at natgas as being maybe the next commodity that's going to join the bull market, having been in not a real bear market but a nothing market, for so long.
--------------------------------------------
This is the time to start buying oil and gas income trusts. I have been buying Paramount (PMT.UN), NAL Oil & Gas (NAE.UN), PennWest (PWT.UN) and Daylight Energy Trust (DAY.UN).
Another commodity that we have not had good things to say about for a long, long time - natural gas - is one I want you to start looking at. And I want you to pull up a long term chart on natgas and what you'll see is this is a long term base pattern after the panic associated with Katrina when we told you to get out of the natural gas stocks and switch to metals.
It's a long sideways move. But the reason why I think you got to look at natural gas, again, is that it looks like it's about to break out of its base on the upside. And if it does, the natural gas, which is a short reserve life index fuel in the US, is now a situation where massive amounts of capital are being committed by the big oil companies led by ExxonMobil on pulling out tight gas from formations where in the past they couldn't possibly extract the gas. They're using new technology. This is expensive gas.
We're going to get a new floor price for gas set by this. In the case of ExxonMobil they're reason for doing it is primarily to protect their reserve life index. They've had to cut it by three full years, this year, because of what's been happening to them on oil from political risk. And, because of this magic that you can use six units of natural gas to equal a barrel of oil then ExxonMobil by developing reserves of natural gas, high-priced gas, can protect its reserve life index on this barrel of energy equivalent.
ExxonMobil is a brilliantly run company. They're going to do what they can to preserve their reserve life index. But another big company is involved in this because you've got General Electric promoting, once again, the sale of gas turbines for electricity. And with oil prices staying high and if you look…if you take the price of oil as far ahead as 2010 - December oil is now at 92.34, which means that for users of residual, what they can't see is any relief in the future. And natural gas, of course, also wins on the basis of environmentally-sound fuel because of small amounts of air pollution.
So I think you're going to have major companies out there with big followings. They're going to be promoting this. And what they can't do is rely on LNG for the reasons we've discussed on so many calls, particularly terror risk, but in addition the fact that the LNG suppliers out there, so much of it is from places in the world that have definite levels of political risk in them. That was going to be the saviour.
And as I told you before, six years ago I attended a meeting of the partners in the natural gas industry in the Chicago Land, which was both the users of natural gas and the major pipelines that delivered gas. And at that time I watched as the head of Marathon Oil's operations for natural gas in North America covered a wall with a chart of all the natural gas fields with their reserve life indices. And he pointed out that by the end of this decade, we were going to be facing a full-blown crisis in this country for natgas, but it was going to be solved by a pipeline that was going to bring it in from Canada.
And I got up at the meeting, spoke after him and said first of all he also said that LNG was going to come in big and I said I don't believe all those LNG projects are going to go forward because of 9/11. And the guy from Marathon jumped up and said “Who invited him to the meeting? We checked out our approvals for these projects with the FBI and they've all been approved as being safe. and I said, "Have you talked to them since 9/11?" and he said "No, we didn't have to. We've got approvals." And then I said, "As for the pipeline in Canada, that's not going to go forward in this decade. Not a chance." Once again he jumped up and said, "We have all the arrangements in place. We've got an agreement from the federal government in Ottawa that it's going forward," and I said, "You haven't got an agreement from the native peoples." Well the meeting became very difficult at that stage because once again he said I didn't know what I was talking about and there weren't going to be a few native tribes holding back a project like this. I tell you that only because it illustrates that the industry collectively had a comfort level on gas, which wasn't vindicated.
So we could get yet another energy surprise coming. And that's not just because we've
had such a cold winter because, of course, nobody out there who could be intellectually respected thought we could have cold winters. But, because it illustrates that the supply side response that you would have ordinarily expected, has been constrained by conditions they can't control.
So I think you have got to start looking at natgas as being maybe the next commodity that's going to join the bull market, having been in not a real bear market but a nothing market, for so long.
--------------------------------------------
This is the time to start buying oil and gas income trusts. I have been buying Paramount (PMT.UN), NAL Oil & Gas (NAE.UN), PennWest (PWT.UN) and Daylight Energy Trust (DAY.UN).
Tuesday, February 12, 2008
When The Sun Doesn’t Shine and the Wind Doesn’t Blow We Need Natural Gas
When the sun doesn’t shine and the wind doesn’t blow, we need natural gas. Until new plants are approved and built for clean coal and nuclear, we need natural gas. If we want to subsidize agriculture, we need natural gas to convert food crops to energy. To supplement oil that faces increasingly short supply, we need natural gas. Finally, if hydrogen is going to be the last clean fuel, it will likely be created from natural gas.
Natural gas weighted Canroy's have natural gas selling at half price, judging by the incremental price of liquefied natural gas in Asia. Last week, according to trade reports, Japan paid $18 a million btu for the liquid form of the same commodity that is priced in the futures market at $8 for the next six years.
Since $18 LNG is roughly equivalent to $100 oil burned in the same Japanese power plants, the stark difference points to an upward price trend for the clean fuel.
Meanwhile, monthly distributions are likely to be higher in 2008 judging from the trend in the price for natural gas prices.
I have been buying NAE.UN, PMT.UN and PWT.UN.
Natural gas weighted Canroy's have natural gas selling at half price, judging by the incremental price of liquefied natural gas in Asia. Last week, according to trade reports, Japan paid $18 a million btu for the liquid form of the same commodity that is priced in the futures market at $8 for the next six years.
Since $18 LNG is roughly equivalent to $100 oil burned in the same Japanese power plants, the stark difference points to an upward price trend for the clean fuel.
Meanwhile, monthly distributions are likely to be higher in 2008 judging from the trend in the price for natural gas prices.
I have been buying NAE.UN, PMT.UN and PWT.UN.
Thursday, October 18, 2007
Target Prices for Canadian Royalty Trusts
Please click here to download a spread sheet summary of Canadian Royalty Trust (affectionately known as Canroys) target prices by various Candadian Investment Houses as of September 28, 2007. Investors should use this information to determine good entry points into Canroy positions.
This spread sheet is courtesy of THOR on the Yahoo Canroy board.
Please note that this link will only be available until November 30, 2007.
This spread sheet is courtesy of THOR on the Yahoo Canroy board.
Please note that this link will only be available until November 30, 2007.
Tuesday, October 9, 2007
Hedging Our Bets on Investing for Income Between Credit and Inflation Risk
Condensed Version of
HEDGING OUR BETS
by Roger Conrad
Editor, Utility & Income
October 9, 2007
Income investments come in all shapes and sizes. But all have one thing in common as far as we’re concerned: We’ve got to buy and hold ‘em to get the most out of them.
Part of that is axiomatic. You can’t collect the distributions unless you stick around for them to be paid. Individual bonds are the exception because they accrue interest as long as you hold them. But as far as stocks, Canadian trusts, limited partnerships, income-paying funds, preferred stocks or anything else goes, you’ve got be in there on the ex-dividend dates or you won’t get paid.
Ironically, the most important reason income investors need to buy and hold is capital appreciation. A healthy, growing company will increase its dividend over time, and its share price will follow. If you’re trading, you won’t get that gain unless you’re very, very lucky.
Buying and holding, of course, isn’t without risks. For income investors, there are basically two: credit risk and inflation risk.
The former has been on investors’ minds this year. And virtually anything perceived as having too much debt—or too unorthodox a capital structure—has taken hits.
There are two ways to protect your portfolio against credit risk. One is by sticking only to high-quality, growing companies and shedding anything where the business fundamentals are weakening. The other is to diversify broadly, both in terms of individual stocks you hold and across market sectors.
When the markets are universally panicked about recession or a credit crunch, big institutional money will pretty much sell off anything that doesn’t have the word “Treasury” in it. And that’s exactly what happened on the worst days over the summer.
The key in a market like that is to avoid the real blowups, i.e., the companies that are really in trouble. This time around, that was basically financial companies that had gotten in really deep in the mortgage market and/or collateralized debt obligations. As JP MORGAN CHASE’S $5.5 billion writeoff announced today illustrates, there are still some landmines in this area, though that stock is actually up today.
In contrast, damage to most other income investments in recent months was largely because of guilt by association. Limited partnerships (LPs), for example, were walloped by concerns about their debt structures and whether or not they’d be able to access capital markets. Both fears have proven largely groundless, at least for the best quality LPs. As a result, money is starting to flow back in and shares are recovering.
The lesson: If you avoid the blowups in an environment of elevated credit risk, your losses will be short-lived. In fact, such times are golden opportunities to buy high-quality income stocks cheaply.
THE GREATER RISK NOW IS INFLATION - ESPECIALLY IN THE USA
The bottom line is, if you pick your stocks carefully, diversify well, shed holdings that weaken business-wise and are willing to be patient in downturns, you can make your income portfolio pretty much foolproof against credit risk.
Guarding against inflation risk, however, is a whole other matter. Income-oriented investments are especially vulnerable to inflation because they’re valued to a large extent on the basis of yield. Rising inflation pushes market interest rates higher, which makes those yields worth relatively less. As a result, income-oriented investments sell off to a point where yields are again attractive.
During the 1970s, Treasury bonds were among the absolute worst investments to own. Credit risk was zero.
But every incremental increase in inflation made investors demand a higher yield to compensate for the erosion of principal. And by the time inflation peaked in the late ’70s and early ’80s, bonds issued at the lower rates of the ’60s had lost most of their real value.
We haven’t had a real inflation problem in the US since those bad old days. We have, however, had occasional flare-ups that have wreaked havoc on everything from REITs to utilities.
In each of the past five years, we’ve had a spring or summer spike in interest rates, as investors have anticipated faster growth and higher inflation. The benchmark 10-year Treasury note yield spiked, and income investments across the board sold off. Each time—including this year—rising rates sowed the seeds of their own reversal, sparking worries about the economy and ultimately sending them lower.
As we move into the fourth quarter, rates are down and credit worries are receding. As a result, income investments are starting to recover their summer losses. That rally should continue throughout the fourth quarter. Utility stocks, for example, have had a positive fourth quarter in 35 of the last 40 years.
After that, however, the future gets considerably cloudier. With the Federal Reserve apparently willing to do whatever it takes to avoid recession, credit risk is no longer the primary concern. Rather, it’s inflation. And the more money the Fed and other world central banks pour into the system now to bail out the likes of JP Morgan, the greater the risk.
One way income investors can protect themselves against inflation is healthy growth. Not even companies that can grow dividends reliably and robustly have historically been able to hold their share value in the face of rapid inflation. But they do a credible job with moderate inflation, if for no other reason than investors need to get their income from somewhere.
How bad can inflation get this time is the $1 million question. And as is always the case with market economics, that’s impossible to forecast.
What we do know, however, is there are investments that pay moderate income and actually do very well in inflationary environments. By adding them to already diversified portfolios, we can cut the inflation risk to our overall portfolios.
What I’m talking about are metals and other vital resources. Over the past five years or so, many of the raw commodities—from copper to zinc—have doubled and tripled in value. The primary reason is global growth.
Not since the ’70s has the world seen such robust, synchronized economic growth. And unlike then, the US isn’t the only driver of growth this time around.
We’re still the most important economy. But China, Japan, Europe, India and the Middle East are also driving things. That makes this growth wave a lot more durable than the last one. In other words, a US recession would no doubt slow things down, but it wouldn’t derail global growth as it did in the early ’80s.
Metals and other raw commodities are the essential fuel for global growth. And the faster and more universal growth is, the greater the strain on supplies. Already, we’ve seen Russia plant its flag on the North Pole, while China and Europe are snuggling up to African dictators and the regime in Iran. And that’s only the beginning, as competition for scarce resources grows.
Eventually, every commodity cycle ends. Ever-rising prices induce consumers to change their habits and develop alternatives, even as they incentivize new discoveries. The process, however, can take years and even decades before the supply/demand balance shifts back in favor of consumers, and it’s never entirely painless.
One of the hallmarks of a top in a commodity cycle is breathless speculation that supplies are truly running out. I’m not hearing any of that now in the financial media.
In fact, the buzz is largely about how the commodity bull has reached unsustainable levels and that its days are numbered. This is in stark contrast to what’s happening in the market place, and the disconnect likely points to a lot more ahead.
Commodities and vital resources are good inflation hedges for one major reason: They represent hard value. Gold, for example, has been a global store of value for millennia. When US inflation undermines the value of paper money, gold holds its own—mainly by surging in US dollar terms.
The best way to play a boom in commodities and vital resources is to buy stocks of the companies that produce them. For one thing, gains are leveraged. For example, a company producing copper at a total cost of $1 a pound will see its earnings double if the metal moves from $2 a pound to $3 a pound—a 50 percent gain in the metal itself. And good companies are always growing, providing a rising base of earnings.
I’ve already been talking about high-yielding energy bets like Canadian trusts, Super Oils and combination utility/producers for some time. We’ve seen some staggering profits in these over the past five years or so. And until we see the factors that ended the ’70s energy bull market in abundance—greater conservation, switching to alternatives (not biofuels), new conventional reserve discoveries (not from oil sands or extreme deepwater drilling) and a global recession—we’re going to see a lot more gains.
The takeover offer for Canadian trust PRIMEWEST ENERGY TRUST by the ABU DHABI NATIONAL ENERGY CO—which was at nearly a 40 percent premium to the pre-deal price—is a pretty clear value alert for that sector. And whether it means takeover for the likes of other strong trusts like Enerplus Resources or Penn West Energy Trust or not, it does add up to big gains ahead for the best trusts, in addition to their high distributions.
Energy is only one resource that offers income investors an inflation hedge.
HEDGING OUR BETS
by Roger Conrad
Editor, Utility & Income
October 9, 2007
Income investments come in all shapes and sizes. But all have one thing in common as far as we’re concerned: We’ve got to buy and hold ‘em to get the most out of them.
Part of that is axiomatic. You can’t collect the distributions unless you stick around for them to be paid. Individual bonds are the exception because they accrue interest as long as you hold them. But as far as stocks, Canadian trusts, limited partnerships, income-paying funds, preferred stocks or anything else goes, you’ve got be in there on the ex-dividend dates or you won’t get paid.
Ironically, the most important reason income investors need to buy and hold is capital appreciation. A healthy, growing company will increase its dividend over time, and its share price will follow. If you’re trading, you won’t get that gain unless you’re very, very lucky.
Buying and holding, of course, isn’t without risks. For income investors, there are basically two: credit risk and inflation risk.
The former has been on investors’ minds this year. And virtually anything perceived as having too much debt—or too unorthodox a capital structure—has taken hits.
There are two ways to protect your portfolio against credit risk. One is by sticking only to high-quality, growing companies and shedding anything where the business fundamentals are weakening. The other is to diversify broadly, both in terms of individual stocks you hold and across market sectors.
When the markets are universally panicked about recession or a credit crunch, big institutional money will pretty much sell off anything that doesn’t have the word “Treasury” in it. And that’s exactly what happened on the worst days over the summer.
The key in a market like that is to avoid the real blowups, i.e., the companies that are really in trouble. This time around, that was basically financial companies that had gotten in really deep in the mortgage market and/or collateralized debt obligations. As JP MORGAN CHASE’S $5.5 billion writeoff announced today illustrates, there are still some landmines in this area, though that stock is actually up today.
In contrast, damage to most other income investments in recent months was largely because of guilt by association. Limited partnerships (LPs), for example, were walloped by concerns about their debt structures and whether or not they’d be able to access capital markets. Both fears have proven largely groundless, at least for the best quality LPs. As a result, money is starting to flow back in and shares are recovering.
The lesson: If you avoid the blowups in an environment of elevated credit risk, your losses will be short-lived. In fact, such times are golden opportunities to buy high-quality income stocks cheaply.
THE GREATER RISK NOW IS INFLATION - ESPECIALLY IN THE USA
The bottom line is, if you pick your stocks carefully, diversify well, shed holdings that weaken business-wise and are willing to be patient in downturns, you can make your income portfolio pretty much foolproof against credit risk.
Guarding against inflation risk, however, is a whole other matter. Income-oriented investments are especially vulnerable to inflation because they’re valued to a large extent on the basis of yield. Rising inflation pushes market interest rates higher, which makes those yields worth relatively less. As a result, income-oriented investments sell off to a point where yields are again attractive.
During the 1970s, Treasury bonds were among the absolute worst investments to own. Credit risk was zero.
But every incremental increase in inflation made investors demand a higher yield to compensate for the erosion of principal. And by the time inflation peaked in the late ’70s and early ’80s, bonds issued at the lower rates of the ’60s had lost most of their real value.
We haven’t had a real inflation problem in the US since those bad old days. We have, however, had occasional flare-ups that have wreaked havoc on everything from REITs to utilities.
In each of the past five years, we’ve had a spring or summer spike in interest rates, as investors have anticipated faster growth and higher inflation. The benchmark 10-year Treasury note yield spiked, and income investments across the board sold off. Each time—including this year—rising rates sowed the seeds of their own reversal, sparking worries about the economy and ultimately sending them lower.
As we move into the fourth quarter, rates are down and credit worries are receding. As a result, income investments are starting to recover their summer losses. That rally should continue throughout the fourth quarter. Utility stocks, for example, have had a positive fourth quarter in 35 of the last 40 years.
After that, however, the future gets considerably cloudier. With the Federal Reserve apparently willing to do whatever it takes to avoid recession, credit risk is no longer the primary concern. Rather, it’s inflation. And the more money the Fed and other world central banks pour into the system now to bail out the likes of JP Morgan, the greater the risk.
One way income investors can protect themselves against inflation is healthy growth. Not even companies that can grow dividends reliably and robustly have historically been able to hold their share value in the face of rapid inflation. But they do a credible job with moderate inflation, if for no other reason than investors need to get their income from somewhere.
How bad can inflation get this time is the $1 million question. And as is always the case with market economics, that’s impossible to forecast.
What we do know, however, is there are investments that pay moderate income and actually do very well in inflationary environments. By adding them to already diversified portfolios, we can cut the inflation risk to our overall portfolios.
What I’m talking about are metals and other vital resources. Over the past five years or so, many of the raw commodities—from copper to zinc—have doubled and tripled in value. The primary reason is global growth.
Not since the ’70s has the world seen such robust, synchronized economic growth. And unlike then, the US isn’t the only driver of growth this time around.
We’re still the most important economy. But China, Japan, Europe, India and the Middle East are also driving things. That makes this growth wave a lot more durable than the last one. In other words, a US recession would no doubt slow things down, but it wouldn’t derail global growth as it did in the early ’80s.
Metals and other raw commodities are the essential fuel for global growth. And the faster and more universal growth is, the greater the strain on supplies. Already, we’ve seen Russia plant its flag on the North Pole, while China and Europe are snuggling up to African dictators and the regime in Iran. And that’s only the beginning, as competition for scarce resources grows.
Eventually, every commodity cycle ends. Ever-rising prices induce consumers to change their habits and develop alternatives, even as they incentivize new discoveries. The process, however, can take years and even decades before the supply/demand balance shifts back in favor of consumers, and it’s never entirely painless.
One of the hallmarks of a top in a commodity cycle is breathless speculation that supplies are truly running out. I’m not hearing any of that now in the financial media.
In fact, the buzz is largely about how the commodity bull has reached unsustainable levels and that its days are numbered. This is in stark contrast to what’s happening in the market place, and the disconnect likely points to a lot more ahead.
Commodities and vital resources are good inflation hedges for one major reason: They represent hard value. Gold, for example, has been a global store of value for millennia. When US inflation undermines the value of paper money, gold holds its own—mainly by surging in US dollar terms.
The best way to play a boom in commodities and vital resources is to buy stocks of the companies that produce them. For one thing, gains are leveraged. For example, a company producing copper at a total cost of $1 a pound will see its earnings double if the metal moves from $2 a pound to $3 a pound—a 50 percent gain in the metal itself. And good companies are always growing, providing a rising base of earnings.
I’ve already been talking about high-yielding energy bets like Canadian trusts, Super Oils and combination utility/producers for some time. We’ve seen some staggering profits in these over the past five years or so. And until we see the factors that ended the ’70s energy bull market in abundance—greater conservation, switching to alternatives (not biofuels), new conventional reserve discoveries (not from oil sands or extreme deepwater drilling) and a global recession—we’re going to see a lot more gains.
The takeover offer for Canadian trust PRIMEWEST ENERGY TRUST by the ABU DHABI NATIONAL ENERGY CO—which was at nearly a 40 percent premium to the pre-deal price—is a pretty clear value alert for that sector. And whether it means takeover for the likes of other strong trusts like Enerplus Resources or Penn West Energy Trust or not, it does add up to big gains ahead for the best trusts, in addition to their high distributions.
Energy is only one resource that offers income investors an inflation hedge.
Saturday, March 17, 2007
Canadian Energy Trusts May Get a some sort of break on the Trust Tax
Richard Lehmann on PBS show NBR thinks Canroys may get a reprieve
Below is a portion of the transcript from the Friday March 16, 2007 Nightly Business Report Market monitor interview. I don't know where he is getting his information.
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Full Transcript http://www.pbs.org/nbr/site/onair/transcripts/070316c/
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Partial Transcript
YASTINE: Really. Well, tell us which ones that you like best here. One area I know that you like are Canadian energy trusts. What are those?
LEHMANN: Canadian energy trusts are actually stocks, but they're income secured because they pay monthly dividends. And they -- they differ from the U.S. energy trusts in that Canadian trusts are allowed to continually replenish their reserves so they never go out of business. And the second advantage of them is that the dividends from them is qualified dividend income, so it's only subject to a 15 percent tax rate.
YASTINE: Do you have a first pick?
LEHMANN: Yeah, the biggest and best energy trust is EnerPlus Resources (ERF). And --
YASTINE: It has a 10 percent yield.
LEHMANN: It has a 10 percent yield, ticker ERF and it's about 50-50, oil and gas. So it's not only just in exploration. They produce from a pool of reserves.
YASTINE: And you have a second one.
LEHMANN: The second one is PennWest Energy (PWE). And this, too, is a very large company with over nine years in reserves and a lot of unexplored properties as well.
YASTINE: And this one, both of these have come down quite a bit from 43 to 27. On PennWest you expect these to go back up in addition to the yield?
LEHMANN: Yeah. The trusts suffered a big drop in November when the Canadian government announced that it was planning to start taxing them in four years. But since then, the government's found that they don't have the votes in the parliament to pass this legislation, so the chances are that there will be some sort of compromise settlement, and my expectation is it's definitely going to be for the better, and so we'll see some spike in the price while you're collecting this dividend.
Below is a portion of the transcript from the Friday March 16, 2007 Nightly Business Report Market monitor interview. I don't know where he is getting his information.
------------------------------------------------------------------------
Full Transcript http://www.pbs.org/nbr/site/onair/transcripts/070316c/
------------------------------------------------------------------------
Partial Transcript
YASTINE: Really. Well, tell us which ones that you like best here. One area I know that you like are Canadian energy trusts. What are those?
LEHMANN: Canadian energy trusts are actually stocks, but they're income secured because they pay monthly dividends. And they -- they differ from the U.S. energy trusts in that Canadian trusts are allowed to continually replenish their reserves so they never go out of business. And the second advantage of them is that the dividends from them is qualified dividend income, so it's only subject to a 15 percent tax rate.
YASTINE: Do you have a first pick?
LEHMANN: Yeah, the biggest and best energy trust is EnerPlus Resources (ERF). And --
YASTINE: It has a 10 percent yield.
LEHMANN: It has a 10 percent yield, ticker ERF and it's about 50-50, oil and gas. So it's not only just in exploration. They produce from a pool of reserves.
YASTINE: And you have a second one.
LEHMANN: The second one is PennWest Energy (PWE). And this, too, is a very large company with over nine years in reserves and a lot of unexplored properties as well.
YASTINE: And this one, both of these have come down quite a bit from 43 to 27. On PennWest you expect these to go back up in addition to the yield?
LEHMANN: Yeah. The trusts suffered a big drop in November when the Canadian government announced that it was planning to start taxing them in four years. But since then, the government's found that they don't have the votes in the parliament to pass this legislation, so the chances are that there will be some sort of compromise settlement, and my expectation is it's definitely going to be for the better, and so we'll see some spike in the price while you're collecting this dividend.
Sunday, February 11, 2007
Penn West Energy Trust
I was listening to this weeks radio show at financial sense and there was a short interview with Zapata George who is a real energy bull. He is recommending Penn West Energy Trust (PWT.UN-T PWE-NYSE) in spite of the Canadian Government's "trust tax".
Financial sense newshour has a large following and I expect that we will see a bump in the price of Penn West on Monday morning.
I all-ready own Penn West but I am delaying adding to my position until I see where the price of oil and gas settle down to in the coming shoulder season.
Financial sense newshour has a large following and I expect that we will see a bump in the price of Penn West on Monday morning.
I all-ready own Penn West but I am delaying adding to my position until I see where the price of oil and gas settle down to in the coming shoulder season.
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