The Mystery of Las Vegas Sands

I started buying Las Vegas Sands at US$5. I bought too little. I also took profit too early and sold off half at US$30. I am still long on this but I cannot understand the logic.

The company will probably achieve US$2.20 EPS in FY11. At US$46, PE is ridiculous at 21x. It's price to book is even more ridiculous at 5.2x. But it's ROE is very high at 32%. I need to get to the bottom of this mystery. In terms of charts, I would take some profit now because it's in the upper channel. But it never seems to go down.

I'll get to the bottom of this. Meanwhile, the stock has paid for a lot of my expenditure this year! It sure pays to buy a casino stock than to gamble in a casino!

Aggressive Portfolio Achieves 17% Per Year

There's no magic, no need to time the market. A combination of picking the best funds and good asset allocation will yield you 16.7% per annum over 5 years. No kidding. Have a look. If an asset allocation model shows you only 10% per year, it's either the funds selected are not good, or the asset allocation is wrong. A good example of poor asset allocation is to put more than 40% into developed countries' funds like the USA, EU and Japan.

The End of Oil's Golden Age

The End of Oil's Golden Age


King Oil

One can argue that the world would be very different from what it is today if we hadn’t found crude oil and invented how to leverage this very convenient and relatively cheap energy source. The energy density of oil derivatives such as gasoline is superior to any other substance in liquid or gas form. That’s why the majority of cars are propelled either by gasoline or diesel and airplanes use kerosene.

Also, approximately 15% of oil is used to make asphalt, plastics and a wide variety of critical chemical products.

Therefore, crude oil plays a key role in the modern globalized world economy. It has truly enabled a golden age for those that can afford to leverage it.

click to enlarge images

Oil derrick in Okemah, Oklahoma, 1922 (Source: Wikipedia)

Peak Oil

Unfortunately, oil is a finite resource and some day we will run out of it if we continue consuming it like we do. Long before this happens we will have serious problems - as soon as demand exceeds the supply. This is the essence of “peak oil” concept. International Energy Agency (IEA) estimated in their 2008 World Energy Outlook that oil production should not peak before 2030 if 64 million barrels per day (mb/d) of additional capacity is taken into use between 2007 and 2030.

In theory this is possible, but in practice there is a very real risk of under-investment since the required new capacity is equivalent to six times the current production of Saudi Arabia. Therefore, the report concludes that an oil-supply crunch can happen as early as 2015.

It is immensely hard to estimate the maximum rate at which the oil can be extracted from all different sources, both conventional and unconventional. Therefore, it is also hard to estimate when oil production will peak. What seems fairly certain is that it will do so within the next 30 years, and I personally believe it will happen within the next 10 years.

US production already peaked a long time ago (early 1970s), as predicted by Hubbert back in 1956 using knowledge of past oil discoveries to predict the future production. Hubbert’s ideas are taken increasingly seriously by mainstream analysts.

Guardian published a very interesting article back in 2005 in which Chris Skrebowski, editor of Petroleum Review, predicted that the peak would be 2008. Remember those oil prices back in 2007? The financial crisis might have actually masked the problem – for now.

The Ever Increasing Demand for Black Gold

China, India and other fast growing economies are currently far behind in per capita consumption of oil compared to the EU or U.S. Consider this: If you sort all of the countries by per capita daily oil consumption and start from the lowest consuming countries, you need to sum up the consumption of nearly 100 countries to match the daily oil consumption in the U.S. Among these countries are China and India.

Altogether the citizens of the U.S. consume the same amount of oil as 4.8 billion people elsewhere.

Crude Oil Consumption Profile Of The World [Data Source: CIA World Factbook].

In the above graph, the country with the highest per capita oil consumption (Virgin Islands) is the leftmost dot while the country with the lowest consumption (Chad) is the rightmost dot. Between those two are plotted all the countries for which I found statistics for both population and oil consumption. The two parameters are summed cumulatively for each country starting from the country with highest per capita oil consumption.

As you can see, the most oil consuming (1 billion) people spend more oil than all the rest (5.7 billion or so). Most of the so called developing nations with huge GDP growth rates happen to be in the group “rest”. I think it’s fairly safe to assume that they will increase the per capita oil spending from the current level in the future.

The Ever Tightening Supply

According to the CIA World Factbook there is about 1382 billion barrels of oil in proven reserves. In addition, there are unconventional resources such as the Athabasca oil sands region in Canada and heavy oil in Venezuela. The problem with unconventional resources seems to be that only a fraction of them are determined to be recoverable:

Source of estimates: Oxford Energy, CIA World Factbook and the Government of Alberta

Even though unconventional resources seem to be vast, they are estimated to add only approximately 10 million barrels per day to the supply side - in the best case - when taking into account all unconventional sources such as biofuels and oil from coal. For example, The National Energy Board of Canada estimated back in 2006 that the best case for oil sands production in 2015 would be 4.4 million barrels a day while the base case was 3.2 mb/d and the low case only 1.9 mb/d.

The current production rate of oil is about 84 million barrels a day, so the unconventional resources will not have a major effect in the long run given depleting conventional sources. Also, a major problem with all sources is decreasing EROEI ratio (energy return on energy invested). For oil it used to be 100 a long time ago and now it is somewhere below 20. EROEI for biodiesel is roughly 3 and for ethanol it is not much more than 1. Depending who to believe, EROEI for oil sands is between 2 and 4. Basically anything above 1 makes sense, but because we are used to a high ratio (= cheap energy), we may have a serious problem when the average EROEI of all supplies of oil goes below 5.

World oil reserves (source: Wikipedia)

The Last Hurrah of Offshore Oil Production

After pumping oil from land deposits, the industry went offshore. First submerged oil wells were drilled in late 1890s. Oil & gas production in Gulf of Mexico in 1990 was almost exclusively done in shallow waters (less than 1000 feet). By 2005, the majority of production was in deep (1000-5000 feet) and ultra deep (more than 5000 feet) water. Before the accident in Gulf of Mexico, it was estimated that by 2020 the majority of production would have come from ultra deep water wells.

However, there is one problem with all of this, in addition to the work being increasingly costly, energy consuming, difficult and dangerous: Yearly production decline in deep water wells is reported to be much higher than in shallow water wells. This makes it increasingly hard to sustain the already achieved production rate in offshore wells as production declines in older wells.

Platform P-51 off the Brazilian coast (Wikipedia/Agência Brasil)

Who Will Profit From the Raising Demand for Petroleum?

The entities owning the oil and gas reserves are certainly going to profit from peak oil as it will drive the value of their reserves and yearly production up while their costs are not likely to increase at the same rate. The big problem with the reserves is that the entity owning them right now might not be the one owning them in the long run. If oil, gas and other critical finite natural resources are not yet at the heart of national interests in some countries, they certainly will be in the long run.

High oil prices are likely to cause unrest and discontent among citizens and politicians will respond with the usual remedies: Socializing either the profits via higher taxation or taking ownership of the resources. While many of the oil majors and super majors seem to be reasonably valued and well positioned right now, one has to consider the possible outcomes of the next energy crisis. Government ownership might be actually a plus.

The companies to consider include Exxon Mobile (XOM), Chevron (CVX), ConocoPhillips (COP), BP (BP), Shell (RDS.A) and Total (TOT), all of which were featured in an excellent SA article. In addition, companies such as CNOOC (CEO), Statoil (STO), PetroChina (PTR) and Petroleo Brasileiro (PBR) are worth considering. Many of these are also heavily involved in natural gas, which is becoming an increasingly important source of energy and is likely to last much longer than oil. The companies with significant investments on the unconventional side include Suncor (SU), Canadian Natural Resources (CNQ), Imperial Oil (IMO) and Nexen Inc. (NXY).

The Case for Offshore Oil & Gas Drillers

The offshore drillers pop up in my stock screens often since they got the right stuff: Growing revenues, relatively low debt burden, excellent margins, low valuations in terms of P/E, P/B and price per cash flow. In exchange of all this, you have the risks which are all too familiar to everybody by now. However, these companies are less likely to experience socializing as they do not own the reserves, but only the rigs used in drilling the offshore wells.

So far it has seemed to be an excellent business and I am betting my money that it will continue to be an excellent business in the long run (5-20 years), as long as there is something worth drilling on the bottom of the ocean.

Different types of production platforms (Wikipedia, NOAA)

Drillers that have equipment used in deep and ultra deep production are the most appealing as that is the segment which is growing. This means that they have floating rigs, drill ships and such equipment either in use or under construction. The more they have these as a percentage of their entire fleet, the better.

Also, I prefer drillers with geologically diversified portfolios and big oil companies as customers (lower counterparty risk). The companies worth studying for these traits include (in the order of market cap): Transocean (RIG), Diamond Offshore Drilling (DO), Noble Corporation (NE) and Atwood Oceanics (ATW). A brief financial and valuation summary of these corporations follows:

Data source: finwiz.com

Disclosure: Author is long Chevron and Noble Corporation

Top 10 Most Undervalued Gold Stocks

Mergers & acquisitions are abundant. I bought Zijin Mining (2699 HK), China's largest gold producer at HKD5.50. It is now HKD7.60. I believe the stock is worth at least HKD25 because its reserves are not marked to market.

Caution: I don't own any of the stocks below.

Top 10 Most Undervalued Gold Stocks


The following is a list of the most undervalued gold stocks, when comparing the current price against the average analyst target price (used as a proxy for fair value).

Yes, there are many limitations to this approach, and we suspect there are many falling knives here. But the goal here is to give you a starting point for your own analysis.

Target price data sourced from Finviz. Full analysis below.

https://www.kapitall.com/framework/#?tool=CompanyListSnapshot&params=RBY,KGN,GBG,ANV,NXG,FRG,IAG,AUY,JAG,GG&options=B64ENCeyJhY3Rpb24iOiJzdG9ja19pbmZvIiwic29ydCI6Im5hbWUiLCJzb3J0QXNjIjoiMSJ9
The list has been sorted by discount to analyst target price.

1. Rubicon Minerals Corporation (RBY): Market cap of $794M. Wednesday's closing price at $3.54 vs. target price of $5.59 (discount of -36.67%). Short Float at 0.36%, which implies a short ratio of 0.84 days. The stock has lost -17.15% over the last year.

2. Keegan Resources Inc. (KGN): Market cap of $337M. Wednesday's closing price at $7.14 vs. target price of $10.98 (discount of -34.97%). Short Float at 0.23%, which implies a short ratio of 1.29 days. The stock has gained 50.41% over the last year.

3. Great Basin Gold Ltd. (GBG): Market cap of $905M. Wednesday's closing price at $2.49 vs. target price of $3.67 (discount of -32.15%). Short Float at 5.69%, which implies a short ratio of 9.79 days. The stock has gained 58.54% over the last year.

4. Allied Nevada Gold Corp. (ANV): Market cap of $2.14B. Wednesday's closing price at $22.51 vs. target price of $31.41 (discount of -28.33%). Short Float at 7.22%, which implies a short ratio of 6.33 days. The stock has gained 139.96% over the last year.

5. Northgate Minerals Corp. (NXG): Market cap of $826M. Wednesday's closing price at $2.76 vs. target price of $3.83 (discount of -27.94%). Short Float at 0.43%, which implies a short ratio of 0.5 days. The stock has gained 1.43% over the last year.

6. Fronteer Gold Inc (FRG): Market cap of $872M. Wednesday's closing price at $7.25 vs. target price of $9.61 (discount of -24.56%). Short Float at 2.84%, which implies a short ratio of 3.68 days. The stock has gained 58.55% over the last year.

7. IAMGOLD Corp. (IAG): Market cap of $6.38B. Wednesday's closing price at $16.97 vs. target price of $22.41 (discount of -24.27%). Short Float at 0.64%, which implies a short ratio of 0.73 days. The stock has gained 22.64% over the last year.

8. Yamana Gold, Inc. (AUY): Market cap of $8.05B. Wednesday's closing price at $10.6 vs. target price of $13.83 (discount of -23.36%). Short Float at 0.56%, which implies a short ratio of 0.53 days. The stock has lost -9.42% over the last year.

9. Jaguar Mining Inc. (JAG): Market cap of $562M. Wednesday's closing price at $6.38 vs. target price of $8.26 (discount of -22.76%). Short Float at 7.39%, which implies a short ratio of 4.72 days. The stock has lost -29.42% over the last year.

10. Goldcorp Inc. (GG): Market cap of $31.24B. Wednesday's closing price at $41.8 vs. target price of $54.01 (discount of -22.61%). Short Float at 1.36%, which implies a short ratio of 1.78 days. The stock has gained 2.66% over the last year.

Disclosure: No positions

Profit Taking, Not Correction is Occuring

I mentioned about 2 weeks ago to take profit. Well, stocks are now facing some resistances and may retrace a little. How big will the retracement be? My take is, very little. I don't see stocks falling > 10%. So my suggestion is to buy soon. It's just profit taking. after a rally that lasted from July to early October, markets are bound to pause for a breath. This is when doubters take profit and exit completely while believers like me take some profit, stay side lines and watch, and then enter again. The doubters who exited will eventually return to stocks next year and miss out another 10 - 20% upside.

Major economies are undergoing QE 2, the yield curve is still very flat, the latest 3rd quarter results season has been better than expected. It's still all-systems-go for the stock market until mid to end 2011. Watch this space.

Bull Market is Healthy But Do Take Some Profits (Part 2)

Markets do not move in a straight line and there will be profit taking and pull backs. I don't see a big one comning, i.e. > 20% drop but I do see a slow down in momentum. The 3mth LIBOR-OIS spread is rising.

However, the Emerging Market spreads are still dropping, confirming what I said in part 1, that money is flowing to Emerging Markets.

Finally, most indices in Emerging Markets are at their upper channel resistances. I'd take profit if I've made more than 15%. Sell some, give yourself a nice dividend like I do from time to time. Go for a holiday. You deserve it if you've been staying invested. After all, a profit is not a profit until you have it in your pocket.

Bull Market is Healthy But Do Take Some Profits (Part 1)

The rally has gone on for over a month. During this period, Straits Times Index rose by over 8%. Elsewhere in ASEAN, the rally is fiercer. The Jakarta Composite rose by over 16%, Philippines around 20%, Thailand 12%, Malaysia 15%. Across the western world, monetary easing has led to central banks buying up government bonds across all tenors, bringing down yields to record levels, causing sovereign bonds to rally. A lot of institutions have taken profit from these bonds, knowing that if they held assets like US Treasuries any longer, prices will eventually fall. QE means an opportunity to take profit at the expense of central banks' printing press.

With no where to put their money, institutions in the west are flooding Asia ex Japan, and emerging markets with billions of dollars. The money primarily flowed to emerging Asia and commodity exporting countries like Brazil, Qatar, Russia, Australia, Indonesia etc. In the new world order, stock market performance will be as such:

1. Best performers: Emerging Markets that are commodity exporting: e.g. Russia (8x historical PE only, oil, gas, coal), Brazil (17x historical PE, oil, gas, steel, agriculture), Indonesia (30x PE, coal, agriculture), Venezuela, Mexico, Chile, South Africa, Gulf states that produce oil etc.

2. Second best performers: Emerging Markets that are partially commodity exporting, partially commodity importing, but are driven by large domestic consumption: e.g. China (exports gold, rare earth, imports oil), India (exports steel, imports food, oil), Turkey, Malaysia, Thailand, Philippines etc.

3. Second tier performers also: Developed countries that are primarily exporters of commodities: e.g. Australia and Canada.

4. Third tier performers: Developing Emerging Markets with no large domestic demand, primarily importing commodities, e.g. Singapore, Israel, Hong Kong.

5. Fourth tier performers (second worst): Large developed countries which export some commodities but import more. E.g. the US and Britain.

6. Worst performers: Developed countries that primarily import commodities, e.g. Japan, the EU.

Bubble, Bubble, Toil & Trouble



Here's a lovey dovey picture of a pair of cats locked in an embrace lazily taking a nap. I took this picture just outside my house. My wife said this is a very sweet picture. Hmmmm...

Let's look back at what I've said over the past few months.

On 24 Aug, I said there would be a very mild correction that would last no more than a month. It happened. Of course, we should have bought on those dips on hindsight.

http://musingsonwallstreet.blogspot.com/2010_08_24_archive.html

On 2 Sep, I said that markets have turned around again and I haven't changed my stance since. This turned out to be the most bullish call I've made since Apr 2009. The half year correction which started at end Apr 2010 has ended and the bull has returned!

http://musingsonwallstreet.blogspot.com/2010_09_03_archive.html

The Fed said that instead of keeping their inflation target at below 2%, they are now targetting inflation to average 2%! This means they will reflate their economy and allow inflation to rise beyond 2%, stoking the flames of another hiper inflation period. The US Fed is playing with fire. If expectations of inflation rise, it will be difficult to rein in.

This QE cycle will not end here. Japan, Britain and the EU have embarked on them. The EU will probably have to continue doing this well into 2011 because Spain and Portugal will have some debts maturing then.

What's going to happen in this crazy bubble world of QE?

4Q2010:

Bonds: yields to fall a little more. Many uncles & aunties will be enticed to buy "safe" stuff like SIA bonds at 2.15%. High yield / emerging market bonds will continue to rise.

Commodities: gold, precious metals, industrial metals, oil will shoot sky high. Agricultural produce will rise slower, but erratic climate won't help.

Stocks: fly exponentially with volume finally piling in.

Property: transaction volumes will thin but continue to rise due to cheap loans / liquidity.

2011:

Bonds: the biggest bond bubble ever seen will burst in 2011. I reckon it could come as early as 2nd half 2011. WHy? Inflation will spiral up to 3 - 4% in the US / EU / UK and central banks will be forced to hike rates late 2011. High yield / emerging market bonds will continue to rise. Poor uncles and aunties who bought "safe" bonds at 2 - 2.5% yield... Please hold them to maturity.

Commodities: could we see gold price rising to 1500 or even USD2000/oz? It is not inconceivable. After all, money is just toilet paper now. Oil could hit 150/bbl again... Welcome to the crazy days.

Stocks: One last hurrah. The rally will push valuations to unsustainable levels. We could see STI's PE ratio rise to 17x with 15% earnings growth, achieving 4800! But you ain't seen nothing yet coz Brazil, Russia and China will rise even more!

Property: Luxury residential to rise further. Mass market stabilise, some signs of falling. HDB starting to drop due to the completion of massive 16000 units. The biggest meltdown of residential properties may have begun! Commercial properties continue to rise healthily.

I have a very bullish short term, 1 year view of all risk assets. But if central governments can't deflate the bubble to land their economies softly in 2011, 2012 could be devastating.

Are Stock Markets Overvalued?

Someone asked me if India is overvalued? Well, yes and no. Let's look SENSEX's valuations. ROE: 23%. Price to Book: 3.7. ROE / PTB around 6.2x. Yes, their PTB is very high at 3.7x, but it's ROE has always been one of the highest in the world. A high ROE means very high returns on equity. E.g. you invest $100 and receive $23 annually. But a high PTB means if the liquidation value is $100 (assets minus liability), you pay $370 for it.

Now is 6.2x very expensive? The Europe's stocks may have a price to book of 1.25x, it's ROE is only 9%. It's ROE / PTB ratio is 7.2x, slightly higher than India's. But I ranked 50 countries' stock markets according to their ROE/PTB ratios and India's fall in the mid to upper decile. It's not the top 4 deciles, that's for sure. But it's not the most expensive.

What about earnings yield premium? India's 10-year government bond yield stands at 7.91%. It's PE is a whopping 20x, which translate into earnings yield of 5%. The bond yield is giving better returns than equity yield. It's a SELL. However, if you take into account its EPS growth rate of around 20%, things become unclear. If you buy a stock or own a company that grows at 20% annually on average, gradually falling to 16% on year 10?, what is your yield on average?  The IRR is 10.55%. If your yield is 10.55% from stocks, and the 10-year bond is 7.91%, I'd still be buying stocks.

The difference of 2.64% in earnings yield premium is not enough for me to BUY because I'd only do so if earnings yield is at least 4.5% > 10-year government bond yield. But it is not a SELL signal either. I'd only SELL if earnings yield is < 0.5% over bond yield.

Chart wise, it appears set for a period of consolidation after rising exponentially. It could pull higher after that. On a macro perspective, many markets' earnings yield are still well above their bond yields. S&P500's earnings yield is 10.66%, factoring some growth assumptions. Its 10 year US T-bill is around 2.7%. It's a screaming BUY. Half the markets in the world, especially in the US and Europe are a screaming BUY, the other half is a HOLD. So the stock rally is unlikely to be over.

It's not a BUY, not a SELL, but HOLD. That means the SENSEX can rise higher. But I'd start taking profit if it you've made > 20%. Profit is never a profit until you have it in your pocket.