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Figure 1: The Last Post

This blog came about, as many do, from a change in employment status, in early 2009, that was not entirely positive. I had been investigating the idea of starting an investment fund company, but soon discovered that idea a) was a very expensive undertaking and b) required occupying oneself almost entirely with the business of asset gathering as opposed to capital allocating.

And so, after a little research into the issue, I decided to take a chance on the $7 monthly fee to Typepad and suddenly was in the blogging business. Although I never charged for my writing, that investment ended up earning a much higher rate of return than even the best of the investment ideas covered in this space.

It was fun following along all the linking and re-posting of various pieces. Sell the Banks was the big viral piece that, despite not yet making anyone any money, provided Marketdepth with its proverbial 15 minutes of fame. However, the post which ultimately received the most traffic was this one, due to its featuring a picture of an apparently adorable hedgehog. There is nothing more humbling than starting a serious investing blog and ending up as a computer resource for elementary school art teachers around the world.

Figure 2: An Apparently Adorable Hedgehog

A bittersweet moment this surely is. While I will miss the interest and exchanges of this site’s regular readers, I will certainly enjoy reclaiming the hours between ten in the evening and one in the morning that were so often the only time available to keep up this activity.

To the hardy band of Marketdepth subscribers, too many to fit comfortably in a school bus but too few to fill a theatre, thank you for your interest. I will leave the site up for a while in case anyone wants to peruse the back posts.

So, that is it. I had fun with the blog but, as Paul McCartney sang on that track on Beatles for Sale, “tomorrow may rain, so I’ll follow the sun.”

Jan 10, 2011 1:04:16 PM

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Morning on Howe Street

It’s morning again on Howe Street.

That’s right, Howe Street, the ancestral home of “pump and dump,” is rising again. This time, however, it is not the push of aggressive promotion, but the powerful pull of fundamentals that is creating opportunity for our city’s most notorious industry.

Precious metals are soaring as gold and silver become re-established as monetary standards. Base metal demand is set to expand rapidly in the large-population economies of Asia and South America. Metal stocks are cheap compared to bullion prices. The world economy is desperately short mine production. These are the opportunities Howe Street exists for.

Figure 1: The Exchange Building on Howe Street – Early Days

Howe Street’s resurgence, and the return of the speculative mining issue to mainstream portfolios, will create bountiful profits for some. Others will make losses. As we head into another potentially euphoric period for mining equities, it may help investors to recall a little history.

Howe Street, The First Generation

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The Pyramid Mines discovery started a bonanza that brought mining investors and promoters from around the world to Vancouver. Amongst these was the inimitable Murray Pezim, formerly a Toronto-area butcher, who quickly became Howe Street’s promoter-in-chief.

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Buy on Mystery, Sell on History

And there were other successes. Carolin Mines was another 40-bagger gold discovery. Dia Met and Diamond Fields also worked out well later on. But unfortunately, Howe Street’s reputation was made mostly by the scam artists who preyed on the gullible in the decades following the Pyramid Mines success.

The schemes were often “close-ology” plays, with promoters staking nearby tracts to large discoveries. “Wash trades” within a close circle of insiders would drive up prices steeply in advance of the release of bogus drilling results. Hapless investors would buy in at the peak, only to watch share values plummet. Insiders profited from outsiders. It was the Vancouver way.

But by the 1980’s the inflationary fundamentals that had underpinned Howe Street’s rise went into reverse. In the era of 20% interest rates, bonds and blue chips were far better values than $800 gold bullion or junior gold speculations. The Dow Jones Industrials grew by more than 10x from 1982 to 1999, while the VSE Composite index tanked. Initiated at 1000 pts in 1982, the VSE Composite closed in October 1999 at 395.

And in 1999, just as bottom of the gold cycle was being reached, Howe Street’s exchange was disbanded and merged into the CDNX. Ironically, the end of the VSE marked the point of extreme fundamental undervaluation of this city’s mining juniors. Alas, by 1999 those who understood the fundamentals were so discredited that no one would listen. Buy on mystery, sell on history. The strategy of the know-nothing retail investor was ultimately applied to the VSE itself.

What to do now

In the last ten years mining stocks have recovered and the safe money has been made. However, my read of this cycle is that a speculative blow-off phase lies ahead. The gold market didn’t spend 20 years bumping along around $350 per ounce to stop at a mere quadrupling, in my view.

Likewise junior mining stocks that can deliver reserve growth breakthroughs appear to be very fertile territory. I spend time these days looking at the tier of juniors just below the size of companies that are eligible for the exchange-traded funds. Within this class, companies with capable management teams and decent properties should be the basis of a portfolio that can properly capitalize on the return of Howe Street.

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Nov 28, 2010 12:02:37 PM | commodity finance, 网页加速器, Northwest Investing

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Change We Can Believe In

Every good skier understands snow. Why should good investors not understand money? This thought occurred to me as I listened to various reactions to the US Federal Reserve’s announcement of phase two of its “quantitative easing” program.

No longer shrouded by the fog of crisis, “QE2” has laid bare the Fed’s dollar debasement strategy. The government of the United States is now funding its entire $100 billion per month budget deficit through printing money to buy its own bonds. Were it not for the necessity to ensure that Wall Street’s bonus pool stays filled, the Federal Reserve might as well cut out the New York middlemen and just dispatch trucks around the country loaded with “Benjamins.”

The investing playbook for this era of quantitative easing is fairly straightforward. Avoid anything that looks like a government bond and buy things like wheat and silver which represent relatively cheap, hoardable commodities.

Figure 1: Silver Quarters – Change We Can Believe In

But while hoarding is definitely the best investing play of 2010, it does strike me as a rather dubious long term economic strategy. Can the troubles of excess debt and inflation be addressed by bringing back the gold standard? Absolutely, I say.

Canada and the Gold Standard

Many people do not realize that this country has a long history of operating on a gold standard. Canadian dollars were exchangeable into a specified quantity (23 grains of gold or 4.7 hundredths of a troy ounce) from the 1850's through to the outset of Word War I and also for a period following that War.

Between 1933 and 1971, Canada ran on a kind of second-hand gold standard, under which the government committed to maintain the C$ value in a range relative to the US dollar (and the British pound in the early part of this period). The US dollar was in turn fixed to gold at $35 per ounce. Under the post-WWII Bretton Woods system, Canada and other countries maintained a virtual peg to the US dollar.

The beginning of the end for Canada’s gold standard came on December 23, 1966. On that day, Mitchell Sharp, Canada’s Minister of Finance announced that coins of the 10c, 25c and 50c denominations would no longer be cast according to their long-standing mix of 80% silver and 20% copper. Given that the price of silver had by then caused the coins’ metal value to pass through their face value, Sharp presented to Parliament an amendment to the Currency, Mint and Exchange Fund Act which would eliminate the use of precious metal. By 1968, the deed was done. Canada's silver coins were removed from circulation in favour of the slugs that continue to be stamped out by the Mint at the cheapest practical cost.

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Gold Standard Benefits

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The allocation of resources in a society on a gold standard involves choices made in plain view of market participants. In a fiat world, bankers and speculators can conspire to build huge asset valuations backed by easy credit. When the inevitable crack-up follows, a government must choose between a prolonged deflationary recession or a bailout. Under a bailout, all the bubble’s non-participants pay by pro-rata dilution of their monetary assets.

The hidden cost of fiat money is a long-run reduction of capital investment of any kind. Investors, burned by confiscatory inflation, become hesitant to make long-term loans at any price. The economic troubles of Latin America over the past three decades has its root causes in undisciplined fiat money regimes. And as the West’s currency and sovereign debt problems now demonstrate, there is nothing fundamentally different about fiat money north of the Rio Grande.

However, if one were trying to fix the problem, as opposed to merely profit from it, there is of course a somewhat different prescription required. Here is my best guess at how we might proceed.

Five Not So Simple Steps

The way out of the mess begins with 1) a recognition that the debts are too big. I laid out some of my homework on that topic here. The next step 2) would be to apply some kind of haircut to outstanding debts. The better places to take the haircuts would be at the levels of private and sub-national debts, so that Canada as a nation might remains a somewhat creditworthy entity. I would suggest forcing banks to take an across-the-board haircut on consumer debts and mortgages. Other sub-national governments might also be moved to haircut their debts to the extent that they are not manageable.

What cannot be achieved through debt writedowns could also be achieved through step 3) a co-ordinated, one-time emission of fiat cash. If we want to extinguish the provincial debt of Quebec, for instance, it could be bought back with a load of freshly printed fiat cash. It would be important that the emission of fiat cash be a one-time measure. Another key step in the process 4) would be in the significant reduction in unfunded entitlement programs that would put Canada on a more sustainable go-forward fiscal footing. Finally, we would reach step 5) the critical part of this process, which would be a permanent fixing of the currency of a newly solvent Canada against gold. What the exchange level might be would depend on circumstances at the time. If it were to be done today, the fix might be applied at C$2500 per gold ounce.

Harsh medicine, indeed. It would make the imposition of the Goods and Services Tax look like a walk in the park. Yet the alternative, to do nothing and twist into inevitable chaos, seems far worse. As an investor, my bets are placed squarely on the do nothing option. But as a citizen, I recognize that there is a plan that could pull this country from the chaos of a broken fiat money system. Can we really leave this purgatory of excess debts and phoney cash for “change we can believe in?” The answer is obvious. Yes we can.

Nov 8, 2010 12:58:55 AM | commodity finance, Sovereign credit and debt

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Vecima Networks - Liquidation Value with Growth Potential

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Figure 1: Vecima – Rotating Downwards, then Turning Up?

About Vecima

Vecima Networks, founded in 1988 by engineering professor Dr. Surinder Kumar is in the business of creating devices that manage and transfer high volume data flows, the likes of which are found in cable networks, wireless communications systems and other similar applications.

The company’s products bridge the final network segment that connects a system directly to end-users, commonly referred to as “the last mile”, where Vecima’s special capabilities in radio frequency are employed. Key applications of Vecima’s technology include DOCSIS standard wireless broadband services and “QAM” (quadrature amplitude modification) that allows the simultaneous provision of video, voice and data services. Vecima’s customers include major cable operators such as Comcast Corp (Nasdaq: CMCSA) as well as large network original equipment manufacturers like Cisco Systems (Nasdaq: CSCO) with whom the company has enjoyed a productive fifteen-year relationship.

In addition, the company operates a nascent wireless data network operator called YourLink in Western Canada. It also acquired Burnaby-based Spectrum Signal processing in 2007 for approximately $20 million.

Vecima had revenues of $113 million in the year ending June 30, and profits of $0.8 million. The annual profit represented more than a 90% decline from FY 2009 net income of $13.2 million. Share prices have followed the decline in operating performance, dropping from $7.50/share earlier in 2010 to a recent all-time low south of $4.00.

Figure 2: Vecima Networks Stock Chart

Vecima chart
Challenges and Opportunities

Vecima’s troubles in 2010 appear to have stemmed from factors both within and beyond the company’s control. External factors include softer than expected end-demand in the US cable market, which has led to somewhat reduced capital spending by larger operators.

Controllable factors may also have contributed. In particular, the company’s large number of small-scale market initiatives may have diluted Vecima’s competitive positioning in key areas. For example, there appears to be little overlap between the business of supplying capital equipment to cable operators and running YourLink, which is essentially a retail operation. Yet these and other disparate businesses compete for management’s time and corporate resources.

To management’s credit, the project of re-focussing Vecima appears to be underway. The company has recently centralized some distributed R&D activities and more moves of this nature could be in store. Likewise, on the marketing front, Vecima is making a concerted push into a niche opportunity related to hotel HDTV networks. This initiative, being pursued directly as well as through a large OEM partner, addresses a market estimated at $450 million without significant established competition.

Valuation and Risks

While Vecima’s business is a little complicated, the valuation is easy. This is a cheap stock. Very solid net working capital is $48 million, property and plant (at a 50% haircut) adds $17 million, and wireless spectrum assets (based on recent transaction values) are worth a further $38 million. Net of debts, a liquidated Vecima is worth at least $100 million, or 10% more than the company’s quoted market capitalization. Beyond liquidation, if one believes that Vecima can recover even half of its historic levels of profitability, then an $8 share price would be well supported.

Due to a controlling stake held by Dr Kumar, Vecima is not a takeover candidate. However, at these levels a take-private bid would not be out of the question.

My main concerns with Vecima are more macro-economic in nature. The growth push into hotel HDTV networks occurs at a weak moment for hotel operators, who face continuing revenue challenges that have been further compounded by the bedbug scare. However, if we wait for the robins, spring will be over. Although we may not be at the absolute bottom for Vecima, I believe we are close enough to be confident of a solid return from current levels.

Oct 19, 2010 11:26:13 PM | Investment Ideas, Northwest Investing

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The Crowded Room

The most crowded investor meeting I ever attended was held in a very large hotel ballroom in Boston. As the event began, the lights dimmed, and the hundreds of analysts and bankers in attendance were treated to a colourful laser show with blaring rock music. Finally, from behind a curtain, a triumphant executive team emerged to a round of applause. The CEO’s name was John Roth. His company – Nortel Networks. The date stamped in my passport was November 21, 2000, mere weeks after now-worthless Nortel’s quoted value had reached its $366 billion apex.

That experience introduced me to one of the investing world’s most dangerous situations, the crowded room. I’ve seen a few crowded rooms since then: one that feted a bearish fund manager as he toured this country promoting an equity fund loaded with over 90% cash (right before a massive commodities and equities rally); and another whose guest of honour touted global base metal demand just as copper and zinc prices began to melt down. And let us not forget the rooms that filled for “peak oil.”

Figure 1: The Plaza: Host to 2010’s Crowded Room?

Plaza hotel

I do not blame the shining lights of finance for burning a few moths along the way. Each crowded room phenomenon started years before with a plausible, often excellent idea. And early followers who got into a trade in advance of “standing room only” signs and fire code contraventions generally made out quite well. But the thinking investor should always be on guard against the perils of a well-loaded bandwagon.

The Crowded Room of 2010

Surveying the investing scene of 2010, there appear to be as least as many “crowded rooms” today as there were ten years ago.加速器I will ignore for the moment the mere swarms surrounding Canadian bank equities and long-dated corporate bonds in favour of addressing the greatest crowded room of them all – a veritable Lollapalooza – that supports the obscene valuation of United States government bonds. From this great insanity, all the little bubbles draw their courage.

The US bond market’s crowded room moment may be coming soon. My guess at its precise physical location would be New York City’s Plaza Hotel, which hosts the upcoming Bank Credit Analyst conference. Topping the bill at that meeting is a much heralded “debate” between two institutionally-approved hot hands, Gluskin Sheff’s David Rosenberg and Oppenheimer’s Brian Belski. Rosenberg is a leading cheerleader for long-dated US Treasuries who has insisted recently that the United States will never default. As a consequence, “Rosie” is convinced that the currently tiny yields on US Treasuries are juicy given the coming deflation. His “opponent” in this event, Brian Belski is expecting the gold “bubble” to burst any day and projects an increasingly strong US dollar and a continuing economic rebound.

Who am I, a humble analyst from a small Canadian city where business lunches generally involve ketchup, to question such financial luminaries? And yet, it does appear to me that the supporters of US dollars and low-interest US dollar bonds neglect certain key questions.

If it is generally true that people and companies with heavy debtloads pay higher interest rates than people with less debt, why does the United States pay a lower interest rate with debt/GDP at 100% and deficits/GDP of 10% than in any other year in the past forty, when US debts were far lower?

What is the effect of “open market” operations whereby the US Federal Reserve and the Bank of China buy US bonds in the market with freshly created cash? What would American interest rates be without such activity?

How is it that money supply (M2), as measured by the US Federal Reserve can grow at a rate of 7 to 8% per year for the past decade and yet ten year US bonds can yield 2.7%? And if US interest rates actually paid investors fair compensation for money supply dilution (yields of 10%, say), how could America possibly service its massive debt?

Now I recognize that these are not the type of questions that earn one invitations to address a crowded room circa 2010. Perhaps we should check in again ten years from now.

Sep 9, 2010 9:37:39 PM | Sovereign credit and debt

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鲸鱼加速器官网

At the end of last year I put together the “Shoeshine Portfolio,” a non-marketed portfolio model designed to preserve wealth, and hopefully provide a little growth, in an environment that looked dangerous. As the summer heat finally arrives, it is a good time to sip a rum punch at poolside, reflect a little on the first half’s market, and make a few adjustments going into the next six months.

As the table indicates, through June 30, the Shoeshine Portfolio returned just over 4% for the half year. This is hardly the stuff of trumpets and parades, but it would rank solidly within the top quarter of Canadian-marketed funds, and ahead of either the comparative returns of market indices (in C$ terms the MSCI All Country World Index returned -9.2% in H1) or fixed income benchmarks (depending on the benchmark, C$ fixed income returned about 2%).

Figure 1: Halfway round the sun: Shoeshine +4%, MSCI World -9%

EarthSun larger

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The biggest driver of returns in the first half was precious metals, a 60% portfolio weight that returned almost 11%. The 30% weight assigned to cash did reasonably well, too, with two-thirds being allocated into US dollars and US-pegged Hong Kong dollars, both of which gained about 1% versus C$ on a capital basis and provided a few basis points of interest to boot. A further 10% in US-dollar inflation-protected bonds grew 4%.

Stocks counted for a zero net-weight, but included a 50% long position spread across six stocks and a 50% short position in Canadian financial firms. While this short position in Canadian banks and insurers was unpopular at year-end 2009, it was nevertheless successful, providing a 5% return that was diminished only partly by -2% in dividend covering.

The long positions in stocks, the pride and joy, were a disappointment, dropping 9% on average. The driver here was a 56% drop in Washington state medical equipment player Cardiac Science Corp (NASDAQ-CSCX). It seems that “product recalls” and heart defibrillators are not a winning combination. Lesson learned. Having said that, I expect someone will now bid for this good company with more than 50 years of accumulated experience at a price somewhat higher than the current 45c on book value. Therefore, I hold on.

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On the whole I continue to favour a net long position of stocks and precious metals set against shorts in the Canadian financial sector. This is in keeping with a general view that while short-term deflation may set in, the real risk to investors is permanent wealth destruction through inflation.

A few additions include a stakes in local satellite communications player Norsat International (TSX: NII), and global grains marketer Archer Daniels Midland (NYSE:ADM), both of which appear undervalued. The stake in good but overvalued Hong Kong-based fast food chain Café de Coral (HK:341) is best sold here. Also, given my increasing unease about the Chinese economy, I will drop the HK cash component as well.

The portfolio is designed to gain in the event that Canadian banks will experience much larger losses than most people anticipate as a result of the unwinding of our housing bubble on the north side of the border. I add, for a kicker, a 2% stake in put options in Bank of Nova Scotia (TSX:BNS). December 2010 $30 BNS puts have been recently offered at $0.50.

In my view, this portfolio is prepared for anything, with a bias towards producing a positive result in even trying circumstances. Now that our pruning is done, bring on the summer!

Figure 2: Shoeshine Portfolio, June 30 Update

Item	Symbol	Original Weight	Simple Return	Rebalanced Weight
Cash/Bonds/Bullion
US$ cash	USD	10%	1.0%	10%
HK$ cash	HKD	10%	0.6%	--
C$ cash	CAD	10%	0.0%	20%
Central Fund of Canada (gold/silver)	TSX:CEF.A	50%	11.7%	50%
E-Tracs Platinum ETN	NYSE: PTM	10%	5.7%	10%
SPDR Barclays TIPS	NYSE: IPE	10%	4.2%	8%
Total Cash/Bonds/Bullion		100%	7.0%	98%
Stocks – Long
Coastal Contacts	TSX:COA	8.3%	(13.5)%	5%
Silvercorp	TSX:SVM	8.3%	0.4%	10%
Cash America	NYSE:CSH	8.3%	(0.9)%	5%
Cardiac Science	NASDAQ:CSCX	8.3%	(55.6)%	5%
Genuine Parts	NYSE:GPC	8.3%	5.0%	10%
Café de Coral	HK:341	8.3%	13.4%	--
Archer Daniels Midland	NYSE:ADM	--	New	10%
Norsat International	TSX:NII	--	New	5%
Total Stocks - Long		50%	(8.5)%	50%
Stocks - Short
iShares CDN Financial	TSX: XFN	(50)%	5.1%	(50)%
Total Stocks - Short		(50)%	5.1%	(50)%
Options
Bank of 78加速器官网	BNS DEC 30 P	--	New	2%
Total Options		--		2%
Return Summary
Return pre-cash flows			5.3%
Net return after cash flows			4.1%

Note: Unaudited results provided for illustrative purposes. Total return includes interest and dividends including outgoing dividends on securities sold short.

Jul 8, 2010 9:51:38 PM | Hedging and Pair Trades

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Westport Innovations - Lighting a Single Candle

Here at Marketdepth, we are not in the business of selling equities to the public. In fact, our focus is often on the somewhat less glamorous activity of preserving capital. However, being of a generally curious disposition, from time to time we do a bit of digging on one of the local companies of our acquaintance. Small cap management in town is generally rather approachable and we enjoy hearing them out. When the time to buy advantageously comes along we know how to hit a bid. But every company knows a lot of other times.

It is in this spirit that I review Vancouver-based engine technology business, Westport Innovations Inc. (TSX:WPT). Recession notwithstanding, the company still grew sales by 9% and its gross margin dollar line expanded by 28% in calendar year 2009. While not cheap on a ratio basis, I consider Westport one of the more promising looking “acorns” in its class and worthy of longer-term consideration. Better to light this single candle of background research than curse the prevailing darkness of overvaluation.

Figure 1: Better to Light a Single Candle…

Natural gas flame

Background

网页加速器 began operations in 1995 with the intent of commercializing a natural-gas fuel injection technology that resulted from research led by UBC engineering professor, Phil Hill. Under the direction of CEO David Demers, Westport has since become the world’s leading technological solutions provider to developers of heavy duty engines that run on natural gas.

The principal current installations of these engines are municipal service vehicles like buses and garbage trucks. However, there is clearly potential to expand the penetration of Westport’s technology into commercial trucks and, ultimately, into any type of engine that currently runs on diesel or gasoline.

雷霆加速器官网’s business model more closely resembles that of an outsourced R&D group rather than a fully-fledged manufacturing business. In fact the company has largely gone to market through product-specific joint venture arrangements with established engine makers. The most significant of these relationships at the moment is Cummins-Westport Inc., a 50-50 joint venture that accounted for the lion’s share of Westport’s revenues in 2009. Recent deals with several international partners including Volvo and China-based Weichi Power Co. may establish a path towards a broader product mix and a more diversified customer base over the next three to five years.

Investment drivers

From an investment standpoint, it is useful to consider two important, and separate, underlying drivers of demand for Westport’s engine technology. The first driver is the global demand for heavy engines. Heavy engine demand has taken a hit over the past year or so due to weak economies. I have no special insight into when that demand might recover, but flag here that Westport’s success is dependent on this variable.

The second key driver of demand for Westport’s product relates to penetration of the transportation energy market that can be achieved by natural gas engines. And the critical factor here is the long-term development of the ratio between natural gas and oil prices.

Figure 2: Oil to Gas Ratio

Oil to gas ratio

On a pure energy equivalent basis, the ratio between the value of a barrel of oil and a thousand cubic feet of gas (mcf) should be 6 to 1. However, with current market prices of about $80/barrel of oil and $4/mcf for gas the actual price ratio is 20 to 1. In other words, the market is paying more than three times the price it “should” pay for petroleum products relative to the price of gas or liquefied natural gas (LNG). Why the discrepancy? Clearly gas is in a glut situation, driven by large new discoveries and improved extraction techniques. On the other hand oil markets are facing dwindling conventional production combined with a growing base of transportation equipment designed to run on petroleum-based fuels.

The other factor weighing against gas at the moment is that the market lacks the necessary infrastructure (pipelines, distribution networks, marketing organizations etc.) which are required to realize the pure chemical arbitrage. However, I believe it reasonable to expect that the long-run oil-to-gas price relationship will converge towards the energy equivalence ratio of 6 to 1. And, given that prospective trend, underlying demand fundamentals appear generally supportive of 开眼加速器官网’s product offering.

Entry Point

With a recent enterprise value of about $450 million, Westport Innovations is somewhat bigger than your typical acorn. And trading at 4X consolidated sales, it is difficult to construct a classic value case here. Simply put, this company needs to grow rapidly in order to justify its valuation.

I tend to agree with management that the prospects for Westport are good in the long-run, but also flinch a little at the current sticker price. However, 2010 could easily deliver bad news on the global truck market or a see a temporary collapse in the oil-to-gas price ratio. Ideally, we might get both situations going wrong at once. At such time, no doubt the chorus of boosters for Westport may be somewhat thinned out. But that would be a wonderful entry point on Westport Innovations, a business with a fundamentally strong story with great potential for future growth.

Apr 13, 2010 9:36:18 PM | Northwest Investing

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