Monthly Archives: November 2014

Teck Cominco Goes “Into The Blue”!

 

NEWS FLASH – NOVEMBER 10, 2014 CITIGROUP CUTS 2015 IRON ORE PRICE EST. TO $65/TON VS $80/TON, SAYS IRON ORE PRICES MAY FALL BELOW $60/TON.

 

Welcome to the new world of decreasing commodity prices.

The business media still hasn’t got their arms around this story. And it’s a big story.

China added 5.9 billion square meters of commercial buildings between 2008 and 2012 – the equivalent of more than 50 Manhattans – in just five years and that’s a lot of steel/copper!

What do you think is happening in China now?

Are they going to build another 50 Manhattans…probably not is my guess.

Iron ore prices started around $16 per dry metric ton in 2004 and spiked to almost $200 a ton in October 2010 and now it’s on the way down as you can read from this tweet from Twitter.

This shouldn’t be any surprise to the Model Price user. There have been many negative transits of Teck Cominco since peaking in price in early 2011 and finally falling into the “Blue” – going below EBV-3 – some six weeks ago and one of our strongest sell signals. See Model Price chart below.

Teck Cominco with monthly price bars, EBV Lines (colored lines) and model price (dashed line)

Teck Cominco with monthly price bars, EBV Lines (colored lines) and model price (dashed line)

 

Now if Teck Cominco was trading at over $60 per share in early 2011 and is now trading for less than $18 today, one would think that most of the pain would be over for shareholders. And you can probably see the value orientated money managers rubbing their hands in glee. Teck now trades at about 45% of accounting book value and pays a generous 5% dividend yield.

As a matter of fact while enroute to the office kitchen last week, I overheard on the trading room television – which is always tuned into BNN – a portfolio manager recommending Teck Cominco to viewers with the usual comments…. “Great management, great assets and of course, a nice dividend”!

Really!

What Model Price Theory [MPT] is saying?

When the stock price of a public company drops below EBV-3 this signifies that balance sheet write-offs of recorded asset values will be coming sometime in the future. And when the company starts to write-off recorded assets, debtholders start to get nervous. And, you guessed it, when debtholders get nervous the dividend payout to the common shareholders will be cut if not eliminated.

In essence Teck Cominco can and probably will be a ‘value trap’ in that, yes, the company looks like it has good value, a high discount to accounting book value, and a high dividend only to potentially disappear before your very eyes.

And, yes I have noticed that our model price is calculated at $26 this year and over $40 in 2015. But this is based on equity analysts’ earnings estimates today. Will these estimates be impacted by Citigroup’s lowered forecast estimates for Iron Ore? Has the declining spot price of Iron Ore fully reflected in the estimates we are currently using? And has the declining price of Iron Ore been so precipitous that equity analysts have been frozen and have not updated Teck’s earnings waiting for some sort of stabilization in the pricing of the commodity so any earnings estimate – guesstimate – can be realistic.

Of the two pieces of information – model price value or EBV Lines – my preference is always tilted towards our EBV Lines especially in down markets. Why? It’s what the market is communicating that has more value to Model Price users than what the analysts are saying.

Most Cyclical Stocks Are Pro-Cyclical

What do I mean by this….pro-cyclical? Cyclical companies balance sheets also seem to explode in the dollar amount of net equity or net worth as a consequence of peak cyclical earnings and intra-industry acquisitions. Have a look at our long-term model price chart of Teck Cominco’s. Notice how the balance sheet of the company has grown since 2004 – upward sloping EBV Lines mirroring the growth of Teck’s balance sheet (below). Hmm…. Can this balance sheet growth be a coincidence with the price of Iron Ore? This is what I mean by pro-cyclical in that, in this case, as the price of the commodity – Iron Ore – escalates so does the balance sheet of the company.

Teck Cominco's Long-term Model Price chart from 1995 to Present

Teck Cominco’s Long-term Model Price chart from 1995 to Present

As commodity prices recede or reset, to much lower prices, the company is forced to write-off excess assets that are non-productive or non-economic relative to the cost of production versus the falling price of the commodity in question.

As the write-offs occur over a period of time or the ‘big bath’ write-off is taken – usually by new management not accountable for past investment decisions – the size of the pro-cyclical company’s balance sheet reverts back to lows seen at the bottom of previous cyclical lows. And cyclical lows for Teck’s balance sheet is a long way down as you can see.

Conclusion

So don’t be fooled. Yes, Teck Cominco seems cheap. Yes, the company is paying out a healthy dividend. And, yes, our model price calculation is above where Teck’s currently trading at what appears to be a 43% upside. But our model price calculation is only as good as the group of analysts with their earnings estimates and nobody I know has a crystal ball or better still knows what is going on in China.

The very important “tell” here is the share price of Teck going below our EBV-3 or as we say in our office ‘Going into the Blue’. This is very important information alerting investors that serious balance sheet realignment (write-offs) will be coming.

Yes, you can see the future in this situation and the counter-cyclical forces will play havoc on investors who think they are purchasing Teck’s recorded assets at 55 cents on the dollar and a dividend stream – yes, getting paid to wait (cough!) – that may not last beyond a few quarters!

 

 

 

 

 

 

 

 

 

 

 

 

November 2014, S&P/TSX Composite Market Strategy Update

My friends this Canadian Index is far more interesting to talk about!

The last month and a half has been brutal to all commodities especially gold. As I have noted in previous blogs the sub-index sectors of Energy and Materials (which includes gold stocks) represents 36% of the Canadian Composite Index weightings compared to 13% of the S&P 500 Index. With such a large weighting in commodities obviously the S&P/TSX Composite Index has been adversely impacted.

Model Price Chart of the S&P/TSX Composite Index

 

S&P/TSX Composite Index with weekly price bars and EBV Lines (colored lines).

S&P/TSX Composite Index with weekly price bars and EBV Lines (colored lines).

 

The first very apparent observation you can make of the above model price chart is the negative transit of EBV+2 in the middle of October – annotated by the arrow.

This is significant.

Negative transits, as I have written about many times, indicates a change in fundamentals. Unfortunately, as longtime followers of Model Price Theory [MPT] know, negative transits usually corresponds to negative future economic fundamentals.

I have said numerous times Model Price Theory [MPT] is NOT ‘Technical Analysis’ in the traditional sense however because we extensively use price graphs to display mathematical fundamentals repeatable ‘graphical formations’ are inevitable.

Keen observers will note that this Composite Index closed above our EBV+2 line on the same week as the negative transit. Unfortunately this is a normal repeatable ‘graphical formation’ of negative transits and I’m speaking with 15 years of experience here.

The first negative transit is usually the market testing or whether the index belongs in a lower zone, in this case between EBV+1 and EBV+2. Again, in general, the market (I’m talking about indices here) usually rallies above the EBV Line it just negatively transited.

And sometime later – could be weeks/months/quarters another negative transit will occur confirming the initial negative transit.

THIS SECOND NEGATIVE TRANSIT WOULD CONFIRM THAT THE CANADIAN MARKET HAS ENTERED INTO A BEAR MARKET.

Do I have your attention!

Does this mean the world comes to an end? Of course not! It’s just that an investor/trader has to adjust their expectations. My most profitable trading has occurred in BEAR markets of the past. You just have to know what kind of market you are in (Bull market vs. Bear) when trades are initiated and rates of return are assessed.

CONCLUSION

The last couple of months in the Canadian market have been interesting and eventful from a Model Price Theory [MPT] prospective. The highly cyclical market weight portion of the S&P/TSX Composite has been “taken out to the woodshed and shot.” Because of the negative transit of EBV+2 in the middle of October, market participants in Canadian equities should be on guard for a second negative transit that would be a negative sign and possible signaling of negative markets in the future. (As of this writing if the S&P/TSX Composite Index fell below an index level of 14,329 a second negative transit would have resulted.) Can you make money in BEAR markets…absolutely. Model Price will lead the way!

November 2014, Monthly S&P 500 Market Strategy Update

Looking at what the US market did for the month of October, I reminded of what I would call a “Crazy Ivan”.

Yes, this is reference to the infamous movie, “The Hunt For Red October” where we were introduced to Russian submarine captains making aggressive maneuvers, turns, on a random basis to see if a US submarine was shadowing the aforementioned Russian sub.

Have a look at our model price chart below and see if you don’t agree.

S&P 500 Index with weekly price bars and EBV Lines (colored lines).

S&P 500 Index with weekly price bars and EBV Lines (colored lines).

 

As a reminder we aggregate all companies in the S&P 500 Index into one chart on a market capitalized basis (like the S&P 500 Index itself), so we can see where the market – S&P 500 – is trading relative to its EBV lines.

As you can observe the US market, as defined by the S&P 500, is still in the middle of the zone bookmarked by EBV+3 and EBV+4. If the market rallied to EBV+4 (2199) this would represent a gain of some 9%. If the market corrected back to EBV+3 (1759) investors would be suffering losses of almost 13%.

For people new to Model Price Theory [MPT] the index value or price can move within an EBV zone with no real consequence. However when a transit occurs – index value or price crosses one of our parallel lines – an EBV line, either positive or negative this gives Model Price users a signal that fundamentals are improving or deteriorating, respectfully.

IS THERE ANY MEANING TO OCTOBER’S MARKET ACTION?

As I have said previously, any and all index moves within ‘the zone’ – between EBV Levels – is without consequence. What we try to do is measure risk levels intra-zone. In other words when the index level or stock price recedes to the lower EBV Line then investors are taking lower risk than if the index level or stock price closes in at the top or upper EBV Line. This should make some sense.

Transits are another matter. Any transit, index level or stock price piercing an EBV Level, is giving model price users information that the fundamentals are changing depending on the transit. If there is a positive transit, the index level or stock price increases through the upper EBV level, this signifies a positive change in fundamentals is occurring. The opposite is true if negative transits occur.

So as you can see from the above model price chart the US market as represented by the S&P 500 Index sold off in the first two and a half weeks of October, only to rebound to new highs in the second half of the month. This ‘high jinx’ in market action was certainly noteworthy however since all this action took place intra-zone no fundamental economic conclusions can be interpreted via Model Price Theory [MPT].

CONCLUSION

The market was certainly more volatile in the month of October than we have seen in awhile. However according to Model Price Theory [MPT] this volatility is par for the course because all the market action took place intra-zone – between EBV+3 and EBV+4.

Until evidence to the contrary, a negative transit of EBV+3, the bull market in US equities is still intact. So the US market did a “Crazy Ivan”, making some investors nervous and of course giving the permabears something to talk about in the financial press. But fundamentally and according to Model Price nothing has changed by October’s market action.