Jeet kune do investing I: the case of Canadian junior oil and gas

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I have great admiration for Beating the Index.  The website provides very valuable analysis of the Canadian junior oil and gas sector, the major plays (esp. Bakken and Cardium), and the macro issue of why the price of oil will likely rise in the long term investment horizon.  In addition, Mich, the website’s sole proprietor, reveals to us a part of his self-managed portfolio, what moves he makes as he beats the index.  His style is his own, adapted to suit his particular portfolio.  For example, because he is using leverage, he has to cash in on his winners–sometimes he also drops losers and holdings which remain  static.  In one post, his commentors on his blog praise him for being willing to take losses and move on, saying that this is the mark of great trader.

But then one has to wonder, if an analyst has done his due diligence and decided that a company is a good buy, and then the market decides to dump the stock, whether that stock just became a better deal.  So in my trading, I very rarely dump losers, though I have sometimes done so to realize a tax loss or to implement a change of strategy.  Rather, I’ve averaged down on losers, and most of the time it works, as I shared in a post critiquing Dennis Gartman’s first rule of trading, “Never, under any circumstance add to a losing position…. ever!”  Gartman says to add to winning positions rather than to losing positions.  Generally speaking, I ride the winners, but I don’t often add to my positions.  Gartman’s rigid style seems to be flawed, and his own HAG fund is still going nowhere.

Now Keith Schaeffer, one of the leading independent analysts of the Canadian junior and intermediate oil sector, provides a compelling argument why it is better to add to the companies with momentum:

When it comes to the junior and intermediate North American oil and gas plays, I want to buy expensive stocks. I rarely buy cheap stocks. That sounds counter-intuitive, but it makes sense.

When a company trades at a high valuation it can raise money with less dilution, and can use its stock as currency to take over other companies. They can grow more quickly and more efficiently than companies with low valuations.

“Dilution” is one of the terms that junior oil and gas investors seem to fear.  Indeed, share price usually seems to drop after a public offering.  Crocotta Energy’s recent share offering is a great example:

CTA share price fell on Feb 3 after announcing a $25 million bought deal

One day on an airplane on the way to Barbados, I met A. Zoic, an experienced entrepreneur, who explained “dilution” to me:  He said, “The number of shares are increased, but the size of the company also increases.  So you have smaller percentage of the whole, but the company is much larger.” Zoic’s words came back to me, the inexperienced investor, time and time again as I watched Midway Energy, my largest holding, take on more and more new shares; and Zoic’s advice helped me over the last couple of years to understand that when a junior oil raises money in a public offering that that is a really good thing because it increases the overall size of the company.  This has the added benefit of increasing the average volume of shares traded which in turn makes all shares more liquid.  A great CEO with an established reputation, like Midway Energy’s Scott Ratushny, has been able to raise the investment dollars to create the momentum that makes a good value into a great investment.

In the end, the best strategy for trading junior and intermediate oil and gas is neither the value nor the momentum strategy alone.  Rather, in my view, the two strategies should be implemented together in an artful Jeet Kune Do of  (1) Momentum–buy winners:  I keep adding to my position of CPG; (2) Averaging down seeking value:  I kept buying MEL (when it was still TFL) as it plummeted in price; (3) Buy and hold:  I watched MEL go from 0.39, my lowest price, to $5.19 (and am still holding).   Junior oils are too volatile to cut losses early, and I’ve found for the last four years as a junior oil investor, that my overall gains far outweigh my losses.

What works depends as much on the investor, his liquidity, credit limit, available margin, size of portfolio, as it does on the style of investing.  I rarely cut my losses.  I don’t see that ability as the mark of good investor.  The mark of good investor is perhaps better described as an even keel temperament to do the right thing without allowing the market to determine his next trade for him.  According to the legendary martial artist, Bruce Lee, the best style is no style–consider how these words fit investing:

Too much horsing around with unrealistic stances and classic forms and rituals is just too artificial and mechanical, and doesn’t really prepare the student for actual combat. A guy could get clobbered while getting into this classical mess. Classical methods like these, which I consider a form of paralysis, only solidify and constrain what was once fluid. Their practitioners are merely blindly rehearsing routines and stunts that will lead nowhere.

I believe that the only way to teach anyone proper self-defence is to approach each individual personally. Each one of us is different and each one of us should be taught the correct form. By correct form I mean the most useful techniques the person is inclined toward. Find his ability and then develop these techniques. I don’t think it is important whether a side kick is performed with the heel higher than the toes, as long as the fundamental principle is not violated. Most classical martial arts training is a mere imitative repetition – a product – and individuality is lost.

When one has reached maturity in the art, one will have a formless form. It is like ice dissolving in water. When one has no form, one can be all forms; when one has no style, he can fit in with any style.

Education bubble XII: Hiring policy, nothing to do with your merit

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I was once interviewed for a job in Georgia.  It was a no brainer.  It was a small pentecostal college that had am academic dean with a master’s degree–it paid probably 30k, and so the money wasn’t anything special.  I waited weeks afterward and only to find out that they gave the job to a guy studying at an American seminary who ABD–nobody bothered to inform me.  The academic game had surprised me.  In today’s analogy, I was Lebron–I studied at prestigious university, my PhD was all but in hand, and to top it off, I could speak three modern languages, and had proficiency in Greek, Hebrew and Coptic.  It was a no brainer.  But in the end, the other guy received the call, and I was still out of job.  How could this happen?  I did everything right and I was ready to step into a job, and they give the job to some guy still working on his PhD!  Well, in the end, I determined that merit often has little to do with who gets a job in academics.  Here are the real criteria:

(1) Ethos:  Who fits into the reigning ethos of the school?  A recent graduate from an expensive school is not likely to fit in well at a small school in Georgia that puts no priority on research or writing.  Such a person has to be used to deprivation and self-sacrifice and must be satisfied with the small wage the school has to offer.

(2) Politics:  a recent informal survey of social psychologists at an academic conference showed that their profession is dominated by those on the Left side of the political spectrum. Only an extremely minute number were self-identified conservatives.  This sort of difference can only happen when the admission policies to graduate programs and the hiring policies intentionally weed out those of conservative persuasion, since the conservatives in the American general population greatly out number liberals.

(3) Diversity (=Affirmative Action):  Michael, who reneged on his obligation to return to Africa, was one of 160 candidates for a job at a Christian University.  When I pointed out that the reason he received the job offer was that the school was implementing a policy of diversity, he was offended, but I was able to point out the page on their website that showed that they were trying very hard and had even offered a job to Botswanan the year before.  Adjuncts who had been working their butts off at one seminary I taught at were passed over as white males to hire full-time females; the next three biblical studies appointments were women.  This wasn’t about their relative merit as professors but about increasing the number of women in the faculty.

(4) Old boys’ school:  J. F. K.’s essay explaining why he wanted to go to Harvard was lamentably lame, but he happened to mention that his father was a Harvard man, and he would like very much to study there too. [BTW, old boys could now be a bunch of liberal woman for all I know–I don’t belong to the club–in fact, I’ve never seen the inside of the club either].

Ok.  So lets consider this question from the standpoint of how good the education is, given that merit is not usually the reason why people get hired.  The Chronicle of Higher Education reviews a recent book by researchers of the products of university education in America:

Growing numbers of students are sent to college at increasingly higher costs, but for a large proportion of them the gains in critical thinking, complex reasoning, and written communication are either exceedingly small or empirically nonexistent. At least 45 percent of students in our sample did not demonstrate any statistically significant improvement in Collegiate Learning Assessment [CLA] performance during the first two years of college. [Further study has indicated that 36 percent of students did not show any significant improvement over four years.] While these students may have developed subject-specific skills that were not tested for by the CLA, in terms of general analytical competencies assessed, large numbers of U.S. college students can be accurately described as academically adrift. They might graduate, but they are failing to develop the higher-order cognitive skills that it is widely assumed college students should master. These findings are sobering and should be a cause for concern.

A cause for concern indeed!  You mean you can send  18-22 year-olds to school and they aren’t one wit smarter after four years of partying and learning about diversity and multiculturalism?  Wow! Who woodda thunk?

I have heard the dogma that if schools become indoctrinators instead of educators, strongholds of political correctness and diversity, that that makes them better places, richer and superior to the monolithic schools (read: professors are all white males) that prioritize academic achievement.  Yet after 30 or so years of this crap, we now have schools where large swaths of kids come out no smarter than they were before they entered.  So what does a BA mean today?  It means a huge debt without necessarily any usable or productive skills.  It means that a university education for something like a third of graduates is a waste of time and money.

Headlines that make laugh

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Journalists who make up the financial news are basically clueless.  There is a saying about teachers:  If you can’t do, teach.  In the case of journalists, it should probably be:  “If you can’t trade, become a financial journalist.”  I would like to say to them, “Let me see your portfolio; how well are you doing?  Not so good?  Then, stop making up stuff that you don’t know what the heck you are talking about.”

Here is an example:

Every day similar headlines are posted at Yahoo Finance and other financial news sites.  But you know, markets fluctuate; they may react to news and they may not.  Maybe one day the market goes down just because traders are taking profits or some other thing.  But most of the time I just shake my head when journalists say that there is a cause and effect relationship between events of the day and minor day to day gains or losses in the market.  The equation is never that simple.  Why wasn’t it yesterday’s news that the Chinese are buying $5.4 billion in Canadian natural gas interests?  I can say for sure that that news is far more monumental to me as trader than the news that maybe Mubarek might resign in the next few months, maybe he won’t.  How the heck does that effect me as a trader any way?  Now the Chinese spending another $5.4 billion on Canadian natural gas, that affects me, and it should also have a detrimental effect on the bond market, and a lowering of confidence in the US dollar because the Chinese have made yet another decision not to buy US treasuries.  Perhaps US investors see that bonds are a bad investment and have decided today to tip the balance towards stocks, in aggregate.  But last I checked, the markets were down anyway, and so easing of pressure due to news of Mubarek didn’t last very long.  Oh well.

Canada’s currency manipulation: the inmates are in charge of the loonie bin (update 2)

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UPDATE 2:  I asked Denis, my economist friend, how much of the US treasuries is owned by the Canadian government and how much would be owned by the private sector, and he suggest consulting the Bank of Canada balance sheet.  It is clear that the total assets on the balance sheet are 60.8 billion, which means that there is no way that the government of Canada could have lent $134 billion to the US, and that most of the ownership of these US securities must be in the Canadian private sector and can be explained by covered interest arbitrage.  Nevertheless, the reason why this arbitrage happens is because the Bank of Canada has kept the interest rates at low levels and is therefore to blame if the loonie is inflating like crazy.  Denis provided me with the following chart of interest rates:

UPDATE:  Thanks to the comment by blogger 101 Centavos, I finally asked my local Canadian economist if he could tell me what the number $134 billion means.  He says it is not the Canadian government alone that holds this debt, but all Canadian holders both sovereign and private.  I am going to try to reach him by telephone for clarification.  Meanwhile, in the words of the ever opinionated Emily Latella of Saturday Night fame, “Never mind”.

[Please note: the updates above are intended to substantially correct  what follows, which is the original post]

I am thinking about writing a blog for the American Thinker about the announcement that China would spend another 5.4 billion in the Canadian resource sector, this time to buy 5.4 billion of Encana’s natural gas holdings.  My view is that China’s purchases of Canadian resources is more about diversifying themselves out of US treasuries.  But  I found a table updated in November 2010, which shows that the Chinese have actually increased their US treasuries by $265.3 billion since November of 2009 (the chart only goes back that far).  Meanwhile, one stat jumped off the page.  In that same period, Canada has increased its holdings of US debt by $84 billion! I am shocked.

Canadians greatly fear the death of the manufacturing sector.  So now they will tolerate this.  But I am dismayed and shocked that our government is manipulating the Canadian dollar so that it will not rise against the US.  The immorality and the bad management of this situation is beyond words.

A couple years ago, I thought that given the bad fiscal policy of the US government would lead to the loonie soaring against the US dollar.  But now I see that rather than allow that to happen, the Canadian government is subsidizing the American lifestyle and the American bubble.  So that finally explains to me why the loonie remains at par and why price inflation is slow to happen in the US–why price inflation is happening in Canada the same as elsewhere in the world.

“I never recommend a trade”, Mark D. Wolfinger

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Mark D. Wolfinger is an experienced options trader who kindly offers his expertise to others.  His blog, Options for Rookies, has excellent advice about buying and selling options, including information on doing spreads like condors and collars–strategies I don’t use because I am a seller of put options.

Recently, he has made the following comment on his blog about recommending trades, which applies not just to options but also to all trading:

As you know, I NEVER recommend a trade. That violates one of my core beliefs:

When someone sells a trade recommendation, the advice seller probably believes the trade will be profitable. However, ultimate profitability is not only dependent on the trade chose, but also depends on how it is managed. That salesman may be able to turn a profit, but that does not mean that you would. Your pain threshold is lower and there would be many instances in which you exit with a loss and he holds and earns a profit.

He claims a profit for his followers and all you see is a loss. Do you understand why that happens?

Each trader has his/her own comfort zone, trading goals and the ability to withstand a loss. Each would exit the trade at a different time. Each is at a specific point in life – perhaps raising a young family or retired. Perhaps wealthy or struggling. No one who understands trading would suggest the same trade to every person. Yet, that’s what these gurus do.

The post in which these lines are found is called, “Risk Management for the Small Trader” in which he recommends that options trader have a minimum of $10,000 trading cash and preferably twice that amount because the newbie with $5000 or less will have just enough cash to enter positions but insufficient cash to manage them well.

His advice about the management of trades applies also to stocks.  If new traders, who enter a stock with the hope that it goes up quickly, sell  it when it goes down 15%, they will likely lose that cash forever.  If they average down, and I believe in such a strategy, then they will be much less likely to lose money as a trader–even the black swan event of the market drop of 2008-2009 could have been overcome with a strategy of averaging down on losing positions.  But alas, if you have only a limited amount of cash, then that strategy won’t work, because you shoot your wad in the first instance, and there’s nothing left with which to average down.