Tuesday, October 12, 2010

12 October 2010 Animal, Mineral, Ore, Plant


12 October 2010 Animal, Mineral, Ore, Plant

We were asked by one reader to introduce them to a nice commodity to bring home to meet mom and dad. I of course thought they meant they wanted a commodity recommendation for her parents. Yeah, I can be very dense sometimes, just ask my wife. Now I mentioned that I am always surprised at the knowledge my wife has on the market. I am not amazed because she is not bright and articulate; I just don’t witness her spending endless hours reading the Journal or Barron’s. So yesterday when she asked me a question about commodities, I remembered that we owed a reader an answer about commodities and then did my best and to her apparent satisfaction answered her question. But I digress.

First off we do not play commodities directly. Historically we have made some really good mental bets on OJ and Grains and Beef, but I have chosen not to get into the actual trading of commodities. We look at it this way. If we pick a bad stock or if something goes terrible wrong with a good stock (BP and RIG come to mind) you might loose a couple of bucks. If you screw up (Financial term for arrogance and or ignorance) in commodities you could end up with 34 thousand pounds of hog lips in your driveway. I am only an alternative delegate on our Home Owners Association Board but I am real confident there must be a CC&R against storing 34 thousand pounds of hog lips in the driveway.

Now in our portfolios we play in several commodities. Those would be Oil, Natural Gas, Silver and Gold. Now these commodities do not trade in isolation. They are impacted by the global economy, emerging middle classes all over the world, other commodity values, currency fluctuations, and geo political issues to name a few.

Here is a great example. Yesterday my wonderful wife asked about all the brouhaha about grain commodity fluctuations of late and why it is so important. (Ok I know she did not hear about global grain demand by watching Oprah or Dr. Oz which makes me think she is a closet Bloomberg watcher.) The explanation as I understand it is relevant to this conversation.

Let’s go back to late August. There were about 600 wildfires in Russia. They consumed about 500,000 hectares. If you did an overlay of the fires in Russia over a map of the US the smoke would run form San Francisco to Chicago. By the end of the month, Russia banned the export of all staple grains, wheat, barley, rice, hops etc. That increased world grain prices.

Now this isolated incident is taking place as many emerging markets are improving the quality of life of their huge populations. Guess what? China, India, other parts of Asia, parts of South America all like shifting from vegetable and fish diets to hog lips, well at least pork and beef. Guess what you feed pork and beef? Yep Grain. Now what do you need to grow staple grains? Water and fertilizer. (Think Potash). It is the perfect storm of price escalation.

Now take all of that and think about Harry Wang a farmer somewhere in an emerging market. He sees grain prices going up, but he sees fertilizer prices going up and adjusts his crops yield to take advantage of the fluctuations in income and expenses and had a great season in 2010 by selling all of his grain to his cousin Larry Wang, the pig farmer. He rewards himself by buying his first automobile and some bling for his wife and daughter. Larry has a great year as the slab bacon market is going through the roof. He buys a bigger car than Cousin Harry and more bling than him and his neighbor the beef baron of Beijing. They are all shipping their grains via rail and trucks.

Here is the linkage grain begats pork and beef begats oil begats silver and gold and potash.

We only buy what we know. Slab bacon we know if it comes in 18 slice packages not whole pork bellies. Beef we know if it comes on the bone with a great cabernet, not on a dry aging rack. Gold I know I can buy with an ETF called GLD. (There are ETFs for almost all commodities, but as we mentioned yesterday we have too many equities to do commodity ETFs justice.) Oil I can buy by choosing oil companies with a great margin of safety. Natural gas I can play with ETFs and well valued stocks.

So here are the commodity plays I have taken home to meet my mom and dad. Okay I have taken them home to meet the IRS. GLD, CVX, PNG, UNG, MDR, and NAK. Again some of these are value stocks in the sector of interest.

Need To Lube The Portfolio?

We had a reader ask for an oil stock to balance their portfolio. They specifically asked about PBR, Petrobas. This has been getting a lot of airplay lately because of the recent joint venture between China Petroleum and Chemcial PNP and Repsol YPF.

Here is our thinking on Petrobas. First off it is an ADR American Depository Receipt which is a trading instrument that a foreign company has to file in order to trade their shares in the US. That in and of itself is not a bad thing as we have owned many ADRs. This one is worrisome to me because the underlying company is owned by the Brazilian Government. Right now that is almost as good as gold. However, Brazil and some other South American Countries have had their share of instability and you must take that into consideration when looking at Brazilian owned companies. (Remember-Margin of Safety. What ever it is this fact narrows it a bit.) Putting that aside, let’s look at the fundamentals.

It is a sizable company with 151 billion in market cap. At face value it appears cheap with a forward looking P/E of 8.73. It has quite a bit of debt and long term debt, but finding and drilling oil is capital intensive. If you look at insider ownership it looks great however the insider is the government of Brazil. There free cash flow is weak, but they are pumping more money into exploration and drilling which should show rewards in 2012 and beyond. There are quite a few oil companies throwing a nice divided, PBR is not one of them. The dividend yield is .15%.

We do like most of the target prices out there. They range from 42-49 and most of those are based on 2011 oil at 70 and barrel and nat gas at 5.00 per 1,000 cubic feet. This implies a nice margin of safety, as their price today is $34.50 share.

Descriptively, we like the fact that it is Brazilian based and serves the Brazilian market which takes a lot of the geopolitical issues and currency issues off the table. Due to the nature of oil fields off of Brazil Petrobas has great experience with partners like RIG to get the job done. A recent law passed gives PBR a distinctive home field advantage, but has pissed off a major trading partner, China. It will be interesting to see if the law holds?

Here is a map of the pre-salt drill sites under development.

At the end of the day, we have a couple of nice plays in our portfolio which we are very comfortable. That would be CVX and on a watch list COP. I would put PBR in third place. If you want an oil stock with a good margin of safety, I’d be inclined to go with CVX. Do your own homework as you may be right, I may be crazy!

How is the crystal ball this week?

Sunday night we suggested that CSX would beat estimates. Here is the clip from that post:

“As this is the beginning of earnings season, there are lots to choose from except for Monday which has a closed bond market so it’s a bit quiet. Rail and Intermodal Giant CSX is reporting Tuesday and should beat the $1.04 a share estimate. I am thinking 1.07.”

Well they did beat and we came pretty close as they reported $1.08 a share. This should be a good tell for the economy, however they beat bottom line and showed solid top line numbers but the top line numbers were very heavy with the auto sector so the good news is tempered a little bit. But as we say a beat is a beat. The earnings report was accompanied by some positive statements by the CEO. We also suggested that the retails sales report today would be sluggish and we were wrong. They did not disappoint and they did not impress.

Lessons learned from The White House

President Truman quickly figures out that if you want walls built with your name on them, build them yourself!
Salve Lucrum


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