trading (ii)

have a game plan

In the beginning, when you’re feeling your way, a plan will likely be relatively simple.  Still, it should contain at least three elements:

–what you intend to do

–why wht you’re doing will enable you to make money, and

–how you are going to measure your performance.

the process

In all likelihood, a trading process will include a healthy dose of technical analysis, which in its saner elements is an effort to read the short-term emotional mood of the market.

Take the case of Tesla (TSLA), where investors seem to alternate between bouts of severe depression and wild enthusiasm.  The plan may consist simply of buying TSLA at, say, $200-, when spirits are flagging, and selling at $250+, when owners are dancing in the streets.

Or it could be that you’ve held Amazon (AMZN) for years.  You observe that the stock is travelling in an upward-sloping channel that’s now bounded on the low side at, say, $750 and on the high side at $850.  You might decide you can trade around a core position by selling some of what you own above $850 and buying below $750.

the source of profits

Ultimately you have to believe that something you do gives you an edge over the average investor. Maybe you are very familiar with the price action of a certain stock because you’ve owned it for a long time.  Maybe your work gives you insight into the publicly traded companies in a given industry or geographical area.  Maybe you think that rising trading volume always precedes rising/falling price and you use screens to identify stocks where this is happening.

measuring performance

There’s a very strong tendency among even professional investors to remember successes vividly but brush losses under the rug.  Because of this, it’s essential to measure how you’re doing, both in absolute terms and relative to the performance of a benchmark index on at least a monthly basis.

This is also the best way to identify your strengths and, more importantly, the mistakes you are prone to.  Everyone has something in this second category.  Simply no longer doing stuff that you always lose money on can give a big boost to performance.  I know this sounds silly, but I can’t think of a single professional I’ve known over the years who hasn’t had to deal with eliminating a chronic bad investment habit.

More on Monday.

 

so you want to be a day trader

why trading?

As human beings, we’re all very complex.  Sometimes(often, in my case) we do things for reasons we don’t clearly understand.  We can be influenced in ways we’re not fully conscious of by our families, our friends, our neighbors, our heritage   …as well as by daily bombardment by media of all types.

Sounds silly, but:

–Early in my career as an analyst, I remember calling the CFO of an oil and gas exploration firm to ask him, in polite terms, why anyone would buy the tax shelter programs he was selling through investment advisers, since my reading of the prospectuses seemed to show that virtually all the benefits went to the promoter.  His reply was that buyers were not particularly sophisticated financially.  They typically bought the programs as a way to signal to others that they were wealthy enough to have a “tax problem.”

–Some people are attracted to the riskiest stocks simply because they’re risky rather than because they might offer superior returns.  Buying them is in effect a substitute for going on a thrill ride at the amusement park.

In my experience, successful investors and successful traders have one thing in common.  They are clear about their purpose   …which is to make money.  They’re not working to feed their egos, make friends, or enhance their standing in the minds of others, although these positive things might be nice as side effects.  It’s all about making a return.

This is not to say one shouldn’t have scruples.  As an active manager, I avoided tobacco stocks, for example, because I believe this is a morally bankrupt business.

There’s also no way to know whether you can make money buy buying and selling financial instruments–whatever your holding period–unless you try.

Nevertheless, if you are going to be successful, the bottom line must be that you intend to make a profit.

 

More tomorrow.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Tesla (TSLA) raising funds

Last week TSLA announced that it is raising $1 billion in new capital, $750 million in convertible notes due in 2022 + $250 million in common stock.

The offering itself isn’t a surprise.  TSLA has been chronically in the situation where analysts can see a point on the near-term future where the company could easily run out of funds.  This is partly the lot of any startup.  In TSLA’s case, it’s also a function of the firms continuingly expanding ambitions.  Elon Musk has been saying for some time that TSLA will will need new capital, too.

What is surprising, to me at least, is that the offering is not bigger   …and, more significantly, that the stock went up on the announcement.

To the first point, why wouldn’t TSLA give itself some breathing room by raising more money?  Of course, it’s possible that the small size is a marketing tactic and that the underwriters will soon announce that, “due to overwhelming demand,” it’s raising the size of the offering to, say, $1.5 billion.  Otherwise, I don’t get it.

To the second, this is just weird.  TSLA shares rose by a tad less than 30% in the first six weeks of 2017 and have been moving more or less sideways since.  So the idea that investors are willing to buy the stock can’t be surprising positive news.  And I don’t see the plus in some commentators’ claims that the market is relieved the offering isn’t larger.  I think the market should be mildly concerned instead.

Something else must be going on.

The only thing I can think of is that Wall Street is beginning to believe that electric vehicles are going to enter the mainstream much sooner than it had previously thought.  At the same time, the Trump administration’s intended moves to make it easier for American car makers to sell gas guzzlers for longer may result in Detroit remaining stuck in the past, paying less attention to electric vehicles.  So market prospects for TSLA may be improving just as competition from the “Big Three” may be weakening.

However, that alone shouldn’t be enough to propel a well-known stock higher in advance of an offering.

 

 

 

why have oil production costs fallen so much?

rules for commodities

From years of analyzing oil, gas and metals mining–as well as watching agricultural commodities and high-rise real estate out of the corner of my eye–I’ve come to believe in two hard and fast rules:

–when prices begin to fall, they continue to do so until a significant amount of productive capacity becomes uneconomic and is shut down.  That’s when the selling price of output won’t cover the cash cost of production.  Even then, management often doesn’t reach for the shutoff valve immediately.  It may hope that some external force, like a big competitor shutting down, will intervene (a miracle, in other words) to improve the situation.  Nevertheless, what makes a commodity a commodity is that the selling price is determined by the cost of production.

–it’s the nature of commodities to go through boom and bust cycles, with periods of shortage/rising prices followed by over-investment that generates overcapacity/falling prices.  The length of the cycle is a function of the cost of economically viable new capacity.  If that means the the price of new seed that sprouts into salable goods in  less than a year, the cycle will be short.  If it’s $5 billion to develop a gigantic deep-water offshore hydrocarbon deposit that will last for 30 years, the cycle will be long.

boom and bust spending behavior

During a period of rising prices, cost control typically goes out the window for commodity producers.  Their total focus is on adding capacity to satisfy what appears at that moment to be insatiable demand.  Maybe this isn’t as short-sighted as it appears (a topic for another day).  But if oil is selling for, say $100 a barrel, it’s more important to pay double or triple the normal rate for drilling rigs or mud or new workers–even if that raises your out-of-pocket costs from $40 to, say, $60 a barrel lifted out of the ground.  Every barrel you don’t lift is an opportunity loss of at least $40.

When prices begin to fall, however, industry behavior toward costs shifts radically.  In the case of oil and gas, some of this is involuntary.  Declining profits can trigger loan covenants that require a firm to cease spending on new exploration and devote most or all cash flow to repaying debt instead.

In addition, though, at $50 a barrel, it makes sense for management to:  haggle with oilfield services suppliers;  do more ( or, for some firms initiate) planning of well locations, using readily available software, to optimize the flow of oil to the surface;  optimize fracking techniques, again to maintain the highest flow; streamline the workforce if needed.   From what I’ve read about the recent oil boom, during the period of ultra-high prices none of this was done.  Hard as it may be to believe, getting better pricing for services and operating more efficiently have trimmed lifting expenses by at least a third–and cut them in half for some–for independent wildcatters in the US.

 

This experience is very similar to what happened in the long-distance fiber optic cable business worldwide during the turn of the century internet boom.  As the stock market bubble burst and cheap capital to build more fiber optic networks dried up, companies found their engineers had built in incredibly high levels of redundancy into networks (meaning the cables could in practice carry way more traffic than management thought) and had also bought way to much of the highest-cost transmission equipment.  At the same time, advances in wave division multiplexing meant that each optic fiber in the cable could carry not only one transmission but 4, or 8, or 64, or 256…  The result was a swing from perceived shortage of capacity to a decade-long cable glut.

My bottom line for oil:  $40 – $60 a barrel prices are here to stay.  If they break out of that band, the much more likely direction is down.

 

Intel (INTC) and Mobileye(MBLY)

A week ago, INTC agreed to buy MBLY, an Israeli company that makes cameras and car safety devices, for $15.3 billion in cash.  Its plan is to merge its existing auto components business with MBLY and have that company spearhead INTC’s entire Internet-of-Things effort to enter the auto market.

Why buy rather than build?

The main issue is time, I think.  Part of this is that the timetable for development of autonomous driving vehicles is accelerating.  More than that, however, and the chief reason for the acquisition, to my mind, is the way marketing to the big auto companies works.

Auto companies plan new models several years in advance.  If you want a component in, say, a 2020 model, you probably need to have already convinced an auto maker of its merits by late last year.  Also, unless a component maker has a unique technology, auto companies tend to move slowly.  They’ll initially buy a single component, or they’ll put a part in one car model, just to see how the part–and the supplier–perform.  If things work smoothly, it will consider expanding that part’s use and/or buying other parts from the supplier.

The result is that convincing a car company to risk of using a new supplier takes a long time.  Without MBLY, which already makes key auto components and has an auto-oriented sales force, I think it could easily be a half-decade before INTC would make any significant inroads into the auto market.  INTC probably doesn’t have that much time.

This is not, of course, to say that INTC will be wildly successful in the auto-related IoT.  Without MBLY, though, its chances for success would be considerably dimmer.

how low can the crude oil price go?

This is my response to the comment of a regular reader.

There’s no easy answer to this question.  I have few qualms about putting a ceiling on the oil price.  In round terms, I’d say it’s $60 a barrel, since this is most likely the point at which an avalanche of new shale oil production will come on line.  Also, for investing in shale oil companies this number doesn’t matter than much, so long as it’s appreciably above the current price.

A floor is harder.

a first pass through the issue

We can divide the source of oil production into three types.  I’m not going to look up the numbers, but let’s say they’re all roughly equal in size:

–extremely low production cost, less than $5 a barrel, typified by production from places like Saudi Arabia

–very high production cost, like $100+ a barrel, which would be typical of exploration and production efforts of the major international oil companies over the past decade or so, and

–shale-like oil, with production costs of maybe $35 -$40 a barrel.

In practical terms, there’s never going to be an economic reason for the low-cost oil to stop flowing.

Shale oil is basically an engineering and spreadsheet exercise.  The deposits are relatively small and the cost of extraction is almost all variable.  So shale will switch on and off as prices dictate.  We know that at the recent lows of $25 or so, all this production was shut in.

The very high production cost is the most difficult to figure out.  Of, say, $100 in production expense, maybe $70 is the writeoff of exploration efforts + building elaborate hostile-environment production and delivery platforms.  This is money that was spent years ago just to get oil flowing in the first place.  What’s key is that for oil like this is that the out-of-pocket cost of production–money being spent today to get the oil–may be $30 a barrel.  From an economic perspective, the up-front $70 a barrel should play no role in the decision to produce oil or not.  So, dealing purely economically, this oil should continue to flow no matter what.

second pass

First pass says $30 – $35 a barrel is the low;  $60 is the best the price gets.

Many OPEC countries (think:  Saudi Arabia again) have economies that are completely dependent on oil and which are running deep government deficits.  Their primary goal has to be to generate maximum revenue; the number of barrels they produce is secondary.  If so, they will increase production as long as that gives them higher revenue.  Their tendency will be to make a mistake on the side of producing too much, however.  Their activity will make it very hard to get to a $60 price, I think.

On the other hand, shale oil producers who can make a small profit at, say, $35 a barrel may tend to shut in production at $38 – $40, on the idea that if they exercise a little patience they’ll be able to sell at $45, doubling or tripling their per barrel profit.

third pass

Second pass argues for a band between, say, $40 and $55.

Bank creditors don’t care about anything except getting their money back.  They will force debtors–here we’re talking about shale oil companies–to produce flat out, regardless of price, until their loans are repaid.  This was an issue last year, and what I think caused the crude price to break below $30 a barrel.  I don’t think this is an issue today.

There’s a seasonal pattern to oil consumption, driven by the heating season and the driving season in the northern hemisphere.  The driving season runs from April through September, the heating season from September through January.  February-April is the weakest point of the year, the one that typically has the lowest prices.

If the financial press isn’t totally inaccurate, there are a bunch of what appear to be poorly -informed speculators trading crude oil.  Who knows what they’re thinking?

my bottom line

This is still much more of a guessing game than I would prefer.  I see three positives with shale oil companies today, however.  Industry debt seems more under control.  Operating costs are coming down (more on this on Monday).  And seasonality should soon be providing support to prices.

 

 

 

why are higher interest rates good for banks?

There are two factors involved:

behavior of bank managements:  To a considerable degree, commercial banks are able to use changes in interest rates to their money-making advantage.  When rates are declining, banks immediately lower the interest they pay for deposits but they keep the rates they charge to borrowers high for as long as they can.

When rates are rising, as is the case in the current economic environment, banks do the opposite.  To the degree they can, and given that most loans are variable-rate that is considerable, they raise rates to borrowers immediately.  But they keep the interest rate they pay for deposits low for as long as they can.

A generation ago, banks had a much greater ability  than they do now to maneuver the interest rate spread.  That’s because money market funds were in their infancy.  There were no junk bonds to serve as substitutes for commercial loans.  There was even a Federal Reserve rule, Regulation Q, that prevented banks from paying interest on checking accounts and put a (low) cap on what they could pay to holders of savings accounts.

Nevertheless, especially as rates are rising, spreads still can widen a lot.

economic circumstances:   bank lending business tends to tail off in recession, since most companies don’t want to take the risk of increasing their debt burden during bad times–even if the potential rewards seem enticing.  The credit quality of existing loans also worsens as demand for capital and consumer goods flags.

The opposite happens during recovery.  The quality of the loan book improves and customers begin to take on new loans.

stock market effects

The market tends to begin to favor banks as soon as it senses that interest rates are about to rise.  Wall Street was helped along this time around when perma-bear bank analyst Mike Mayo turned positive on the group for the first time in ages last summer.

After the anticipatory move, banks have a second leg up when the extent of their actual earnings gains becomes clear.  It seems to me the first move has already come to an end   …but the second is still ahead of us.