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Profitable Trades Based On USD Changes

Summary A strong USD will affect the value of commodities. Commodities are traded in USD and will therefore be more expensive for non-USD countries when the USD goes up. Changes in commodity prices will affect countries that are highly dependent on export/import of commodities. Many asset classes are affected by changes in the USD, and therefore great investing opportunities. During the last year, the USD had a massive rally. The USD Index hit a multi-year high in March 2015 of 98.66, up 23.6% from the 79.81 level in June 2014. Why did the USD have this strong rally? To answer this question, it is good to look at the USD Index breakdown. The Euro has a weighting of 57.6%, and is therefore able to move the USD Index very easily. One of the reasons why the USD rallied is the fact that the Fed started tapering. It stopped doing POMOs (Public Open Market Operations). During the taper phase, traders and investors expected the ECB to do QE. This would put double pressure on the EUR/USD. Fed tapering lowers the money growth rate of USD in the markets, and the ECB’s QE would push the EUR even lower. The BoJ is doing stimulus too. The main target: devalue the JPY to stimulate exports. QE from both BoJ and ECB means that the two biggest components of the USD Index are too high according to BoJ and ECB. The fact that the USD soared was therefore not really a surprise. Of course, it is easy to predict things after they happened. So that is not the reason I write this article. I want you to understand which asset classes are affected by the USD, so you can avoid “stupid” mistakes and make trades to profit from central planning and major macro changes. Rising USD When the US Dollar rises, commodities, which are priced in USD, will get relatively more expensive. Therefore, demand will decline, which will put downward pressure on commodities. The chart below shows the correlation between USD and commodities. I used the iShares S&P GSCI Commodity-Indexed Trust ETF ( GSG) to display the Goldman Sachs Commodity Index (GSCI) and the PowerShares DB USD Bull ETF ( UUP) for the USD Index. (click to enlarge) Commodities have a high correlation with the USD as shown above. With this info in mind, it makes sense that commodity-related countries and companies have a high correlation too. A country which highly depends on commodity exports will suffer when commodity prices decrease. Most of the commodity-dependent countries are emerging markets. The emerging market is therefore a good tool to trade an USD impact. Not only do many emerging markets export commodities, but they also have a part of their debt in USD because it is cheaper to borrow. If the USD gets more expensive, their debt will weigh heavier and put pressure on their balance sheets. If you want to trade emerging markets, it is very important to know where to invest. Not all emerging markets are the same. If you look at the correlation vs. the USD, you will see huge differences. Brazil, Russia, Malaysia and Poland have by far the highest (negative) correlation vs. the USD. It would not make sense to short an ETF like EWT when you are bullish USD. In fact, it is all about leverage and volatility. Let’s say you expect the USD to rally. Therefore, you want to short emerging markets. There are a few options you can choose from (and many more): Trade the i Shares MSCI Emerging Markets ETF (NYSEARCA: EEM ) By shorting EEM, you short an emerging markets ETF. By doing so, you are shorting all emerging markets, in particular China, because the weighting of 23% is by far the heaviest. Why would you want to short? You have less volatility because the ETF contains many countries, and therefore a huge amount of companies. On the other side, you are shorting countries that have a low correlation vs. the USD. Trade the iShares MSCI Brazil Capped ETF ( EWZ)/the Market Vectors Russia ETF ( RSX)/the iShares MSCI Malaysia ETF ( EWM) As mentioned in option 1, by shorting, you short countries that have almost no correlation with the USD. You solve this problem by shorting a country like Brazil or Russia. The volatility is higher, but you get way more momentum in case of bigger changes to the USD. Trade single stocks If you have a strong feeling about a certain USD move, i.e. a rally, you can choose to short a single stock. This can be a component of one of the most affected ETFs like EWZ/RSX/EWM or stocks from developed countries that are affected by the USD changes. The table below shows a few options: (click to enlarge) As you can see, most of the companies in my list are oil and gas drilling related. Most of them offer drilling services or provide drilling equipment. These companies are more dependent on a high oil price than the actual drillers. Since drillers can cut production easily when oil prices decline, the actual providers of the services and drilling products however lose a tremendous amount of business. With this in mind, you can short oil drillers in a USD rally or choose to short a Brazilian company for example. Itau Unibanco Holding S.A. (NYSE: ITUB ) has a weighting of almost 10% of EWZ and a 24-month correlation of 90% ( Sources: iShares, TradingView ). ITUB data by YCharts To summarize everything, I made an easy overview: (click to enlarge) On top, you see USD. That’s what it is all about. When the USD rallies, commodities and emerging markets are likely to dip since the correlation is negative. US Bonds and real estate however will profit when the USD goes up. Hence the positive correlation. The table above gives you an overview of possible trades. The higher the position in the table, the lower the volatility. For example, shorting commodities can be done by shorting GSG. If you do so, you are shorting an entire basket of commodities, and have therefore lower volatility. The next step is trading a single commodity. By doing so, you increase not only the potential returns, but also the volatility. If you want to maximize returns, trading a single stock gives the highest potential returns. The chart below confirms the table above: EEM data by YCharts This article gave you an overview of the different asset classes that can be traded in case of an expected USD change. Both the long- and short-side deliver interesting choices that can be trades as outright long/short trades as well as spread trades. Of course, there are way more options than I discussed in this article, but these are the basics of understanding price changes and researching profitable trades.

Karoon Gas – Give Me $1.00, I’ll Give You $1.20 And 2 Significant Oil Discoveries

Summary Karoon is a depressed stock trading 20% below cash backing due to a low oil price, and several major shareholders exiting the stock. A major selloff has resulted in Karoon being significantly undervalued. Provides fantastic long term exposure to a rising oil price with 85 mmbbls of 2C reserves from 2 recent oil discoveries. Karoon Gas is currently in the process of buying back up to 10% of stock on issue. Overview Karoon Gas (ASX: KAR, OTCPK:KRNGF , OTC:KRNGY ) is an Australia-headquartered oil and gas company with exploration opportunities focused in North-West Australia, Peru, and Brazil. With a set of great oil prospects, and no major gas prospects, they should consider changing their name to Karoon Oil. Of all the sell-offs in the oil and gas sector, this one has intrigued me the most. On a market cap of AU$450 (US$319) Million at the current share price, they sit on cash of AU$550 (US$390) Million. This cash came from their recent sale of their Browse Basin permits to Origin for the following: An upfront payment of US$600 Million (Received) A deferred cash payment of US$75 Million payable on FID A deferred cash payment of US$75 Million payable on first production A deferred cash payment of US$5 Million for every 100 BCFe of independently certified 2P reserves exceeding 3.25 TCFe Reimbursement of the costs associated with drilling its 40% held Pharos-1 well. (Received) So why are they trading so low? Apart from the oil price, I think it is primarily due to these 3 factors: Several major investors have exited the stock over the last year. IOOF Holdings, Future Fund Board of Guardians, and Paradise Investment Management all ceased to be substantial holders, selling out a major portion of the stock. The company has some corporate governance issues. There are concerns that family members of the chairman Bob Hosking are appointed on key positions at the company, as pointed out by the activist hedge fund manager Pegasus. The majority of shareholders may or may not agree with this, and I myself have questions regarding it, but none of the three candidates that Pegasus put up for election were voted in. A lot of Australian companies have corporate governance issues, and activist investment is much lower than in the US. Like any market risk, this is a risk that must be weighed against the benefits. Speculators pushed the price up to obscene levels, and then pushed the price back down in fear Despite these issues, Karoon has a great track record of increasing the long-term value of shareholders when you normalize for the boom and bust cycle. Past speculation during the boom had driven the share price as high as $12.10 – it currently sits at $1.81 at the time of writing. Karoon is, at present, up over 950% from 2004 and has managed to unlock plenty of cash for the exploration and appraisal of their major Brazil operation in the Santos Basin. (click to enlarge) ( Google Finance ) Offshore Brazil (Two Significant Oil Discoveries) The map below shows the Kangaroo and Echidna resource as well as the Bilby oil discovery dating back to 2014. (click to enlarge) ( Source – Karoon Annual Report 2015) Kangaroo went through further appraisal in 2014, production testing at rates that signaled a single vertical well could flow 6,000-8,000 bopd from a net pay of 135 meters ( Source ). It needs to be noted that Kangaroo 2 also had two side tracks as part of the appraisal that indicate that this may be a complex reservoir which would enhance the cost and difficulty of production. Despite the complexity, it remains a significant find that has a great chance of commerciality. Echidna followed up the Kangaroo discovery with a 103 meter net oil column and a facility constrained flow test 4650 bopd, further enhancing the chance of a commercial discovery for the region. (click to enlarge) ( Source ) From an operational perspective , Karoon is looking at a variety of options for producing the Echidna and Kangaroo discoveries that are less than 50km apart. The lowest capital cost method includes a Floating Production Storage and Offloading Vessel (FPSO) producing roughly 20,000 barrels of oil per day (bopd), then expanding that to 50,000 – 70,000 bopd once the field has been proven. Discussions for the development of Kangaroo have also involved Petrobras for an integrated oil hub in the region, which could be economic as low as $43/bbl according to Citigroup ( Source ). The same article also denotes the drop in costs which could make the project economic at even lower prices “Because it’s a distressed market now worldwide, we are looking at redeployed assets, for example, a redeployed FPSO [floating production storage and offloading vessel]. The labor market is getting cheaper, the labor is getting cheaper; we see there’s a lot of cost savings for us.” One of the primary reasons for investing in Karoon is that there is almost no value attributed to the Kangaroo and Echidna discoveries. After writing off Karoon’s AU$105 (US$76) million tax liability against its cash reserves, the 2C reserves equate to a value of AU$0.41 (US$0.29) /bbl. However, investors must keep in mind that production isn’t likely oncoming until 2018 at the earliest while Karoon moves through engineering and approvals, and this may hold the share price back for the medium term. Offshore Peru and Offshore Australia After all this, Karoon still has more to offer. A possibility of more major discoveries exists offshore Peru and Australia. Nearly 27000 square kilometers of permits sit on the acreage outside of Brazil, with significant long-term potential for Karoon. They have a habit of bringing in joint venture partners to free carry them through the initial drilling stages to minimize the capital outlay from Karoon. These are likely to sit for several years during the current supply glut, however, they provide some great upside for an oil recovery. (click to enlarge) (Karoon Annual Report 2015) Share Buyback One of my favorite things to see a company do is an all-cash share buyback – specifically when their share price is trading at an all-time low. Karoon has bought back 9.4 million shares at $3.27 over the last 12 months as well as announcing plans to buy back a further 25 million shares. That comprises up to 10% of the company’s ordinary shares on issue and will further expose investors to the upside of an oil price recovery in 2-3 years. On top of all that, Karoon has a significant amount of built up exploration expense of $AU485 Million that can be written off against future cash flows. Risks and Uncertainties Karoon is in the early stages of several significant oil discoveries. There are plenty of issues that need to be sorted out, and a significant amount of cash that needs to be spent to bring these oil fields into production. Production is not likely to begin for several years, and the oil price currently sits at levels that would make these projects uneconomic. Most investors would agree that the current supply glut will not extend out to 2018, however, it is possible and poses a significant risk as Karoon spends more on the appraisal process. Karoon also has no source of cash flow, and Origins deferred payments are unlikely in the current environment. Conclusion Having several major investors exit the stock over the last 18 months has left the share price in the doldrums. While Citigroup has calculated a combined development for Kangaroo and Echidna would be economic as low as $43, I would not expect the project to go ahead unless oil moved well into the 60’s – unless the resource is found to be much larger than current estimates. There is plenty of unrealized value in this stock with hardly any value attributed to the Kangaroo and Echidna discoveries, and no value to the significant amount of exploration expense that Karoon can write off against future cash flow. Karoon’s cash reserves can be used to develop these discoveries and increase shareholder value at the same time the share buyback is increasing investors oil exposure per share. As for the remaining Australian/Peruvian blocks, Karoon will likely delay drilling as much as possible to preserve cash for the Kangaroo and Echidna discoveries. Overall, there is a significant amount of risk around Karoon going forward. They are in the early stages of appraising these reservoirs while the oil price has crashed. However, a crashed oil price means cheaper drilling, completions, procurement, and construction. Karoon would not be likely to produce oil until 2018 at the earliest, and there is plenty of time for the oil price to recover in that time period. As the Financial Review quoted from an RBC Capital Markets report “Whilst high risk, this is a freebie and success would open a significant new oil play.” I love Karoon as an asymmetric bet on an oil recovery, and I can confidently see an upside of well over 100% in the next 3-5 years in the event that the oil price recovers. Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

ETF Update: An Abundance Of Currency Hedged ETFs

Every week, Seeking Alpha aggregates ETF updates in an effort to alert readers and contributors to changes in the market. There were 17 ETF launches over the last 2 weeks. Have a view on something that’s coming up or a new fund? Submit an article. Welcome back to the SA ETF Update. My goal is to keep Seeking Alpha readers up to date on the ETF universe and to gain some visibility, both for the ETF community, and for me as its editor (so users know who to approach with issues, article ideas, to become a contributor, etc.). Every weekend, or every other weekend (depending on the reader response and submission volumes), we will highlight fund launches and closures for the week, as well as any news items that could impact ETF investors. Every time I take a week off from reporting on ETFs I seem to come back to a tidal wave of launches. It is almost like the industry knows I had the flu. Before we dive in, I want highlight an image and quote from the 2015 Investor Brandscape study by Cogent Reports and the press release that followed: Clearly ETFs are becoming the norm and will continue to be a product investors will turn to for broad exposure. Sorry Kraus . Have any other questions on ETFs or ETNs? Please comment below and I will try to clear things up. As an author and editor I have found that constructive feedback is the best way to grow. What you would like to see discussed in the future? How can I improve this series to meet reader needs? Please share your thoughts on this first edition of the ETF Update series in the comments section below.