Tag Archives: seeking-alpha

As Producers Get Out, You Should Get In: Why I’m Long XLE

Summary WTI crude in the mid-30s is close to the cash operating cost of many high-cost oil producers. As oil trades in the mid-30s, production will be shut in and supply will fall, in theory creating a floor in the price of oil. Continued low oil prices will likely create an underinvestment in oil production, and could create risk to the upside in future oil prices. Investors should consider buying XLE, as it will likely be able to weather the storm, and avoid XOP, as it contains much smaller producers that may not survive. Investors should avoid USO as it is subject to the decay associated with negative roll yield in WTI futures contracts. On December 15th, West Texas Intermediate Crude traded through $35 a barrel. This is close to the variable operating cash cost of many high-cost producers operating out of North America. At these prices, producers potentially stop pumping crude from their wells because it is more expensive to pull it out of the ground than the oil is worth. North American rig counts have already fallen precipitously; at these levels, they are likely set to fall even more. As rig counts fall, supply lessens from this area, and investment in future productive capacity also likely falls. This may set the oil market up for much higher prices in the future, repeating past energy cycles. Investors should consider buying the Energy Select Sector SPDR ETF (NYSEARCA: XLE ), which contains the larger players in the energy sector, to capitalize on this potential for higher oil prices in the future. Investors should avoid buying the SPDR S&P Oil and Gas Exploration and Production ETF (NYSEARCA: XOP ); however, as many of these producers are smaller and may not be able to ride out the storm. Investors should also avoid the United States Oil ETF (NYSEARCA: USO ), as contango will eat away at profits over time. Cash Operating Costs of the Marginal Shale Producer Below is a chart of the estimated cash operating cost of oil production for oil producers globally. “Cash cost” is the variable operating cost of pulling oil out of the ground. These figures are roughly a year old, but are probably still relevant. Note that Canadian oil sands, U.K. producers, and U.S. producers are on the upper end, within a $25-40 barrel cash cost range. As oil prices dip into these levels, independent producers will begin to shut-in production as it stops making economic sense to continue producing. This, in theory, should create a floor on the price of oil, as the price-determining marginal supply from these producers diminishes. Note that as the price dips as low as $30, almost 30% of producers are operating at levels that don’t make sense to continue. (click to enlarge) Source: Morgan Stanley and Business Insider Falling North American Rig Count Rig counts have fallen dramatically since last year as oil has collapsed and oil producers have cut back CAPEX in the face of a deteriorating credit market in the oil and gas sector. New rigs that would be too expensive to operate at low oil prices are not coming online, and old rigs being phased out are not getting replaced. Per Baker Hughes, North American rig counts have collapsed from a high of 2,300 rigs to 883 today, or a decline of 61% in one year. North American Rig Count through Time (click to enlarge) Source: Baker Hughes and Bloomberg Given that many producers have cash costs of oil in the $30-40 range, rig count is likely to decline further with oil breaching $35 a barrel, in my opinion. As rig count falls, the industry as a whole sets itself up for stronger oil in the future. The effect is twofold; supply of oil falls initially, stabilizing prices, but then the ensuing underinvestment in oil infrastructure creates a situation where oil prices could increase dramatically as underinvested producers are less able to quickly increase production in response to higher oil. We could see a repeat of the underinvestment of the late 1990s that led to the boom in oil prices in the mid-2000s. Buy XLE, Avoid XOP and USO Investors should consider XLE, as it contains very large producers such as Exxon Mobil (NYSE: XOM ), Chevron (NYSE: CVX ), and Schlumberger (NYSE: SLB ) that have the ability to weather the storm of lower oil prices for a long time. Investors should avoid XOP, as it contains a higher concentration of smaller capitalization companies that may not be able to survive mid-30s oil for a long time. I could imagine a situation where oil remains in the mid-30s, and XOP continues to tank, as smaller producers come under increasing financial pressure. See below for the breakdown of top holdings of XLE and XOP; note that some of the largest concentrations in XOP are in stocks with market caps of less than 4BN: Source: Bloomberg Investors should also avoid USO, as it is long oil futures contracts, and is therefore subject to the negative roll yields associated with contango. Oil contracts trade for future delivery at specified points in time. Currently, the market is in contango, meaning that contracts further into the future are more expensive than contracts expiring closer to the present. Contango in WTI Crude (click to enlarge) Source: Bloomberg USO owns short-dated contracts, and as those contracts expire, it sells them and buys contracts further into the future. With today’s prices, for example, USO would sell the Jan. 16 expiries at 37.11 and buy the Feb. 16 expiries at 38.27, creating a 37.11/38.27-1= -3.03% yield in just one month. A rough annualization of that yield means that USO is currently losing 36.4% annually! It is better to own the producers themselves who sell their production forward in the futures market than to own a fund exposed to the cost of maintaining a long position in futures, as the price performance between XLE and USO over the past five years has shown. Shorting $1 of USO and buying $1 of XLE, price performance over past five years, excluding dividends: Source: Bloomberg Conclusion Oil in the mid-30s is approaching the cash operating costs of many North American oil producers. As oil falls, they will shut in production, theoretically creating a floor in the price of oil in this range. Underinvestment in oil production in the future due to low oil prices today may also one day contribute to strong future oil prices. Investors looking to take advantage of this potential floor should look to buy XLE, as it contains some of the largest oil-producing companies in the world, and should be able to weather the supply glut in oil, and avoid XOP, as it has smaller producers that may not be able to survive lower oil. Investors should avoid USO as it is subject to negative roll yields associated with contango in WTI futures markets.

Long/Short Equity Funds: The Best And Worst Of November

After posting losses in September and gains in October, Morningstar’s long/short equity mutual fund category was flat for the month of November – but this doesn’t mean there weren’t standout funds. Indeed, one of the worst performers from October was able to bounce back into the top three for November. In this review of the category, we look not only at the one-month returns of the month’s best and worst funds, but also the composition of their three-year returns in terms of alpha and beta, as well as their three-year Sharpe ratios and standard deviations. A quick refresher: Beta refers to the risk level of a security relative to the market. A beta of 1.0 implies the same risk level as the market, while a beta of more than 1.0 means the security (or fund in this case) is riskier than the market. A beta of less than 1.0 implies a risk less than the market. Alpha is the amount of performance in excess of a security’s beta adjusted benchmark. Sharpe ratio is a measure of return (above the risk free rate) per unit of risk – the higher, the better. (click to enlarge) Top Performers in November The three best-performing long/short equity mutual funds in November were: For the second straight month, a Catalyst fund topped the list. But while October saw the Catalyst Hedged Insider Buying Fund (MUTF: STVIX ) lead all long/short equity mutual funds, in November it was the Catalyst Insider Long/Short Fund that led the pack at +7.21%. For the first eleven months of the year, CIAAX returned an even 2%, and its three-year return through November 30 stood at an annualized 4.42%. The fund had a negative alpha (-0.60) for the three-year period, with a three-year beta of 0.39, and a Sharpe ratio of 0.35. The Burnham Financial Long/Short Fund was November’s second-best-performing long/short equity mutual fund, with returns of +5.53%. While its gains lagged those of the Catalyst Insider fund, BURFX’s longer-term numbers are much more appealing: Its three-year return of 20.31%, and alpha of 11.98%, was accomplished with a relatively low level of volatility (9.17% standard deviation) and a beta of just less than half the market (0.45). The fund’s three-year Sharpe ratio of 2.07 is outstanding. Finally, the Turner Medical Sciences Long/Short Fund was the third-best long/short equity mutual fund to own in November, boasting returns of +5.36%. This was a turnaround for the Turner fund, which was the third-worst performer in October, with losses of 4.99%. Over the past three years, TMSCX has returned an annualized 14.61% with a beta of just 0.19. This has resulted in the fund’s alpha of 11.94% ranking just 4 basis points less than the Burnham fund above, despite a much lower 3-year annualized return. However, with it’s higher standard deviation over the period, the fund’s Sharpe ratio stood came it 0.93 for the three-year period, a bit less than half the Burnham fund’s Sharpe ratio. (click to enlarge) Worst Performers in November The three worst-performing long/short equity mutual funds in November were: The Philadelphia Investment Partners New Generation Fund, the month’s worst performer, lost more than the month’s top-performer gained, with a one-month return of -7.55%. Its dismal three-year returns of -5.45% can be broken down into a 0.80 beta and -17.54 alpha, resulting in a Sharpe ratio of -0.49 for the three years ending November 30. The Clinton Long Short Equity Fund hasn’t been around long enough to have three-year return data, but its one-month losses of 4.84% in November made it the second-worst long/short equity mutual fund to own that month. For the first eleven months of 2015, WKCIX lost 13.49% of its value. The Whitebox Tactical Opportunities Fund ( WBMIX ) was November’s third-worst long/short equity fund, with returns of -3.58%. For the first eleven months of 2015, WBMIX generated losses of 19.50%, and its three-year returns of -3.17% through November 30. The fund has a low 3-year beta of 0.13 and a -4.90 alpha. The fund’s three-year Sharpe ratio stood at -0.33 as of November 30. (click to enlarge) October’s Best and Worst: Follow-Up The Catalyst Hedged Insider Buying ( STVIX ), Tealeaf Long/Short Deep Value (MUTF: LEFIX ), and Giralda Manager (MUTF: GDAMX ) funds were October’s top three long/short equity mutual funds, with respective one-month returns of 10.71%, 9.05%, and 8.73%. In November, STVIX returned a category-matching 0.00%, while LEFIX and GDAMX posted respective one-month returns of 3.02% and 0.15%. October’s worst performers were the CMG Tactical Futures Strategy Fund (MUTF: SCOIX ) and the Highland Long/Short Healthcare Fund (MUTF: HHCAX ), which lost 6.74% and 5.54%. In November, those funds continued their losing ways with returns of -2.02% and -1.55%, respectively. Past Performance does not necessarily predict future results.

The Dynamics Of Liquidity And Investing

I’ve been getting questions recently about liquidity , specifically in the context of exchange traded funds ( ETFs ). Liquidity is a hot topic in financial markets these days, so let’s spend a little time going over it. First, we’ll explore what we mean by “liquidity” and then we’ll explain what it means when it comes to ETFs. Defining liquidity When I think about liquidity, I think about a transaction: I am able to buy or sell something at a known price. The more liquid an investment, the easier it is to buy and sell without affecting the asset’s price. More fully, liquidity has three main components: price, time and size. If an asset is liquid, I can trade it quickly, and I can trade a large amount of it, without moving its price. In reality, most investments involve trade-offs between these three components. Want to trade quickly? You may not be able to trade a large amount, or you may impact the price you are going to receive. Want to trade a large amount? Do it slowly, or be prepared to impact prices. A general rule of thumb for liquidity for most investments is that you can get two of the three attributes, but not all three at once. If we consider liquid assets, a large cap stock is a good example. Unless you are trading a significant number of shares, you can generally trade fairly quickly at a price that is close to what you see on the exchange. A home, on the other hand, is relatively illiquid; you can get an estimate on its price, but until a buyer signs on the dotted line and you have a check in hand, it’s unclear what you’ll actually get when selling your home. And it will generally take you a while to sell your home, no matter what its size. Liquidity and ETFs When it comes to a security like an ETF, I can see that it’s trading at a certain price, and I can generally buy or sell that ETF at a price that’s pretty close to the quoted price. I can generally trade fairly quickly, as long as my trade is not large compared to the security’s volume. A large ETF trade is in some ways similar to a large equity trade; I need to trade over time or risk impacting the price. Let’s take it a step further and look at bond ETFs. If you want to go out and buy a bond, you can’t just buy it on the open market via an exchange. Instead you would buy it over the counter, in a negotiated transaction with a broker. The price you would trade at is often unclear, and it can be difficult to trade a large amount, or trade quickly. In fact, some investors may find that individual bonds don’t have any of the three aforementioned features of liquidity. With a bond ETF, which is a basket of bonds traded on an exchange, you have much more price transparency. You can actually see the price at which a bond ETF is trading and have a sense of the price of a trade and how many shares might be available to trade at that price. As the bond ETF trades on an exchange, you can generally trade it with the same speed as an individual stock. The liquidity rule of thumb still applies to bond ETFs; it can be difficult to trade in large size, quickly and without impacting price, but overall, exchange trading liquidity can be greater than liquidity in underlying markets . And that is an improvement that all investors can benefit from. This post originally appeared on the BlackRock Blog.