Tuesday, December 27, 2016

Drinks with the Dragon: Find your investing soulmate, 2016’s biggest miss and most important lesson



Hey, value investing crew. It’s been awhile, but welcome back to another session of “drinks with the dragon” where I ramble about random shit related to business and investing. So, 2016 huh? A year that started out depressing as fuck but ended with a motherfucking bang. The Greedy Dragon portfolio had been hitting record highs soon after Trump won the presidency and the republicans maintained control of the house and senate. Republicans have always been better for the economy than the closet socialists aka democrats. If Trump would only be pro free trade and completely support free speech, he might actually turn out to be a pretty good president. The Greedy Dragon portfolio has backed down a bit from its highs in the past 2 weeks because that puta we call Mr. Market can’t let a real guy like me win too much. But whatever, 2016 was still awesome (as long as I don't get fucked over by the markets in the last week of the year).

Anyway, I think that most people can achieve better investment results if they had a partner. And when I say partner I don’t mean someone that you have sex with. I mean someone you could bounce ideas off, someone who is willing to argue with you if he thinks that you’re wrong. Although, I must say that it would be pretty fucking awesome if you could find a gal that you could both talk investing and sleep with. Warren Buffett & Charlie Munger, Batman & Superman, Walter White & Jessie Pinkman, and Sean Mcnamara & Christian Troy are some examples of two people coming together to do awesome stuff. You don’t need to pool your money together with your partner or nothing. Just go grab a cheeseburger or something, and have an honest conversation about investing ideas. I would have saved at least a few thousand ringgit if only I had someone to fight me and convince me to avoid just one bad investment. Just make sure your partner is not a moron. Or worse, a fucking yes man who nods along and smiles as you commit financial harakiri. You feel me?

Looking back on 2016, I should have invested in natural gas when Henry Hub natural gas was trading below $2 per MMBtu early in the year. Putting aside the fact that I didn’t know how to get exposure to the commodity, I felt that I could have made a few bucks betting on natural gas when the price was low. There’s the United States Natural Gas Fund that trades on the NYSE Arca, but there’s this issue with contango. Anyway, natural gas prices got whacked earlier in the year because stockpiles were very high as a result of the strong supply from shale and what with last winter being rather mild. No doubt, the price of natural gas needed to get got for the oversupply situation to be worked out. However, I thought that the selloff was excessive as natural gas share of power generation in the US had recently increased and had even surpassed coal-fired generation most months. I figured that with more normal temperatures, the increased reliance on natural gas for power generation would result in stockpiles eventually getting back closer to normal levels. The low natural gas prices also made many of them natural gas drilling locations unfeasible as evidenced by the falling natural gas rig count back then. According to YCharts, the US natural gas rig count stood at 88 on April 1, 2016, down from 222 on April 2, 2015. I believed that the sharp drop in natural gas rigs would eventually translate to lower natural gas production which would also help bring stockpiles back to more normal levels. Note: I have no opinion on natural gas as an investment at today’s prices.

Hindsight 20/20, I wasn’t too far off the mark. The January 2017 Henry Hub natural gas futures closed at $3.662 per MMBtu on December 23. The huge natural gas stockpile situation has improved dramatically.  According to the EIA, as at December 16, 2016, working gas in storage was 3,597 Bcf. This is down 5.9% from a year ago and just 2.2% above the 5-year average for this time of the year. U.S. natural gas production has also come down some. For the week 12/15/16 - 12/21/16, dry production was 70.4 bcf/day. This is down from dry production of 73.8 bcf/day last year. Winter is still young, and will probably play a big role on where natural gas prices will go from here. Will it be a warm, normal or cold winter this time around? Well, that’s something you should ask Sansa Stark or someone who knows what a fucking polar vortex is.

The most important thing that I learned in 2016 would be to pay attention to the covenants that apply to the company you’re analyzing. A company could be considered to be in technical default of its debts despite appearing solvent on the surface. A company with an EBITDA that’s 2 times greater than its interest expense would be in violation of a covenant that requires it to maintain an EBITDA/interest ratio of 4. The most common financial covenants would require a company to maintain a certain debt/EBITDA ratio, EBITDA/interest ratio and maybe some liquidity ratio. I would perform a scenario analysis to see if the company is able to comply with its covenants if its businesses were to take a significant hit. 

Sure, a company in violation of its covenants might be able to negotiate with its creditors to avoid default. But I had rather not be in a situation where I’m at the mercy of the creditors. The company might also be subject to a variety of other covenants such as covenants that restrict changes in control, additional borrowings, sale of assets, dividends, acquisitions and etc. You got to read like a mofo to know what’s up.

I hope y’all had a merry Christmas and a good 2016 overall. Thank you for following my investment journey despite me not punting out content on a regular basis. Have a happy fucking new year. Take care and stay rational.

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