Specious Argument

Congratulations To Canadian Olympic Athletes

2010-02-28T23:35:00Z

Congratulations to Canadian Olympic Athletes! In Vancouver 2010 Olympics, Canada won 14 Gold, 7 Silver, and 5 Bronze medals. Canada holds the record for the most gold medals in a Winter Olympics. All Canadians are proud of all our athletes and their accomplishments.

I just finished watching Hockey gold medal game between the United States and Canada, with Canada winning 3-2 in overtime where it was four on four. Watching Canada give up its 2-0 lead with the last goal scored in the remaining 24 seconds was certainly difficult. I am sure all Canadians were sitting on the edge of their seats. Fortunately, Sidney Crosby scored the goal at 7:40 in overtime.

Team USA played extremely well throughout the entire Olympics. They are a young team that many expected would exit early. In fact, they had to rebook their flights because of their unexpected final gold medal game. Congratulations to Team USA on their silver medal.

Congratulations to all athletes from all countries. I hope you enjoyed your stay in Canada.

Finally, my heartfelt sympathies to the family of Nodar Kumaritashvili and all those who knew him. Nodar Kumaritashvili was the Georgian luger athlete who died while practicing prior to the start of the Olympics. I hope his death causes the International Luge Federation to examine the safety of all tracks.

Again, congratulations to all Canadian Olympic Athletes!

On Thursday, 10 September 2009, I photographed Calgary model Anya near Mount Rundle in Banff National Park, Alberta. If you click on my Flickr profile link, you will be taken to Flickr where you can see more of my pictures.

A Pivotal Challenge In 2010: Unemployment

2010-01-11T01:24:20Z

If you haven't seen the video (embedded above) with Peter Schiff, Euro Pacific Capital president, then I urge you to view it. He articulated his bearish case on Monday, 4 January 2009. For those of you who are tuning in via email or RSS and are unable to see the embedded video, please select the video link to Peter Schiff on CNBC Fast Money.

Barry Ritholtz over at The Big Picture showed a series of unemployment charts. Again, if you haven't seen them, visit Ritholtz's site and view the charts. For a picture story, I especially like the last graph from Calculated Risk. The unemployment graphs reinforce Schiff's thesis of a challenged consumer.

I enjoyed reading John Mauldin's 2010 Forecast: The Year of Uncertainty (PDF, 203 kb). Mauldin chose a very appropriate title. In his article, Mauldin discussed the unemployment and what it might mean for the economy in 2010.

All three sources—video, charts, and 2010 Outlook—point to unemployment being a pivotal challenge in 2010. Unemployment is unacceptably high, especially when you consider the U-6 unemployment statistic at 17.3%. 2010 is indeed the year of uncertainty.

Happy New Year 2010!

2010-01-02T01:40:00Z

Happy New Year 2010!

I wish everyone much happiness, health, and prosperity. Many people found last year, 2009, difficult and challenging. So I hope that 2010 is a much better year, one filled with more joy and optimism.

I further wish our NATO troops well and hope we can make substantial progress toward resolving conflicts. Too many people are suffering.

On Thursday, 10 September 2009, I photographed Calgary model Anya near Bow Falls in Banff National Park. If you click on my Flickr profile link, you will be taken to Flickr where you can see more of my pictures.

Exxon Mobil Takes Over XTO Energy

2009-12-15T04:00:00Z

Today, Exxon Mobil Corporation (XOM) announced that it plans to acquire XTO Energy Inc. (XTO) for about $31 billion in stock plus another $10 debt in assuming XTO's debt obligations.

IRVING, Texas--(BUSINESS WIRE)--Exxon Mobil Corporation (NYSE: XOM) and XTO Energy Inc. announced today an all-stock transaction valued at $41 billion. The agreement, which is subject to XTO stockholder approval and regulatory clearance, will enhance ExxonMobil's position in the development of unconventional natural gas and oil resources.

Under the terms of the agreement, approved by the boards of directors of both companies, ExxonMobil has agreed to issue 0.7098 common shares for each common share of XTO. This represents a 25 percent premium to XTO stockholders. The transaction value includes $10 billion of existing XTO debt and is based on the closing share prices of ExxonMobil and XTO on December 11, 2009.

Although I have a net long position in ExxonMobil that decreased in value with ExxonMobil's share price falling $3.14 from $72.83 on Friday to $69.69 at today's close, I am positive on ExxonMobil's takeover of XTO. I believe that with natural gas prices near their lows, now is an opportune time to acquire natural gas companies. Moreover, XTO's core positions are in unconventional natural gas plays located in Texas, Louisiana, Arkansas, Oklahoma and Pennsylvania. XTO's skills and knowledge on how to develop these resources will be helpful to ExxonMobil, because it has other unconventional natural gas plays, including foreign opportunities in British Columbia, Poland, Germany, and Argentina. A good summary document that explains the benefits is ExxonMobil's investor presentation (PDF, 174 kb).

Please note that you can click through the chart to see a full sized image.

One comment that I heard from Tim Seymour on today's CNBC Fast Money (see the below embedded video between the four and five minute marks) is that ExxonMobil must believe that its stock is overpriced since it used an all stock deal. From having listened to ExxonMobil's earlier conference call, I believe Seymour's assertion is false. XTO wanted an all stock deal because it would be tax free to XTO shareholders. Had ExxonMobil used cash, then XTO shareholders would be deemed to have sold their shares. By having an all stock deal, XTO shareholders can decide for themselves if they want to sell their shares and pay taxes now or hold ExxonMobil's stock for further appreciation in the future. If an executive of XTO has a large number of XTO shares and believes that XOM's share are inexpensive, then she might prefer to hold the ExxonMobil stock rather than incurring capital gains tax. As far as ExxonMobil is concerned, it can continue to buy its own shares back. Regardless of which path chosen, it would have continued to use its surplus cash for repurchasing shares.

Email and rss readers might not see the embedded CNBC video above. If you don't see the video, please visit my blog.

Despite losing today, I am positive on the overall transaction. I believe that XTO and ExxonMobil shareholders will benefit from the transaction. XTO brings substantial physical resources and skilled employees with specialized knowledge while ExxonMobil has financial strength, global scale, and exceptional development and management processes. Brought together, they can find and develop more profitable opportunities.

I used today's lower stock price to increase my net long position.

Disclosure: I am long Exxon Mobil stock as well as long and short puts for an overall net long position.

On Saturday, 18 July 2009, I photographed North Glenmore Park in Calgary Alberta. If you click on my Flickr profile link, you will be taken to Flickr where you can see more of my pictures.

Thanksgiving Weekend 2009 Best Ever For Blue Nile

2009-12-01T17:10:00Z

On Monday, 30 November 2009, Diane Irvine, Chief Executive Officer, of Blue Nile (NILE) spoke with CNBC and with Business News Network in Canada. The above embedded video is from CNBC and, although I am unable to embed the video from BNN.ca, you can click the following link to BNN's interview.

While I recommend viewing both videos, here are some quick points:

Best Thanksgiving Weekend ever;
Company has 4.5% of U.S. engagement ring market;
Competition is the high end brick and mortar jewelers across the country;
Industry consolidating and Blue Nile continues to gain share;
Looking for double digit growth in the fourth quarter;
Great business in Canada, its first international location;
Addressing security concerns, company ships its products fully insured and uses FedEx (FDX) Priority Overnight service;
Most transactions through credit card and bank wire; and
Irvine is confident that, by remaining steadfastly focused on operating the business, the company's stock price has a lot of runway in the longer term.

Blue Nile stock closed on Monday at $55.89.

For those reading my article by RSS or email, you might need to visit my blog to view CNBC's embedded video.

Disclosure: I am long shares in Blue Nile.

Pan American Silver Third Quarter 2009 Conference Call

2009-11-22T17:45:00Z

I will discuss the Pan American Silver Corp. (PAAS) third quarter conference call held on 11 November 2009 by providing the conference call's major themes in point form. Because I believe the company is well managed by seasoned and competent professionals and because of my concern with potential inflation, Pan American Silver remains one of my core holdings.

In addition to transcripts of the company's conference call (see Seeking Alpha for the transcript), I used the company's press release with financial highlights (PDF, 49 kb). The press release is well worth reading for a quick snapshot.

General Comments

New quarterly record silver production of 6.4 million ounces, up 31% from same quarter last year and up 10% compared to second quarter 2009.
New quarterly record gold production of 28,000 ounces, up 12% from same quarter last year. Gold is the most significant byproduct, accounting for almost 20% of total revenues.
Consolidated cash costs declined 26% to $4.91 per ounce, which is well below the company's full forecasted amount of $6. The company has managed to keep its cost savings that it created earlier this year.
Cash flow from operations before working capital adjustments was $43 million or $0.50 per share. Pan American had net income of $17.4 million or $0.20 per share, an increase of 172% from third quarter last year and $7.2 million higher than second quarter this year when it was in crisis mode.

Manantial Espejo, Argentina

Company very happy with its results thus far.
Over 1 million ounces of silver at a cash cost of negative $3.11 per ounce, which is the result of over 20,000 ounces of gold production that more than covered all operating costs. Remember, byproducts are treated not as revenue but rather as negative costs.
Pan American solved its mechanical problems (failed grinding mill motor), and the mine processed nearly 170,000 tons of ore.
Silver mill feed was 214 grams per ton, of which 88% was recovered, just shy of the company's expectations. The shortfall, however, was more than compensated by better than expected gold grade of 3.9 grams per ton and better than expected gold recoveries of 95%.
Pan American expects slightly improved performance in the fourth quarter at similar cash costs.

Peru

Produced just above 2 million ounces of silver at a cash cost of $8 per ounce of silver.
Higher base metal prices helped to offset the Doe Run smelter closure in Peru.
Company expects that its production will increase by about 10% from the current 910,000 ounces of silver per quarter to close to one million of ounces of silver per quarter with costs decreasing from $10.35 to $7.50 per ounce.
Pan American is pleased with its Morococha mine where it is producing at nearly 750,000 ounces of silver at a cash of $5.33 per ounce. Company expects similar results for a substantial, but undisclosed, period.
The Quiruvilca mine is operating at reduced yet profitable conditions. It produced more than 360,000 ounces of silver at a cash cost of $7.69 per ounce. The cash costs include capital expenditures, which are expected to continue into early 2010.

Mexico

Alamo Dorado mine produced 1.6 million ounces of silver at a cash cost of $4.37 per ounce. Gold production was nearly 5,000 ounces versus expectations of only 3,000 ounces.
Production rates will decline for Alamo Dorado. Expectations for the fourth quarter are one million ounces of silver. This rate will extend to mid to late 2010. Production should increase again as high grade ore from Phase II pit is used.
La Colorada mine produced 885,000 ounces of silver at a cash cost of $7.92 per ounce.

Bolivia

San Vicente produced over 870,000 ounces of silver at a cash cost of $5.81.
Ramp up continues ahead of expectations with the plant processing just over 600 tons per day against design capacity of 750 tons per day.
Higher grade ores are being mined.
Winterization projects have been completed. Mineworkers are gaining confidence in the plant's operation as their familiarity has increased.
The mine expansion and plant construction has brought economic benefits to the local community of San Vicente.
Company believes that its success at San Vicente is viewed positively in the country and that it might provide additional incentives for further foreign investment into a region that desperately needs more economic activity.

Exploration

I did not provide a detailed summary of the exploration portion of the conference. While it is vitally important, it is specialized information. Please consult the transcript for more detail.
Key comment from the transcript is as follows: "All of this new information will included in general reserve and resource update, which I will share with you in January 2010. I'm confident that once again, we will more than replace all of the resources ounces we've mined in 2009."

Financials

Pan American reported record sales of $118.6 million, a 49% increase from a year ago. This increase is attributable to record silver and gold production and strong silver and gold prices.
Mine operating earnings were $34.7 million, more than double last year's value and up 48% from last quarter. Net income was $17.4 million, which translates to $0.20 per share, again more than double last year's value and up 70% from Q2.
Cash flow from operations before working capital adjustments was $43.3 million. With reduced capital expenditures of $5.8 million, the company banked $28 million.
The prior results would have been even stronger had the company been able to sell more of its metals. Concentrate shipments and the Doe Run refining schedules resulted in a buildup of inventory.
The addition of high margin production from Manantial Espejo and San Vicente mines and the continuation in and recovery of strong metal prices helped boost the company's results. The average margin per ton of ore milled has gone from $10 in Q4 2008 to $53 in Q3 2003. Moreover, the total number of tons moved has increased by 50% over that same period.
Sales increased by $39.1 million from the third quarter 2008. This results almost entirely from increases in the quantities of silver and gold sold, which increased by 30% and 450% respectively.
Working capital increased by $41.6 million to $258 million. Most of the increase in working capital is higher cash and short term investment balances, which rose $37.1 million to $150 million. The Doe Run concentrated inventory increased during the quarter, which added an additional $10.3 million to working capital.
Company has no debt.
With the construction of Manantial Espejo and San Vicente accomplished, the capital expenditure for the third quarter on property, plant and equipment was only $5.8 million.
The Doe Run of the La Oroya smelter situation has improved. It was closed during the third quarter and remains closed today. Doe Run was a larger buyer of the company's copper concentrate production and only buyer of the stockpile material. The company has been able to sell a couple of concentrates shipments to other buyers during the third quarter 2009. Because other financial terms were inferior, an added $1.35 per ounce of cash costs were incurred at the company's Huaron mines. The company believes that recent developments surrounding Doe Run have been positive. It expects that the smelter will resolve its financing requirements and resume operations in the first half of 2010. Moreover, the company retains a debt provision of $4.4 million in the second quarter related to accounts receivable from Doe Run.

Closing Comments

Company remains positive: maintaining 2009 production forecast of 25.1 million ounces of silver at or better than $6 per ounce cash costs.
More than double, nearly triple gold production at 85,000 ounces.
Company has discovered an exciting new extension at the MCTU zone at the La Colorada mine. Good things should result.
Progress is being made at Manantial Espejo and the company is targeting a full feasibility study by year-end. There are several new exploration targets.
Company has a defined silver resource La Preciosa with an excess of 135 million ounces of silver in Mexico. The location is within an hour of its existing infrastructure in Durango. It is well positioned to take advantage of this opportunity.
The friendly takeover of Aquiline Resources Inc. will create value for shareholders of both companies. It will combine Pan American's financial strength and proven mine development expertise with Aquiline's work class primary silver deposit Navidad. Because of the company's success in working in Argentina, being able to address local and political sensitivities, the company is well positioned to move Navidad forward. With La Preciosa and Navidad, Pan American will possess a strong growth pipeline.

Questions and Answers

Much of the question and answer was related to detailed mining operations information. There was one question related to the company's hedging policies.

The company's philosophy firstly on silver is not to hedge the exposure that we have to silver. So our hedging program is really confined to byproducts particularly base metals and from time-to-time currencies. The moment we have a very small residual zinc program in place, which runs out at the ends of December and the same that goes to our currencies.

We have a small Mexican peso and Peruvian sol position, which also in December. So for 2010, we actually won't have any hedge positions open. However, the subcommittee of the Board of Directors and the Hedge Committee does review those businesses from time-to-time and we maybe adding to them depending on the circumstances.

The company receives spot prices for its gold byproducts.

My Overall General Impressions

Pan American Silver Revenue and Earnings Estimates
Financial Metric	Current Qtr Dec-09	Next Qtr Mar-10	Current Year Dec-09	Next Year Dec-10
Data Sources	Yahoo Finance 21 November 2009
Revenue Estimates	117.75M	127.37M	426.37M	470.24M
Earnings Estimates	0.27	0.26	0.75	1.33

Please note that you can click though each chart above to see full sized images.

One of the hedge fund managers that I follow is Bill Fleckenstein of FleckensteinCapital.com (subscription site). Fleckenstein has been extremely critical of central bankers and in particular Greenspan (see Greenspan's Bubbles: The Age Of Ignorance At The Federal Reserve), who served as Chairman of the Federal Reserve of the United States from 1987 to 2006. Because of the Fed's prior and current policies and actions, Fleckenstein has been and remains bullish on precious metals and some mining companies. Please note that he is a director of Pan American Silver.

As an aside, for all those who wish to listen to a few podcasts featuring Bill Fleckenstein, you can listen to Eric King's interviews.

As I indicated in my prior article (Pan American Silver 2Q 2009 Conference Call), I believe that Pan American is an extremely well managed company. Like Fleckenstein and others, I further believe that with the massive money printing by central bankers, excess liquidity might manifest itself in higher commodity prices, especially in silver and gold prices.

One concern that I have, though, is that the stock price of a mining company sometimes underperforms the price of the commodity being mined. Jim Rogers, who wrote Hot Commodities: How Anyone Can Invest Profitably in the World's Best Market, stressed that it is often better to buy the actual underlying commodity rather than a mining company. His rationale is that when you invest in a company, you then have to worry about such things as management, confiscation through rising royalties and taxes, environmental regulations, increased labor costs, increased energy and other input costs, political disruptions and many other similar factors. These problems sometimes cause a company's share price to underperform the price of actual commodity itself. When compared against Pan American Silver's share price over the past two years, iShares Silver Trust (SLV) shows superior performance. iShares Silver Trust is an ETF that tracks the price of silver.

As an aside, iShares Silver Trust has 293,087,484.400 ounces of silver in trust as of 22 November 2009. On 12 September 2007, slightly more than two years ago, iShares Silver Trust had roughly 139 million ounces in trust.

A cautionary note, however, with the two year comparison chart. Comparisons are often highly dependent upon the start date and duration. Changing either or both will often result in an opposite conclusion.

My impression is that Pan American lost ground to iShares Silver Trust in October through November 2008. Since then both price lines have been highly correlated. I suspect that if silver and gold metal prices were to rise quickly, all other things being equal, then Pan American would benefit more than iShares Silver Trust because other Pan American Silver's input costs would remain reasonably stable. If silver and gold prices were to rise slowly, however, then I am less certain which would benefit more.

Against this two year historical backdrop where the iShares Silver Trust share price outpaced Pan American Silver's share price, however, are the company's plans to add more low cost production, which should favor Pan American Silver's share price. I expect that, after the friendly takeover of Aquiline is complete and during its fourth quarter conference call early in 2010, the company will provide more details on its plans to expand production.

The key point from this discussion is that sometimes investing in an underlying commodity is better than investing in a mining company.

Unless my fundamental outlook changes or Pan American Silver begins disappointing, it will remain a core holding. On Friday, 20 November 2009, Pan American Silver stock price closed at $24.88.

Disclosure: I am long Pan American Silver Corporation shares. As part of the Amazon Associate program, I receive remuneration for each book sold by clicking on the Amazon.com links in my article.

While biking around the Glenmore reservoir in Calgary on 18 July 2009, I saw some people sailing in their boat hi9. If you click on my Flickr profile link, you will be taken to Flickr where you can see more of my pictures.

Book Review: Options Volatility Trading By Adam Warner

2009-11-17T20:30:00Z

Preface

For those of you who don't know, Adam Warner writes the excellent and influential blog Daily Options Report. I began reading his writing when he co-wrote the options column on Street Insight (part of the TheStreet.com family) from spring 2003 to spring 2005. He is currently Options Editor at Minyanville.com. You can read his profile at his About on his blog.

Readers should know that I correspond occasionally with Adam Warner and that I respect him. I have learned a tremendous amount from his articles and from his answers to my questions. Moreover, I admired his warning readers that they might wish to exercise caution when following Lenny Dykstra's options articles on The Street.com. His warnings were long before Dystra's problems became fodder for the mass media, including CNBC. Adam is a friend and thus some might consider my book review biased.

Overall Summary

I use options in my trading and investing. However, I am not a sophisticated options trader who rebalances his delta hedge on an hourly or daily basis. Instead, I tend to use options to profit from the view I have of the markets or a stock.

As part of my on-going learning, I do read about options on websites, newspapers, and blogs. I read about options traders taking advantage of gamma, and, although I had a sense of what they were doing, I was never clear. After reading Adam Warner's book Options Volatility Trading: Strategies for Profiting from Market Swings, I have a solid understanding.

I thoroughly enjoyed this book because it was like having a conversation with Adam, where he gave me a tutorial on how he thinks about options and how he trades them. He could easily have used complex mathematics, charts and diagrams, overly complex strategies to confuse most readers. Instead, he chose a conversational tone with sufficient material that most options readers would readily understand.

If you are brand new to options, this book might not be the proper entry point. Instead, you might wish to view the learning tutorials covered by Options News Network, an online site dedicated to, surprise, options.

If, however, you have a reasonable understanding of options, then you will find this book invaluable. By reasonable understanding of options, you know what a put and a call are and can describe them. Moreover, you have a rough idea of the Greeks, though Warner does provide a quick snapshot of the Greeks in his book. You don't require a strong or thorough understanding, just a reasonable understanding, to benefit from reading this book.

As fair warning, I did read some sections slowly and more than once. However, when I learn new material, I often read sections slowly and more than once. I learn better using this technique.

After reading Warner's book, I am much more comfortable in reading options articles. For example, when authors talk about the VIX, I am knowledgeable about the VIX, how it works, how to interpret it, and its shortcomings. I have a better appreciation of which options strategies to employ when.

Now that I have read this book, do I plan to become an aggressive options trader? I do not think so. Will I use strategies discussed in this book to enhance my returns? Yes, absolutely.

Is this book a worthwhile investment? Yes, most definitely. Even if the only benefit you derive is being able to understand options articles better than you did before, the book is a worthwhile investment. My knowledge is much stronger than it was before. And, I know that will profit from the knowledge and strategies discussed in the book.

I highly recommend Options Volatility Trading: Strategies for Profiting from Market Swings—Five Stars.

Introduction

Adam Warner sets out the tone of the book where he explains that he will focus on volatility and the VIX. You will learn how to measure volatility or how to manage an active account or an investment portfolio with an ever-changing set of backdrop conditions.

Chapter 1: Who Am I? Why Am I Here?

From August 1988 until the 2000 timeframe, Warner worked as a Market Maker on the floor of the Amex Options Exchange. He describes his experiences and how the Amex changed during his tenure. My most important take-away is that Warner had to think quickly on his feet. Thus, through his experiences, he not only understood the technical aspects, but also gained an intuitive feel. I like that the author has achieved a wealth of knowledge and confidence.

Chapter 2: Know Your Greeks

Warner provides a quick high-level tutorial on the options Greeks. If you are looking for a thorough, rigorous text discussing the intricacies of the Greeks, then you'll need to consult other texts. His purpose in this chapter is to ensure that you have sufficient knowledge to understand the rest of the text.

As part of his quick overview, he teaches you how to think about your position sizing by using delta. That is, convert your option exposure through delta into a stock position. Given your portfolio, is your option size reasonable? While options can employ leverage to positive effect, they can, if you are not careful or have a string of poor luck, destroy your portfolio. He cautions readers to ensure that their positions are not outsized for their portfolios.

Here's a mental model that helped me:

Delta - Useful for sizing and judging risk exposure.
Theta - The slope on a hill while driving or biking. Either it is a positive force driving forward or it is a negative force that you need to overcome through trading.
Gamma - Represents the energy or power. If I have lots of gamma at my disposal, I can more readily overcome theta.

Chapter 3: Understanding the VIX

Warner provides a high level overview of the VIX. As part of his overview, he instructs you on how you should view and make sense of iVolatility.com historical and implied volatilities. He also provides some historical contexts and provides some quirks with the VIX.

Chapter 4: Nuts and Bolts VIX

This chapter picks up from the last and provides more detail. Warner teaches you how to interpret the VIX in that it provides an expectation, not a guarantee of future price movement. Moreover, market volatility expectations are formed from the volatility of individual stocks and their correlation.

Chapter 5: Volatility Timing

Not all days are created and not all months are created equal. Warner uses historical analysis to help guide you when it is usually better to buy and sell options.

Chapter 6: How Do Traders Trade Volatility

In general, net selling options at a higher volatility and net buying options at a lower volatility than they ultimately realize is profitable. However, active trading is often required. Warner discusses how often you should rebalance your delta hedge among other considerations.

Because of my style of trading options is so much different from Warner's volatility style, I found this chapter particularly rewarding and helpful.

Chapter 7: Options and the Quarterly Earnings Report

Often you hear analysts say, "Stock ABCD is expected to move X%, either up or down, after the bell when it releases its earnings."

This chapter teaches you how you can determine for yourself how much the stock is expected to move. This knowledge is helpful whether you are an option or stock trader. If your expectations are different from that of the market, you can play accordingly. But, as Warner mentions, you have to be prepared to defend your position and take your medicine when the markets surprise you.

Chapter 8: Like the Weather--The Trader VIX and Why It Doesn't Do What You Think It Does

For those that don't understand them well, VIX, VIX futures, VIX Options on Futures, and VIX ETNs are complex and confusing. After reading this chapter, I have a clear understanding of how these instruments work. Consequently, I will take Warner's advice not to use them. Instead, as he suggests, I will keep it simple by using a different set of common indexes and ETFs.

With all the discussion in the media about VIX and fear index and how people might want to protect themselves against volatility, investors and traders should understand VIX. I suspect a surprising number do not.

Chapter 9: Ratio, Ratio

Put call ratios should be interpreted and used with caution, especially for individual stocks. By themselves, they could indicate any number of scenarios, and for you the trader, it is often difficult, if not impossible, to understand which scenario is at play.

Chapter 10: We're (Pin) Jammin'

Warner discusses the circumstances that make pins more likely. A pin is where a stock expires at a strike price. If you knew in advance where a stock would be pinned, then you could profit from this knowledge.

Chapter 11: Myth-Busting and Other Assorted Options- and Expiration-Related Stats

There are several urban legends related options and options expiry. Warner examines a few of them and provides you with his analysis. For example, we often hear that expiration week is more volatile? Is that true, and if so, how can you profit from it?

Chapter 12: Buy-Write--You Bet

I found this chapter surprising because the results were exactly counter to my expectations. A buy-write is when an investor or trader buys a stock and sells a call. The call provides extra income while limiting potential capital gains. Under what circumstance is it advantageous to engage in buy-writes?

Chapter 13: Strategy Room

This is a great chapter because Warner provides his thoughts and analysis on some common strategies such as:

Naked Put;
Bull Call Spread;
Bear Put Spread;
Backspreads;
Calendar Call Spread;
Backspread and Calendar Spread Combined;
Butterfly Spread;
Iron Butterfly;
Condor;
Iron Condor;
Synthetics; and
Dividend Plays.

Armed with this knowledge, you are better equipped to think about which strategies you want to employ under various circumstances.

Chapter 14: Ultra and Inverse ETFs

I found this chapter surprising, because even though I am well versed in how double and triple exchange traded funds (ETFs) work, I didn't realize the size and scope of some of these ETFs. If you don't understand how ultra and inverse ETFs grind your results down over time, you definitely need read and understand this chapter. And perhaps you'll be surprised too at how important these ultra and inverse ETFs have become to the markets.

Chapter 15: Chartin' Them Derivatives

Many investors have profited by using technical analysis. In this chapter, Warner cautions traders not to employ the same methodology to derivatives. Under certain circumstances, it might provide some additional guidance around the edges.

Chapter 16: Plus Ticks and Other Rules

The key theme in this chapter is that you must trade the market you're given, not the market you would like it to be. Whether you agree with the plus tick rule for shorting stocks is irrelevant. Trade the market with rules as they exist.

Disclosure: As part of the Amazon Associate program, I receive remuneration for each book sold by clicking on the Amazon.com links in my article.

On Thursday, 4 June 2009, I photographed Ana Avramovic at Heritage Park in Calgary Alberta. If you click on my Flickr profile link, you will be taken to Flickr where you can see more of my pictures.

Where Did We Come From? Why Are We Here?

2009-11-17T03:30:00Z

On 14 November 2009, The New York Times published an article Water Found on Moon, Researchers Say (free registration might be required). I found that interesting because wherever there is water here on earth, there is life. Even in the most inhospitable places on earth, where there is water, there is usually life. So now that we have found water on our own nearby moon, is water found with abundance throughout our universe?

As a kid, I was never satisfied with the notion that life only exists on earth. Other stars and planets are so far away for us to understand them well. How could scientists and others possibly have concluded that life does not exist elsewhere? I wonder if our educational system still teaches students that earth is the only planet that supports life. I hope not, because I have confidence that someday we will find life existing elsewhere within our universe.

Late last week, over at the Edge.org, I viewed an interesting video presentation on Why Does The Universe Look The Way It Does. I particularly enjoyed his discussion on why there might be more than one universe.

Why do we find ourselves so close to the aftermath of this very strange event, this Big Bang, that has such low entropy? The answer is, we just don't know. The anthropic principle is just not enough to explain this. We really need to think deeply about what could have happened both at the Big Bang and even before the Big Bang. My favorite guess at the answer is that the reason why the universe started out at such a low entropy is the same reason that an egg starts out at low entropy. The classic example of entropy is that you can take an egg and make an omelette. You cannot take an omlette and turn it into an egg. That is because the entropy increases when you mix up the egg to make it into an omelette. Why did the egg start with such a low entropy in the first place? The answer is that it is not alone in the universe. The universe consists of more than just an egg. The egg came from a chicken. It was created by something that had a very low entropy that was part of a bigger system. The point is that our universe is part of a bigger system. Then you can start to try to understand why it had such a low entropy to begin with. I actually think that the fact that we can observe the early universe having such a low entropy is the best evidence we currently have that we live in a multiverse, that the universe we observe is not all that there is, that we are actually embedded in some much larger structure.

If this science material interests you at all, I encourage you to read The New York Times article and watch Sean Carroll's video. It's fun to ponder where we came from and why are we here.

On Thursday, 4 June 2009, I photographed Ana Avramovic at Heritage Park in Calgary Alberta. If you click on my Flickr profile link, you will be taken to Flickr where you can see more of my pictures.

Traffic Data For Blue Nile In October 2009

2009-11-15T18:00:00Z

Please click through for a full-sized chart.

The following quote came from today's Wall Street Journal article Less Sparkle at Blue Nile (subscription might be required).

Yet Internet traffic data suggests Blue Nile's competitive position may be eroding. The number of "unique monthly visitors" to its site dropped 39% in October to 281,000, compared with a year earlier, according to comScore. That took Blue Nile out of comScore's top 10 jewelry and luxury goods Web sites. Over the same period, visitors to Web sites operated by offline retailers Zale, Tiffany and Kay saw declines ranging from 6% to 18%.

Blue Nile says comScore's data "is completely wrong." But data from another Web-measurement firm, Compete, also shows a decline--of 17%--but growth in rivals' traffic.

I find that information from the two web measurement firms interesting. According to comScore, traffic to Blue Nile (NILE) is down nearly 40%, while Compete it's down 17%. What's a factor of two, or nearly 20% in absolute value, between friends? And then comScore says Zale, Tiffany, and Kay saw declines between 6% - 18%, while Compete says it saw growth in the rival websites. And to make matters more confusing, Blue Nile says comScore is wrong.

So how do we make sense of this? Let's look at Google Trend data, as shown in the chart above. There are several things that jump out at me. One, searches for Blue Nile, engagement ring, diamond ring, and wedding ring have all trended down. Two, the relationship among all four items appears reasonably constant over time. And three, every fourth quarter, there is a spike for search terms Blue Nile and Diamond Ring. We are midway into the fourth quarter now.

Recall Blue Nile's third quarter conference call article. In that article, I showed a chart with the quarterly revenues clearly shown. As seen from that chart, the fourth quarter is where most of the revenue for the year occurs. And on the conference, Blue Nile raised its guidance for this year's fourth quarter. A quote from the company's press release as is follows:

"The trends in the business during the third quarter improved sequentially, and we project that trend to continue in the fourth quarter. Based on our third quarter results and our expectations for the fourth quarter, we are raising our guidance," said Marc Stolzman, Chief Financial Officer. "We are projecting fourth quarter net sales between $100 million and $109 million, and diluted earnings per share in the range of $0.35 to $0.39."

The company's quarter ended on 4 October 2009, and the conference call was on 5 November 2009. Therefore, Blue Nile had about one month's data into the fourth quarter before issuing its raised guidance.

Given that I don't see a 40% drop in Google searches, that the two web measurement firms see wildly different results, and that the company raised its guidance for the fourth quarter only ten days ago, I am skeptical of the web search firms' findings.

Disclosure: I am long Blue Nile stock.

Exxon Mobil Featured In Barron's: What A Gusher

2009-11-14T19:00:00Z

Barron's cover story this week is What a Gusher! (subscription might be required), an article about Exxon Mobil Corporation (XOM). Given that I am net long Exxon Mobil and that I wrote two articles recently on oil, I enjoyed reading Andrew Bary's well written article.

As an aside, my recent two prior articles are Do Not Believe Long Term Oil Forecasts and Long Term West Texas Intermediate Forecast Price And Uncertainty. Both articles were popular and generated some lively comments over at Seeking Alpha Don't Believe Long-Term Oil Forecasts and Don't Believe Long-Term Oil Forecasts: Part II.

While I encourage you to read the full article in Barron's, I will provide a few quick highlights.

Although Exxon Mobil is well managed, it is second from the bottom in Dow performance this year. Some suggest that fair value for Exxon Mobil is $90 per share. At present prices, the refining and chemicals divisions are being given away. Exxon is known for its financial discipline where it focuses on profits, not on production. Consequently, it enjoys the highest return on invested capital at 34%. Moreover, because of its discipline, it does not enjoy feasts of activity during the good times, or famines during the bad. Instead, it remains focused on its planned activities. It has replaced more than 100% of its production during the last 15 years at an average cost of less than $7 per barrel, which is below that of its peers'. During the past five years, Exxon has favored stock buybacks over dividends.

As the leading energy company with the most diversified revenue base, Exxon is the most defensive play in its group, which includes BP (BP), Chevron (CVX), ConocoPhillips (COP) and Royal Dutch Shell (RDS-A). Exxon's defensive characteristics and sheer size have worked against it because aggressive institutional investors now favor oil-and-gas-exploration stocks like Apache (APA) and XTO Energy (XTO), or oil-service stocks like Schlumberger (SLB) that offer more leverage to rising energy prices.

...

It isn't easy to maintain, let alone increase, such production, particularly because Exxon and its international rivals face a diminishing set of opportunities, given increasing resource nationalism in the Middle East as well as in places like Venezuela and Russia. It's estimated that 85% of the world's oil reserves are locked up in OPEC countries and the former Soviet Union, where access comes on tough terms to Western oil companies, if at all.

In my prior article, I wrote:

And, the rise of oil prices has given new prominence to some national oil companies. A sample, though incomplete, list of companies include: Gazprom OAO (OGZPY.PK), Petróleos de Venezuela, S.A., and Petróleo Brasileiro S.A. - Petrobras (PBR).

Because the Barron's article is a great summary of Exxon Mobil, I have printed and saved a copy for future reference. I encourage you to do the same.

Disclosure: I am long Exxon Mobil stock as well as long and short puts for an overall net long position.

On Saturday, 18 July 2009, I photographed two young men fishing at Glenmore Reservoir in Calgary Alberta. If you click on my Flickr profile link, you will be taken to Flickr where you can see more of my pictures.

Strong Third Quarter 2009 For Blue Nile

2009-11-12T04:00:00Z

Prior to the release of the third quarter results, analysts had the following expectations as set forth in the table below.

The company's results were ahead of expectations with revenue at $66.9 million and earnings of $0.17 per diluted share. According to Yahoo Finance, analysts have revised their estimates.

As an aside, it is interesting to look at how the annual estimates have risen from the first quarter when I wrote Strong First Quarter 2009 For Blue Nile.

I listened to Blue Nile's positive conference call. Using the company's press release and my notes from the conference call, I will highlight key items in point form.

Prior to Conference Call: Blue Nile's Revenue and Earnings Estimates.
Financial Metric	Current Qtr Sep-09	Next Qtr Dec-09	Current Year Dec-09	Next Year Dec-10
Data Sources	Yahoo Finance 5 November 2009
Revenue Estimates	65.64M	95.88M	293.41M	330.90M
Earnings Estimates	0.16	0.33	0.81	1.02

Blue Nile's New Revenue and Earnings Estimates
Financial Metric	Current Qtr Dec-09	Next Qtr Mar-10	Current Year Dec-09	Next Year Dec-10
Data Sources	Yahoo Finance 11 November 2009
Revenue Estimates	106.27M	75.07M	303.37M	351.16M
Earnings Estimates	0.38	0.20	0.85	1.10

Company Commentary

Sales rose 2.9% for Q3 to $66.9 million on the strength bridal jewelry sales and growth in international markets.
Diane Irvine, President and CEO, indicated that the company performed well, "One of the key highlights of our quarterly financial performance is our profitability. Our gross margin in Q3 reached its highest level in nearly 4 years at 22.1%, an expansion of 180 basis points year-over-year."
Company grew operating income over 17% to $3.9 million and expanded operating margin by 80 basis points to 5.8%. Moreover, it generated $6.3 million of EBITDA, an increase of 17% year from last year and a record third quarter EBITDA level.
Earnings per share in the third quarter increased from $0.15 last year to $0.17 this year.
Irvine stated, "In 2008, there was a 5% contraction in retail jewelry capacity in the US; and industry sources predict a similar contraction for 2009. The total number of jewelry businesses, retailers, wholesalers and manufacturers that have gone out of business in the first nine months of 2009 increased by 60% from the same period a year ago."
Even though global market for jewelry is expected to decline by 15% this year, Blue Nile expects to exceed its 2008 sales level.
While US sales were down only slightly at 0.5% from last year, international sales in Q3 grew at 27.5% to $8.8 million, which surpasses 13% of the company's total sales. International growth was hampered by foreign exchange. On a constant exchange rate basis, international sales grew 34.8%.
Company's strongest category was bridal jewelry, including diamond engagement rings and wedding bands. This category grew in proportion from last year's sales and increased in sales as well as units.
On 1 September 2009, the Company launched it new Blue Nile website. The aim of the new website is to provide a better shopping experience with more innovative tools and features such as improved search for diamonds, customization, and search for jewelry.
Irvine stated that the Company is excited and optimistic about the upcoming holiday season. Moreover, the Company expects significant year-over-year growth in the fourth quarter. As such, the company raised fourth quarter guidance. (See Stoltzman's commentary shortly.)
Marc Stolzman CFO took over from Irvine on the conference call and indicated that in the fourth quarter, foreign currency should provide a tailwind compared to the fourth quarter in the prior year.
In the third quarter, the total number of orders increased about 4% from the year prior. Average order decreased 1.7% to $2123 because of product mix as well as lower average ticket in core bridal category, which includes diamond engagement rings and wedding bands.
Engagement and wedding bands continue to be the strongest category, with sales under $25,000 growing most rapidly.
Gross profit was $14.8 million, with gross margin up 180 basis points to 22.1% of sales. Gross margin improvements are attributable to better sourcing for diamonds and jewelry. Margins for the fourth quarter will be up from last year's fourth quarter level. Margins should stabilize at these higher levels for 2010.
SG&A was $10.9 million versus $10.0 million last year.
Effective tax rate for the third quarter was 35.0% versus 34.4% third quarter last year.
Net income increased 10.3% to $2.6 million and earning per diluted share rose from $0.15 to $0.17.
Inventory level was relatively flat compared to last year at $17.8 million.
Cash, cash equivalents, and short term investments totaled at the end of the quarter at $47.5 million compared to $26.6 million at last year's third quarter ending balance.
Non-GAAP free cash flow was $20.9 million, a gain of $0.8 million from last year.
Stolzman stated, "As is typical with the seasonality of our business, we have a significant buildup of our accounts payable in the fourth quarter related to holiday sales. It is our expectation that our free cash flow in the fourth quarter of 2009 will exceed the level achieved in 4Q 2008, thereby increasing our free cash flow level for the full year well above the trailing 12-month level of $21 million."
Stolzman further stated, "We are projecting fourth quarter net sales between $100 million and $109 million, and diluted EPS in the range of $0.35 to $0.39. Our capital expenditures are projected to be approximately $2.5 million for the year."

Question and Answer with the Analysts

With the downturn in the diamond mining industry, several diamond miners either shut-in mines or stockpiled product. Irvine believes that diamond prices have stabilized and that there is some downward pressure because of all the goods that need to come to market. Moreover, there should not be a significant upward movement in prices in the near term.
International sales as a proportion of overall sales are becoming significant to Blue Nile. Even though gold jewelry and watches are not doing well internationally for all jewelry retailers, the bridal category remains stronger, which plays into Blue Nile's strength.
Mark Vadon, Chair, commented that as product mix eventually shifts toward more non-bridal jewelry and as the business grows larger, both factors will contribute to higher gross margins. In other words, gross margins will grow with time.
Recent gross margin improvements resulted from mostly improved sourcing. As the company continues to grow, it has more influence and significance in the industry. This benefit will continue, regardless of diamond pricing. Moreover, diamond prices were weaker, which allowed the company to capture some incremental gross margin.
With regard to the new website, Irvine mentioned the increased conversion benefit and Vadon mentioned the aspirational branding. As expected, the Company will not provide detailed data on its website. That information is too strategic in its importance to divulge.
While gold prices have risen, they are a small part of the overall cost equation. Vadon estimates gold is about 15% of cost of goods sold (COGS). Diamonds are the key cost consideration.
With regard to repeat customers, Irvine mentioned that because of the emphasis on bridal, customers don't repeat frequently. However, repeat business is about 20% of the overall business. That reflects the non-engagement part of the business where a customer starts with an engagement ring and continues to purchase other important items for special occasions. As Vadon mentioned, as the product mix begin to emphasize other items besides engagement rings and wedding bands, gross margins will increase.
International business is in its infancy. Furthermore, Blue Nile is able to grow its international business with minimal capital. As an example, Blue Nile launched its facility in Dublin to serve its European markets for about a $500,000 investment.
Stolzman indicated that the stock buyback program remains active, though no shares were purchased last quarter and he didn't provide buyback guidance for future quarters. I was left with the impression that the company will remain opportunistic to use excess cash to buy back shares.
At present, all international websites are English, but in the future, the company will expand to where it makes sense to have websites in the local language.
Blue Nile spends approximately 4% of revenue on marketing, which is focused on online marketing through search, affiliate programs, and portals.

Before providing my overall comments, I will provide some additional data and graphs with some additional commentary.

Blue Nile: Key Financial Metrics
Financial Metric	Blue Nile
Data Source	Yahoo Finance, 11 November 2009
Market Cap.	$884.49M
Enterprise Value	$829.42M
Forward P/E (fye 04-Jan-11)	55.31
PEG Ratio (5 yr expected)	3.57
Enterprise Value/EBITDA (ttm)	45.522
Qtrly Revenue Growth (yoy)	2.40%
Float (shares)	13.98M
% Held by Insiders	3.01%
% Held by Institutions	122.10%
Shares Short (as of 12-Oct-09)	2.70M
Short Ratio (as of 12-Oct-09)	21.4
Short % of Float (as of 12-Oct-09)	19.10%

Please note that you can click through the next two graphs to see full sized versions.

Let's review some of the information contained in the tables and charts. The market capitalization is nearly $900 million. Forward Price-to-Earnings multiple is 55.31 and the five year PEG Ratio is about 3.6. Quarterly revenue growth is 2.4%. At first glance, these numbers seem to suggest that Blue Nile is richly valued. If you look, however, at the numbers published in my review of Q1 2009, you'll note that the outlook has become much brighter. That is, revenue and earnings have increased dramatically. If Blue Nile can perform this well when the U-6 unemployment statistic is 17.5%, imagine what it will do when the economy eventually returns to normal.

The key point is that the future estimates are subject to wild changes. And, during this time of unprecedented economic turmoil and uncertainty, Blue Nile is doing reasonably well, becoming stronger and healthier, while its competitors are suffering, becoming sicker and weaker. So be careful when looking at the traditional valuation metrics in isolation.

I have glanced at some of the commentary regarding Blue Nile over at Seeking Alpha. There are some vitriolic comments regarding Blue Nile's share price and short interest. The short interest values deserve further comment.

Before reading my brief discussion on short interest, you should know that I enjoy shorting stocks occasionally. Furthermore, I do not believe the shorts in Blue Nile are having a material adverse effect on Blue Nile's share price. Whether they were shorting Blue Nile or not, I think the share price would be roughly the same.

I'd like to engage in a small thought experiment. Let's assume that there are four large fund managers that each own 25% of the stock of a new company called NewCo.

NewCo Owners

FundA: 25%
FundB: 25%
FundC: 25%
FundD: 25%

FundA and FundB each allows 15% to be borrowed through its brokerage firm. That is, FundA and FundB have 10% that cannot be borrowed and 15% that can be borrowed.

The shorts come along, borrow the shares and short the stock. Now there are 30% shares short.

As part of the 30% purchase of the short shares, FundE purchased a 25% interest and small retail investors purchased 5% of the shares.

We have the following situation:

NewCo Owners

FundA: 25%
FundB: 25%
FundC: 25%
FundD: 25%
FundE: 25%
Small Retail: 5%
Short sellers: -30%

Total ownership is 100% (=130% long and 30% short).

Along comes a hostile company that makes a bid for NewCo. FundA, FundB, FundC, FundD, and FundE all cease trading while their analysts begin preparing copious PowerPoint slides. FundA and FundB instructs their brokers to call in any shares that were lent.

The key questions is, where do the shorts find their shares to repurchase?

As you ponder that question, you might wish to use your search engine with the terms Volkswagen short squeeze. I am not suggesting that the facts in the Volkswagen situation are similar or even relevant. I do, however, want to draw your attention to what is possible.

I rarely short stocks that have a high short ratio. The short ratio is the number of days of average trading required to equal the outstanding short interest (number of shares that are short). A ratio at or above five is usually enough to keep me away. It's frustrating when the company issues negative earnings news and the stock rises rather than falls. That sometimes happens because professional shorts have a catalyst in mind for their short sale. They believe that the company will disappoint and that the stock will fall. If the stock doesn't immediately fall, they begin buying back their shares because their catalyst event has come and gone with the planned subsequent fall in share price missing. So be careful when shorting stocks with a high short ratio.

If you are determined to short a stock with a high short ratio, you might wish to consider using options. For example, you might wish to purchase puts. I can almost hear some of you complaining that puts are expensive. And my response is, if you are concerned about the cost of a put, then you probably lack the conviction of your argument that Nile is wildly overpriced. One of the benefits of a put is that it forces some discipline to pick a price and a time. That is a far better situation to have than to have a short position that you watch grow in size and, unfortunately, importance with time. At least with a put, the worst that can happen is that it expires worthless.

If you shorting a heavily shorted stock such as Blue Nile, exercise caution and discipline.

Moving away from the short sale discussion to my overall thoughts on Blue Nile, I am long the stock and will continue to hold Blue Nile. I like that it continues to execute extremely well. The management team impresses with the laser focus on the customer. Throughout the entire conference call, management emphasized that it wants to deliver solid value to the customer. In other words, if Blue Nile continues to satisfy the customer, then the stock will take care of itself. I like that the company is growing, especially during these difficult economic times. I like that it is in the early phases of its international growth and that it is able to expand its global footprint at minimal costs. And I especially like that it is gaining market share from its competitors.

What about its financial metrics? Aren't they wildly excessive? After looking back at the first quarter in 2009 when the share price was much lower, I noticed that Blue Nile had a five year peg ratio of about 3.3. Today, that ratio is about 3.6, which is not so different? The reality is, we are unsure of the overall economic growth, let alone the company's growth.

As long as the company continues to perform well, I am not worried about the financial metrics. For strong growth companies, they really don't matter too much. In point form, in no specific order here are some positive factors to consider:

The Company has a focused and consistent management approach to building a stronger brand and business.
Management is focused on improving and growing its business, while the competition is distracted and fighting to stay afloat.
Blue Nile gaining market share.
It is considering buying back more shares again.
It is growing in its domestic and in international markets.
International efforts are still in their infancy with considerable headroom (for example, websites to serve foreign markets in their local languages).
Blue Nile has no debt.
The Company not in danger in any way of going bankrupt (can the same be said of its competition?).
It enjoys strong customer loyalty as evidenced by its growing repeat business.

In summary, I am not concerned that, at first glance, that financial metrics appear rich. As long as the company keeps its focus on delivering value to the customer and continues to execute well, then I fully expect that the share price five years from now will be substantially higher than today's closing price of $60.84.

Disclosure: I am long Blue Nile stock.

On Sunday, 10 September 2009, I photographed Calgary model Anya at Lake Minnewanka in Banff National Park, Alberta. If you click on my Flickr profile link, you will be taken to Flickr where you can see more of my pictures.

Long Term West Texas Intermediate Forecast Price And Uncertainty

2009-11-09T21:00:00Z

There are known knowns. These are things we know that we know. There are known unknowns. That is to say, there are things that we now know we don't know. But there are also unknown unknowns. These are things we do not know we don't know.

Former US Defense Secretary Donald Rumsfeld on 12 February 2002.

My recent article Do Not Believe Long Term Oil Forecasts caused some good discussion over at Seeking Alpha.

My prior article drew attention to a Wall Street Journal article that commented on the long term oil demand growth with price implications. In my article, I commented that it is difficult projecting West Texas Intermediate supply and demand as well as oil prices beyond five years. I discussed why these variables are hard to predict without referencing much numerical data by requesting that readers begin thinking of different scenarios. I wanted readers to think about possibilities rather than be anchored to numerical data. I also provided reference to Professor Bartlett's lecture that is recorded on YouTube. If Professor Bartlett's lecture is good enough for Jeremy Grantham, well known institutional investor and co-founder of GMO LLC, then it's good enough for me.

After investors thought of different scenarios, I further asked readers that, as investors, how might their views change toward various national oil companies such as: Gazprom OAO (OGZPY.PK), Petróleos de Venezuela, S.A., Petróleo Brasileiro S.A. - Petrobras (PBR); and oil sands companies such as: Suncor Energy, Inc. (SU) and Canadian Oil Sands Trust (COS-UN.TO); and large multinationals such as ConocoPhillips Company (COP), Chevron Corporation (CVX), and Exxon Mobil Corporation (XOM).

Please click through on the above charts to see larger versions..

As we can see from the historical WTI Prices chart, WTI began breaking free from its historical price range of $20-$30 per barrel near the year 2000. What about the future? Well, we can look at the CME Group's Light Sweet Crude Oil (WTI) Future's prices. And using the futures prices as a guide, I don't expect a return to a sustained price range of $20-$30 anytime soon.

Do professional consultants or forecasters have a different view? While I don't know all forecasts, I looked at oil price forecasts from GLJ Petroleum Consultants, a prominent and well respected oil and gas consulting company located in Calgary, Alberta. If you are interested, you can register at Sproule Associate Limited, another prominent and well respected oil and gas consulting company located in Calgary, to receive its forecasts. GLJ's forecast, dated 30 September 2009, has WTI nominal (as opposed to real) prices at $74.00 per barrel in 2010 and rising to $101.59 in 2018 and rising by $2% per year thereafter.

The challenge for creating long term supply, demand and price forecasts is that nobody knows the future. Setting aside the two Calgary consulting companies, if a consultant or forecaster provides you with a long term forecast, ask the following questions or requests:

Is your price forecast substantially different from the WTI futures? Often the forecast is materially different. Ask the consultant to explain why. They will often tell you that the futures curves are a) wrong, b) change with time, and c) are heavily influenced by Wall Street types who are not using fundamental analysis to arrive their futures prices.
If the consultant has strong conviction that its price forecast is correct and that the futures curves are wrong, then is it putting its money at risk? This is a rhetorical question meant to emphasize that few have strong conviction. In reality, this is an unfair question because the consultant would lose its credibility if it were playing the markets while providing price advice. It might, however, make the consultant worker harder when it has some skin in the game.
Has the consultant's price forecast changed or is it expected to change? The answer is yes.
Request to see the last two years worth of price forecasts. Note that the forecasts do change, often materially so.
Request to see its price forecast from the year 2000. Did it even allow for the possibility that oil prices would be sustained at or above $70 per barrel by 2010? Most likely not.
Ask the consultant to provide its methodology to arrive at its price forecast. This is just a general interest question. The reality is, it doesn't matter.

As we have seen from historical prices, futures curves, and one oil and gas consultant forecast, the prior range of $20-$30 per barrel for WTI does not look imminent. If prices are known fluctuate wildly, which would then change the future curves and consultants' forecasts, then why am I confident that prices won't return its prior range?

Last year, many oil companies had internal long term price forecasts of $70-$75 per barrel in real terms. Some might have been lower and others higher. And last year, I read that new greenfield oil sands develop projects required $70-$110 per barrel to achieve an economic return. While construction and operating costs have been reduced over the past year, they haven't been reduced much. Yet, many oil sands development projects by large and sophisticated companies are moving forward. Furthermore, look at the rate of returns most oil companies are enjoying at today's prices (they are not extreme), and then ask yourself what their returns would look like at sustained prices near $25 per barrel. Hint: it wouldn't be pretty.

It's interesting to watch the dynamics of senior executives of oil sands companies. As they plan and prepare for a new project, they all acknowledge that oil prices are volatile and that between now and the end of the project, there are likely going to be several stomach churning price drops. At this point, they are undaunted. Yet, when the prices drop, these same executives begin to reassess if they can scale back, postpone, or phase in projects over time. It's amazing how much influence short term prices have toward a long term outlook.

If you ran an oil company and believed that $20 per barrel prices were imminent and didn't want to play the futures market, then you would likely stop investing in new projects and wind down or sell existing production, fire all but essential staff, and just bide your time. When oil prices hit $20 per barrel, there will be many distressed assets available at fire sale prices. Moreover, many oil and gas companies will be shutting down, throwing their talented workers on the street. At that point, you could relaunch the company with better (lower costs) and greater (more production and reserves) assets than you had previously. I am unaware of any company embarking on this strategy.

As you do your own research and analysis, remember that the treadmill gets steeper as world production increases. What do I mean by that? Most oil fields (oil sands being an exception) experience a natural decline rate. For argument sake, let's assume that at some time in the future we have the following conditions: a) annual oil production at 100 million barrels per day; b) annual supply and demand growth rate of 1%; and c) a natural decline rate of 7% annually. Then, just to maintain production for the following year, an additional 7 million barrels per day of production must be found. And, another million barrels per day must be added as part of the supply growth. As annual production increases with the same decline rate, more reserves and production must be found.

I am neither in the bearish camp that says the sky is falling nor in the bullish camp that says we have plenty of oil at affordable prices. I believe we do have challenges in front of us. Furthermore, I believe we will have significant changes. It's best to keep an open mind and watch for signs that indicate abrupt changes are about to take place.

One last closing comment: I am glad that I do not provide long term oil and gas price forecasts—there are too many known unknowns and too many unknown unknowns.

Disclosure: I am long shares in Canadian Oil Sands Trust, Suncor Energy, and Exxon Mobil as well as long and short puts in Exxon Mobil.

On Sunday, 18 July 2009, I photographed Fish Creek in Fish Creek Provincial Park, which is located within Calgary. And, if you click on my Flickr profile link, you will be taken to Flickr where you can see more of my pictures.

Do Not Believe Long Term Oil Forecasts

2009-11-07T21:00:00Z

On 4 October 2009, The Wall Street Journal ran an article World Need for Oil Expected to Ease (subscription might be required), where the author, Spencer Swartz, wrote:

The International Energy Agency next week will make a "substantial" downward revision to its long-term forecast for global oil demand, a person familiar with the matter said, marking the second year running the group has slashed its view of the world's thirst for oil.

...

If demand pessimists are correct, future increases in the price of crude could be damped as weaker consumption stretches world oil supply by billions of barrels. Various analyst estimates maintain that the roughly 2% a year average growth rate in world oil consumption seen earlier this decade -- the biggest reason for crude prices hitting a record $147 a barrel last year -- may turn out to be an anomaly and that annual growth in the neighborhood of 0.5% to 1% is more the norm.

The reality is that no one knows what the long term future holds. The IEA itself struggles with the Bull versus Bear oil outlook. Ask yourself, how many pundits foresaw the mess we are in now and anticipated the dramatic easing of oil demand?

Sure, one can gather relevant information and make a reasonable guess as to oil demand next year and the year after that. But after five years, the potential paths of demand growth become unwieldy. How will economic growth be sustained over the next five years? Will the OECD countries lag emerging countries? Will China and the rest of Asia power ahead and create substantial demand? If Asian countries do power ahead and create many millions of middle class citizens, will they demand their own vehicles and tickets on jet planes to see the world? Will Brazil and other South American countries enjoy strong economic growth? Will the Middle East be stable over this period? Will Iraq resume its full production capabilities? As you see, one can begin asking any number of questions that are impossible to answer with an accuracy or certainty and that might have a major bearing on demand or supply or both.

What do we know? We know that for a long time, oil prices were usually within $20-$30 real per barrel. Now those prices are laughable. No reasonable person expects the world to return to those prices any time soon. Many major oil fields around the world are in decline. Oil companies are searching in more remote and sometimes more unfriendly regions of the world to develop further existing fields and to discover new fields. And, the rise of oil prices has given new prominence to some national oil companies. A sample list, though incomplete, of companies include: Gazprom OAO (OGZPY.PK), Petróleos de Venezuela, S.A., and Petróleo Brasileiro S.A. - Petrobras (PBR).

If we were to accept the 1% annual growth of oil demand mentioned in the WSJ quote for a long duration, what would that mean or imply? A child born tomorrow will see by her seventieth a doubling of daily world oil production from about 85 million barrels per day to 170 million barrels per day. Moreover, during her seventy years, the world will have produced more during that time than the total cumulative amount prior to her birth. Call me a skeptic, but I am unable to see where we would find that much additional oil to produce at such high rates for such a sustained period.

To be clear, neither the article nor the IEA is suggesting that we endure a 1% growth forever. Rather, I wanted to use this seemingly small innocuous number of only 1% growth to draw attention to its implication. If the long term growth were 2%, then in 35 years the daily world oil production would double to 170 million barrels per day and the oil produced during those 35 years would exceed the prior total cumulative amount of oil produced.

Two excellent sources of information to learn more about oil, oil demand, oil prices and various policy initiatives, I recommend two sources:

Statistical Review of World Energy from BP p.l.c. (BP). I found the link to the Adobe pdf document toward to the bottom on its homepage.
Monthly Oil Market Report from the International Energy Agency. The link is to the webpage that hosts the document that is released two weeks after the initial release date. Subscribers receive immediate access through a different link.

Both documents are extremely helpful. I find the BP document provides concise information and historical context. The IEA document provides the agency's latest thinking and forecasts.

As the world struggles to find new sources of oil, there will be dramatic changes. I have already discussed some questions we should ask ourselves as we contemplate future oil demand growth. Of course, many more questions need to be considered. And I have indicated that some national oil companies have gained strength and prominence with higher oil demand and prices. As investors, we should also think about what long term oil demand growth means for oil sands companies such as Suncor Energy, Inc. (SU) and Canadian Oil Sands Trust (COS-UN.TO), and for large multinationals such as ConocoPhillips Company (COP), Chevron Corporation (CVX), and Exxon Mobil Corporation (XOM).

As demand continues to rise, I am curious what will happen. Will scientific breakthroughs help? How will the world cope with the environmental consequences? How will people adapt to possibly much higher prices? How will countries and regions change because of either having or lacking domestic oil supplies? If the world does experience higher prices, what are the implications for global world trade? And do higher prices imply that people will travel less and have less of an understanding of other regions? These questions are just a small sample of what investors should begin considering.

A few years ago, Professor Bartlett gave a compelling lecture, captured in a series of YouTube videos, to some students at the University of Colorado. In his lecture, he discussed oil demand growth. The lecture starts a bit slow; however, when you reach the latter part of the third video, you'll see how the prior information is relevant to his discussion on oil. In other words, because they are important, don't skip the initial video segments and jump to the third. I urge you to watch the complete video series.

And after you've watched the videos, ask yourself, "What time is it?" This question will make sense once you've seen the videos.

When I initially saw the WSJ article, I was drawn by the long term forecasts. My personal bias is that most longer term things in life are difficult, if not impossible, to forecast with any reasonable degree of accuracy. Then as I read the article, I saw the 1% growth number, which by itself seems very innocuous. But if you think about what 1% growth means over a long and sustained period, you quickly realize there are going to be changes. Moreover, the world has already witnessed a significant shift in oil prices over the last decade. We are no longer in our prior historical norm of $20-$30 per barrel. Some might argue that we are now in unchartered territory. As part of that possible unchartered territory, I wanted you to think about some larger questions. The questions mentioned in this article are just off the top of my head without much thought. I am sure you can think of many more. And last, I wanted to draw your attention to Professor Bartlett's excellent lecture. His lecture will make you think about oil demand (and others) growth differently. I hope this article causes you to further your own research.

Disclosure: I am long shares in Canadian Oil Sands Trust, Suncor Energy, and Exxon Mobil as well as long and short puts in Exxon Mobil.

Book Review: Options Volatility Trading By Adam Warner - Part II

2009-11-07T00:15:00Z

Building on my prior article on Adam Warner's book, Options Volatility Trading: Strategies for Profiting from Market Swings, I will comment on the next four chapters.

Chapter 3: Understanding the VIX. This is a critical chapter because it serves as the backbone for the book. You learn what volatility is and how it is represented through VIX. VIX is how many investors and traders express fear and complacency. However, VIX is not perfect and this chapter explains why.

Chapter 4: Nuts and Bolts VIX. You learn that VIX represents the expected volatility of the SPX, the S&P 500. Notice that it is an expected volatility. For example, a VIX of 32 implies a roughly 2 percent range in the SPX on any given day. You also learn that volatility has two key components: volatility of individual S&P 500 component stocks and correlation among those stocks. That is, if stocks are extremely volatile but uncorrelated, then the VIX will be lower than when the stocks are undergoing the same volatility but are tanking in unison.

Chapter 5: Volatility Timing. With regard to buying and selling options, you learn that not every day is created equal. There are better days within the expiration cycle to either buy or sell options. And, there is seasonality to options as well.

Chapter 6: How Do Trader Trade Volatility. This chapter is where the real fun starts. Now, you are beginning to use your knowledge from the previous chapters to think about how you want trade. If you buy or sell options, what are your considerations with regard to volatility, delta, and gamma? Can a buyer and seller of the same options both make money, and if so, how? Do you prefer a high or low volatility environment, and why? What does volatility mean to options traders?

In a few days, I will provide another update.

On Sunday, 18 July 2009, I photographed Fish Creek in Fish Creek Provincial Park, which is located within Calgary. In a larger version of this photograph, you can easily see one of the many bridges in Fish Creek Park. And, if you click on my Flickr profile link, you will be taken to Flickr where you can see more of my pictures.

Disclosure: As part of the Amazon Associate program, I receive remuneration for each book sold by clicking on the Amazon.com links in my article.

Book Review: Options Volatility Trading By Adam Warner - Part I

2009-11-04T22:05:00Z

I have begun reading Adam Warner's new book Options Volatility Trading: Strategies for Profiting from Market Swings. For those of you who don't know, Adam writes the excellent and influential blog Daily Options Report. I started reading Adam's writing when he co-wrote the options column on Street Insight (part of the TheStreet.com family) from spring 2003 to spring 2005. He is currently Options Editor at Minyanville.com. You can read his profile at his About on his blog.

Readers should know that I correspond occasionally with Adam and have tremendous respect for him. I have learned a tremendous amount from his articles and from his answers to my questions. Moreover, I admired his warning readers that they might wish to exercise caution when following Lenny Dykstra's options articles on The Street.com. His warnings were long before Dystra's problems became fodder for the mass media, including CNBC. Adam is a friend and thus I will likely be biased in my review of his book.

So far, I have just covered the Introduction, Chapter 1: Who Am I? Why Am I Here?, and Chapter 2: Know Your Greeks. The introduction is great because Adam sets out that the book will not be a cookbook with easy to follow recipes for success nor will it be steeped in heavy mathematics or formulas. Instead, the book will be focused on how to use information and data to manage an active account or portfolio with an ever changing set of circumstances. Adam provides his personal background in Chapter 1. I found knowing his background interesting for a couple reasons. First, I was amazed at how primitive the options markets were only a few years ago. And second, because of Adam's experience as a floor trader at the Amex Option Exchange, I know that Adam has a well honed intuitive feel for the markets and is able to think rapidly on his feet. In Chapter 2, Adam provides the reader with a high level overview of the major Greeks in options trading. As stated earlier, Adam skips over the mathematical treatments and provides the reader with the essential information.

If you are just starting out with Options, this book is not your best starting point. You should have a basic understanding of calls and puts. If you don't have that understanding, the free educational videos at Options New Network ONN.TV are a good resource. You don't require an in-depth understanding of options to read Adam's book. However, you should know what calls and puts are and understand their basic payoff diagrams.

So far, I am thoroughly enjoying Adam's book. After a few more chapters, I will provide another update.

On Sunday, 18 July 2009, I photographed the Weaselhead area in North Glenmore Park in Calgary. I know that Adam enjoys riding his bike, so I thought this photography from one of my bike rides was an appropriate photograph to include with my review. And, if you click on my Flickr profile link, you will be taken to Flickr where you can see more of my pictures.

Disclosure: I am long TheStreet.com stock. And as part of the Amazon Associate program, I receive remuneration for each book sold by clicking on the Amazon.com links in my article.