Tokyo based, expat Cape Bretoner. Learning to live in a de-leveraging world. Better suited to the crusades. CFA & FRM charter holder. Disclaimer: @Firehorsecaper reminds investors to always perform their own due diligence on any investment, and to consult their own financial adviser or representative when warranted. Any material provided is intended as general information only, and should not be considered or relied upon as a formal investment recommendation.
Joined Jun 23, 2015
81 Blog Posts


Zoonotic pandemics were not on the list of tail-risks for investors coming into 2020. In hindsight, the timing of Chinese New Year, the world’s largest annual migration (US Thanksgiving x26, 1.3bln Chinese travel for CNY vs. 50mm Americans for Thanksgiving), could not have been worse. Closing borders, once a pandemic has started, has more limited utility.

In mid-February the global equity market was blissfully ignorant of the potential negative effects of the public health emergency, spawned by the infectious disease COVID-19, caused by the SARS-CoV-2 virus.

The Dr. Tedros led World Health Organization (WHO) has not made the global “pandemic” call yet, but this certainly could be the week. The range on unreported cases, due to the lack of testing outside of S. Korea (165k tested, 18k per day pace) is 10x (Johns Hopkins) to 38x (Lancet).

COVID-19 cases in China have crested, thankfully. Outside of China the cases have doubled >3 times in 12 days. Japan cases stand at 461 (>1,000 incl. Diamond Princess), USA is at 439, S. Korea 7134, Italy 5883 and Iran at 5823. Global cases stand at 106,200 with 3,600 dead. The epidemiological assumptions of the COVID-19 outbreak are, let’s just say, fluid. The case fatality rate (CFR) quoted most recently by the WHO is 3.4%, the range is a wide 0.68%-3.4% with S. Korea yielding the lowest CFR’s globally. Unreported cases are assumed to be less serious cases, hence it stands to reason that mortality rates will be lower for the broader group of infected sapiens (a terribly wide 7-34x more deadly than the flu, hopefully closer to 7). Spread rate, aka “r nought” est. 1.1-2.6 = 62% of contacts (approx. 2x virulent as flu). Morbidity, 20% will undoubtedly put a strain on global healthcare capacity. Many governments have been reluctant to invest sufficiently in their healthcare systems. Public health systems in less developed countries is of great concern. The cavalry is coming. The IMF has pledged $50bln in aid to assist countries dealing with COVID-19. The WHO has allocated $12bln ($8 new, $4bln re-allocated) and the USA just got approval for $8.3bln, just signed by DJT (not to mention an emergency intra-meeting 50bp rate cut by the Fed, other mopes falling in line on the follow with their short-end monetary spigots primed).

Trump signing $8.3bln COVID-19 spending bill

The potential COVID-19 effect on planet Earth is still being surmised. Listen to those with both skin in the game and involvement in the market (Andrew Brenner “The UST 30 year rate could break 1% by U.S. Sunday night) vs. the talking heads (Rick Santelli of CNBC; “Give COVID-19 to everyone, so we can get past this.”). The IMF released their estimates for China’s forward GDP estimates -0.4% to +5.6% for 2020 (not a chance, more cow-bell), and -0.1 for global GDP. More plausible estimates see the global impact to GDP at -$2.5 tln outright, just shy of 3% of global GDP, which would certainly trigger a global recession of unknown tenor. Price effects; The effect will overall likely be deflationary due to the shock to global consumption demand. There will be inflationary effects clearly with respect to the shock to the cost of production in many key sectors. The negative shock to global equity risk premia is what we have seen thus far (>$5tln), a long overdue re-tracement of multi-year multiple expansion driven by buybacks financed by a +100bln debt orgy post-GFC. The shock to labor supply will likely show itself quickly, especially in the critical global health-care sector. Child-care is another evident global bottleneck  in places like Japan where 13 million public school kids (joined by a couple million more from private school and universities) are homebound (aka self-quarantine, for a month) due to the closing of public school at the behest of PM Abe last week. Even the beleaguered cruise line industry has felt the effects, feeling the need to employ staff from the Yokohama docked Diamond Princess on the sister vessel, the Grand Princess now anchored off the California coast near San Fran (to be confirmed, but Pence, “Mr. COVID-19” has suggested this is factual/likely). The Port of Oakland has agreed to accept the vessel, it has been reported. Best wishes to all aboard for speedy resolution with next years’ resolution  to never board another cruise. Folly of the highest degree.

Financial market reaction:
Re-enforcing the repeated shortcomings of risk metrics like VaR (Value at Risk), the move we have seen in this “stress episode”, a 13% equity risk asset sell-off in 7 trading days is in many ways without precedent. As a “tail event” it would happen 0.1% of the time, running data back to 1896. Setting a confidence interval for VaR at 99% would not capture this event. 99.9% would just touch it. As Nassim Taleb would agree, it is not so much the breach as the magnitude “given breach” VaR falls down on.

The list of stress events of this magnitude is short. I have weathered them all, hence the grey hair!:
1.) Asian Contagion (1997). SE Asia currency crisis, laid at Thailand’s feet, but the MIST currencies, i.e. Malaysia, Indonesia, Singapore and Thailand all played a role.
2.) WTC attack (2001). Across the street at One Liberty Plaza for 9-11. 800 windows out, but no fatalities gracefully.
3.) The Big One (2008-2009). GFC (Global Financial Crisis). Epicenter in NYC, $5bln of credit (long). Indoor fireworks.
4.) Flash Crash (2010). Quite a day. Bonds had a good day, as you might imagine (re-allocation from equities, fear trade).
5.) Eurozone Crisis (2011). Sovereign debt crisis. Forced to sell 2 year Ireland paper at a yield of 14.5% (it eventually traded sub 1% before maturity).
6.) VIX event (2018). Structured, levered VIX ETF to zero. Caveat Emptor. Read the prospectus.

Last week 10 year US Treasury yields stood at 0.96% (0.70% intra-day Friday, 1st time since 1871). Long bonds (30 year UST) yield stands at sub 1.50%. Tough environment for pension fund managers, insurance companies and individuals looking to “build” a retirement income, that is for certain. The tumble in US treasury yields, by 1/2 in the case of the 10 year in less than 10 days (1.6% to sub 0.80%), has greatly increased the fragility of the rates complex (25%+ increase in duration translating to great price risk going forward).

Spread assets, like corporate bonds have experienced a massive sell-off. The US$5.3bn withdrawals from IG corp bonds this week was the heaviest on record. With the number of oil & gas credits in the HY (high-yield) market, this is the area likely to crack first with 7.9bln in outflows. CDX (spec grade credit) moved out (widened, i.e. more risky) by 42 basis points on Friday to +451 (365 recent LT avg.).

If you thought that central banks looked flat-footed in recent days, cast your eyes on OPEC. The break down in R-OPEC talks last week precipitated a 10% swoon in global oil prices, on the day (Friday). The demand destruction in the petrochemical complex is real, China alone will likely account for a 2-3 MMBRD (million barrel per day) demand shortfall versus prior run rate, and there is another 2 MMBPD in lower demand from elsewhere globally. Saudi Arabia plans to boost production is an all-out price war versus the prior expectation of a 1 MMBPD cut back in production. These are heady numbers and might bring back memories of oil with a 2 handle per barrel, as in sub $30 (well above the cost basis for most global conventional oil production). Peak Saudi production is 12 MMBPD, as a point of reference. As Stephen Innes puts it, “There Will Be Blood”. China’s “force majeure” declaration on LNG deliveries is wreaking havoc in the natural gas market with prices in the US now negative through the end of summer (-5 cents per mmbtu). Warren Buffet has reportedly pulled his funding commitment for the $9bln LNG project in Saguenay, Quebec, due to “challenges” in Canada. This, from a man who has been seen running into burning buildings, most recently with an incremental United Airlines stock purchase. Ill timed, rear view mirror, as airlines will have a $113bln revenue shortfall (projected) vs. 2019.

The only things up on the year include;

i.)VIX, largely to be observed, related tradeable instruments can be widow-makers (see VIX event above), if involved, with stops of course, trading sardines, not inventory sardines for certain. The vix stubbornly holding > 30 telegraphs 2-3% daily swings until further notice. Typical size reduction, stop widening strategies will be employed for certain. A Gatlin gun of global liquidity has been assembled, most yet to be deployed.

ii.) 30 year UST, iii.) 10 year UST, iv.) 5 year UST, v.) 2 year UST, vi.) Gold, and vii.) Palladium (20% +).

Analytics / like minds / support:

Within ibankcoin’s “Exodus” (multi-year subscriber, non-compensated post) platform there is a constantly transforming list of existing and emerging CODID-19 equity plays and the Pelican room spends a goodly portion of daily discourse on the topic of coronavirus. Few rooms are positive month-over-month through the lunacy that COVID-19 has triggered. A sampling of names currently on what I’ll call the “spec” basket include; $SPEX (Spherix, up 130% Friday past), $TOCA (Tacagen +57%), $INO (Inovia +44%), $NNVC (NanoViricides +39%) scalped short as what I view as a “suspect” name/play, akin to cannon fodder $XAIR, Beyond Air, -20% Fri.), $CBLI (Cleveland Biolabs, +25%), $ALT (Altimmune +13%), $OPK (OPKO Health, +13%), $TRIB (Trinity, +9%), $AEMD (Aethlon, +8%), $NOVN (Novan, +10%),  $BCRX (BioCryst, +7%), $VXRT (Vaxart, +7%), $CTSO (Cytosorbents, +8%), $COCP (Cocrystal, +4%), $VIR (Vir, +4%), $HAPP (Happiness Biotech, +6%), $CERS (Cerus, +4%), $VCNX (Vaccinex, flat), $APT (Alpha Pro, -13%), $LAKE (Lakeland Industries, -2% Fri.)., $CODX (CoDiagnostics, -10%), $NVAX (Novavax, -3%), and $ONEM (1Life Healthcare, -1%). All of these % moves are 1-day moves. The inter-web can provide historical and ytd numbers, but needless to say there are endless contenders afoot, many well over their skis. The real contenders will show themselves soon enough. Most will not be successful in terms of their COVID-19 aspirations,  but those with a broader platform will avoid being taken out by failure with respect to CODID-19 efficacy. Best to diversify a bit as well, hygiene, masks, test kits, vaccines, anti-viral, etc. These are all common sense considerations. With the outsized support both provided and promised for global risk markets, skew will favor the assumption of risk versus the shedding of it going forward. It is the timing of when best to ford the river that remains very much in question.


$MRNA. Moderna sports a $11bln mkt cap. A novel (pardon the pun) approach. My only other current long after taking profit on $GILD calls Friday past. Moderna intends to develop a messenger RNA (mRNA) vaccine for the virus. The company will use the CEPI* funding to manufacture the vaccine. Promising, as others are, especially given the high tech nature of their approach (akin to $SGMO, Sangamo one of my long term plays).

*Coalition for Epidemic Preparedness Innovation (CEPI) was est. 2017 with an initial grant of $460 million by Germany, Japan, Norway and the Bill & Melinda Gates Foundation. While I was not negative, I think Bill Gates is “moving on up” as an aside.

$AZN. AstraZenica. $124bln.

Clinical trials:

The big boys (maga big cap) are clearly safer investment vehicles and is where I have focussed my recent due diligence efforts.

1.) $GILD. Gilead’s Remdesivir is currently conducting 2 trials (one mild/moderate, one for severe), 297 patients total. First results April. A failed ebola drug that never got FDA approval. Some promise in treatment of SARS & MERS (good anti-viral activity). Worked on 1 patient in the USA, sample size as small as possible, i.e. N=1. $GILD stock has gone up 17% inside of a month, much higher than pv of an approved drug, but with a $100bln mkt cap and a suite of other drugs, seen as a lower risk play.

Varied success, but just closed out a profitable call option trade on $GILD (Gilead +5% Friday to $80) June $70 strike called sold at $13.00 (basis $3 mid Feb.). Yield 3.7% p/e 19, even after recent run-up. Will re-establish long outright or via calls on a retrace to mid 70’s on underlying.

2.) $ABBV. AbbVie Inc. is a $130bln diversified global pharmaceutical company. ABBV’s HIV drug Ritonavir (Kalentra marketing name) has just completed a 199 person trial and results are expected soon. Another untested drug in their arsenal is Erbevo. HT James Bourne on several items in this blog post.


3.) $RHHBY. Roche is a behemoth, $287bln mkt cap . Oseltamivir (Tamiflu, marketing name) is a tried and true flu drug and esp. if the L and S strains of COVID-19 stay with us on a seasonal on-going annual basis, we will require the full menu of treatments at our avail. At peak valuation (prior) during the SARS breakout a lifetime supply of Tamiflu cost $100k. Rights to Tamiflu now owned by Sanofi, $SNY ($120bln mkt cap).

4.) $JNJ, Johnson & Johnson. Near all time highs, strength to strength, $374bln mkt cap. Steady as she goes.

5.) IBB, iShares Nasdaq Biotechnology ETF. $7bln. Less idiosyncratic risk, buy them all. One way to go. Screen holdings well.

The knife catchers stand at the ready, but never bring a knife to a gun fight. Patience is warranted. Catching the meat of the move is much more important than catching the bottom tick. Central banks must of course show a “chin up” demeanor, but they of course know their runway configuration has issues. Too much accommodation was held for too long a period and they find themselves without stores of ammunition for the battles ahead. Calls for an expansion of Fed mandate, first whispered on Friday last, sparked the valiant final hour recovery. Weekend bookies see much of that final Friday gasp getting retraced before futures open Sunday evening. Rest up, the days ahead will test us all. There will be 5% up days, there will be 5% down days.


Professor Gibbons, CFA, FRM

Follow me @firehorsecaper

PS: Some numbers could be stale due to source and/or passage of time. In most cases meant to signal magnitude, not false precision.


Jan. 27, 2020: (Discord chat history). Do we need a #coronovirus tab for both longs ($ZNO $NNVC $APT $LAKE $NVAC $BCRX $ATHX $AZN, $MRNA $LLIT, etc. ) as well as shorts? (airlines $TCOM).?

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Offshore Drillers: Seadrill Limited ($SDRL); Leap Option on Higher Oil; Drill Baby Drill – Offshore

The 10% rise in Seadrill Ltd (SDRL US) equity to $1.91on Oct. 11, 2019 is rare and masks the 81% drop ytd in 2019. Seadrill has been the laggard, but the other names in the offshore drilling space are down >50% as well (the largest player $3.7bln mkt cap Transocean Ltd (RIG US) is down 45%). Seadrill Ltd. is a micro cap, $190mm.

Macro weakness and high levels of financial leverage are the primary culprits for the performance of the group.

The world needs oil and increasingly the only viable answer is deepsea. Frackers, oil sands, deepsea; Seadrill is a concentrated bet on offshore being deemed the “cleanest dirty shirt”. 5-bagger on an 18th month time frame provides an ample, if not compelling risk:reward profile. Dig deeper in the article that follows.

$SDRL Sunrise or Sunset?

Any discussion of Seadrill Limited must start with its founder John Fredriksen (self made fortune, net worth exceeding 11 billion):

#129 John Fredriksen His offshore drilling rig firm Seadrill emerged from bankruptcy in 2018, with Fredriksen helping to raise about $1 billion in new debt and equity. His biggest holding is Marine Harvest, now named Mowi, which has rolled up competitors to become the biggest fish farmer in the world. (source; Forbes)

Mr. Fredriksen is key to the Seadrill story and is the main driver. Seadrill’s plan of reorganization (Ch. 11) was filed in September 2017 and they emerged from bankruptcy in July 2018 after a protracted negotiation with creditors. Fredriksen had $5 billion of his worth tied up in Seadrill at peak in 2014. As part of the restructuring plan, largely crafted and executed by John Fredriksen and a compact investor group, no draconian DIP financing package was required, importantly;

-Maturities on $5.7bln of secured bank debt were extended (5 years). 97% of secured lenders agreed to the plan. Debt servicing begins in 2021/22.

-Unsecured debt of $2.3bln was converted to equity in the new company (15% ownership stake). 40% of bondholders were onside with the restructuring plan.

-Legacy equity holders were effectively wiped-out (dead last in the cap structure) garnering 2% ownership in equity in newco.

-New money, $1.08bln in fresh capital came from Fredriksen and his investor group, $200mm in equity and $880mm in secured notes;

Seadrill New Finance Ltd. bonds with a coupon of 12% and a 2025 maturity have been holding in despite all the calamity in the listed equity. SDRLNO 12 7/15/25  last traded $94.166 for a yield to maturity of 13.48%. Bond investors are a conservative bunch overall. Seadrill Limited tendered for up to $311million of the noted bond issue in April 2019 at $100.70 (post the tender offer closing just over $476mm remain outstanding). Typically not a move you see from a company experiencing death throws. As a comp, the Transocean bonds of equivalent maturity are trading with a yield of 10.9% (RIG 7 11/1/25 @$85.74).

Seadrill Ltd. reported $1.5bln in cash after the Senior Secured Notes tender offer and an order backlog of $1.bln (Q2 2019, 30 June 2019).

Usually equity holders are the optimists and debt holders the pessimists (as their coupon and par at maturity are their capped upside). In the case of Seadrill Ltd., the roles appear reversed, where the debt is holding in and the equity has been in virtual free fall. When the roles are reversed “hedged high yield” can often be a compelling trade, where one buys the bond and concurrently sells the related equity (notional on the equity short matching the expected recovery rate on a filing). The canary appears to be fine in this example, with the bonds trading in the mid 90’s in price terms.

One potential reason for the recent relative weakness in $SDRL shares (vs. peers) is the recent delisting of affiliate company, Seadrill Partners, by the NYSE. The company has stated they will appeal, but now trade otc (pink sheets). The delisting was due to the low market capitalization of Seadrill Partners.

Seadrill Limited has the newest high spec drillships and semi-submersible fleet in operation globally, with a lease up rate approaching 80% (versus sub 70% for the industry). Drilling contract take up shows signs of recovery (5 of the contract confirmation months in the last 5 years have taken place in the last 15 months, Brazil, Angola and India active). The harsh environment floater market is tight. New, higher spec rig pricing could be the catalyst for an upward trajectory in overall rig pricing (Seadrill Q2 fleet status attached).

Given the skull and cross bones warning of the sector, based on recent equity performance,  and Seadrill Ltd’s track record of flying too close to the sun from a leverage perspective (Ch. 11 exit in 2018), modest allocations are recommended (2% max). Despite recently being re-rated lower due to a combination of multiple de-rating (compression) and EBITDA revisions lower by the street, Transocean and Valaris are the other 2 players in the space warranting further vetting. Their stories are in some ways cleaner, but both are working through ill timed acquisitions which added to their leverage and hence uncertainty.

With respect to John Fredriksen there is certainly some key man risk. While John is in good health and certainly has experience to pull off a Seadrill resurgence, he is 74 presently.

Deepsea competitors:

1.) Shale

Some think the sun is setting on the oil shale revolution. A investment in Seadrill Ltd. is partially a bet on shale’s demise (it costs little comparatively to drill shale). Wells are reaching peak production quicker than modeled before declines set in, requiring a faster drilling pace to maintain production. Some firms expect the maintenance spend to exceed 80% of total as soon as 2021.

Most prime areas have been drilled already in the US shale patch and prospect quality is low. Prime offshore sights have B/E well below shale. Exxon recently announced plans to reconsider long shelved plans to a tap a 100 billion barrel oil field in ultra deep waters off Brazil. Exxon recently expanded the oil resource in Guyana (wedged between Venezuela and Brazil), first announced in 2015 (Liza discovery, 190km offshore Stabroek Block) and with the recent expansion is surely the biggest E&P story of the decade with economics far surpassing the best of US shale, a potential Oman by 2026.

National Oil Co. (NOCs) are active in the semi submersible space whereas the international oil companies (IOCs) tend to dominate the deepwater space in terms of rigs (Exxon, Eni, Shell, Equinor, Oxy, etc.).

2.) Oil sands

Growing restrictions on fracking have US shale players, frustrated by well performance issues and a lack of profits looking north to the Canadian oil sands. The supreme court in Canada changed the law to have environmental reclamation rank ahead of all other claims in bankruptcy going forward. Several of the biggest operators lease their land from indigenous tribes.  Ongoing infrastructure issues abound and while some have been tempted in on valuation metrics, this might me my #1 choice for stranded asset status, at least as long as oil remains < $100 barrel.

Geopolitical backdrop:

Saudi Arabia:

Recent attacks on critical petrochemical infrastructure in Abqaig, Saudi Arabia in mid September has highlighted the fact that the global sheriff, the United States is less omnipresent. While production was brought back on line quickly, the fact that 10 drones could wreak such havoc was a wake up call to the world with respect to potential global oil supply disruptions going forward.

In absolute terms Saudi is the 3rd biggest spender on defense, much of it coming from US suppliers. Only the US and Saudi spend >8% of GDP on military spending. China is the 2nd largest because of the size, but as a % of GDP stand at 1.9%, below the 2% min. threshold recommended by NATO (Canada is 1.5% as an aside).

Saudi Arabian Oil Co., aka Aramco is planning to move forward with their initial public offering (IPO) soon. They will be floating 2% of Aramco for $40bln implying a valuation of $2 trillion for Aramco. Trusted advisors are walking it back to $1.5 trillion given a few factors. While still the world’s largest, the Ghawar oil field is in an advanced stage of depletion. The IPO will be listed exclusively on the domestic stock exchange, Tadawul, not in New York and/or London as initially envisioned. Some of the kingdom’s richest families, some who previously boarded at the Ritz Carleton, have been asked to “dig deep” as anchor investors.

Friday past, the US announced they will be sending an additional 1,800 troops to Saudi Arabia to assist in their defense efforts against and to deter Iran.

An Iranian oil tanker was struck last week on the Red Sea by missiles, less than 100 km from the port of Jeddah, Saudia Arabia on October 11, 2019 (as an aside John Fredriksen ran oil for Iran in the 80’s and was struck by missiles; if you live long enough you get to see everything twice).

Strait of Hormuz:

The Strait of Hormuz is a strait between the Persian Gulf and the Gulf of Oman. It provides the only passage from the Persian Gulf to the open ocean and hence is a both a bottleneck for oil supply and a critical artery for supply to China (>60% passes through the strait).

VLCC shipping rates have skyrocketed in the last week. This is a direct result of the US sanctions on COSCO. A trade deal resolution between China and the US may have seen this relaxed, but as per the latest meeting, much work lies ahead. 11 year highs in crude shipping rates ($11 million for 1 ship topped by $13mm later in the week). Even clean tankers are opting to transport crude at these prices. This hurts China most and helps increase the shipping rates for all.


The offshore drillers perform a critical role. Day rates remain 20%+ below 2014 levels, but signs of life abound, due to issues of supply/demand. Oil prices will be the driver and increased geopolitical risk could be the thumb on the scale going forward.

Global PMI’s drifting sub 50 are signaling global slowing and have stoked fears of a global recession, but the world still needs its 1000 gallons of oil a second.

Offshore drillers, a key oil services supplier, could be due for a day in the sun.

Caleb Gibbons, CFA, FRM


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Note: MTUM: iShares MSCI USA Momentum Factor ETF (monthly returns, incl. dividends).

MTUM has $10.5bln in AUM (0.15% expense ratio). The average P/E is 31 and P/B 6.24. The top 10 momentum names owned by the ETF carry a 42% weighting in aggregate; AMZN, MSFT, VISA, BOEING, MASTERCARD, JP MORGAN, CISCO, NETFLIX, INTEL & ADOBE. The annualized vol of $MTUM is 15.6% vs. a compressed 12.5% for the S&P (87″ S&P index vol spiked to 50, 2008 > 62). S&P correlation is +0.95 as one would expect.

This graph is one all investors should heed this week. Black Monday is soon upon us, an ominous anniversary. Momentum investing has had a great run, as the graph reflects, but the blade has 2 edges, as investors are finding out. We kissed the 200 day m.a. like Joe Biden, with intent. This week, all eyes are on the heartless bots, ready to sell indiscriminately if/when the key technical level is breached decisively. $SPY ETF is the big dog, $280 billion in AUM (0.28 trillion). SPY monthly returns through October 18, 2018 are much less extreme at the margin, but note in the Feb. 2018 market hiccup MTUM outperformed SPY:

Note: SPY: SPDR S&P 500 Index ETF (monthly returns, incl. dividends).

If you are going to panic, panic 1st. There is a great deal of AUM managed via momentum metrics at present (sitting somewhere between traditional active and passive management). Backtests reflect outperformance based on side-stepping the big drawdowns in the equity market; the decision factors can be tweaked but a standard weighting is 40% on 3 mth returns, 30% on 20 day returns and 30% on 20 day volatility. Risk assets are sold in favor of ETFs like SHY (Barclay’s Low Duration Treasury, 2-yr) that will hold in should the market continue to plummet into the bowels of hell. It is all very methodical, “Jesus take the wheel” kind of stuff and risk assets are not entertained until the model says to (on a decided turn for the better in terms of observed performance). There will be little sign of rotation, EM (China, Russia, Brazil, India, Indonesia ….) don’t make me laugh. EEM, the biggest emerging markets ETF has AUM of $30bln.

Note: EEM: iShares MSCI Emerging Markets (monthly returns, incl. dividends).

This is a binary risk on/risk off allocation decision. Think light switch. The lights go off. Downside volume has been outstripping upside by as much as 40% in cruel October 2018 so far, but it could be just throttle steering so far.

We are all aware of the macro factors that got us to this precipice. Italy, China-USA relations, hard(er) Brexit, Fed rate hike cycle (US Dollar strength), QE unwind, Saudi fight club, and mid-term elections in the USA.

Buckle up. Keep your wits about you. JCG

Follow me on Twitter @firehorsecaper

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CHINESE AUTO STOCK: Geely Automobile Holdings Limited (0175.HK)

Late cycle, autos struggle, leading some to question when “cash for clunkers 2.0” might be given consideration for the US market. China overtook the USA as the largest car market in 2009 when 13.8mm units were produced. By 2014 23.7mm units were produced for a 26% share of global automobile production. As of 2017 China is at 30% with 29mm units.

Globally, auto stocks are having a terrible 2018:

Toyota: -6% Nissan: -9% Tesla: -16% Volkswagen: -16% Honda: -17% GM: -18% Daimler: -22% Ford: -25%

Geely Auto Holdings Ltd. rallied 5% today on the announcement of a ride hailing JV with Daimler for the China market, in a bid to take on Didi Chuxing. Didi is larger than Uber and is expected to achieve a mkt valuation of $70-80bln when it IPOs in Hong Kong. To put Didi’s private valuation into perspective, Daimler’s market cap is $67bln and Geely is a mole like $16bln. Geely is Daimler’s largest shareholder at just over 10% ($9bln invested in February 2018, now worth $6.7bln).

Under Li Shufu’s leadership, Geely has been both acquisitive and opportunistic in managing their stable of brands. One standout purchase was Volvo Cars, which Geely bought for $1.8bln from Ford in 2010. As Fiat did with Ferrari ($RACE), Geely plans to spin out Volvo Car by way of an IPO when the environment is more accepting. Joint underwriters Citi, Goldman and MS had a range of $16-30bln in mind for Volvo Cars, who have put up record sales for the last 4 years and respectable EBITA of $1.6bln per annum. Even with the low end valuation for Volvo Cars, it is not hard to back into a sum of the parts valuation that makes Geely a compelling investment in a challenged industry (the cleanest dirty shirt, if you will). Unlike Daimler, where cars and trucks are under the same corporate umbrella, Volvo separated the two some time ago. AB Volvo is the publicly listed truck division of Volvo. Geely separately invested $3.3bln in AB Volvo.

Geely Automobile Holding Limited:


$125bln HKD, USD/HKD 7.82 US$ market cap $16bln

US$ 16bln Enterprise Valueess: Daimler investment $6.7bln, AB Volvo investment $3.3bln, Volvo Car IPO valuation $9.6bln (60% of low end IPO valuation, to account for timing, execution risk).

Net value paid for Geely: US$-3.6bln.

This seems a comfortable buffer for further downside (i 22.5% of current value), especially when Geely itself is down 45% year to date 2018. The dividend yield is 2.05% as well.

In addition to the 4 sedan variants and 3 SUV/Crossover models marketed under the Geely nameplate, Geely is controlling shareholder in Proton Holding (long standing Malaysian value brand), Lynk & Co., London Electric Vehicle Company and Lotus. The new Proton SUV will be produced on the same line as the Volvo XC40 in China, with clear “rub off” quality effect expected to bolster sales. Perceptions of quality change over time, look at the reputation of South Korea’s Hyundai over the last decade. The new Genesis G80 looks as polished as anything coming off the line in North America.


I like the Geely story, even if the Volvo Cars IPO gets shelved or delayed. Volvo had made a commitment that all their cars post 2019 will be electric. Looking at the reception newcomers like $NIO have received by the auto EV market, an incumbent with onshore China manufacturing capability could be a powerful combination.

I’m long at HKD$14.00 (US$1.79) and I think a double is not out of the question within a 12-18 month time frame. The strongest near term price catalyst would be a Volvo Cars IPO at a $16bln + valuation in Q1 2019. I’m not too concerned with the fx risk of buying in HKD (peg to USD). There is very good volume for 175.HK but scant volume in the otc listing $GELYF. Note: Also long $NIO, but it is high beta compared to $175.HK.

Follow me on Twitter @firehorsecaper

Safe trading. Caleb Gibbons

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I have written on miners several times in the past for ibankcoin from the peanut gallery, but from inception no event has been as profound, so glorious, as the “Fathers Day Vein” find by Canada’s Royal Nickel Corp., dba RNC Minerals (RNX.TO, RNKLF otc/pink sheets) at their 100% owned (via sub lease) “Beta Hunt” mine in Western Australia, at Kambalda, 560km (320 miles) from Perth.

RNC Mineral have mined specimen rocks, from a single cut, with visible gold this month from their Beta Hunt mine grading in excess of 2200 g (68.4 oz.)/t (no typo). The largest specimen rock at 95kg. had 69kg. of total gold (quartz making up the bulk of the rest) and required no further processing, being sent directly to the Perth Mint. The scale of this discovery should not be discounted. The nugget sample is the 2nd largest ever mined by man and the grouping  of high grade nuggets ranks in the top 10 ever found (107 billion humans have lived on Earth since existence, 7 billion currently present and accounted for). Profile picture with the larger “Fathers Day Vein” specimen rocks features from left to right; SLM Geologist, Lachlan Kenna, Air-leg miner credited with the find Henry Dole, Beta Hunt mine foreman Warren Edwards and Snr. Geologist Zaf Thanos. Happy lads all.

Strike length continues to be refined (2x original now) and an addition 2 km of potential lies ahead. The gold find, from a space basically the size of a large living room, is 24,000 ounces (worth US$29mm, C$38mm). This leads all to think house, football field, airport runway, Newark, NJ., hence the buzz. Given the richness of the find, margins have been estimated at 90%. The specimen stones will likely be sold at auction for a premium as high as 30% to the gold content (15% offered already by yet unnamed museums). The interweb is loaded with coverage on the story as one might expect. In the age of social media issues of continuous disclosure are sure to arise, but the team at RNC Minerals seem up to the task at hand.

Press release related to the “Fathers Day Vein” discovery by RNC Minerals at their Beta Hunt mine is available on their website; http://www.rncminerals.com/2018-09-20-Fathers-Day-Vein-Yields-24-000-Ounces-of-Gold-Worth-38-million There is an informative Webcast of their 11-Sept.-2018 press release which is worthwhile also. For further information: Rob Buchanan, Director, Investor Relations, T: (416) 363-0649, www.rncminerals.com


Note: The other visible metal in the sample is quartz (fly is for scale I assume).

Mining has become expensive, the easy stuff has been done …so we thought. Many jurisdictions are difficult to operate in, subject to government overreach and/or outright nationalization. Spectacular gold grades are largely a thing of the past, trending to 2-3 g/t (5g/t was thought to be economically viable at historic gold prices). . Pretium, $PVG, another Canadian miner, was putting up (modern day) staggering numbers of 14.1 g/t from their Brucejack mine in British Columbia, Canada. Recent Milli Vanilli allegations re: sampling abnormalities have compressed PVG’s market cap aspirations, but with a market cap of $1.6bln Pretium is still a full 10x bigger than lowly junior miner RNC Minerals.



Many of the biggest finds (individual gold nuggets, of all time) have been Australia domiciled:

Top left in the graphic, Welcome Stranger (mined In The Year Of Our Lord 1869) from Australia netted 2520 troy ounces of gold. The biggest nugget of the “Father Day Vein” netted 2440 ounces for a very close 2nd place, but now takes the record as the largest nugget still in existence.

Largest nuggets still existing (others processed for precious coins and deliverable bullion by various mints):

1.) Canaan nugget, Brazil 1983, 60.8kg. (1682 troy ounces).

2.) The Great Triangle, Russia 1842, 36.2kg. gold assay 91% (32.94 kg gold). (Father’s Day Vein 82.5% 95 kg. gross, 78.4 kg gold).

3.) Hand of Faith, Australia 1980, 27.66kg. (largest ever found via metal detector …. a good day), currently housed at the Golden Nugget in Las Vegas, NV, USA.

4.) Normandy nugget, Australia 1990, 25.5kg. (820 oz. gold … 80-90% purity).

5.) The Kum Tow (aka Kum Fow, Rum Ton), Australia 1871, 22.5kg.

6.) Ironstone, “Crown Jewel”, 1992, California, USA 16.4kg.

RNC Valuation:

As with many mining juniors, RNC has has its ups and downs, on balance, more downs of late. As you might expect from their name, Royal Nickel Corp. (dba RNC Minerals) is primarily a nickel miner. Their key asset is their 28% stake (JV with Waterton) in the Dumont Nickel-Cobalt Project in Quebec, Canada. The project contains the world’s biggest reserve of both cobalt and nickel (demand coming largely from the growing electrical vehicle market). The value of Dumont alone was enough to justify the C$0.44 (US$117mm market cap) price once you take insolvency off the table, which is what the Beta Hunt gold find has done. Money was tight and RNC was in the midst of selling “non core” Beta Hunt to fund their portion of the development plan at Dumont (C$1bln total cost). Dumont has a mine life of 33 years and 1.18 billion tonne reserve (proven & probable), containing 3.15mm tonnes of nickel and 126k tonnes of cobalt. The Father Day Vein find of 24,000 oz. of gold at the working Beta Hunt mine in Oz has clearly taken sale off the table (potential suitor likely steamed at the timing). Assuming the current valuation is largely for Dumont (Ni-Co), the Beta Hunt gold call option is hard to value until further exploration work is done to define the potential scope. What we do know is 12mm ounces of gold have come out of the region of which Beta Hunt is a part of. RNC Minerals are the first to explore the Lunnon Basalt at this depth (500 meters), level #15 (of 6 levels total being mined). Gold Fields Limited have rights to the first 200m as I understand it, with RNC mining below that depth threshold.

Eric Sprott, a self-made Canadian billionaire likes the RNC Mineral story, a lot. This week in a regulatory filing Mr. Sprott announced he had purchased 561,000 shares of $RNX.TO on the open market at an average price of C$0.4284, taking his ownership % > 10%. The bulk of Eric’s holding are from a 2016 bough deal financing which came with warrants (9.265mm exercised this week at C$0.43). Current shareholding 40.2mm shares of common. The current float is 390.3mm shares (fully diluted 477mm). Eric does a weekly for Sprott Money and has never seen anything like the specimen stones mined at Beta Hunt.

The majors will be all over developments at Beta Hunt. There has not been a find of this magnitude in a long, long time. RNC Minerals owns 100% of Salt Lake Mining (SLM) who purchased Beta Hunt in 2013 for A$10mm, mining rights secured from Gold Fields Limited ($GFI).

RNX.TO shares went from lower left to upper right all day Friday (yesterday 21-Sept-2018) closing up 31.7% at C$0.56 on 27.99mm share volume. The US dollar RNKLF (oto, pink sheets) closed at $0.4389, up 30.9% on 2.29mm shares.

Conjecture on the potential share price is premature until further mining is undertaken by SLM at Beta Hunt. Any indication of repeat occurence or continuity of the current seam will be well received given the richness of the recent grades. The geography has shown itself to be condusive (gold in quartz touching sediment), but coarse gold finds (>10g/t) typically do not have the consistency of lower grade gold mines. SLM previously had a plan of mining 60,000 ounces of gold per annum from Beta Hunt. How much there Beta Hunt numbers go up will take time to discern, the good news is they will have the money to get on it with a much quicker timetable than their budget previously allowed (114 employees; mgmt, tech srv and operations). While a micro cap at present (<$300mm), this is not a low float stock with almost 400mm shares outstanding. Real movement will only come with real results, but anchor investor like Eric Sprott help to provide a floor pending further clarity. This is a story and a ticker to monitor. In Q4 2010 RNC Minerals stock traded at just over C$2.50, as a point of reference.

Mark Selby, President & CEO of RNC Minerals takes the floor at the Denver Gold Forum Monday next at 4:30pm and you can bet RNC and Beta Hunt will be the belle of the ball. I will be watching developments closely.

Safe trading.

Follow me on Twitter @firehorsecaper

Regards, Caleb Gibbons, CFA

USD/CAD 1.2912

Disclosure: Long RNX.TO from open 21-Sept-2018 at C$0.44. On position sizing, I have a rule of thumb that has served me well in terms of sleeping at night on idiosyncratic single name exposure; never invest more in a single stock that you would pay for a car. I bought 100,000 shares.



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Denis O’Brien, Ireland’s richest native ($4.3bln) is the 94% owner of Digicel Group. Digicel Group offers telecommunications (wireless, cable, and business services) media and entertainment services to 14 million subscribers in 32 markets, primarily in the Caribbean and Central America. Largest markets; Haiti (16% revenues), Jamaica (16%), Papua New Guinea (13%), Trinidad & Tobago (6%).

Digicel bonds have been the worst performing emerging market bonds of 2018, losing 30% of their value year-to-date.

Macroeconomic/FX Risks:

The strengthening US dollar had been a big factor and analysts expect the effect to be ongoing, lessening top line revenues by as much as $220mm and EBITDAR by approx. $100mm per annum. A full 95% of Digicel’s debt is US dollar denominated whereas 50% of revenues are either USD or from markets where the currency is pegged to the US dollar.

Bond information:

DLLTD 8.25% 9/30/2020 RegS. Issue size; $2bln. Maturity 9/30/2020 (2.05 years) sub 2 year duration. Net leverage 7.0x (up from 6.4x prior year). Recent price $69.76, current yield 11.83%, yield to maturity 39.33%. Fitch downgrade 8/24/2020 to B-, neg. outlook. It remains to be seen what the bond market reaction will be to Fitch’s downgrade of Friday past, but I suspect it will be muted. Bond CUSIP USG27631AD56.

Digicel Group Limited (DGL) debt, of which there is $3bln total outstanding is structurally subordinate to $3.7bln of debt held in 2 other Digicel entities, 2.3bln in senior unsecured Digicel Limited debt and $1.4bln in senior unsecured terms loans/revolver at DIFL (Digicel International Finance Limited).

Potential sources of refinancing:

The market is anxiously awaiting the game plan from Mr. O’Brien on the refinancing of the DLLTD 8.25%’s of 2020. The fact that the market is trading at the current level of distress (i.e. sub $70.00) may offer opportunities for restructuring Digicel. Given the large issue size of $2bln, a successful tender for the bonds at $80.00 could save Digicel $400mm. XTract Research recently released a report eluding to this possibility, but as I understand it no price indication has been proposed. One potential value catalyst noted in the XTract report (I have only seen an exerpt) is rolling in the assets of the currently unencumbered Digicel Pacific Limited entity.

-It is possible that $1.2-1.3bln of additional secured debt could be raised related Digicel entities.

-Denis O’Brien has eluded to the possibility of an equity infusion in the past. When Digicel was “rolling in clover” as they say, Mr. O’Brien took out $1.1bln in dividends from Digicel, the bulk ($950mm) in the form of a special dividend. This action (an equity infusion) would be in keeping with O’Brien’s plans to eventually IPO Digicel. Denis last attempted the IPO route in 3Q 2015, but it is doubtful he will try again before 2H2019 when leverage can be brought down to a more manageable level of 5.7x. Fitch and the other rating agencies note there is a lot to like in the competitive positioning of Digicel which operates largely in duopoly markets boasting a market share of 50% in many (not to mention 40% margins). What the rating agencies are more concerned with is the liquidity situation of the group with $158mm in cash/near cash versus an annual interest expense of $456mm, approaching 50% of EBITDA (Note: IF Digicel were a US company their interest expense would only be partially tax deductible as the 2017 Tax Cuts and Job Act caps/limits the tax deductibility of interest to 30% of EBITDA).

-Asset sales. Digicel recently effected a sale/lease back on their cell phone towers which helps at the margin, but with net proceeds < $100mm the effect is minimal in the grand scheme of things. Beyond the 450 towers covered by the sale/leaseback details have been scant of the other $400mm O’Brien has eluded to (i.e. $500mm total asset sale program).Perhaps more important is getting capex back to 14-15% of FCF from the recent highs of 21% due to heady network investments.

-Cost cutting. No further meaningful cuts are achievable as 25% of the group work force was retrenched in 2017.

Value comps: EV/EBITDA; C&W (bought Liberty) 11.2x, Columbia (bought) 9.6x, AT&T (T) 8.5x, American Mogul (AMX) 5.3x, Telefonica (TEF) 5.4x, T-Mobile (TMUS) 6.2x, Orange (ORAN) 5.6x = avg. 7.4X.


The DLLTD 8.25%’s 2020 have traded as low as $62.90 in 2018. The minimum lot size for the bond issue profiled is $200k (par value), hence if one were to buy the bond at $70.00, the initial investment would be $140,000 (plus accrued interest of almost $7k), qualifying as a substantial investment for an account sized at $5mm (i.e. 3% of invested capital). Too much single name risk for me, $100k par value is more typical. JP Morgan’s EM bond ETF, ticker EMB would offer similar exposure for individual investors with more modest account size. The ETF has $13.6bln in AUM with a dividend yield of 4.62% and a ytd -5.13% return in 2018.

Digicel (B2, neg. outlook). A total return >35% is attractive, especially when compared with the paltry 7.7% yield on longer duration single B3, neg. outlook credits like TESLA (i.e. TSLA 5.3% August 2025 bonds last traded at $87.20 to yield 7.7%) which carry much higher interest rate risk (TSLA’s 5.8 year duration versus sub 2.0 year for Digicel). Tesla’s current EBITDA is -326.2mm (analysts estimate $3.2bln in EBITDA for 2019) hence a potential double headwind of EV subsidy cessation and loss of interest deductibility. Shorting TSLA is too expensive and foolhardy, but you don’t have to own it for certain.

Follow me on twitter @firehorsecaper

Safe trading. JCG

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$CACC – Credit Acceptance Corp has been in the subprime used auto loan game for a long time, since 1972. The company currently sports a market cap of $7bln (enterprise value of almost $10.5 billion, inclusive of $3.45bln in debt), with a P/E of 15 on earnings of $24* a share driving a current market price of $360. The short thesis that will be laid out in this article will be driven by a steep drop in earnings on a go forward basis due to an increase in realized credit losses. One would expect P/E multiple compression to be a factor as well, once the rally has crested.

*Tax Cuts and Jobs Act accounted for $5.10 per share in ’17 GAAP (one-time effect).

The US consumer is more heavily indebted than at any other time in history. The unemployment rate has rarely been lower at sub 4% and all states are currently sub 7%. Consumer debt stands at $12.96 trillion. Student loans are at a record $1.36 trillion, sporting an 11.2% delinquency rate (Powell put?). Auto loans outstanding stand at $1.21 trillion ($282 bln to sub prime borrowers) with worsening delinquency stats; 5.8% > 60 days (higher than through the global financial crisis where rates peaked at 5%). Underwriting standards have tightened overall, but the numbers for non-bank subprime auto are worse at just under 10% delinquent (per Equifax). As one might guess, used cars do not result in high recovery rates when things go pear shaped. 107 million Americans carry auto loans at present, +35% since 2012.

This folly can of course continue for a while longer. $CACC’s cost of debt is currently just over 4%. Their most recently completed $450mm subprime auto loan securitization (non recourse) was well received. Zerohedge recently wrote on the phenomenon “Junk in the trunk” and included the recent auto loan delinquency table. Similarly generically named (i.e. ACME Auto) Consumer Portfolio Services, Inc.  (CPSS) recently completed a $40mm securitization of their residual interests in 13 previously completed securitizations. Feed the ducks when they are quacking, indeed.

Credit Acceptance Corp (CACC) 5 year chart – a thing of beauty.

Things that should worry the bulls:

1.) Credit quality of CACC’s loan portfolio:

Similar to strategies like selling volatility, lending money on easing terms to sub-prime borrowers can be a recipe for lackluster investment returns, if not outright disaster. Credit Acceptance Corp clearly has the data to provide further stratification, but instead disclose that 95.6% of their clients are sub-prime (< 650 FICO score).

Car loan term extension. 5 year ago the average car loan was 48 months. No more …. over 40% are now 61-72 month and 32.5% are 73-84 months. Moving on to the used segment, terms have also been extended. CACC’s average loan term for advances on used cars stands at 50.4 months (almost 20% longer on a rolling 5 year basis). Cars financed at 20% interest rates do not yet easier to own with the passage on time.

2.) Shareholder Distributions:

Considerable time is spent in the annual reports of CACC on the merit of stock buybacks versus dividends.

A sample from the most recent 2017 report:

“Like any profitable business, we generate cash. Historically, we have used this cash to fund originations growth, repay debt or fund share repurchases. We have used excess capital to repurchase shares when prices are at or below our estimate of intrinsic value (which is the discounted value of future cash flows). As long as the share price is at or below intrinsic value, we prefer share repurchases to dividends for several reasons. First, repurchasing shares below intrinsic value increases the value of the remaining shares. Second, distributing capital to shareholders through a share repurchase gives shareholders the option to defer taxes by electing not to sell any of their holdings. A dividend does not allow shareholders to defer taxes in this manner. Finally, repurchasing shares enables shareholders to increase their ownership, receive cash or do both based on their individual circumstances and view of the value of a Credit Acceptance share. (They do both if the proportion of shares they sell is smaller than the ownership stake they gain through the repurchase.) A dividend does not provide similar flexibility. Since beginning our share repurchase program in mid-1999, we have repurchased approximately 33.4 million shares at a total cost of $1.6 billion. In 2017, we repurchased approximately 610,000 shares at a total cost of $123.5 million.”

It is separately disclosed that CACC is fully restricted in paying any dividends by its Lenders ($3.45bln and the Lenders get paid 1st from a priority of payment perspective). Dividends matter and CACC management can not claim to be Warren Buffett, despite the impressive track record CACC has logged. There is no portfolio effect to be relied upon in this instance. CACC finances used cars to insolvent borrowers at above market interest rates in the hopes that the net margins secured over numerous economic cycles compensates for the considerable risk assumed. Estimating the intrinsic value of CACC at any point in time is poppycock as a result. Caveat emptor, especially CACC themselves in buying their own stock. Red flag.

CACC have not repurchased shares since $220. CACC, “If we are inactive for a period, shareholders should not assume that we believe our shares are overvalued.”

3.) Management turnover:

President from 2007 Steven Jones retired mid 2017. Founder and former Chairman Don Foss has sold $450 million in CACC stock since exiting.

Car Trouble;

“They Had Created This Remarkable System for Taking Every Last Dime From Their Customers”





4.) Relative valuation comparisons:

$CACC’s  P/E of 15 seems quite punchy for a sub-prime auto lending operation. Much better diversified banks are lower; WFC 13.6X, RY 12.5X and WBC 11.7X. In the exact same space the valuation asymmetry is even more marked. Santander Consumer USA Holdings Inc. ($SE) has a similar market cap ($6.9bln) yet sports a P/E of 5.9x

GM bought AmeriCredit (ACF) for a 24% premium to the then public equity valuation in July 2010, 1 year post a $50bln bailout by the US government while still 61% owned by the US Treasury. In this space, silly can remain silly, approaching ridiculous at times.

Action plan:

Monitor Credit Acceptance Corp. ($CACC). Short interest is relatively high (12%) and the high-beta rewarding market we currently enjoy could see CACC reach towards $400 in calendar 2018 as the indices pinch higher. Remarkably, the only down month for CACC historically is October. With spot at $360 I’d think September might offer a good entry point for a short:

Spot price: $361.15

9/1/2018 projection $380 (short entry target)

Take profit (TP) $210 (I buy where CACC buys)

Stop-loss (SP) $418

Risk reward (R:R): 4.5:1

Follow me on twitter @firehorsecaper

Disclosure: Flat $CACC, monitoring for initiating a short position of 2-3% (of overall portfolio).

Caleb Gibbons

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Few things are viewed with as much distain as US Treasuries, or more generically the “rates” market for 2018 and beyond. Finding the correct instrument to short the rates market and perhaps more importantly choosing the right tenor (target duration) is difficult for the average investor.

10 year UST sold off by 7bp today and went out yielding 2.55%, the cheapest of the year (near term target 2.625% aka 2 5/8%). Estimates are for a 3 handle and even 4% 12-18 months out. Barron’s recent poll saw 10 year UST estimates ranging from 1.95% to 3.10% with the median estimate 2.65% (not likely within the range let alone correct on a stand alone basis).

HT Patrick Burbon @pbourbon

All the “big guns” have declared open season on the long duration US rates market, it appears:

Gundlach holds the current title of bond king having built Doubleline from scratch post TCW to > $100bln in AUM in just a few years. DSL, Doubline Income Solutions is only $2bln of this AUM, but continues to impress (writer up 25% on initial purchase, 15.7% blended across two). Jeff is calling the current environment the era of quantitative tightening, driven by a hawkish ECB. Stateside Gundlach sees a US$1.9tln in 19′ bond supply (no ultralongs). He also noted that it is a very poor time to buy corporate bonds (high yield bond index yield 4.93%) and Gundlach sees a negative return for the S&P in 2018 as the rates rout eventually gives the equity market the yips. Gundlach see the 10 year UST yield getting to 3.25% in short order. Everyone seems to need to comment on bitcoin too, Jeff thinks the highs have been printed.

Bill Gross (same age as my Dad) from Janus Capital Group, who built his >$1bln wealth at Allianz’s Pimco and was the bond king ($270bln AUM at its zenith) until Gundlach wrestled it from Gross’s arthritic hands, is also a bond bear. Gross stated today that 25 year trend lines in both 5 and 10 year treasuries have been broken, signaling a bear market.

Sovereign buyers (China and Japan in the press most recently) are taking pause with respect to incremental UST purchases as the hedging costs to bring the assets back to their home currency have become prohibitive, in some cases. The big players are reticent to place large UST positions on unhedged given most are marked to market, with the degree to which they are offside promptly reported. Significant career risk indeed.

While 10 year UST closed out 2017 almost the same yield as 2016, much has transpired with respect to curvature, namely curve flattening. 5-10’s closed the year sub 0.20% (20 basis points), whereas 2-10’s went out at 0.518%, from a relatively steep 1.28% to start 2017. Best to stay clear of long bonds on any bearish bets, as term preference and relative value (versus peers like German bunds) could see yield well contained in the long end, on a relative basis (i.e. 10-30’s inverted, from +12bp currently).

While bond bears are numerous, the view in not unanimous (thankfully, one needs someone to take the other side, as it were). The California Public Employees Retirement Systems (Calpers) at $342.5bln AUM is the largest public pension fund in the USA (as social security is not funded, opting for a “pay as you go” approach). Calpers made a watershed move to INCREASE their bond allocation to 44% from 19% in November of 2017. Calper’s resultant return expectation has been lowered by 0.5% to 6.5% to reflect the more conservative asset allocation, leaving their funded status at an unimpressive 68%. Outright losses on a bond allocation of this magnitude would result in overall Calpers returns being impaired by more than 50bp, for the actuaries out there. The new allocation went into effect January 1, 2018 and changes are made every 4 years.

If you are in the bond bear camp, the next decision is your optimal means to short the bond market. There are several alternatives.ProShares UltraShort 20+ Year Treasury (TBT) has $2bln in AUM and provides an ETF solution to shorting the US treasury market. The payout is -2X the daily performance of the ICE U.S. Treasury 20+ Year Bond Index. ETFs are a fully funded solution. I am leaning towards, for tactical positioning, is interest rate swaps (paying fixed 10 year). Just as the natural inclination for the stock market in a given year is positive (approx. 65%), the natural interest rate curve is positive, as in upward sloping.

Positioning for higher interest rates via shorting treasuries or paying fixed on an interest rate swap are negative carry trades. There is a trading adage that the road to hell is paved with positive carry trades (i.e. selling vol as an example). It is important to know the mechanics of the trade you are contemplating entering. To show this by way of an example, if one were to pay fixed on $500,000 notional 10 years you would pay 2.612% in the current market. In exchange for paying fixed you receive 3 month USD Libor flat (current setting 1.70%), hence for the 1st 3 months of the interest rate swap you have a negative carry of 91.20bp (0.9120%), approx. $1,140 on $500k notional. Each 3 month forward rate agreement (FRA) going forward will reset at the then current 3 month Libor (less negative carry as Libor sets higher) and if you are correct about fed fund futures underestimating the pace of Fed rate hikes the trade will “flip” at some stage, earlier than expected by the market, to a positive carry trade as 3 month Libor sets above the fixed rate you agreed to pay at trade inception. At trade inception, the difference between the fixed rate payments committed to and the expected floating rate payments should be equal to zero (NPV=0).

Interest Rate Swap Futures 101 for IB (1)

Product_Summary (1)

Interactive Brokers (IB) is now offering ERIS swap futures platform access to their 400k + person account base. This is an exciting development as the margin requirements are modest and there is no better way to replicate over the counter (otc) swaps available in the market at present. The uses are varied; those in an adjustable rate mortgage (ARM) can potentially hedge their interest rate risk for much cheaper than a refinancing. Those long credit with concerns about the rate market can hedge their rate exposure, creating synthetic floating rate notes (FRNs). Those looking to speculate of further a further sell-off in the rates market can participate with surgical financial precision. Trading hours are New York, but this is to be expected for a US dominated product. Most would hedge in New York hours regardless, but stops could be executed cross market in a pinch (i.e. buy 10 year Treasury to hedge a stop loss on a pay fixed swap position).

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While much of the US populace navel gaze over “he said, he said”, rear view mirror stuff with the 2016 US Presidential appointments/elections, real world carnage is taking place, in real time. Venezuela’s communist government slinky has run out of gravity and steps, falling at the feet of mother Russia. Venezuela has defaulted on $60bln of debt, officially termed “selective default” at present by the rating agencies. Russia is not sure what all the noise is about as their bi-lateral payments have been made on a full and timely basis? Ditto for China.

Caracas is 3,317 miles from Washington, versus the 4,861 miles from Moscow to Washington, DC (and much closer to key US energy assets in the Gulf of Mexico). Beijing is 11,158 miles fromWashington, for reference. Russia/China having strategic energy assets so close to the US should be a point of concern both for the current administration and for the bigger US GOM refiners. Billions of US dollars are flowing into Venezuela from Russia and China, along with a brain trust of skilled workers numbering in the thousands to ensure both execution and return bogeys are met. Russian war ships are on the way to Venezuela as we speak, a strong sign of Russia’s support for the struggling communist nation and the “financial aid” Russia has extended. Putin must have a good giggle daily at having a South American domiciled Ukraine-like foothold without an argument, let alone a public conflict with the US (for now). Back in August, Trump stated publicly that he could not rule out a military option with respect to dealing with the struggling South American nation.

Venezuela has a population of 31.6 million, about 15% less than Canada’s. Venezuela boast the largest conventional oil reserves and the second largest natural gas reserves in the Western Hemisphere. Venezuela’s non-conventional deposits are approximately equivalent to the world’s reserves of conventional oil. The majority of Venezuela’s domestic energy needs are met with hydroelectric power.

Bahrain has requested assistance from neighboring Saudi Arabia and UAE. Saudi Arabia has taken a page out of Brazil’s playbook with “Car Wash 2.0” anti-corruption crackdown. Zimbabwe overnight has seen a coup. Fun times to have the VIX in the low teems (12.6, up 9%). Sovereign EM is not the only story here as EM corporates are the ones with the more heady issuance of late, US$8bln a week at the  most recently clip. IG EM US$ bonds returns have been stellar thus far in calendar 2017 with 5 nations clocking > 10% returns year to date; Uruguay, Panama, Peru, Mexico and Kazakhstan. So much room to fall from here. Not a sky is falling comment, buy many assets are priced for perfection when we have blemished prospects for continued/further levity.

Back to Venezuela, recovery rates are very hard to handicap in EM credit, especially when the key assets that would result is some recovery have been sold to Russia and China respectively. VENZ, sovereign rating “D” standing for default,  (bond ticker, Benz with a V) 7% 1 December 2018 sold off 40% to trade $32/$35, (seems high given scant recovery prospects). Plenty of info in the popular press on the “deals” that have been struck between Petroleos de Venezuela (PDVSA) and Russia’s Rosneft in the run up to Maduro’s most recent restructuring  announcement.

The pace of EM bond issuance will be greatly curtailed, if not ceased near term. The US$ EM bond craze we have seen evident since the GFC has seen US$3 trillion of new debt issued. Little wonder high yield ETF’s have taken a knee in recent sessions, the dry heaves are coming. Calpers most recent tactical asset allocation back into bonds from DM equity will not be soon enough or far enough down the ratings spectrum to provide an air bag for the coming head on collision.

Venezuela, for their part, have been very critical of the rating agencies, “”In the last 36 months, Venezuela has canceled, for the concept of Reimbursed Capital and Paid Interest, the amount of $ 73.35 billion, an immediate consequence of each payment and each compliance has been the increase of country risk by rating agencies risk, which have been deeply inefficient to prevent scandalous financial setbacks in financial power centers in the United States, Europe, and Asia, but which are used as an instrument of devious action against our country: the more we have paid, even though we have always been timely in honoring our payments, risk rating agencies, following the pattern of financial blockade undertaken by the Trump Administration, makes it expensive with reports devoid of any form of rigor and veracity, the cost of our debt and intervene to hinder Venezuela in its condition of good payer and solvent country, access to external financing, common and frequent for almost all countries of the world”

Only 2 non muslims nations are included in Trump’s most recent travel ban. North Korea and Venezuela. Good luck getting plug nickel out of Venezuela near term if you are a US$ bond holder. Dalio’s call on gold, increasing his weighting significantly, seems precient. A number of geopolitical fuses have been lit, we just don’t know which one goes boom first.

Credit wider, bond steady / curve to stabilize, equity vol to spike, global equities softer, gold firmer.

Follow me on twitter @firehorsecaper

Don’t forget, cash is an option from an asset allocation perspective.


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tRump’s GOP tax plan is not sitting well with the high tax, blue leaning states of California (11.4% rate for State and Local Taxes, aka SALT), Connecticut (11.4% SALT), New York (12.6%) and New Jersey (12.3%). These four states account for 22% of the US population and 23% of US GDP. I frankly expected a higher percentage GDP wise, with so much of the vast contiguous states dedicated to energy production (1000 gallons a second in demand) and animal husbandry (9 ounces a day per capita).

With the proposed changes to the US tax code, removing the deduction of SALT payments from ones Federal tax bill going forward, the effective tax rate for the wealthy will be increasing significantly on passage of the bill in close to its current form. This will greatly enhance the attractiveness of municipal debt and has resulted in a stonking rally in muni bonds this week. Early innings with respect to the rally, unless the federal deduction for SALT survives in the final drafting. Rolling back SALT deductions offsets approx. 1/3 of the $1.3tln “hole in the bucket” left by the proposed GOP corporate and individual tax cuts (largely paid for by the 3% resultant GDP growth). The rally moves in muni credit will likely be muted on the heels of the ongoing Puerto Rico default/debacle, hence there is time to put in the work and do the analysis required to come up with a rational investment decision.


The initial read of Trump’s tax reform plans appeared to be hemlock for muni debt, driven largely by lower absolute tax rates, with the highest 39.6% (solo income >$418.4k, joint filer >$470.7k) bracket moving to 33%. With key tweaks to the tax reform plan on the deductions side, as many as 25.5% of taxpayers could see their taxes increase from current levels under the currently tabled tax reform plan. It appears the 39.6% bracket will likely be kept for those earning above 7 figures.

As an aside, NJ, post election, is expected to re-institute the millionaire tax for resident making > $1mm (2% effective surcharge on income > 1mm). In addition to the egregious existing taxes NJ levies, for no good reason other than winning geographic roulette in being commutable to NYC, one should expect a portion of NJ’s millionaires (7% of the population on net worth metric, much lower % on income) to pull up stake, taking a page out of Tepper (formerly #1 NJ taxpayer, now in Florida) playbook. With nine states credit watch negative, including NJ, a betting man would place odds on more downgrades than upgrades going forward.

For muni bond investors in the 4 high tax states profiled, there are a bevy of state specific funds that cater you your investment needs, if purchasing bespoke muni bonds is beyond your ken. The advent of on-line trading platforms is improving the state of play, but the bid/offer spreads on muni bonds is high, both outright and compared to taxable peers.


Two funds with comparable scale and liquidity are BlackRock Muni Holdings New Jersey Quality Fund, Inc. ,MUJ  and Nuveen New Jersey Quality Municipal Income Fund, NXJ. The big daddy is a Vanguard offering, 4x bigger at $2bln +; Vanguard NJ Long-Term Tax-Exempt Inv., VNJTX, yielding 3.46% (Federal and NJ tax exempt) which may seem paltry, until you calculate the taxable equivalent basis (TEB). Speaking to investment income, a NJ taxpayer in the top tax bracket in all categories pays 39.6% in Federal tax, 8.97% in direct NJ State Tax and Obamacare 3.8% tax on investment income (muni bonds are exempt). Adding up this stack gets you to 52.4% in taxes, coincidentally the same as the Province of Ontario in Canada (ditto on distress, save the pension funding shortfall issue).  Vanguard, and other veritable institutional investors have online calculators for TEB for those not mathematically inclined.

In my rudimentary NJ example, the VNJTX yield is 3.46% and the denominator is 0.476, resulting in a taxable equiv. yield of 7.27%. A quick perusal of global fixed income markets will find many gobsmacked to realize how high a 7% taxable yield is in the current environment.

US state pensions remain woefully underfunded in aggregate (70% funding rate, > $1 tln unfunded) and the public pension gravy train keeps on chugging, at least for now. Even for a $18 trillion dollar US economy, so many debt tallies in the trillion plus club should give the non-billionaire adults in the room cause for pause, if not reflection. Student loan debt; $1.3 tln, auto loans $1.2 tln and credit card debt (“revolving”, at least in theory) $1.1 tln. Those reticent to buy NJ domiciled muni debt and or NJ dedicated funds can of course give NJ a wide berth from an investment perspective. The rub is that your tax exempt muni yield will be only federal tax exempt, not state tax exempt. Following on my previous NJ example, your TEB (aka, your taxable basis “bogey”) becomes 6.11% instead of 7.27%.

The same analysis should be done for potential muni investors in “the big 4”, NNCC, as you are spoiled for choice in terms of muni debt and/or state specific funds (mutual, closed-end and ETF forms) to choose from.

When things get really interesting, “cross over” buyers, those that can not use the US tax exemption, find it compelling to buy US muni credit versus other investment options available in their home market. I’m a holder of BlackRock Taxable Municipal Bond Trust, BBN in my IRA (the underlying bonds are taxable hence distributions, currently yield 6.75% is taxable in non tax sheltered accounts). Pension obligation bonds, issued by states attempting to improve their pension funding % (in lieu of also paring benefits, which other countries do on a near 50/50 basis, until fully “funded” from an actuarial perspective) are also taxable.

With equities “off the leash”and vol compressed due to medicated markets, munis have a valid place in the asset allocation for US taxable investors (likely a multiple of gold and/or crypto). The US municipal bond tax exemption is one of the few near-free lunches on offer in global investable fixed income markets.

Keen to address any questions, as I know this space well. Follow me on twitter @firehorsecaper. Good to be back.

Caleb Gibbons, CFA

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