Melting Up

As equities push higher into the close, all my positions are rocketing along higher as well. Unfortunately, that includes ERX, but then when you’re playing with hedging, you expect some part of you to get burned.

Meanwhile, today I received glorious news, as the great country of Ukraine has agreed to cut obstinate export quotas, which I’m told were primarily being used by the politically connected to fill their coffers, thus clearing the way for Bunge to take further advantage of soaring global grain prices.

Of course, you will all now go to your local brokerage firm, and sell short 120% of the companies average float, because that is the sort of idiotic thing you lot do when good things happen to BG.

I expect BG to absolutely mock earnings estimates, for the fourth consecutive quarter in a row, all thanks to them under valuing their own book, continued agricultural strength, global turmoil, poor growing seasons coupled with decreasing operational farm land of competitors, and of course, now open ended exports from one of their sizable grain operations.

It looks that if oil bounds back to its highs, I will be sitting on about a 30% unrealized loss on my hedge, being short ERX. That amounts to roughly a 3% unrealized net loss when comparing it to the big picture. If crude oil should go “2008,” then my losses will be worse.

And I am perfectly willing to accept that.

Simply, even in the face of dollar destruction, the risk of a collapse of oil prices is far more real than the likes of Goldman Sachs would suggest. Take a closer look at the economies of countries around the world, and what I am personally seeing is the risk of an industrial slowdown.

Also, we have several countries, mostly BRIC types, who are heavily subsidizing their use of oil or, in some cases, like Russia, refusing point blank to export it. This is creating an artificial collapse of inventory in the Western world, a.k.a. where prices are set. However, like a taut rubber band, should these economies be stretched to the point of no longer being able to afford the massive expenditures needed to keep gasoline flowing cheaply, or be pressured to release their iron grip on global trade, and you will witness the price per barrel of crude unwind at an alarming rate.

There are plenty of other potential events that could similarly affect the commodity markets, with respect to crude; like the Middle East fire being put out or a Europe double dipping back into recession. Even massive easing and continued inflationary pressure, when coupled with a collapsing demand on the part of industry for crude products, can lead to lower oil prices.

While I would not be caught dead betting against most commodities, at this stage in the game, maintaining a low net hedge, but one that is highly volatile, against crude oil is a comfortable security to have, in my opinion.

If we should breeze past this point, then my gains will dwarf my hardships, and I can always tax-loss sell for the end of the year. Or, if oil should look like it’s going to continue appreciating, I can double down and wait for its crippling effects to grind an axe against consumerism’s face.

But I cannot be suckered into betting on the continued depreciation of the US Dollar before it has been assured. Not while already being mostly long.

I’ll let you in on a little secret. Bunge’s assets are being heavily discounted in their financial reports.

They admit to as much themselves, under their explanation of pricing inventories.

Of their $6.7 billion in inventories, the preponderance (about $4.3 billion) are carried at fair value. However, the remaining inventories are not.

Most of Sugar & Bioenergy, Edible oil products, Milling Products, Fertilizer, and a small portion of the large Agribusiness line, are carried at the lesser of cost or market value. What this means is that, in a market such as this where agriculture products are increasing so dramatically, the most the company is ever acknowledging is what its resources cost.

What they cost, not what people will pay for them.

Excluding the edible oil and milling segments for a moment, what are the odds that inventories from their other lines of business are being fairly accounted for?

Sugar is held at fair value, but bioenergy is almost certainly being under reported in this high fuel cost environment. Agribusiness is where most of the action is at; yet there is almost $700 million worth of inventory being held, at best, at what it cost to acquire them. And the fertilizer division is the most intriguing of all.

Fertilizer inventories, all $777 million of them, are carried at the lower of cost or market. So how much are those $777 million really worth right now?

The price of fertilizers has tripled in the past decade. Something to keep in mind; I had created a graph, but my computer is blowing up, so you’ll have to use your imagination. Imagine a line starting at 1 and then zigzagging to 3, right now.

Do it.

There is no way that BG’s Fertilizer division is only worth $777 million. Not a chance.

And as for the lines of business where the environment is unfavorable, like the edible oils and milling products, well…they’re already carrying those at or below real value. There’s no surprise left in that.

The bottom line numbers for BG were phenomenal this past quarter. The company’s intrinsic worth has advanced past $77 per share, the level where I calculated it based on last September’s numbers. Their most recent earnings of $1.49 work out to roughly 2% per quarter.

That’s the lowest they’ve been since the third quarter of 2010.

Plus, those earnings have been growing at an average 5 year rate of 27%. That’s even after they succeeded in shooting themselves in the foot in the early quarters of 2010 and beyond.

And the party is not stopping for Bunge any time soon, as they have locked in the current prices in the markets with over 4 million contracts, futures or otherwise. These margin levels will continue for the foreseeable future. I fully expect Bunge to perform for at least another two years as static labor contracts, controlled input prices, and historically low grain reserves of potential buyers take them home.

The final conclusion is that BG is terribly undervalued.

They are undervalued because they trade at a steep discount to their book.

They are undervalued because that book value is calculated using extreme discounting, making the situation even more ridiculous.

They are undervalued because they trade at a steep discount to strong earnings growth.

They are undervalued because they are reaping full reward of this environment and its opportunities.

And they are a must own for me.

Just how undervalued is BG?

Well, that depends on the profitability of their inventories, of course. But to get a feel for it, let’s just look at the business with theoretical profit margins of 10%, 20%, and 30%. (As an aside, I have no idea as to the actual mark downs of their holdings, and just looking at the price of fertilizers, grains, etcetera, I’d guess that the profitability could be much higher. As a rule, each 1% of error seems to add about $0.10 to the value of the shares.)

On what we’ll just say is $1.5 billion worth of “questionably priced” inventories (itself an underestimate), that would leave us with $150 million, $300 million, and $450 million worth of uncounted value.

Thus, the real intrinsic worth of the shares is more likely somewhere between $78 – 80, using just modest assumptions. That is without considering (as crazy as this must seem) that BG as a performing and valuable company, should perhaps trade at a premium to its book, as opposed to a discount of it.

Just another day in paradise, on this here Lazy Hedge River.

As the world lights up in a pyre and children go about the streets, I’m sipping on weak fruit cocktails with 8% alcohol by volume, not caring.

My positions are down for the day, but my “sanity investment” is all up, as my short on ERX plays off the general blow out occurring in the energy space and my losses are muted.

I want oil and related investments to bleed like it’s fall of 2008. As the American, European and Asian consumers suffer so thoroughly that they crawl into a hole I want oil to go to $60 a barrel and lower. On February 2, 2012, I want said consumer to see their finance-shadow, which of course will signify 6 more decades of “Oil Price Winter.”

I want all of this, so that the entire region known as the Middle East gets thrown into a wood chipper. I want those assholes so thoroughly buried beneath weak demand for their only natural resource that they literally start murdering each other, for the right to sell to the U.S. and similar countries for dirt cheap prices. I want them to be so utterly incapable of making a cent off of oil production that they are largely incapable of rebuilding their economies, and I don’t have to hear about their bullshit for the rest of my lifetime.

God willing, they will be so broke, my children won’t be bothered by them either.

Going forward, I will keep my position sizing and balance until I see developments within the U.S. government directing me to the tempo of the dollar. I will remain long half destroyed and uninteresting businesses like real estate, agriculture, utilities, uranium miners, and entertainment/gaming because, frankly, how much lower can these industries go?

I will hold cash because you don’t have any.

And in the meantime I will continue getting drunk on inner tubes while forgetting to apply sun lotion, that I might develop melanoma in my later years.

I have been drinking mimosa’s with the archangel Gabriel since 8:21 am, also known as THE OFFICIAL 2011 END OF DAYS PARTY START TIME. We are both ripped and loving…um…afterlife. We’re thinking of playing a prank on Harry Reid (D-Nevada), telling him he is already dead and seeing if we can’t get him to walk off the edge of the Grand Canyon in a trust exercise.

Ciao,

Cain

This market is essentially an ADHD addled teenager fresh off of getting bombed on PCP.

ERX was down more than 3%. Now, with little to no improvement in the oil markets, ERX is for no real reason down only a few hundredths of a percentage.

Random other positions in my holdings skipped unexpectedly up, for no real rhyme or reason, while volatility is cropping up in surprising ways.

Meanwhile, Congress is no closer to coming to an agreement, and so any decisive relief that may be experienced remains out of sight. Until those things are known, disagreement of the outcome will keep prices jerking up and down in choppy swings. However, it’s equally as dangerous to bet these swings will continue as it is to bet on the wrong direction.

This is not an easily traded situation. You want to play all points of the field, while shirking the crowded positions.

To make matters more unstable, there are riots and unrest cropping up all over the planet. The Middle East is obvious, but now Europe is on the cusp of crisis, there are reports of massive shortages in developing countries, and the whole world seems on the verge of a complete restructuring of global leadership.

The second biggest danger right now, aside from all out rebellion and warfare, is the damage that is being done to food supplies and basic materials. There is no way, judging by the reactions of governments to these developments, that investment in critical infrastructure is being made. Take for instance Argentina. They’ve been waging war against the big grain exporters, like Bunge.

Watch closely as losses are forced on the grain exporters, forcing them to shut down operations, which will both drive prices up higher while paving the way for a future shortage. I would not be surprised if riots started cropping up in Argentina in the next year or two, or in some similar country in the South Americas, as they have in the Middle East.

All in all, these are interesting times we live in friends. Watch your back, and be safe.