point

 

 Remember me

Register  |   Lost password?










December 2015

Technical Analysis of the Corn Market

December 31, 2015 by EconMatters   Comments (0)

By EconMatters

 
Corn Market 2015

I have been watching corn prices lately as they are getting low enough to at least pique my interest into looking at a market that usually just gets bypassed with the rest of my agricultural futures prices tab on my trading platform, more out of habit than having anything in particular against the agricultural markets. The March 2016 Futures contract was down about 16% in 2015 along with most of the commodity space on fund outflows, a weak China, and a strong dollar.

Economics of Agricultural Space

This goes against my intuition regarding long-term supply and demand drivers in the global economy. For example, the world population continues to grow, good farming land with proper soil management is a finite resource, and the world is going to need more food in the future. The Corn market looks like a buy over a five year time frame, unless the Midwest lobby loses big in Washington politics and the corn ethanol production market completely goes by the wayside, this probably would result in a drop before another spike as farmers readjust crop sizes to the new economics. But all else being equal I expect the corn market to go on another one of those massive runs higher sometime over the next five years given its recent history from a trading standpoint, and the broader economic drivers for the commodity over time.

Market Timing

But from a trading standpoint what I really want to know is are there any good trading setups because although I try to eat relatively healthy and exercise when I can for practical purposes I could be dead in five years. Maybe Warren Buffet can wait for 5 years for his investments to pay off but most of the street gets paid on an annual and quarterly basis. If a fund has a bad quarter, redemptions go up, and their assets under management go down. This is not good for fund managers as their compensation goes down from a lower management fee base, and obviously if they are having a bad quarter their percentage of profits number is headed in the wrong direction.

The bottom line is that most people have to get the timing right in an investment or trade, at least within the same calendar year. So what do the technical look like in the corn market? The theory is that everything that is going on with the fundamentals of the corn market are reflected in the charts, along with the technical and psychological drivers of the market. The idea is that the technicals will tell me when to get back into the corn market at least for a nice trading setup, they will tell me when something regarding market sentiment is changing at least from a fund flows perspective.

Technicals

Therefore in looking at the two year futures chart I have picked out the 410.00 cents per bushel area where I start to get interested in the corn market. We are currently at the 358.00 cents per bushel area, and I am not looking for a short in this market. However, from a trader`s perspective there is a two year trend line going from the 510.00 cents per bushel area to the current price area of 358.00 cents per bushel area. If price breaks above this trend line around 370.00 cents per bushel, this could be a good buy stop entry with a relatively tight protective stop in the area of 364.00 cents per bushel to 357.00 cents per bushel depending upon your trading style.

Overhead Resistance

The first target on this entry would be a break of the 396.60 cents per bushel high in late October of this year on the six month chart to test overhead resistance at the 410.00 cents per bushel high last hit October 7th of 2015. The Reward to Risk profile is 6.67 Units of Reward to 1 Units of Risk with the tighter stop around 364.00 cents per bushel , and 3 to 1 with the wider protective stop at 357.00 cents per bushel. I would watch price very carefully because what I am in this trade for is a break of the 410.00 cents per bushel overhead resistance area with the next profit target around 464.00 cents per bushel last established in July of 2015.

As long as you have a winning trade, why not let the market tell you when it is done going in your direction? Has the trade broken any key technical levels of support? These markets are a lot bigger than one would think, and once the fund flows start coming into a market, a trader or investor needs to take this into account, as often the results are binary. For example the market is either going to go your direction, and if it does expand your profit target more because it is going to move a good way on changing capital structures. Or alternatively the trade is a non-starter, and a tight stop will tell you pretty early that your timing is just not right on the trade for a relatively cheap price.

The next overhead resistance level in the corn market is around 510.00 cents per bushel last established in late April of 2014. The five year high in the corn market was established on August 6th 2012 at around 845.00 cents per bushel. The 10-Year Corn Futures chart basically has a double top on it around the 800.00 cents per bushel area, which give or take the short squeeze effect, is good enough for a price barometer where the market starts to entertain that it is overvalued, and lots of shorts and hedges enter the market for good.

Long Term Support

The fifteen year chart has the 200.00 to 250.00 cents per bushel area as longer term support for those wanting to look at the trade on the short side. With the 25-Year chart reinforcing the idea that the 200.00 cents per bushel area represents solid long term support for corn futures. The problem is that a lot of this history is before modern electronic markets really took off and became global marketplaces for investors. And when inflation effects are factored into the equation, on an inflation adjusted basis corn is probably at or near a 25 year low right now at the current price.

The Patient Investor

And for those investors with a five year time frame and no pressure from outside investors, given the nice bull moves of the last 10 years in the corn market, it makes sense to try and anticipate the next large move in this agricultural staple. Therefore, if you want to get into the corn market now and wait for the move, one needs an instrument or asset where they can stay in the trade and not be liquidated, depreciated beyond reasonable time decay, and get the best full value of the move if it transpires.

Corn Futures Curve

For example, the December 2019 Corn Futures contract only has 9 contracts of open interest at the close today with a prior close at 417.40 cents per bushel with the last actual trading volume today in the December 2018 futures contract with a price of 410.00 cents per bushel with a lofty 3 contracts trading hands. Most of the open interest in the corn futures market only goes out 2 years to the December 2017 futures contract which is trading around the 400.00 cents per bushel area at the close of this year.

For those who don`t like to roll over futures contracts the December 2017 contract probably isn`t the worst way to play it since most investors may not want to get into the complexities of buying up farm land, and are not going to have access to the swaps market for practical purposes. Thus, we will see if 2016 brings better fortune for the corn market than the past 3 years where corn futures are down nearly 50% over this timeframe.

© EconMatters All Rights Reserved | Facebook | Twitter | Free Email | Kindle

Technical Analysis of the Lumber Market

December 31, 2015 by EconMatters   Comments (0)

By EconMatters

Housing Demand Thesis

The last two years rents have been rising primarily due to supply and demand issues. There hasn`t been enough multifamily housing to keep up with the demand, and as the employment levels go up and more millennials move out of their parent`s house, I expect the housing market to continue to be on the slow but steady upswing of the last several years for 2016.

I think more and more single family homes will have to be built to keep up with the demand as renters for the last couple of years start to want to build equity in real estate versus throwing the money away on rent. And I expect the trend of more multifamily housing projects being built to continue for 2016 as well due to the escalating rents as the population growth has outstripped the conservative building strategies following the housing bubble that led to the financial crash in 2007/08. The builders were just very cautious and financing was subdued to say the least and now there is a lot of catchup going on in the housing sector.

Technical History for 2015

I thought I would take a look at the lumber market as my spider sense tells me that lumber could possibly be a buy here for 2016 and beyond. The March Lumber futures contract is trading at around $255 per mbf on Wednesday as the calendar year of 2015 comes to a close. The Lumber contract reached a low of $226 per mbf in September of 2015 when the rest of the financial market was looking vulnerable during the end of the third quarter selling that picked up steam on China Recession concerns. The Lumber market has been putting in higher lows into year end, and it seems to be setting up nicely for a move higher into 2016.

2016 Technical Levels to Watch

The play is relatively straight forward as there is 4 month overhead resistance at $270 per mbf on the charts and a breakout above this level with a buy stop letting buyers take you into the trade is one way to play this projected rise in lumber prices for 2016. I would put my protective stop at $255 per mbf if I entered on the breakout of the $270 resistance level. My initial target would be $310 per mbf for a 2.67:1 Reward/Risk profile for the trade. I would judge the price action from there and the overall market sentiment with the idea of letting it ride from this initial profit target.

The next area on the two year chart for a profit target to the upside is the $340-$360 per mbf level. If you like to take half off and let the other half ride on the trade then this would be one way to play it by taking half off at the first profit level around $310 per mbf and then taking the second half off at $360 per mbf. One could also break the trade into 3 sections by having 1/3 of the trade riding for a breakout of the $360 level.

Just for perspective there is 15 year resistance around the $400 per mbf area; but one thing about financial markets is that a trader wants to see how the contract reacts to price at key action levels. Therefore it would be nice to pocket a nice chunk of profits moving your protective stop up in a conservative manner and letting the last 1/3 of the trade prove to you that the trade is done to the upside. If we ever broke $450 per mbf the charts say that $500 per mbf is definitely possible, as back in March 1993 the Lumber futures went as high as $493.50 per mbf.

In Summary

Of course there are a myriad of different trading strategies in how to best take advantage of this possible setup in the Lumber market from an entry and exiting standpoint. I just like to add some trading color to the analysis so that readers can better understand the context of the key technical levels to watch for in the Lumber Futures Market for 2016.  

© EconMatters All Rights Reserved | Facebook | Twitter | Free Email | Kindle

Faber 2016 Outlook: Recession and Falling Stocks in the U.S.

December 29, 2015 by EconMatters   Comments (0)

By EconMatters

Marc Faber, the publisher of the Gloom, Boom & Doom Report, said in an interview with Bloomberg on Monday morning that “I believe that we’re already entering a recession in the United States.” Because of his outlook for a weakening economy, and also FANG stocks (Facebook, Amazon, Netflix, Google) skewing the real market performance, he thinks U.S. stocks will fall in 2016 and sees investment opportunities in U.S Treasury, and the Emerging Market (EM).

Although EM is moving into a "buying range" (EM has been under-performing the U.S. since 2011), Faber thinks right now it is still pre-mature to commit a major position.  Since he is the "Gloom-Boom-Doomer", Faber always include rural and farm properties as part of his investment strategy.  With no exception this time, he likes the real estate in the country side of Portugal, Spain, Italy and the Indochina region (Vietnam, Laos, Cambodia, Myanmar, and Thailand).

The other guest on the video is Frank Berlage, CEO of a investment consulting firm, also has a pretty bearish view on commodities, China and sees the the debt burdens in advanced economies like Japan, the Euro Zone and the U.S. will put us either in a recession or a very slow growth trajectory.

In contrast to Faber's pessimism, Yellen showed a lot of confidence in the U.S. economy by raising interest rates this month for the first time in almost a decade. Many economists questioned the timing of Fed’s decision because the inflation rate is stuck near zero despite an expanding GDP.  U.S. economic growth registered a 2% annual growth rate in 3Q 2015, down from from 3.9% in the previous quarter.

According to Bloomberg, Faber’s predictions have not always hit their mark. Last year, he made a similar prediction that U.S. stocks would plunge and favored gold as the investment choice.  Since then, gold has plummeted and stocks have gained.  He also warned about long-term U.S. bonds “a suicidal investment” four years ago, but Bloomberg reported that the 30-year Treasury has returned 8.7%  per year for the past four years.  Right now, the consensus view is that U.S. 10-year Treasuries yields will climb to 2.80% by the end of 2016


The views and opinions expressed herein do not necessarily reflect those of EconMatters. © EconMatters All Rights Reserved | Facebook | Twitter | Free Email | Kindle

The Oil Market

December 29, 2015 by EconMatters   Comments (0)

By EconMatters

 
Prediction Game

Anybody who tells you they know where the oil market is headed for 2016 is inexperienced, too stupid to realize there are far too many variables in play that are unknowable to predict with any accuracy their effects on other variables in the oil equation, talking their own respective books, just piling in with the recent herd mentality on the street, giving an opinion about as valid as the best paint color for a room, or like to see themselves on television talking about the hot market moving topic du jour.

If Experts were paid for Accuracy

We have written extensively on the topic, have a lot of experience in the industry, were right regarding the direction, but frankly wrong about the timing of the inevitable market correction. I remember reading all the comments at the time of our analysis with reactions such as “Shale requires $80 a barrel oil prices”, or “OPEC needs $85 a barrel oil prices so oil can never go lower than $85 a barrel”, “Shale wells depletion rates mean…”, and “China is going to use so much oil that…”. I have to sit back now and smile when IHS, Goldman Sachs, and the IMF or any other oil analyst gives their predictions for the price of oil for the end of 2016.

Just look at all the predictions at the start of 2015 for oil prices by year`s end? Most analysts saw oil prices being weaker the first half of 2015, only to rise by the third, and be even higher by the 4thquarter of this year. I would say most analysts had the price of oil much higher than $55 a barrel by year end if we made them commit to a price at the beginning of 2015. Well we aren`t even going to end the year above $40 a barrel.

Futures Curve

And similarly don`t look for the oil futures curve to be any better predicting future price points in the commodity as just look at where it was priced right before the turn in oil markets in 2014. The futures curve has basically become a lagging indicator of a lagging indicator, basically mimicking the current sentiment in the market and extrapolating out the curve. It is about as useful as a personal psychic reading is in predicting one`s future course in life.

Dependent Variables

There are just too many variables that effect other variables within the oil market dynamic to determine with any accuracy where the price of oil will be by the end of 2016. If two variables go one way instead of another, they affect other dependent variables, causing a whole cascading effect which leads to an entirely different outcome. And the problem with the oil market is there are in excess of 10 extremely important variables that if any one of them goes offline or different than the consensus forecast this throws the entire oil market equation analysis game completely off course.

Unknowable Assumption

Consequently if one starts with the premise that the price of oil is unpredictable for 2016, then what do we know? Where can we at least have a foothold for pretty reliable assumptions? Well let’s start with this, we know at some price oil operations will shut down. What price does oil need to go to before oil operations shut down? Moreover, that such money is lost that banks will not finance operations even if oil prices rise because they realize that this would just bring new production online only to have oil prices fall again, and they lose money all over again.

The Real Pain Threshold

Thus it isn`t can an outfit make money for six months or a year, but can they make money for 10 years, can they withstand a downturn in prices? There will be a much higher bar for lending just like the end of the no down payment loans in the real estate sector. This probably means there needs to be a whole lot more pain in the credit markets where even if oil rises to $55 a barrel it doesn`t mean one is getting a loan to start pumping again only to have oil fall due to more shale production going back online.

I would surmise that around $20 a barrel major money is lost, and lost fast with major credit events bringing about so much destruction and pain that lending decisions aren`t based on where the price of oil is for six months but can it average such an such a price for 5 years without an over glut in supply happening all over again. Therefore I am latching onto the $20 a barrel floor because of the idea that production goes out of business at this price, and stays out of business the longer duration oil hovers around this level.

Long-term Project Evaluation Metrics

At this price it doesn`t matter whether oil will rise back to $55, if enough money is lost at $20 a barrel, this is a major deterrent for future projects going back online without an outright raging bull market in oil. The way oil projects were viewed after the oil collapse in the 1980s, conservative lending environments with 10 year time horizons required and supported by a consistent cash stream of average oil prices well above production costs for the project on a 10-year going forward basis. Just because an oil operation can make money for 6 months isn`t a reason to provide lending for said oil operations, and banks are going to start getting this principle.

 
Unknown Variables: US Production

An example of an unknowable variable in the oil market is what happens to Shale oil if oil gets down to $20 a barrel? Does US Production drop off a cliff to 6.5 – 7 Million barrels a day? Does it go even lower, say 5 million barrels a day? And how fast does this happen? You see how one variable is dependent upon another variable. These two concepts of speed and depth of the fall in price are inextricably linked in the equation; and they are completely unknowable in my opinion.

 
Saudi Arabia

Another unknowable variable is how do the budget changes in Saudi Arabia just two years after the Arab Spring, and cutbacks in government subsidies to the general populous affect political stability in Saudi Arabia? This hasn`t occurred in the modern era of Saudi Wealth and this generation of always having ample resources and strong pricing power for their main funding source as a country. Just imagine all the London shops, hotels and medical facilities all courting and setup up around Middle East Oil money built upon an $80 a barrel price model. Saudi women are going to be put on major budgets, i.e., they cannot leave the country to spend or shop!

But on a serious note, what happens to the price of oil with a political instability event in Saudi Arabia causing major oil production in the country to go offline in the process of a political uprising? If this variable goes different than the current status quo this changes the entire oil market at the drop of a hat! If Saudi citizens were unhappy with $120 Brent oil easing their existential pain, how about $40 Brent prices? Is the real Arab spring in the cards for 2016?

 
The Event Variable, and Reaction Variable

I can make a case for oil being below $30 a barrel for the majority of 2016, and I can make a case for oil being above $60 a barrel sometime in 2016, and a bunch of places in between. It all depends on how certain variables play out, and how other variables react to each other, and off of the “played out” variables. The event is one thing, how a certain variable plays out; but the reaction to this event, is an entirely different event that needs to play out. For example, oil prices dropped and instead of OPEC curtailing production they started pumping more to try and make up for lower revenue coming in by raising production as a reflexive coping mechanism.

 
Oil Exports Ban

I bet OPEC never factored into their analysis the lifting of the US Oil Exporting Ban in 2015 after being a non-starter for so many decades. This is a prime example of an unknowable variable, and wasn`t even part of OPEC`s analysis in 2014 when they decided to not cut production at their initial OPEC meeting after prices broke $80 a barrel. And I can make an argument for this lifting of the export ban as being bullish and bearish as a catalyst in the oil market over the longer term. It depends upon how other variables and market dynamics play out and off of this change going forward as to whether this lifting of the exports ban ultimately becomes a bullish or bearish variable for oil prices.

 
2016 Market Considerations

Obviously the oil market is down a lot from its five and ten year averages, and market participants are trying to figure out if this represents an opportunity to make money going forward. It really comes down to timing, and most market participants are paid for performance. The next quarter, the next 6 months, the next year is all that matters for most market participants. Can I make money in oil from the long side in 2016? How do I best position myself to make money in the oil market for 2016? What does the timing look like?

 
Potential Long Scenario Setup

I don`t know where the oil market is going, and I sure cannot predict the bottom. However, I think one can make money at the $33 a barrel level sometime in 2016. If you held me to a prediction scenario, here is one such of many scenarios I could envision. We start 2016 and new money comes into the oil market from the short side pushing it lower. This plays out in seasonal builds as the refining industry slows down capacity for maintenance with some large weekly inventory builds similar to last year. Then buttressed by production cuts in US domestic production and an anticipation of the ramp up to the summer driving season the dip buyers are rewarded with a nice run from the bull side supported by gasoline demand. This is probably the most likely scenario for making money from the long side of the equation in the oil market for 2016.

 
Economist Answer: It all depends…if X then possibly Y

But this could all change as early as the next inventory report if we have back to back to back large drops in US Production and suddenly we are at 8.6 million barrels per day and a rather large short squeeze has ensued in the oil market by late January. You see how fast variables can change? And trust me there is a good $15 dollars of “shorts covering” in the current price of oil that can happen faster than a contract rollover period! Therefore, when you want to know where the price of oil is going? Well it all depends on variables – and many of these are unknowable. Sometimes the wiser analysis is taking note of the shortcomings of the prediction business.

© EconMatters All Rights Reserved | Facebook | Twitter | Free Email | Kindle

Currency Markets offer some of the Best Trading Opportunities

December 28, 2015 by EconMatters   Comments (0)

By EconMatters

Markets Going Nowhere

The last several years equities markets have been best characterized as buying the dips and selling the rips. The past three years the currency markets have probably offered the best trending opportunities when taken into context that the Central Banks purposefully telegraphed traders for market direction in helping them weaken the Japanese Yen and the European Euro currencies. There have been strong Central Bank coordinated Trending Trades in both the Japanese Yen and the European Euro the last three years. Why not be involved in a market where the power brokers who run the market tell you ahead of time which direction they are going to move the market in the future? Imagine if Casinos told you in advance what the next card from the deck in a game of Blackjack was going to be? This is essentially what has transpired over the last three years in the currency markets.

Forex Markets Support Many Different Trading Strategies

Besides the trending plays, the currency markets offer many support and resistance opportunities, scalping setups, and technical breakout – (buy and sell stop) entry setups. The currency markets like many markets these days are dominated by technical price action trading mainly because of the preciseness of the algo`s and their programmed responses to price and key technical levels.

Protective Stops

With this in mind it only reinforces the use and benefit of utilizing stops to protect investment and trading capital, and to maximize your trading edge from an efficiency standpoint. Don`t try to average into or scale into a position. If the market breaks a level where your stop is placed, it is going to go lower or higher from there, you are better off just cutting the loss right there, and reevaluating the merit of the original trading idea. Stops are especially important in the Forex market given the fact that many traders take full advantage of the leverage opportunities offered through various types of trading platforms. A run away trade can liquidate many a trading account, and you have to have capital to stay in the game. It is one of the few things traders can control in markets, their defined risk profile.

Poker Analogy

The stop forces you as the trader to complete the trade, now move onto the next play like a hand in poker. This is one of the great things about a game like poker it forces the players to end the hand rather quickly with finality. It should be no surprise that a game like poker has so much similarities to decisions that come into play for financial markets, because after all financial markets are one giant strategic game. Just instead of poker chips, financial markets utilize digital currency in the form of numbers and P/L scorecards. Stops are essential for currency markets!

Master these 2 Forex Crosses: EUR/USD and USD/JPY

Master two currency crosses like the EUR/USD and USD/JPY and see how geo-political events, risk on versus risk off, economic data and reports, Central Banks Meetings and Statements, Bond Market Relationships to these currency crosses, commodity moves relationships to bonds and the crosses, and how this all revolves around the funding mechanism of carry trades. If you are new to trading currencies just put these two currency cross charts on your trading screen and watch them every day for three months in relation to the economic news and market behavior and you will start to understand the patterns of the crosses.

Risk-Off Relationships

After a while you will be able to understand and act real quickly that in a risk off day you buy the yen against the US Dollar as some carry is unwound. It doesn`t even matter if any carry is being taken off, the algos are programmed to automatically move this currency relationship on a risk off market day. If crude oil is spiking or has a bid, then buy the Euro against the US Dollar. These are types of relationships that you will learn to recognize in the Forex arena and they will eventually become reflexive trading opportunities with relatively manageable risk reward setups.

Bond Yields

If US Bond yields are spiking, then buy the US Dollar against the Euro. However, here is the tricky part, if bond yields are orderly rising, and money is flowing out of US Bonds into US Equities, then you can also buy the US Dollar against the Japanese Yen. The Japanese Yen is often a funding currency from a carry trade standpoint for US Equities. Conversely, if US Bond yields are spiking and this is viewed as a Risk Off event, and US Equities are selling off, then you short the US Dollar against the Japanese Yen as carry trades are being unwound, and capital is going to cash or money market funds. This may seem confusing at first but stick with the vanilla relationships and as you progress in an understanding of the currency markets in relation to the financial markets, geo-political events and Central Bank policies even the most complex relationships become relatively easy to predict and take advantage of with enough screen watching experience.

Malcolm Gladwell`s 10,000 Hours for Master Level Knowledge

Just keep in mind that you will have to pay your dues, think in terms of the book Outliers, where author Malcolm Gladwell says that it takes roughly ten thousand hours of practice to achieve mastery in a field. Yes one has to have some aptitude for pattern recognition, and be capably smart, but trading and investing is not exactly rocket science. However, the psychological aspects of discipline, avoiding going on tilt, and sticking to one`s edge are often severe obstacles for many an aspiring trader. Keep in mind that the markets are an uphill climb for retail traders and investors.

Information Disadvantage

You are at an information disadvantage on a daily basis. Goldman Sacks for example can just look at the order flow from their clients and know at 2:00 am in the morning the day is going to be a major risk off day, and the same for J.P. Morgan. These investment banks really have to be leaning the wrong way to lose money in any market. It doesn`t take any skill at all to know ahead of time a risk off day, and to front run client and clearing trades from the details of order flow in the system which they are privy too unlike retail traders. The statistics bear out the fact that retail trading is a specialized talent and skillset with over 95% of all retail traders consistently losing money.

Myriad of Reasons Most Traders Fail

This is due to many factors from being poorly capitalized to not having a trading mentor to stay in the game long enough to master the skills necessary for being profitable to having the mental makeup necessary for avoiding going on tilt. But the currency markets are easier to trade from a predictability standpoint compared to many other markets once one learns the relationships. The currency markets are highly liquid instruments, especially the main crosses I have recommended for traders getting their feet wet trading. Can you imagine all the shorts who got their heads torn off trying to short that GoPro stock based upon a fundamental valuation standpoint, lots of funny business in IPOs with small trading floats! Moreover, after they have finally had their short positions margined off and their trading accounts vaporized, then the GoPro stock drops like $70 dollars.

In Conclusion

To sum up, learn the major crosses and give the currency markets a try, just always utilize stops to protect your capital, and study some good technical analysis trading books until you master 4 or 5 nice vanilla price action trading setups. Maybe you have the right stuff to be part of the 5% of the retail crowd who can be profitable traders in the financial markets. But don`t be afraid of the Forex markets in and of themselves. They are probably much easier to trade once you master the fundamental relationships of these funding markets that buttress all financial assets then trying to predict whether Twitter will ever learn how to monetize its platform.

© EconMatters All Rights Reserved | Facebook | Twitter | Free Email | Kindle

The Natural Gas Market Play

December 19, 2015 by EconMatters   Comments (0)

By EconMatters

 
Bearish Sentiment

A lot of bearishness has been priced into the natural gas market due to many factors including robust production, bulging inventories, and mild weather on average across the country. Natural gas in the futures market reached a low of $1.68 MMBtu for Henry Hub on the January contract this past week. Natural gas closed trading on Friday at around $1.77 MMBtu.

These prices for natural gas are the lowest in 15 years and the questions that accompany such lows are the following: How low can prices go, do these low prices create a buying opportunity, what kind of timeframe is involved, and what is the best strategy for capitalizing on a rebound in natural gas prices.

How Low

In regard to how low natural gas can go, back in 2012 traders and analysts were talking about sub $1 MMBtu natural gas based on the fact that the derivative product`s markets related to natural gas production were actually booming for the specialty gases. Hence a producer was incentivized to produce natural gas below costs because the margins were so high for the specialty gases associated with producing natural gas in the drilling process. In 2012 natural gas for the front month contract in Henry Hub futures dipped briefly below $2 MMBtu around the time when traders were discussing sub $1 natural gas.

Given the fact that even the best traders and market analysts have no idea the exact low point for any market, let us just use this $1 MMBtu price for the worst case scenario for how low natural gas prices can go. I firmly believe in the rationality of financial markets in the longer term, and from this follows the old trading axiom that there is no cure for low prices like low prices. I don`t think there is that much more money to be made from the short side of the natural gas market over the same three year time frame.

Buying Opportunity

Therefore I view the current price of natural gas as a buying opportunity over a three year time horizon. I realize that I cannot predict the bottom in the market, and I am not going to try and be perfect regarding timing the turn in the market. However, I do predict given the decline in oil and gas drilling rigs, the economics of producing below longer term costs, and the fact that markets often lead the fundamentals, that this represents a buying opportunity in natural gas. I am basically buying when everyone else and their grandma is selling the natural gas market. I am sure corporations, wildcatters and trading firms are all making business decisions based upon these low natural gas prices, and they are not from the bullish side of the equation. I want to be on the other side of this trade given my three year time horizon.

Timeframe

As I mentioned the timeframe for this trade or investment decision to play out is three years. Do I think the natural gas market will put in a bullish move more towards the front end of this timeframe? I would say the probabilities are sufficient to suggest that I may be trading around a core position that has substantial profits during this 3 year time frame, as a year is an eternity in a market like natural gas. Natural gas can easily move to $5 MMBtu in a reduction in production and an extremely hot summer, followed by an overly brutal winter heating season.

The market can really trend, it can spike, it can retrace, and it can do all kinds of strange things. Remember two winters ago? I am confident the investment makes money over a three year time frame, and it is up to the individual where and when to take profits on the trade. It may make sense to reallocate capital after a nice fifteen month`s trending move in natural gas, or it may make sense to just ride the trade well past three years if circumstances dictate.

Upside Variables?

There are so many unpredictable variables like more Power Generation continuing to transfer from coal based to natural gas, the economy starts growing 3 to 4% instead of 2%, demand outstrips existing capacity in the electricity market, demand for a period outstrips supply in natural gas, an insane hurricane season knocking production offline and doing damage to natural gas infrastructure.

What I do know is one way or another natural gas somehow finds its way back to the $5 MMBtu level even during the shale revolution. I expect that sometime over the next three years natural gas finds its way back to this ‘natural gravitational’ market price. It may even make several trips up to $5 MMBtu over the course of the next three years. It was just over $7 MMBtu two winters ago after the last crushing of the market back in 2012 to below $2 MMBtu. It took just two short years to really move well above the $5 level.

Best Strategy

The best strategy for playing this move depends on a trader`s resources. Most traders are not going to employ swaps, options or other derivatives due to resource constraints and sophistication concerns. Investors could buy futures and just roll over the positions each month, buy back dated futures contracts, or even buy stocks highly correlated to the price of natural gas. But with bankruptcy and individual company specific concerns I would stay away from this option until more visibility on the ramifications of sub $2 natural gas plays out on companies` balance sheets.

You don`t want to be forced out of the trade due to factors outside of your control like management incompetence that wipes out your equity stake before natural gas prices recover which is open-ended to a large extent. Rolling over the futures contract may be more than the average investor is willing to stomach, and the volatility of the front month futures contract may create havoc on one`s sleeping bliss after a poor inventory report. The back month futures contracts have some premium factored into them as well, and liquidity concerns are involved.

UNG ETF

I would recommend using the UNG ETF, it has been around since 2007, has decent volume, consists of natural gas futures contracts, and roughly tracks the price of the natural gas market over the last eight years. It isn`t going to totally fall apart like some of those poorly constructed ETFs that are supposed to track markets but inevitably lose value over time regardless of long term price returns of the underlying assets being tracked.

In short, this instrument will do what an investor needs to accomplish to track any rebound in natural gas prices over the next three years without being margined out of the market or having to worry about timing this rebound perfectly. I would not worry about trying to scale into a position based upon price. If one is using size on this investment then a nice Algo buying program will suffice for next week`s action. We are not trying to pick a bottom here, we expect that prices can go lower, but the current price represents value for us over a three year time frame both from a trading an investment standpoint.

The question here is can I make money at these prices if I buy right now over the next three years. Am I going to be able to stay in this trade until the turn plays out in the natural gas market? And will I be able to at least double my initial investment over this timeframe if this is my longer term goal? My analysis is that the affirmative case can be made for these questions. The minimum profit goal is 20% on this investment play. An investor should not be looking to take any profits on this play until this minimum profit threshold is met.

Therefore, assuming an investor has an average position price in UNG around $7 a share, the minimum profit target would be $8.75 a share for any timeframe during this three year investment window for justifying taking off this trade from a profit perspective. This trade profile is built upon being rewarded for taking risk and providing liquidity to a market that is basically in freefall mode. A 5% profit target on the trade is just poor risk reward trade management. Keep this in mind when thinking about profit targets for this investment.

Therefore unless I have a better opportunity with the same risk to reward profile for this investment capital over the next three years then this is a good place to park some capital and put it to work for me. I realize this play seems highly contrarian in the current market environment, and this is a positive, it means that I am being paid for taking this risk, and my upside reward is what makes this play worthwhile in my trading book.

© EconMatters All Rights Reserved | Facebook | Twitter | Free Email | Kindle

NRG Energy is a Free Roll on Natural Gas Prices

December 14, 2015 by EconMatters   Comments (0)

By EconMatters

 
10 Year Lows

The Stock price is at a 10 year low, a myriad of factors have come together over the past 6 months to push the stock down from $25 a share on June 22nd to as low as $8.81 on December 4th2015. The previous 10 year low in the stock was $15.32 on April 30, 2012 on similarly low natural gas prices for the spot market where natural gas dipped below $2 per MMBtu. Thus a low natural gas environment is nothing new for NRG, and Natural Gas prices recovered on declining rig counts and colder weather as did NRG`s stock moving from the 2012 low of $15.32 towards $37.20 a share as recently as May 31, 2014.

Negative Catalysts

The catalysts for the recent plunge in the stock are many fold. First the utilities sector is weaker as investors anticipate a 25 basis point rate hike by the Federal Reserve. Second the Power Generation Firms like Calpine, Dynegy and NRG are all getting hit on lower priced electricity at the wholesale level due to a mild winter so far, and a downward trek in Natural Gas prices moving from $3.30 MMBtu on August 13, 2015 to $2.12 MMBtu on December 7, 2015. NRG has company specific headwinds in a failed and costly excursion into Green Businesses with the likes of Home Solar, Renew: Solar/Wind, and EVgo. And the sudden resignation of David Crane who has been the face of the company for over a decade. Add to this over $20 Billion in debt, a dismal 2015 for earnings, around an 8% short interest in the float and technical algo selling on new lows and you end up with an $8 stock.

Are these catalysts reversible?

The utilities sector and bond prices could continue to take a hit in 2016 if inflation takes off and the Fed is forced into playing catchup with several rate hikes in the span of the next 6 months. However, given the tepid global growth environment and other central banks` dovishness this scenario seems less likely. It is looking like a “One and Done” rate hike for the next 6 months by the Federal Reserve. Money should not retreat from the utilities sector in 2016 due to extensive rate hikes. At any rate, this catalyst shouldn`t be the defining reason for investing in NRG one way or the other.

Low Natural Gas Prices

In regard to the Power Generation Firms trading down on low natural gas prices, if this correlation continues, this actually serves as a positive catalyst with natural gas prices close to where they bottomed in 2012. We are heading into the heart of the winter heating season in February where natural gas prices tend to rise, this bodes well for Electricity pricing at the wholesale level. At any rate, natural gas prices trend, and given enough natural gas rigs going offline, natural gas prices will recover to the $5 MMBtu level. Sure there is a lot of natural gas in storage, but there was a lot in storage in 2012 as well, rigs were idled, weather patterns changed and natural gas prices moved well above $7 MMBtu on cold weather two years ago. It is just a matter of time but natural gas prices will make a long sustained trend higher towards the $5 MMBtu level sometime over the next two years. It is just how the market trades, but even if it is different this time, I anticipate a rebound in natural gas prices this winter to around the $3 MMBtu area which should serve as a positive catalyst for a rebound in NRG and the rest of the Power Generation Firms.

Going Green is Costly

NRG`s attempt to revolutionize the electricity market with its Green initiatives like Home Solar, Renew: Solar/Wind, and EVgo is already being reversed out as the market has voted and this is what got David Crane fired. He understood this fact, but it was too little too late. Somebody had to pay for destroying shareholder value in 2015. NRG is trying to spin these Green assets out in a joint venture type of structure, but basically these assets are for sale, and have already been given a $125 Million runway to either start making money or fail altogether for 2016.

This change is not being reflected in the stock price, for example, Home Solar alone had a $50 million budget for 2015 and David Crane`s ego let that balloon to a $175 million loss for full year 2015, this is why the board forced him out. This $125 million runway is the aggregate exposure for these Green businesses for 2016 and beyond. The company is changing its strategy and focusing on running a much better P/L with its existing core business of solid Power Generation Assets and a highly successful retail arm in Reliant Energy, and ditching the earning`s drag of the Green Businesses. They haven`t announced a job cuts number for morale reasons, but make no mistake behind the scenes they are reassigning personnel, and embarking on a substantial cost cutting program across the various business units. There is enough fat that can be cut to make a difference going forward in 2016 in speaking with insiders at the company. In short, the company gets it and they are going to be much more fiscally responsible for 2016, and these changes will eventually find their way to the quarterly earning`s reports next year. This strategy change should be a positive catalyst for a rebound in the stock for 2016.

David Crane Resignation

With regard to the resignation of David Crane, he was the face of the company and he had grand visions for the future of the electricity market. However, just like Enron with broadband ambitions he was ahead of his time, and the execution just wasn`t good enough, given the other headwinds the company faced in a low natural gas environment. Mauricio Gutierrez has been with the company since 2004 in various roles and he understands the core business. It is obvious that the board understand the market mandate as well: get back to the basics, focus on the businesses that bring in cash flow, get rid of the Green initiatives that eat into corporate profits, cut costs across the board, and improve earning`s results for full year 2016. In short, David Crane`s enormous ego had NRG writing checks that albeit in part laudable, just didn`t make for good operational business sense. The board felt that his presence was always going to be too big at the company to fully recognize underlying value in getting back to the basics of a much leaner, less transformative, but better run company from a profitability standpoint. His resignation is a positive catalyst going forward given what NRG`s new mandate is for 2016, running the business focusing strictly on a P/L standpoint.

Debt Concerns

The $20 Billion in debt is a concern, but the debt has always been there as NRG has a collection of great assets acquired through this debt financing. The concern was the fiscal approach by the company, they needed to be throwing off much more cash flow towards paying down some of this debt, as opposed to incurring further expenses trying to transform into a Green Next Generation Technology company. Now that the market has spoken, the market is going to reward NRG for paying down some of this debt due to cutting costs, and improving the profitability of the company. Although it is currently a lower Wholesale Power Rate Environment due to lower natural gas prices, the core business generates solid cash flows; more than enough to start paying off some of this debt, now that costs are being addressed at the company. Moreover, the board has gotten the message to start focusing on being more fiscally responsible with these existing cash flows. In short, NRG is in no danger of going bankrupt or having solvency issues in the foreseeable future. The company had this much debt 6 months ago when it was a $25 stock. The debt issue isn`t prohibitive from NRG recovering as a stock to the $22 a share range.

Earning`s Recovery

2015 was a dismal year for earnings, but this is reversible given a focus on the bottom line, and executing on the cost cutting initiatives spread out throughout the company. NRG will have better year over year comps in 2016, and if natural gas prices rebound a little this should help on the earning`s front. The big boost to earnings will be getting out from under the “GreenCo” assets that were a real drag on corporate profits, not to mention a major distraction from focusing on maximizing earnings for shareholders.

Short Interest

With a substantial short position in the stock, all these shares will have to cover at some point guaranteeing future buyers in the stock. NRG is not going bankrupt, they generate too much cash flows for that. There is no cure for low natural gas prices like low natural gas prices. Sure conceivably the stock could go lower, but I wouldn`t press a short here as one could wake up to a buyout of NRG at $18 a share on a sleepy Monday morning. I would prefer to be on the other side of this short squeeze.

Technical Selling

The technical selling often leads to overshooting on the downside, especially when key technical levels are breached towards year end. There was 4 times normal trading volume on Friday and a retest of the $8.80 level at the open on Monday on a risk off day in the overall markets. Buyers stepped in with support at this level and found value here. There should be substantial upside technical buying yet to go sometime in 2016, as shorts begin to cover positions, and new longs initiate positions as the cost cutting measures play out on the bottom line in 2016.

Forecast

I have followed this company`s stock for 10 years, and Friday as I watched it getting clobbered to the tune of nearly 20% I felt that the selling was overdone. This stock has moved around a lot over the last 7 years but it usually finds its way back to the $18-$22 a share range. This has not been a good year for the company. But none of the catalysts for the stock being so low now are permanent in nature, and overly cumbersome to overcome.

Oftentimes the stock moves before the underlying fundamentals, but in NRG`s case the Fundamentals are already changing for the better in the form of a change in strategic operational structure, this change has yet to be reflected in the current stock price. Alternatively, if investors view this strategic change as a negative then their analysis is incorrect. The strategic change will definitely unlock shareholder value in the future of this beaten down name. Furthermore, if NRG is strictly tracking spot natural gas prices, which given the operational strategy mistakes at the company I seriously doubt, the shares will recover along with natural gas prices just like 2012. Economics will play out in the natural gas market, because there is no OPEC inspired price war playing out in natural gas like there is in the oil market. A drop in Natural Gas and Oil Rigs which as a byproduct bring some natural gas to market will eventually lead to natural gas inventories being reduced. Natural Gas prices will move to the upside long before inventories rebalance as traders anticipate the effects of the idled rigs on future supply. It is just a matter of time before economics play out in the natural gas market, natural gas prices will eventually rise. We haven’t even gotten to the winter heating season yet. For example, last year natural gas prices rose from December 22nd 2014 to February 23, 2015 on colder weather.

However, let us assume that natural gas prices just hover around this $2 MMBtu level. The question for investors here is how much of this natural gas price is being currently reflected in NRG`s stock price? And are any changes to corporate strategy currently being priced into the stock? My assessment is that investors have the opportunity to initiate a position in the stock because of the negative sentiment regarding these two issues. This is why the opportunity exists in the first place.

This negative sentiment regarding these two issues is likely to change over time. It is my contention that the change in corporate strategy is able to mitigate the negative effects of low natural gas prices for 2016. Even with no rebound in natural gas prices for 2016, the positive changes in corporate strategy for 2016, should lead to positive operational growth profits year over year. In effect an investor is free rolling the eventual turnaround in natural gas prices over the next two years.

In conclusion, NRG Energy represents real value at these levels, and anything in the $8 area denotes an exceptional long term investment opportunity. I expect the stock to trade back in the $16 area sometime over the next 6 months. And if management really executes on the cost cutting measures, now that the company is no longer bogged down with green ambitions, this stock can reasonably move up to the $22 a share level sometime in 2016. Anything above $22 a share is just gravy given this entry point, but definitely a possibility.

© EconMatters All Rights Reserved | Facebook | Twitter | Free Email | Kindle

NRG Energy is a Definite Takeout Candidate

December 11, 2015 by EconMatters   Comments (0)

By EconMatters

 
David Crane Resigns

In case you missed it David Crane resigns Thursday and the stock gets hammered on Friday to the likes of almost 20% at one point in trading, putting in a low print of $8.81. Hopefully the more sophisticated investors out there bought some calls three month`s out as NRG Energy is a definite takeout candidate with this shockingly low stock price given its actual assets.

Twitter Market Cap versus NRG Revenue

NRG Energy just for comparison`s sake has Revenue of almost 16 Billion while Twitter has Revenue of 2 Billion, NRG has a market cap of less than 3 Billion while Twitter has a market cap of 17 Billion. I could bore the reader with numerous other financial metrics, suffice to say, those interested in studying the balance sheet further will likely conduct their own due diligence.

NRG History

Here is the high level analysis of what led to NRG`s downfall, and the resignation of David Crane. David Crane aspired to be more than just a Power Generation company that maximized earnings each quarter. He wanted to take the Power Generation Company into the era of being a clean provider of electricity, and associated full services of residential products revolving around the retail side of the business and greener, renewable energy initiatives.

Growth by Acquisition Model

It is interesting because originally when Crane joined NRG their model was to increase earnings by acquiring Power Generation assets, with their big acquisition being the Texas based Power Generation assets which are real cash cows, they generate tons of cash flow for the company each year. This was going to be the model going forward, and if they would have stayed the course with this strategy David Crane would still be CEO of NRG and the stock would be much higher than it is today.

The reasoning here is yes natural gas prices are depressed, and there is going to be legislation necessitating higher costs for cleaner Power Generation. But it isn`t like demand for electricity is going anywhere, and not even the Obama administration is going to legislate Power Generators out of business completely; as there is leverage in the fact that electricity is a necessity. It can and will never be legislated out of business.

However, this even supports the case for more consolidation within the industry, especially for the existing fleet of Power Generation Power Plants of coal, natural gas and other fossil-fuel generation. Consolidation helps spread these increased costs over a larger scale and improves pricing power both from the rate side, and the associated costs in cleaning up the ‘dirty coal’ assets where necessary.

2007 Financial Crisis

But the Financial Crisis happened in 2007/08 and that changed financing for acquisition deals, some of the best financing that was available was through the Obama Administration in the form of Green Loan subsidies. This started NRG down the road to investing and developing projects in the Green space from Wind farms, to Solar projects.

Reliant Energy

Next to occur in this transition was the fact that Reliant Energy got into severe financial distress with out of control costs, Reliant was a bloated retail provider with some generation assets. NRG bought the retail side of the business for literally a song. It was instantly accretive to NRG`s earnings because Reliant needed the cash at the heat of the financial crisis where the capital debt financing markets dried up, and they sold this piece to NRG at below market value by a factor of fifteen.

Yes I said fifteen, the deal was so accretive that it far exceeded even NRG`s announced accretive date! It was like a house flip that could be turned around and flipped the very same day because it was listed originally with an incorrect address. The Financial crisis had JP Morgan stock with a $15 handle, so there were a lot of mispriced financial assets during the credit freeze up at the zenith of the panic on Wall Street. Nobody wanted to do any deals, it was hunker down mode.

NRG transition towards Green Company Focus

However, NRG started investing a bunch of money in ancillary retail add-ons with the idea of growing the retail consumer base and profits with new retail product offerings, none of which are instantly cash flow positive for NRG. Many of these businesses may be profitable 5 and 10 years down the line, but right now they are running through cash like classical startup businesses. An example is one of these startups has an annual budget of $10 million, and they spend $50 million: $10 million in each of the 5 business units.

These startups have no sense of budgeting, the accountability and supervision is that skewed because remember these entities under NRG still have a startup mentality. They spend like Silicon Valley startups spend. NRG basically has a bunch of Green startup businesses rolled up into the parent company`s balance sheets, all sucking away from the core cash flow operations leading to -0.04 earnings for the latest quarter.

Add this to acquiring a bunch of actual external Green startups with the idea of transitioning NRG into a different kind of Green Energy Provider and you see how these Green companies with their “future” cash flow positive deliverables to the bottom line all started sucking cash away from the core capital generation power plant`s businesses, which really are cash cows.

Power Generation is NRG`s Core Profit Center

NRG needs to get back to their core business, this wonderland fantasy crap is great when you have a google balance sheet monopoly that can subsidize money losing business ventures like google self-driving cars and google glass to name a few. However, NRG isn`t in that position to realize and subsidize all of David Crane`s vision and ideals. I do think solar energy has a tremendous future, but not at the expense of hijacking a perfectly good company and its stock price, and this is why David Crane was pushed out.

Sold the Profitable Assets from a Poor Negotiating Position

He sold some power plant assets which are profit generating to the balance sheet, and not the money losing Green startup crap companies. Obviously these power plants are cash flow positive assets or nobody would have bought them, but they lowballed NRG because they knew NRG was desperate to sell assets because they preannounced a public reorganization plan. NRG had no leverage in selling these assets from a negotiation standpoint.

NRG Breakup Value is $22 - $25 a share

With a $9 stock price for a company that is easily worth $22 a share it is time for rational decision making at the company. Forget trying to spin off these Green assets, especially in a $2 Natural Gas Environment. NRG can try but in the meantime, start cutting costs to the bone in these assets. Frankly, if the company just cut bait completely, just fired all employees in these money spending boondoggles, and jettisoned operations completely with write-offs. The stock would take off immediately, as investors would realize that earnings are about to skyrocket based upon the core cash generation business.

Balance Sheet: Revenue & Expenses

There are two sides to running a great business the first is having businesses that generate cash flow, and NRG has that in spades. The next is controlling your costs and NRG thinking they are the next Silicon Valley startup was spending like crazy supporting businesses that may be great in the future, but currently only detract from the bottom line results every earning`s quarter. All this in a low natural gas environment is just too much to overcome. But very easy to fix to realize the ‘breakup’ value of the company`s assets.

The Activist Strategy

If I was an activist investor with some clout I would buy some calls up to three month`s out, maybe six months. This most likely would mean that by the time I had finished my acquisition stake, given the current stock price, and the inevitable short covering in the process, my calls would be substantially in the money, and further subsidizing my purchase. [I could hedge these profits out with options if necessary to ensure these gains, but would limit future profits by so doing – but it is an available strategy here.] Therefore after building a 5% stake in the company, then I would send a letter to the NRG board stating that I wanted to get two board members replaced with my own people. This puts management on notice, forces many shorts to cover, and gets other investors interested in piggybacking on my cause, so to speak!

My position should be quite profitable right here by a substantial degree. Next I would start soliciting bids for the company as it is a nice value for a takeout candidate in the $18-$25 a share range. I would look into private equity deals as well because taking NRG private is a viable option, as they have plenty of cash to spend, and this company is a cash generating machine.

Otherwise, from a longer term perspective I would start cutting costs once I had board influence at the company, and announce a huge layoff release, and get rid of all the money losing business ventures at any price. Stock prices love job cut announcements because it shows some fiscal discipline is being applied to the firm`s books; all of which creates additional shareholder value. This being done with the purpose of focusing on the core of the cash generation assets, which would lead to huge earning`s jumps in the future, a definite recipe for a rising stock price.

NRG Doesn`t Have Google`s Balance Sheet to Subsidize Utopian Ideals at the Expense of Running the Company and Stock Price into the Ground

And once this is done there would a line of companies wanting to take over NRG`s tremendous core power generation business that throws off huge chunks of cash on a recurring basis. Once you get rid of all the Green Cash eating businesses, the true value of NRG is unlocked. NRG is a case where upper management`s vision, although grandiose in nature, is just not practical in this current environment; and makes for poor business sense.

It is tolerable by shareholders when Google has a Monopoly on search and is basically making more than enough money to satisfy shareholders, and save the world at the same time. But NRG just isn`t in that position, and they need to run a company to operate within their own means, i.e., balance sheet resources.

This is where David Crane`s vision made him a poor operator from a profits standpoint. He got caught up in the future of energy, instead of focusing on maximizing profits and running the business in the here and now. All this offers the smart investor a wondrous opportunity in NRG stock once a solid business focus is reapplied to the company, some fiscal discipline is all that this undervalued gem requires.

© EconMatters All Rights Reserved | Facebook | Twitter | Free Email | Kindle

UFC 194 as Good as it Gets for Fight Fans

December 10, 2015 by EconMatters   Comments (0)

By EconMatters

The Big Fight Weekend

This Saturday December 12th the UFC will have their closest thing to a Super fight in the stellar matchup between Conor McGregor and Jose Aldo at the MGM Grand in Las Vegas. This fight should set all kinds of UFC pay per view records as fight fans have awaited this matchup for a long time. And frankly now that college football has winded down, there isn`t a lot of sports competing for these sports dollars over the weekend.

This better be a great fight, and not a total dud because the UFC is running a little thin on credibility after their foray into women`s mixed martial arts with the hype machine that was Ronda Rousey. As she became just the latest example of the UFC Promotion machine getting a little ahead of its fighter`s capabilities and experience level.

The Talent Gap

This is part of the problem that the UFC faces is that in order to truly have a high level of mixed martial arts fighting skills it takes at least 10 years of training, even for a talented athlete to reach the mastery level. There just aren`t that many people who will be able to subsidize their living standard for at least ten years that it takes to gain this type of advanced fighting skillset.

For example, professional football has junior high, high school, and college training programs doing all the prep work training, and then they weed out the best, and have plenty of qualified candidates to choose from to run their business model. The same for basketball, baseball and even soccer. Because these sports are supported and developed in the education curriculum as part of a well-rounded educational program, there are lots of potential employees being developed by the professional sports leagues at no cost.

Developmental Programs

The UFC has had to rely on college wrestling programs, private Jiu Jitsu gyms, and some Karate clubs for their ‘subsidized’ athlete pool. And hope like heck they can get enough of these individuals to master some boxing, and the other disciples of the mixed martial arts game. But the UFC runs into a sheer numbers issue, as most of the other sports developmental programs not only take athletes away from these much smaller niche hobby sports endeavors for the youth. But also the UFC has such a small athlete pool to begin with, that once in any athletic sport where the majority are weeded out who just aren`t athletic enough, or have the mental makeup, persistence level and dedication to develop high level skills required to reach an elite level of performance. The UFC is basically left with a very limited number of fighters who are worth spending money on, and make for compelling “must-see” entertainment. And usually the capable interesting fighters are not in the same weight class because there are just so few to begin with here with this supply chain model.


Some Progress Made

The UFC has known about this problem, and they anticipated with the ‘mainstreaming’ of the sport in getting a national television contract with Fox, and getting more sponsorship from corporate advertisers that the fighters would come up through the ranks. But this is where the miscalculation came in by the UFC. It takes at least 10 years to actually master multiple martial arts disciplines, and there just aren`t that many candidates who will sacrifice 10 years of making no money for a sport where they routinely get hit in the face or have some malodourous person lay on them on top of a dirty mat for 2 hours a day. In high School you at least get a nice letter jacket that impresses the ladies for your ineffectual efforts at playing football, baseball and basketball.

The UFC is left with the occasional college wrestler who can learn how to box at a novice level, an Olympic Judo competitor who can learn some basic wrestling and kick-boxing moves, or Brazilian Jiu Jitsu students who can learn some boxing and wrestling skills. But even these fighters are not complete mixed martial arts fighters but rather have one good skill set, and the other skill sets necessary for legitimate mixed martial art`s fighting are at the novice to intermediate level at best.

5 Fighters at Master`s Skill Level

As a result the UFC has basically had about 5 guys who could actually fight as a true mixed martial artist and were talented athletes at a commensurate professional advanced level on their fighting roster at any given time. This makes it hard to put actual high level watchable shows on pay per view multiple times a year, let alone several times a month like the UFC tries to do without completely alienating your fans with subpar shows of overhyped events that are basically watered down fighting club events.

Whenever you have fighters with less than 3 fights fighting on main events like Brock Lesnar, Ronda Rousey, and over the hill boxers like James Toney you know there is a talent issue in the sport. Can you imagine putting in a quarterback to read modern NFL defensive coverages with such little preparation and years of experience? The UFC has basically devolved into the modern day equivalent of the Ringling Brother`s circus show promoting the latest freak show in the ring. We will see if Conor McGregor can actually fight this Saturday, and the Aldo – McGregor fight ends up meeting considerable expectations by fans.

Reinvest Profits in the Business – Like Amazon

However, until the UFC finds a way to reinvest their profits in developing fighters for the future, in some sort of amateur training program they are going to continue to tread water as an organization competing for the sports entertainment dollar. Maybe work with high school sports programs to have basic mixed martial arts clubs as alternatives for youths in lieu of football, basketball, baseball, track, golf, swimming, gymnastics, tennis and soccer. Or alternatively provide yearly stipends to have fighters on the roster in a developmental program like the minor leagues in baseball.

Legitimate Sport or Professional Wrestling?

Alternatively, they can hope that the fight fans will continue to purchase expensive pay per view events for overhyped fighters who lack the requisite training and skillset of the other sports leagues. Can you imagine if Tom Brady had only 10 starts in his entire football training life before playing in the Super bowl? The UFC is basically a flawed product right now, which relies upon hype, and an incompetent uncritical sports media accomplice in promoting underqualified participants as professionally qualified athletes with advanced mixed martial arts skillsets. In the glory days of boxing, which is the most common comparison sport, fighters had 5-10 years of amateur boxing training, at least 20 professional fights gradually building up there skillset, and then they worked their way into title fight contention.

Overhyping is not Good Branding

The UFC for the most part is one giant hype machine, promoting overhyped fights with fighters who are inadequately prepared, often not even meeting the 10,000 hours threshold of mixed martial arts training, let alone actually being gifted to any high degree in the sport. In the past, athletes tried to compensate for lack of skill by taking performance enhancing drugs (steroids, Hgh, etc.), dropping 20 plus pounds of water weight right before the fight (weight-cutting cans), and any other means available like laying on an opponent for 15 minutes due to only being able to wrestle or having a limited mixed martial arts toolkit.

Develop a Roster of 100 High Level Fighters: Business/Fighter Developmental Plan Required

We have written in the past about the progress of the sport, but in going after the almighty dollar in the short term, the UFC has failed to build a solid foundation going forward for its future. As of right now, despite the best fight this Saturday in years, the product is reaching a stagnation standpoint. It hasn`t evolved or taken near advantage of its opportunity as we would have anticipated given the uptick of a national television contract with Fox Sports, and the multitude of corporate sponsorships that have come the UFC`s way the last 3 years.

In short, if the UFC was a stock we would be shorting it right into the Aldo-McGregor spike this weekend. The UFC is going to have to make some changes if they are going to take their sport to the next level; promoting women fighters in bikinis can only fool the sports buying public for so long. Unless they want to remain a freak show niche ‘sport’ like professional wrestling with its declining pay per views, they better formulate a plan to develop a roster of 100 fighters who are truly compelling to watch from an overall athletic and advanced skill standpoint – a roster of fighters who are actually competent well rounded Mixed Martial Artists.

© EconMatters All Rights Reserved | Facebook | Twitter | Free Email | Kindle

The Gold Market

December 5, 2015 by EconMatters   Comments (0)

By EconMatters

 
Mario Draghi is a Hype Machine

The Gold Market is pretty interesting here as investors realized on Thursday that much that comes out of Mario Draghi`s mouth is complete hyperbole, because things aren`t nearly as dire in Europe as some bankers try to persuade for additional stimulus out of the ECB, and Germany isn`t going to sign off on the extreme bazooka stimulus measures because Germans by nature are conservative, and there is a commensurate symmetry between ratcheting up extreme monetary measures and stoking the fire of unintended consequences.

December Rate Hike Fully Priced into Markets

The Federal Reserve is all set to go on with a 25 basis point rate hike in two weeks, the financial markets have priced this in to the tune of around 80%. The surprising tone of the precious and industrial metals price action of Friday in the face of the US Dollar strengthening and oil getting hammered on OPEC news was interesting to say the least. The entire complex rallied from Copper, Aluminum, Platinum, Palladium and Silver to Gold as new money moved into the sector, and stayed there even after Mario Draghi tried to walk back the Euro from Thursday`s currency gains on the US Dollar.

Gold Price Action

After putting in the low for the year on Thursday morning of $1,045 per troy ounce, Gold finished Friday at $1,084 on the February 2016 futures contract. Gold has been hovering right around the $1,060 - $1,070 level for the last two weeks, and even if this is just short covering, somebody forced some shorts to cover. Maybe financial markets and the Metals markets are starting to realize a ‘One and Done’ rate hike by the Federal Reserve isn`t the end of the world. And given the $18 Trillion and climbing in US Debt facing central bankers at the Fed they are going to have to be doing a whole lot of “monetizing” or in layman`s terms currency printing for the foreseeable future so Gold and other Metals look attractive here at multi-year lows.

Follow Through

We will see if there is any follow through next week, but Copper had its first weekly rise in two months, and China smelters announced production cuts earlier in the week. Several of the other industrial metals showed signs of strength as well for the week. Even though there is a rate hike in two weeks by the Fed, markets often move before the fundamentals. Have the metals markets already priced in the effects of this rate hike on the US Dollar; that the Fed is likely to hike but be relatively dovish in hiking so as mitigating any takeoff in the US Dollar going forward for the next 3 months?

Crowded Trade – Portfolio Repositioning

Is this long the US Dollar, short the Industrial and Precious Metals trade losing steam, or is this just some short covering ahead of the Federal Reserve meeting hoping to avoid the similar fate of Euro Shorts on the morning of the ECB Policy Announcement? Best to take some profits on this trade before the actual event.

It will be interesting how Gold trades next week, and for the remainder of the year; but it and many of the industrial metals look like longer term buys at these prices from an investment standpoint.

$1,100 Level in Gold

Consequently watch the $1,100 level in Gold, if Gold breaks above this mark things could get interesting again for the shorts, as many who took this ride down from the $1,190 level probably want to avoid giving back much more profits on this trade, and have lots of stops placed accordingly at this key resistance level of $1,100.

Dovish Fed Speak

If the US Dollar tanks on the Fed announcement and Press Conference look for Gold to test the $1,190 resistance level with a huge couple of days of major short covering, and new longs pressing the trade from the long side just based upon the momentum Algos smashing the US Dollar and Buying Gold Futures as part of the same programmed trade. The type of day where Gold futures are up $45 one day, $27 the next and voila “let`s see where overhead resistance lies into year-end squaring of positions”?

Silver Market Leading Indicator of Money Flows

2016 will be interesting for the price of Gold to say the least, but let`s not get ahead of ourselves, there are still 4 weeks left in 2015. And for some reason traders didn`t feel like pressing those Gold shorts at $1,045. They couldn`t even hold Gold below the $1,060 level which obviously some traders tried to accomplish and failed miserably with how Gold ended the week trading all the way back to $1,088 before some profit taking ensued into the close.

Moreover, this happened when the Euro weakened and the US Dollar Index was up +0.73% on Friday. Therefore pay attention to any follow through for Gold and the other Metals next week. But the price action on Friday piqued my interest, especially in Gold and Silver; as I expected some of the Industrial Metals to climb with the production cut announcements. But Gold and Silver I figured were dead in the water until the Fed announcement on December 16th and they both showed signs of life from the long side on Friday.

© EconMatters All Rights Reserved | Facebook | Twitter | Free Email | Kindle