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When to be a 'pig'
Posted By Porter Stansberry On 04/25/2013 @ 8:47 pm In Front Page,Money,Politics,U.S. | No Comments
There are times when it pays to be a “pig.” Today, I’ll explore the idea with you. But a word of particular warning before you begin reading:
I’m about to write about doing something dangerous, something you probably already do (but shouldn’t). Yet I’m about to encourage you to do it more often. For lots of you now reading, unless you’re careful, this advice will almost surely prove to be catastrophic.
Therefore, if you don’t have at least five years of successful investing under your belt – that is, five years of profitable, safe investing – just stop reading right now. This is not for inexperienced investors. It is not for anyone who hasn’t mastered the emotions of trading. And it is emphatically not for anyone who is just a gambler at heart.
With that warning, let me show you how you can make a fortune, from time to time, in the markets.
The most obvious difference between the average “at-home gambler” and the average professional investor is position sizing. The professional is never ever a pig. That is, professional investors never allow themselves to build huge positions – not even in their best ideas. They would never pile 20 percent of their portfolios into a single idea. They know there are too many things that can go wrong, to many factors impossible to foresee.
As a result, professionals always diversify their equity portfolios. The most focused professional investors will usually have at least 20 different positions. Meanwhile, the most diversified individual investors rarely have more than 20 different positions. Thus, individual investors are sometimes “pigs” – overloaded into an idea – without even knowing it.
We consistently remind our readers not to put more than 4 percent or 5 percent of their portfolios into any single security, but we might as well be talking to a tree. No one listens to us, at least not until they’ve taken a beating once or twice. Not until they realize there’s just too much volatility in the market to survive holding onto a 10 percent or 20 percent weighted position.
But from time to time we do advocate being a pig. In fact, I’d argue that if you want to make a lot of money in stocks in any given year (more than 10 percent or 12 percent), you have to be a pig sooner or later.
What’s a pig? In 1988, legendary investor Warren Buffett bought 7 percent of Coca-Cola. The position made up 35 percent of Buffett’s entire portfolio. That’s a big, determined bet, one that had better pay off.
Buffett, of course, knew what he was doing. He had studied the company for nearly 40 years. He knew it was one of the greatest businesses the world had ever seen. And he knew why the business was so great: The company sold sugary syrup at a huge markup, to fanatical customers, via bottlers who shouldered almost all the real capital costs. Coke is a study in capital efficiency.
To be a successful pig, you have to know the investment inside and out. And it has to be trading at a price that’s so extremely cheap that there’s no way you can possibly get hurt buying it. (The stock market crash of 1987 allowed Buffett to begin building his position in Coke, a stock he’d wanted to buy for years.) You can’t go looking for something to pig out on. It has to be so big, so obvious and so well-known that you literally couldn’t miss it.
Let me give you an example: I’ve been studying the oil and gas industry closely since the mid-2000s because I believed natural gas prices trading above $15 per thousand cubic feet (mcf) represented a massive bubble.
Likewise, I thought West Texas Intermediate (WTI) oil prices – the benchmark for U.S. oil – trading above $100 a barrel made no sense from a fundamental standpoint. I also knew that the theory driving these bubbles forward (Peak Oil) was nonsense. Anyone studying the data of oil and gas production could have seen this, too. Simply put, production rates were not falling the way geophysicist M. King Hubbard predicted they would.
I famously told a room full of energy investors in March 2009 that anyone who was still long natural gas “should have their heads examined.” (I even won a bet with master resource investor Rick Rule about whether or not prices would go below $3 per mcf. They did.) And I told a group of oil investors last spring that anyone still long oil was “screwed.” (No, oil hasn’t collapsed to below $60 a barrel yet, but trust me, it will.)
Following the natural gas market from the peak of the cycle all the way to the bottom allowed me to see clearly that prices for natural gas had bottomed last spring. As I wrote a year ago in my Investment Advisory:
As you probably know, natural gas now trades for less than $2 per mcf, a price that’s lost all relationship with its utility in the world’s economy. There’s no reasonable fundamental explanation for the size of the spread between oil prices and natural gas prices. Natural gas is trading at the lowest price I’ve ever seen compared to the price of oil.
There are few things in life I know with certainty, but I know this: Barring the end of the world, the price of oil is going to fall and the price of natural gas is going to rise. In my mind, you ought to buy all the natural gas you can afford because these energy resources will not be cheap forever.
There were other signs that natural gas was at a very significant low. First and foremost, Wall Street had gone from being massively long natural gas in 2005 and 2006 to being almost uniformly short. Trading volume on natural gas futures had soared – up 31 percent in a year, with almost all the financial firms being short.
But the most important factor in my analysis was that from a physical, arbitrage perspective, natural gas couldn’t get any cheaper. Natural gas is just one form of energy. In theory, as an energy source, it’s totally interchangeable with other fossil fuels. Think of it this way: A barrel of oil has 5.825 million British thermal units (Btu) of energy. One thousand cubic feet of gas contains just a little more than 1 million Btu of energy.
Thus, on an energy-equivalent basis, you might expect natural gas to trade for one-sixth the price of oil. That doesn’t actually happen very often, though. In the real world, oil has vastly more utility, it’s far more widely used in transportation and it’s much easier to transport. (It doesn’t have to be frozen first, like natural gas does.)
So in the real world, historically, oil has carried a 10x premium in price to natural gas on an energy equivalent basis. But last April, the price of oil was trading at over a 50x multiple to the price of natural gas. This enormous premium simply couldn’t last – it was impossible.
That’s why I was telling you to be a pig in natural gas. First, I had studied the investment carefully for a long period of time.
Second, I knew that Wall Street was lined up on the wrong side of the trade – there would be plenty of people scrambling to unwind their short positions, which would push the price of natural gas up all by itself.
Third, and most important, I knew the ratio of natural gas to oil prices had gone so far beyond the point of profitable arbitrage that it was impossible for natural gas to get any cheaper. That’s when you know it’s time to be a pig.
So, how did that advice turn out? Here’s a chart showing the performance between natural gas and WTI crude oil. Being long gas and short oil would have earned you around 75 percent over the last year.
The main factor causing natural gas prices to be so incredibly low is an explosion in supply from U.S. shale and other large discoveries in Australia. Globally, the supply of natural gas has increased from around 96 trillion cubic feet in 1995 to more than 141.6 trillion in 2010 (the latest data available).
That’s almost a 50 percent increase – and we know that supplies and stockpiles have continued to increase. This energy is in high demand in places like Asia (especially Japan) and Europe, where nuclear energy is being phased out as the primary source of electricity. But right now there’s almost no export capacity in the U.S. and precious little around the world.
That’s why moving natural gas around the globe will be a major growth industry for at least the next two decades. To ship natural gas, first you have to turn it into a liquid by cooling it to 160 degrees below zero Celsius. In this form, natural gas is called liquefied natural gas (LNG). To use it, you have to warm it back up – re-gasify it.
Today, around the world, there are 89 LNG export facilities operating with a total liquefaction capacity of around 300 million tons per year. Meanwhile, there are 93 LNG import (regasification) terminals operating with a total capacity of around 700 million tons per year.
As you can see, that’s 300 million tons of export capacity versus 700 million tons of import capacity. That’s an export shortfall of 2.3 times capacity. The primary reason this gap exists is a lack of liquefaction trains (production units that cool the gas) in the U.S.
Why don’t we have more LNG export facilities in the U.S.? Politics, mostly. There are 20-plus companies waiting for export licenses from President Obama’s administration. The only company able to legally export LNG from the United States today is Cheniere Energy (NYSE: LNG), which was my top recommended way to profit from low natural gas prices last year. (My subscribers are up 76 percent in nine months.)
We also recommended Chicago Bridge & Iron, which is a leading global builder of LNG infrastructure. (Readers are up 42 percent in 10 months.)
We’ve also recommended Teekay LNG Partners (NYSE: TGP), which is one of the leading LNG transportation firms. (Readers are up 35 percent in just under a year and a half.) And we’ve recommended a natural gas liquids processor, Targa Resources (NYSE: TRGP), which is able to export natural gas liquids legally, thanks to a loophole in our country’s byzantine (and idiotic) energy export laws. (Readers are up 37 percent in four months.)
All in all, we’ve recommended around 10 different equities associated with natural gas production distribution over the past two years – all because we were fundamentally bullish on natural gas when most of the world was bearish.
We’ve made a lot of money on these recommendations, which now make up a huge chunk of our portfolio. Today, with WTI oil trading around $95 and natural gas trading around $4.10, the ratio between these two energy sources is still unusually wide – at a multiple of over 20x.
The point is: On rare occasions, it’s OK to be a pig. To do it safely, make sure you’re very familiar with the company or commodity you’re buying. You should have been following it for years. Or decades. Make sure you’re buying at a price that’s beyond what arbitrage should allow.
And make sure Wall Street is lined up on the wrong side of the trade. If you follow these three guidelines, you really can safely make a killing.
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