(P&I) Extreme Economics – The Canadian Mines

The Great Depression

Drama. The Canadian oil and gas industry is in a “depression” which began to unfold last year and the Canadian mines are also in a depression but that has lasted much longer and although low oil prices and a lack of demand for commodities are the causes of this “bad behavior” in these industries, depressions are only a part of much broader range of economic “behavior” that is happening all of the time and these “depressions” – however alarming – are not exceptional but merely something that needs to be dealt with and for which there are solutions that are not merely happenstance.

As investors in the stocks of these companies and more generally in the economy of bonds and stocks, we don’t have to man the pump-jacks or move the rocks but we do have a job to do – our job is to find a way to profit from these misadventures in good times and bad because that’s not only convenient, it’s also essential that we might avoid the worst consequences of depressions, recessions, deflationary economies, inflation and hyper-inflation, and somewhere in there, there is a “normal economy” of benefit to all and it’s not found by government policy and brave speeches and the wrong solutions in the aftermath of the economic extrema.

Of course, if we don’t like that job – or can’t do that job – there isn’t one for us in the oilfields or in the mines right now and the banks, retail, and manufacturing are not looking all that good either – fast food, fishing, or farming?

The Market Ecology and the Free Market Yield

The market ecology is defined by its “Free Market Yield” and we noted in our earlier Post “(P&I) The Federal Funds Rate” that the Dow Jones Industrial Companies are currently “waiting” for new money to come into the market or for the old money to leave it and how that breaks depends only on the alternatives – are there higher yielding investments elsewhere or will this market prove itself with adequate earnings that will bode well for the current high prices as a “bargain” – which is what we expect (the latter) but the investors in this market aren’t necessarily “rational” in that way or predictable in their feverish thirst for capital gains and capital losses which they can only get from each other and for which the companies don’t have much to do with it.

Bubbles? For our depression?

And although the market might be thought of as a “bubble” or “dismissed” as a “bubble”, it’s nothing like that because the “price of an income” has to be high in a deflationary economy – that is its signature and the hallmark of a deflationary economy.

And although “money” or wealth in money might be thought of as a “store of value”, it’s nothing of the sort for very long because in the absence of an income which might occur in a depression or in a highly inflationary or hyper-inflationary economy, “money” can evaporate in an instant and be worthless because there’s nothing to buy or nothing to earn on it and there’s many an oligarch who has experienced that but not learned from it.

For bond investors, starting particularly at “risk-free” government bonds, the Free Market Yield is the Federal Funds Rate (0.25% currently) or something like it in other economies in which there is a sovereign “currency” but it escalates after that depending inversely on how much money is available for investment or savings and what the investments are in corporate debt but that equation is not any different from our investments in the stock market which are neither more nor less “risk-free” or “risky” in principle than the bond market and we’ve shown how to consistently obtain “risk-free” non-negative real returns in any stock market which can’t be done in the bond market because inflation and government intervention in the bond market are not predictable; for examples, please see our Post “(P&I) The World’s Worst Pension Plan” (or almost any of our Posts of which there are well over six hundred) but we have embraced the plight of the Canadian mines in this one.

Negative Money

We also note that the Federal Funds Rate could be negative (-0.25% for example) which would mean that the banks could earn a nominal profit from the government by systematically lending money in excess of their capital requirements and the cooperative central bank could “print” whatever new money it needs with the obvious inflationary consequence for the value of the currency.

We’ve got inflation – how much do you want?

For example, the banks themselves created an effectively “negative Federal Funds Rate” by their reckless lending on mortgages (and stocks prior to the Great Depression of 1929) which they eventually had to pay for but couldn’t because of their customers’ insolvency and which precipitated the “banking crisis” of 2007 and 2008 and that same situation arises regularly in the problem of making money from “real money” in a “depression” which is our problem now (please see below) but as another example, Greece has exactly that problem now – the Euro area countries have refused to “buy” the Greek inflation and in the past, many countries have enforced that “purchase” on others with a declaration of war or an “invasion” and there are no exceptions to that rule – for example, the current “trade sanctions” on Russia are a declaration of war and an invasion in all but name and, again, the Euro area countries are increasingly reluctant to “buy” the Ukrainian inflation which is occurring in an economic depression.

The Canadian Mines

By analogy, countries are “markets” and the companies in them are “workers” and their investors or shareholders are “owners” and there’s no economic distinction between them as countries or markets even though some are more prosperous (liquid) than others.

For example, a country is a market and it has customers outside of itself in its trade relationships although we can also consider the World as a market and the countries trading with each other as “companies” and “investors”; and we shouldn’t have too much of a problem in equating a company with its employees who are among “the” workers but we also need to account for the capital requirements of a company and its sources in the debt and equities markets of its own country and others; and then there are the “owners” who are trying to derive an income from their investment in lieu of manning the pump-jacks and moving the rocks, so to speak.

We have sixty companies in the Canadian mining portfolio and they produce gold, silver, copper, nickel, iron ore, diamonds, potash and assorted other rare-earth metals such as palladium and their operations are not only in Canada but world-wide for which the Canadian industry is well-regarded for its expertise.

The current market value of them all is about $211 billion and that’s down from $370 billion in early 2012 for a loss of (-42%) whereas other markets have gained at least that much in the past several years; moreover, they have traded in a narrow range between $200 billion and $250 billion since mid-year 2013 with a high volatility of about 28% per year and the entire market value of $200 billion is in the same ball-park as the total assets ($310 billion), the net worth ($177 billion) and the fixed assets ($188 billion) and the inventory that they’re currently carrying is about $20 billion.

Last year, these companies lost ($12.6 billion) on earnings of $4.9 billion for a net loss of ($7.8 billion) but they still paid dividends of $4.5 billion for a current dividend yield of 2.13% and a capitalization-weighted payout rate of 84% which is an extraordinary number; please see Exhibit 1 below for the details.

The current owners of these stocks don’t seem to be troubled by these numbers and it also seems unlikely that the aggregate market value will slip below $200 billion (which is approaching the price of the hard-core assets as above) or that these owners will have a “liquidity” problem if they haven’t had one already because they’re continuing to hold these stocks in the absence of an income and including the dividend yield (2.13% which was only 0.75% in 2012) their “money” is “eroding” (or “rusting”) at the rate of (-1.4%) per year which is the Free Market Yield (-1.378% and down from about +1.1% in 2012) and owning these stocks is creating negative money in this market as above and as was typical of the banks only a few years ago.

In order to “lift” this economy, new money has to come into it and that could be in the form of an acquisition or even some of the companies buying each other in order to improve their markets at a low price; on the other hand, the conservatively managed (B)-class portfolio gained +66% even as the market value of these companies descended in aggregate by a similar amount and the difference is that the (B)-class portfolio is always managed to protect the capital but it’s only willing to hold ten of these companies at the present time and it has never held more than a third of them at any time for very long; please see Exhibit 1 below for further details (and click on it and again to make it larger as required).

Exhibit 1: (B)(N) Extreme Economics – The Canadian Mines

Figure 1.1: (B)(N) Extreme Economics – The Canadian Mines

For more information and examples on the Free Market Yield and the terms that we have used above, please see our Posts “(P&I) The Dismal Equation (Ecclesiastes 9:1)” and “(B)(N) S&P 100 Volatility Risk and The Full Moon” and “(B)(N) NASDAQ 100 Volatility and The Stone Bunnies“ and for an introduction to The Barometer “(B)(N) What’s A Girl To Do” or “(P&I) The Swiss Franc Debacle“.

And for more information on real “risk management” in modern times and additional references to the theory and how to read the charts and tables, please see our Post, The RiskWerk Company Glossary and “(P&I) Dividend Risk and Dividend Yield“, and our recent Posts “(P&I) The Profit Box” and “(P&I) The Process – In The Beginning“; and we’ve also profiled hundreds of companies in these Posts and the Search Box (upper right) might help you to find what you’re looking for, such as “(B)(N) TLM Talisman Energy Incorporated” or “(B)(N) ATHN AthenaHealth Incorporated” or “(B)(N) PETM PetSmart Incorporated“, to name just a few.

And for more applications of these concepts please see our Posts which rely on the Theory of the Firm developed by the author (Goetze 2006) which calibrates The Process to the units of the balance sheet and demonstrates the price of risk as the solution to a Nash Equilibrium between “risk-seeking” and “risk-averse” investors within the demonstrated societal norms of risk aversion and bargaining practice. And for more on The Process, please see our Posts The Food Chain and The Process End-Of-Process.

And for more on what risk averse investing has done for us this year, please see our recent Posts on “(P&I) The Easy (EC) Theory of the Capital Markets” or “(B)(N) The Easy (EC) Theory of the S&P 500“, and the past, The S&P TSX “Hangdog” Market or The Wall Street Put or specialty markets such as The Dow Transports & Utilities or (B)(N) The Woods Are Burning, or for the real class action, La Dolce Vita – Let’s Do Prada! and It’s For You, Dear on the smartphone business.

And for more stocks at high prices, The World’s Most Talked About Stocks or Earnings Don’t Matter – NASDAQ 100. And for more on what’s Working in America, Big Oil, Shopping in America or Banking in America, to name just a few.

Postscript

We are The RiskWerk Company and care not a jot for mutual funds, hedge funds, “alternative investments”, the “risk/reward equation” and every other unprovable artifact of investment lore. We have just one product

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Disclaimer

Investing in the bond and stock markets has become a highly regulated and litigious industry but despite that, there remains only one effective rule and that is caveat emptor or “buyer beware”. Nothing that we say should be construed by any person as advice or a recommendation to buy, sell, hold or avoid the common stock or bonds of any public company at any time for any purpose. That is the law and we fully support and respect that law and regulation in every jurisdiction without exception and without qualification to the best of our knowledge and ability. We can only tell you what we do and why we do it or have done it and we know nothing at all about the future or the future of stock prices of any company nor why they are what they are now. The author retains all copyrights to his works in this blog and on this website. The Perpetual Bond®™ is a registered trademark and patented technology of The RiskWerk Company and RiskWerk Limited (“Company”) . The Canada Pension Bond®™ and The Medina Bond®™ are registered trademarks or trademarks of the Company as are the words and phrases “Alpha-smart”, “100% Capital Safety”, “100% Liquidity”, ”price of risk”, “risk price”, and the symbols “(B)”, “(N)” and N*.