Double Blind

This was back on May 5th, so it is a little out of date:

VANCOUVER, BRITISH COLUMBIA–(Marketwire – May 5, 2009) – Teck Resources Limited (TSX: TCK.A and TCK.B, NYSE: TCK) announced today that it has priced its previously-announced offering of senior secured notes, and will issue US$4.225 billion in aggregate principal amount of senior secured notes, consisting of US$1.315 billion aggregate principal amount of five-year notes, US$1.06 billion aggregate principal amount of seven-year notes and US$1.85 billion aggregate principal amount of ten-year notes.

The five-year notes will bear interest at the rate of 9.75% per annum, will be issued at 95.27% of face value and will be non-callable. The seven-year notes will bear interest at the rate of 10.25% per annum, will be issued at 94.654% of face value and will be callable on or after May 15, 2013. The ten-year notes will bear interest at the rate of 10.75% per annum, will be issued at 94.893% of face value and will be callable on or after May 15, 2014.

Teck Resources (formerly known as Teck Cominco) management made a real brain-dead acquisition of Fording Coal, correctly picking the top of the commodity boom. They did a bridge loan to pay for it, and after the commodity market crashed along with the rest of the world financial markets, they discovered they had to pay it back, without the advantage of the dramatically increased cash flows they assumed from their acquisition. They managed to get $4.225 billion in bonds out the door but really had to pay for that capital – you can see the 10-year issue is sold at a current yield at 11.33%. They also had to secure the debt with hard assets.

If you had to stick a gun to my head and forced me to invest my life savings in either 10-year Canadian government bonds (yielding 3.14% at the time), or Teck 10-year bonds, I’d choose the Teck 10-year bond issue – you’ll have a lot more in your bank account after the issue matures. With any luck you’ll get called out on May 15, 2014, but either way, despite the fact that management really botched up their capital structure for the next decade, Teck should still be around and quite profitable whenever the commodity comes back from the dead.

The risk, and what you are receiving an extra 8% for, is the fact that Teck could default on their loans. They do have a considerable amount of debt on their balance sheet and it will take some time for them to continue chipping away at it. But they will.

Generally, for fixed income, the corporate debt world is much more attractive than government bonds, and there remains plenty of very high-yield and not-so-risky opportunities in this particular market. Something even safer is CP Rail offering 10-year notes at 7.25% a few days ago. I still very much like Sprint 19-year debt, trading at 51 cents on the dollar (the trust preferred has a coupon of 7%), although I should warn the reader that most of my purchases were made at the 35 cent level.

As a humorous comparison, General Motors debt is currently 5 cents on the dollar, and I would highly recommend not touching anything that is on the radar of the US Government, or any institution that has taken money from the government. If by some holy miracle that GM does not go bankrupt and continues paying its debtholders forever, you will be sitting on a 148% current yield (e.g. in the quoted issue above, you would invest $10,000 in GM bonds, and get back $14,800 a year in income for 42 years, and 42 years later you’ll also get back $200,000).

I still will not pay par value for most debt issuances – the real money to be made in the bond market is through capital gains on purchasing debt below par and being patient and waiting for them to mature at par. Purchasing debt at par (e.g. the CP Rail offering) will make the investment vulnerable to interest rate increases, which will then result in unrealized losses. For example, if you bought the 7.25% investment, and the 10-year government bond rate goes up 1%, you will suffer an approximate unrealized 12% loss as the market factors in the spread. If you hold the debt until maturity, however, there is no loss suffered.

If interest rates go nowhere, as the issue matures, the trading value will go somewhat over par value because of the interest yield curve; for example, if in five years nothing happens to interest rates, and if the spread over government rates remains steady, the bond will trade above par value.

There are a lot of “ifs” involved, and not to mention analyzing the underlying company itself to make sure it will be able to pay off or refinance the debt. Most people tend to think of the bond market as boring, but there is a surprising amount of complexity involved that I don’t see too many retail investors (at least ones on the internet) getting involved with. Chances are most of the ones that do the detailed analysis work are professional portfolio managers.

Anthony writes:

So you pay your credit card off every month, on time? Then a credit card is a blessing, right – while you reap the rewards of all those suckers who miss their payments and pay upwards of 20% interest (Babylonian era interest rates)? Wrong.

I agree that you should pay off your credit cards monthly without incurring the usurious interest payments. Anybody not doing so is making a huge financial mistake (unless if they’re planning on defaulting on their debt).

The other issue that Anthony talks about (the ease of purchasing more junk with credit cards) is much more psychological in nature. Anthony is also correct when he states that one of the “benefits” of credit cards (from the vantage point of the issuers) is that it enables people to spend more freely than if they had to deal with paper cash. There is a similar analogy here with casino chips in Las Vegas – it doesn’t “feel” like you are spending money, so you would gamble more otherwise than if you had to put paper money on the table all the time.

Credit cards offer fundamental advantages that cash does not. One is that you have the recourse of a charge-back in the event that something goes wrong (e.g. you purchased an airplane ticket and the airline subsequently went bankrupt). Two is that some cards offer ‘free’ fringe benefits (e.g. extended 1 year warranty, cash-back bonus, etc.) that you wouldn’t get with cash. Three is that if somebody robs you and takes your cash, you will have zero recourse. If some guy robs you and gets your credit cards, you’re legislatively protected even if the robber spends money to the limit with your cards.

Finally, what is missing is the argument about what the merchant has to pay in credit card fees; this is embedded in the price of the product/service you are paying for, and because of how the cash system works, it will be very difficult to get rid of this factor as competition in the credit card space is very limited. In other words, by paying cash, you are forfeiting the benefit of 1 month of interest-free deferred payment (with today’s interest rates this is worth relatively little, but if rates go up to 5% again, this typically would represent about 0.4% of the transaction value), and the ‘reward’ option (typically 1% with most cards).

About the issue of spending more with credit cards and accumulating junk, the only solution to this is discipline. What makes credit cards particularly dangerous is that you might buy stuff that you don’t have the cash to pay off.

One other issue which generally is not talked about is privacy concerns with respect to using credit cards. Essentially everybody that takes a credit card out will have a file on them that will get reported to a credit bureau. Your information and the information you generate from your purchasing habits, and your card payment habits, will be used and sold off to third party agencies.

Finally, I write this with a hint of irony since I received my monthly credit card statement in the mail, and on the very bottom it contained a notice saying:

As one of our most valued customers, we are pleased to increase your credit limit to the amount shown on the right-hand column under “Credit Limit”. If you do not wish to take advantage of this new limit, please call 1-800-xxx-xxxx.

That limit up 20% from a 5-digit number to a larger 5-digit number. I’ve never gotten at all close to this limit – it’s rare when I even have more than a thousand dollars on my statement, usually this only happens when I make large single item payments (such as buying a new laptop!). I also resent the “negative option billing” style of this, although the credit card company probably assumed that it only worked to my benefit.

This link has a video that compares Star Trek to Star Wars… and they got it pretty much correct.

I’ve compiled some miscellaneous statistics. The financial markets are probably at a turning point, so it is good to review some numbers to make sure that the strategy I am employing is along the right track.

US currency exposure: 34% – this is the lowest I can recall my US exposure. I’d like to bring this even lower, down to 25% or so, but there is no way to do this without selling the US components of my portfolio.

Equity / Income Trust Units: 38%
Corporate Debt (maturities from 2-5 years): 36%
Corporate Debt (maturities from 19-24 years): 38%
Average current yield of debt portfolio, based on current market value: 11.5%
Cash: -13%
Interest rate paid on cash debit balance: 1.7%
Direct exposure to the financial sector: 0%

If/when corporate credit markets continue to improve, the current yield should go lower as the market value will increase. The shorter duration debt will appreciate due to the shorter maturity dates (assuming the underlying companies don’t declare bankruptcy), while the longer duration debt will be much more sensitive to macroeconomic factors, such as inflation, short term interest rate changes, etc. However, my cost basis on the long term debt was ridiculously low, so I do not think that taking prices at 16-20% yield (on the cost basis) will be a money loser. If 16-20% is truly the market rate for BBB rated debt, then we are in a bigger economic crisis than anybody envisioned.

In any respect, the theme is that sticking money in ING Direct at 1.5% is a money-losing decision. It has to be invested or it will get whittled away through inflation. I don’t know when inflation will hit the economy, whether it will be next year, three years from now, or whenever, but there is only one way the US economy will be paying for their largess – inflation. Whatever hits the United States will be affecting the rest of the world as well, including Canada. Canada will be in relatively better shape than the rest of the world (for example, our corporate tax system is getting to be amazingly competitive and will attract capital) and as a result, I have no problem with my Canadian exposure – especially in the natural resource sector.

I am keeping the leverage ratio at a rate where one year’s worth of income from investments will be able to pay off the debt. It just becomes a matter of going on a huge vacation and waiting for the debt to pay itself off. The only active involvement I need is to review quarterly reports and ensure that the underlying companies are not going to go bankrupt. The other challenge is keeping a proper accrual to pay income taxes at the end of the year since a large component of the portfolio is not tax sheltered (i.e. through an RRSP/TFSA).

At my stage of life, I should be more of a “growth” investor, opposed to “income”, but I am very conscious of the fact that the end goal of investing is to eventually generate income (whether this is in the form of interest, dividends or capital gains) at a rate higher than you could otherwise through the risk-free route. There is also a lot of capital gain potential involved with the income trust units and the debt. The fact that all of these investments yield a regular cash return is a bonus.

I have been fortunate to take significant advantage of the financial crisis by making some opportune transactions. I estimate that the equity markets are going nowhere over the next couple of years, which is why my portfolio is so heavy on fixed income products purchased below par – they are more likely to outperform the marketplace, and corporate debt offers a margin of safety because they are higher on the capital structure than equity.

Conflicting with this is the expectation of inflation, but for the shorter duration products, they will be maturing as interest rates will increase, so they can hopefully be rolled over into low-risk products whenever they mature. I am also willing to keep them in risk-free products if I can’t find anything with an acceptable risk/reward ratio. For the longer term debt products, my long-term expectation is that they will trade around a current 8-9% yield.

I have no problem holding the investments to maturity, but if they start trading at par value tomorrow, I will look to sell them.

Now that the British Columbia election is behind us, the entire country (yet again) is in for another election this year.

Here is the start of the Conservative election campaign.

I said earlier this year that Harper would be Prime Minister on December 31, 2009 and this will still be the case, election or no election.

The best news for holders of debt is when the underlying company raises money through an equity offering. Harvest Energy raised CAD$117 million through an equity offering of their trust.

The people who “pay” for this transaction are the existing shareholders – they are forced to share the earnings of the company with the other shareholders.

As an owner of Harvest Energy’s debt, however, I absolutely love it since I am higher up on the capital structure. My ownership is not diluted in any respect and the company will be receiving CAD$117 million extra, which means that it is more likely I will be paid when the debt matures in 2012/2013.

The debt was a great buy at 40 cents on the dollar (where my TFSA went), it was a good purchase at 50 cents, but right now at around 70 cents on the dollar it is becoming OK, which puts it out of my investment criteria as I tend to look for dirt cheap bargains. I stopped purchasing the debt at 55 cents.

Usual spoiler warning (i.e. I’ll spill it all here).

From the perspective of a non-science fiction fan, and somebody that has not seen any Star Trek episodes or known anything about the franchise at all, I would have thought the movie would have been a fairly good action flick, albeit not memorable. It reminded me of a two-hour jazzed-up episode of Andromeda. It was also patently obvious that there will be a sequel to Star Trek.

From the perspective of somebody that has watched Star Trek and Star Trek : The Next Generation, I thought the movie was mediocre in terms of how they handled the plot. They really mangled up some elements, but they presumably did this to bust through the continuity issues that was plaguing the television show in general (specifically, Deep Space 9, Voyager and Enterprise were all severely handcuffed by what had been written in previous series) – especially how they managed to involve time travel elements to establish that the past is not going to be like the future (i.e. all the episodes that aired on television).

By getting rid of the planet Vulcan and Romulus and other such stuff, they can clear the slate for future stories.

The introduction of how Kirk, Spock, and the other people got aboard the USS Enterprise was nice. It was all very sudden, however, like they were quickly trying to clear this part of the story for the people in the movie theater that actually watched the show.

The thing that really disturbed me as a Star Trek watcher was the involvement of Spock and Uhura. Something was just weird about throwing that in, it seemed quite irrelevant. In a previous scene (before Spock/Uhura was established) Kirk sleeping with the green-skinned alien girl was a very correct scene in the movie, but having the gratuitous shot of Uhura undressing shortly after was just inappropriate – it just seemed to be an excuse to see her partially naked for “ratings”.

The movie was much more “lighter” than previous Star Trek Movies (except for Star Trek 4), which seemed to take away from any seriousness of the movie.

The new Spock and Kirk seem to be well casted, I thought they did very well together. The new McCoy wins on appearances but in terms of “personality”, something was off. There wasn’t enough interaction between the three of them, it was always one on one. Traditionally in the series, the three of them would always get into arguments. Plus, McCoy also used to be sent on the away missions as well.

The new technology, the bridge, and just the general appearance of the show was very well done. I especially like how the transporters work.

The movie was fun to watch. Although the reviews I had read made me thought it would have been a lot better, had I not read those reviews, I would have been happy, although not overly so. The writers had to get out of the lock that the previous televisions shows had bound them into, so they did an OK job getting out of that. I can imagine this is how fans of the original Battlestar Galactica felt when they saw the new remake.

One huge negative was that during the fight scenes, and the starship battle scenes, the camera angle would always keep changing, and it was very difficult to keep track of who was punching who, or what the ships were doing in combat, etc. This was very distracting.

I’m looking forward to the sequel, I can easily see how the sequel would have potential. This current movie is something that can be watched for the first time, but won’t be easily remembered, and I probably wouldn’t want to waste another two hours seeing it again. On the Star Trek Movie Scale(tm), I’d rank this one below Star Treks 2, 4 and 6, but above any of the “next generation” movies (7 to 11!).

The US 30-year treasury bond market experienced a significant decline today, mainly because the last auction of US debt received a tepid response from investors.

It turns out that demand for 30-year debt at 4.25% was lacklustre.

Institutional investors would be insane to take this rate, especially considering the future debt issuance of the US treasury – the US running a 1.75 trillion dollar deficit in the 2009 fiscal year and 1.17 trillion in fiscal 2010 (the US fiscal year ends in September). Three trillion dollars is a lot for anybody to swallow (just to give an example, Canada’s entire GDP is $1.3 trillion) and there is only one way that the US government will be paying for this: inflation of currency.

Central banks have a mandate to ensure that inflation is kept at a low level, and the only lever that they have to fight inflation will be to raise interest rates. The last time this happened in an intense fashion was in the early 80′s, where interest rate increases basically slaughtered the real estate market to the tune of 40% in a year.

The bond market is potentially signaling this. It will just be a matter of time before interest rates rise, and this will likely kill the real estate market (which the media is humorously reporting is “getting a second wind”). A couple years from now when interest rates on a 5-year mortgage are up to 8% or so, this will take out any of the speculators that are left from the marketplace as people will try to dump their real estate holdings to reduce leverage. My guess is that we still have another 25% decline or so to face. The trick for those would-be buyers out there is to have enough cash on hand ready to purchase a place when the residential property market goes into the tank – because mortgages are going to be ridiculously expensive to finance.

Where can money be safely stored during this time? Traditionally precious metals have been the place to be when inflation hits, but any industry with assets that will continue to produce inflation-adjusted cash flows will be relatively safe – like the mainstream telecommunication companies, or infrastructure holding firms. Companies that especially have long-dated debt will do quite well since they will be able to pay back debts at inflated dollar levels. Discounted bonds should do OK since companies will be able to better service debt, but bonds that are trading at or close to par will fare very poorly in such an environment.

The most paranoid of people can buy 10 troy ounce gold bars for about CAD$10,800 a piece presently. My sense of market timing would suggest that you could be patient for the next few months and wait for a lower price. This is likely to outperform the 1.5% you will get at ING Direct in the short run. My long-term concern with gold is that it doesn’t produce any return – you’d just buy it and stick it in a safety deposit box. However, in the event of a collapse of the economy, nothing would be better currency that would be more universally accepted than pure gold.

I must be turning into a Luddite. I have no idea why people would ever use Twitter, unless if they want to replace their weblogs with something that is compacted into micro-messaging.

So far, a month into my experiment, I’m quickly concluding that it is a useless service to me. I will be tolerant, however, and give it another five months before getting rid of my account. Something might change that might actually make me consider using the service – my guess is if I text messaged more with my cell phone I would probably get something more out of Twitter.

If the whole Internet turns into 140 character text message soundbites, we truly live in a sad world.

There was an oil spill at one of the facilities up in Burnaby today.

However, this oil spill was successfully contained by good safety engineering – a liner underneath the tank, which quarantined the 1200 barrels of oil that spilled out.

Critics will scream that this is further evidence that we should not be doing anything with crude oil in the province.

I say that this was a perfect example of a successful failure of a storage tank. The design assumed a failure, and when the failure did occur, it was contained because it was anticipated.

The same critics of this project would have probably screamed during the design phase that they were designing a project that assumed it would fail, so therefore it should never have been built. This is why politics and good engineering design should always be kept as far apart as possible.