Each January I look back at last year’s trading and remind myself what cost me money. In Part 1, I wrote about what MADE me money.  In this article, I look at what decisions, what trading patterns, didn’t work out?  What lessons did I learn–again?

So what cost me money in 2011?

1.      BUYING PENNY EXPLORATION STOCKS IN THE OPEN MARKET.  I capitalized this because the best time, and one could argue the ONLY time, to buy a drill-punt stock is when it raises money; equity; issues shares to the public (or even better, to a select group of institutions).

These junior exploration stocks have BIG appetites for capital—especially the offshore drill punts where wells cost $30-$200 million, or the true penny stock companies trying to do expensive onshore resource plays, where raising money for a $5 million horizontal well can double the amount of shares outstanding.

The underwriters always win with these stocks; they will sell it down to get a good deal, or price, for a financing.  These guys are the pros; they know what the real value of the stock is.  They try to make sure their best clients, the buyside institutions who play the junior resource market, will make money on these financings.

Sometimes you and I—retail—get to buy these financings, and that is generally the best time to buy these junior, high-risk, high-reward plays. But sometimes retail gets cut out and brokerage firms rely on their analysts to be bullish (within reason now...;-)); stimulating demand and getting retail to buy the stock in the open market, and help ensure their institutions make money.

So instead, buy around the same time they do—whether you can get the financing or not.  There’s a good likelihood that will be the best price for a profitable trade.

2.      BUT—what ALSO cost me A LOT of money (on paper) in 2011 was not selling those financings I bought–once the stock traded below the financing price, or issue price as the market calls it.  THIS IS A HUGE LESSON I LEARNED AGAIN (I already knew this but like many mistakes, I learn it many times…).

My experience is that once a financing goes more than a few pennies below issue price for a couple of days—sell the stock; especially if it’s a “bought deal” financing, in which the underwriter/brokerage firm MUST buy the entire financing with its own capital.

I know there are experienced investors who would disagree with me.  But when the underwriters can’t hold the financing price (especially in a bull market), it’s a sign of weakness and I saw it happen this year with Xtreme Coil (XDC-TSX; XTCMF-PINK) and Tuscany Drilling (TID-TSX; TIDZF-PINK).  Once those stocks broke below the issue price, they fell DRAMATICALLY—40%-50%.

Now, I still own these companies as operationally, they are doing very well, and I think they’re going higher.  But my point is that a year after these financings, they are all still at least 20% below what I paid for them.

This is no different than having a stop-loss on your trading.  Generally I have a mental 20% stop loss on my trades, but on these financings it would be 5%-10%.

———————————————————————————————————————————————

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Oil producers today finish drilling reservoirs knowing that a full 60% of the oil is still left in the ground.

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3.      BAD DRILL RESULTS cost me money in 2011.

Now, this is the junior markets, and many stocks in which I invest live or die by the drill bit.  I do the research to find the good teams with good assets at good valuations, but they don’t all work out. And the important thing is I didn’t have a large amount of money in any one of these plays.

My sense from some subscribers is that they put too much money into the riskiest plays with binary outcomes—hit or miss.  Jackpot or zero.  That’s not how I build wealth in this kind of market.  There are really good bull markets in the juniors where you can sell your penny stock drill punts into a speculative fervour (think Sept 2010-April 2011), but they don’t happen every year.

Torquay Oil Corp. (TOC.A-TSX) had very little success in the field and their stock shows it.  It lost 85% of its value from its high.

Sterling Resources (SLG-TSXv; SGURF-PINK), Bengal Energy (BNG-TSX; BNGLF-PINK) and PetroFrontier (PFC-TSX; PFRRF-PINK) also had less-than-hoped-for drilling results which caused the stocks to have big drops from their highs in 2011.

4.      Lost Opportunity Cost–Waiting for stocks to come back or return to a price that I think I deserved to buy them at.  Out of the early October downturn, I was watching two market leaders—Legacy Oil and Gas (LEG-TSX; LEGPF-PINK) as a producer, and Canyon Energy Service (FRC-TSX; CYSVF-PINK) as a services play (they’re the leading junior fracking company in Canada).

As these stocks started to rocket out of their early October lows, I watched.  And watched. And watched.  I put a price in my head that I think I might be able to buy them at; that I deserved to buy them at. But with momentum, they just kept going up.

Sometimes it’s hard to jump on a moving train, but if you want to own market leaders, the bellwether stocks that the institutional money flows go to FIRST, and HARDEST, you just have to buy them out of the downturns—even if it’s for a quick 20% trade (and out of those severe downspikes, you really only want to own the leaders).

Sadly, I don’t own either stock right now.  They’re well managed companies with fantastic growth rates.  Too much thinking on my part.

5.      Buying high priced stocks that had a corporate miscue; or rather, not selling them right after a miscue (for some reason there is rarely just one miscue).  I actually prefer high valuations vs. low.  Expensive stocks generally stay expensive—the market rewards them faster and more heartily–and cheap generally stay cheap. Once the market pegs a stock as a winner or loser, it’s hard for management to shake that tag.

The big risk in buying a stock with premium valuation is that they have an operational mis-step and the market then gives them a standard or even a discounted valuation.

Xtreme Coil (XDC-TSX; XTMCF-PINK) experienced delays in getting its new, high-margin service rigs to market, impacting calendar Q4 2011 and Q1 2012 financials.  I like their position in the market.

They actually have a new MINING rig they are developing with a mining major for development drilling, but hasn’t been approved for commercial use yet.  The stock dropped 50% from my purchase price through the year.

LOOKING FORWARD INTO 2012

I’m actually quite excited about 2012.  The market and the world’s economies threw everything it could at oil, and the global oil price—which is now Brent, not WTI–had its highest average price ever, even more than in 2008.

Junior oil stocks and junior services stocks were not so lucky.  Despite great fundamentals, they lost investors on average about 20% last year, and many were down 50%.  I see that sentiment turning around the leading junior/intermediate plays are likely the trade of the year in 2012.  Valuations are low and oil prices—and service contracts—are high.

Despite the fact that 9 of the 10 top performing stocks in 2011 in the junior/intermediate oil and gas sector in Canada are liquid rich natural gas stocks, I am not tempted to go there—except for two that subscribers will hear about in the next couple weeks.

I continue to see oil in that golden range of $80-$120 per barrel, where exploration success and growth gets rewarded.  I think 2012 will see a lower average price for oil than 2011, but overall market sentiment and risk tolerance will be improved, lifting valuations.

Junior oil stock investors do NOT want to see oil over $120/barrel—history says we then have an INVERSE relationship between oil and oil stocks as the market prices in recession.

Canada is a good place to be right now — It has a fragmented junior market (meaning lots of little companies), the most transparent trading system/stock exchange in the world.

In Canada you get 8 cent stocks that go to 90 cents as well as $2.50 stocks that go to $15.

The charts on some of the leading Canadian intermediates are turning positive—notably Legacy Oil and Gas (LEG-TSX).

But a lot of charts are still negative. Interestingly the charts on the major US and Canadian service companies—Halliburton, Schlumberger in the US and Trican, Calfrac and Canyon Services—have broken out of recent downtrends, but are just moving sideways.

I told subscribers on January 3 I expect to be fully invested by third week of January in anticipation of a bull run…which has started. I expect it to last at least into March—our regular seasonal top.

I’m a position trader, with a goal of making 50%-100% on every single trade over a 9-18 month window.  But one last thing that cost me money in 2011 was not selling some of my positions (especially ones that did not have imminent catalysts) during this seasonal top last year.

Note to self: sell more at the top this year.

- Keith

P.S. Two days ago, in an interview with Fox News — I gave my views on the oil markets, how oil’s trading, and the situation in Iran. It’s a short segment – under 5 minutes and done via Skype — but I think you’ll appreciate it. Click here to watch the video on Fox News Online.

– 2011 PORTFOLIO TRACK RECORD DISCLOSURES –

48.2% average gain on closed trades — stocks sold in 2011
36% average gain on open trades — stocks initiated, or first bought, in 2011
36.7% average gain on open trades — stocks bought in 2009, 2010, and 2011

By Dave Blais

Despite the recent bounce back in the precious metals sector in the past several days, I am electing to remain in an all-cash position, on the sidelines. As readers of my blog know, I sold all my gold and silver stocks before Christmas.

The reason for my stance is that I see the potential for significant risk ahead in the precious metals sector, especially the shares. Also, I have an idiosyncratic black-or-white point of view on investing in the precious metals shares — I believe they are an “all or nothing” affair.

That’s because my experience is a when the precious metals stocks are on the rise, they can provide outstanding profits. But on the flip side, when they are weak for an extended period, they can also deliver outstanding losses. In the last part of 2011, I was seeing signs that the sector may rise in the near term — but all those signs have since reversed.

In fact, I believe the risk that I see ahead is potentially great enough that it is prudent for me to stay in cash until the situation clarifies. Because I believe the potential risk in the precious metals market is high, I do not mind missing out on some potential upside in the meantime. If the risk I see fully expresses itself, then I see tremendous opportunity by getting back into precious metals stocks at what may be much lower prices down the road.

The potential risk

To review, here is what I see:

Gold (and silver) has been extremely weak in what is more often than not its strong season (November, December, January).  Despite the rebound in gold in recent days, for almost three trading weeks gold has remained below its 50-day, 150-day and 200-day moving averages — it is only in the last couple of days that gold has popped above its 200-day moving average.  Gold also remains below a three-year support line (the straight green line in chart below).  This previous support line can now be expected to act as resistance. The action in gold is poor — period.

To see gold (and silver) so exceptionally weak in what is usually a period of strength, I believe, is a potential warning that should not be ignored. To see such weakness in summer would be expected, as summer tends to be historically a weak period for the precious metals — but it is not to be expected in a period of seasonal strength.

Unless gold can quickly repair the technical damage it has experienced, gold is potentially opening the door to a much larger drop. By breaking below a three-year support line from 2009, gold increases the odds of being drawn to the lower boundaries of its current trading channel, which lie roughly at the $1400 area, then the $1300 area, followed by the $1200 area:

Of more concern, the HUI gold mining index may be replicating a very similar chart pattern that was present before the 2008 crash. The HUI has not yet definitively broken down from this pattern as shown in the chart below. (Several days ago it did break down, but it reversed the breakdown).

In the chart above, it can be seen that prior to the 2008 crash, the HUI gold mining index was supported by a key three-year trendline (orange line). Back then, just before this trendline broke, the HUI formed a “head and shoulder” type top that broke down, signalling the start of a devastating decline. An almost identical chart pattern exists today.

If a similar definitive breakdown occurs in the HUI now, I believe it could result in a possibly sizable decline for the gold (and silver) stocks in the near term.  Whether or not the decline would be as great as 2008 is not knowable in advance. And just because a chart pattern is similar does not mean will necessarily resolve the same way.

Nonetheless, the risk is the situation could turn into a real doozy to the downside, if a breakdown in the HUI occurs. The cause of such a decline would likely be an escalation of the debt crisis in Europe, causing another large wave of de-leveraging across the globe.

Given the potentially profound risk that I perceive, I prefer to stand aside and see how the situation resolves. On the downside, a definitive break of the HUI below the 495 level, I consider to be the trigger for a potentially bigger decline.  On the upside, a clear break above the 620 upper-level resistance in the HUI, in my opinion, would largely negate the risk to the downside, and give a potential “all-clear” signal to re-enter the market for gold and silver shares.

There is always more than one way to look at a chart. Below is an alternate view of the long-term chart of the HUI. This alternate chart shows a slightly different chart pattern replicating. If this alternate view is correct, a breakdown may have already occurred.

The purpose of showing this alternate chart is to explore possibilities. In any case, the message from both charts, I believe, is one of caution.

The HUI gold mining index isn’t the only chart looking dodgy. The Dow Jones Industrial Average is also looking a bit tenuous. Despite the positive action of the past few weeks, there is a potential “head and shoulders” top forming there as well:

In sum, the there are noticeable “echoes” from 2008 evident in the charts here and now. If these echoes resolve similarly in the weeks ahead, it could signal the start of a severe decline in the gold (and silver) stocks — and possibly other markets as well.

The opportunity, if such a decline in the gold and silver stocks actually occurs — could be life-changing for those who are prepared for it, and who patiently prepare to seize the opportunity such a decline would present.

In the 2008 smash, many quality gold and silver stocks were crushed beyond reasonable valuations. Those who were prepared by having a large cash position could have made a small fortune by buying near the bottom.

As an example, Novagold Resources fell from about $8 in the spring to well under $1 in the fall. (The actual low was below 50 cents, but few investors were actually able to catch the rock-bottom lows).

Once the bottom was in, Novagold over the next year rose to around $6, for a gain of more than 6 times. Had an astute investor bought Novagold near the lows, they could have turned a $50,000 investment to more than $300,000 in just a year. Two years from the 2008 low, Novagold rose to $14, which would have turned that same $50,000 into $700,000.

Novagold was one of the more extreme examples of the severe undervaluation that took place in the precious metals stocks in the 2008 smash, but it is by no means a unique example. Pull up the charts of almost any gold stock, and a similar story will be told. While I am not anticipating the same degree of mega washout as occurred in 2008 if the HUI breaks down, I am expecting that a another remarkable buying opportunity may present itself.

In 2008, what caused the precious metals stocks (and other stocks around the world) to fall below reasonable valuations was the extreme, rapid de-leveraging that occurred triggered by the failure of Lehman Brothers. This rapid de-leveraging caused individuals, hedge funds and others who used leverage or margin into forced selling. This forced selling caused more forced selling, and so on. In some ways, the 2008 episode could be described as a giant global margin call.

What if the gold stocks don’t break down, and reverse higher?

In standing aside here, I accept the possibility that the risks evident in the charts may not come to pass.  Indeed, many analysts believe that the precious metals sector has bottomed here and is poised to move strongly higher in the days and weeks ahead. That could very well happen.

If the market does not break down, and instead bolts higher, I will wait until the HUI gold mining index definitively clears key overhead resistance at the 620 level, before re-entering. In breaking above 620, the HUI will likely be signalling the next big leg higher is likely in the cards.

The bottom line for me is that I believe the precious metals shares are at an absolutely critical juncture — and I have positioned myself to preserve my capital while waiting to take advantage of whichever way the precious metals shares ultimately break — higher or lower.

Dave Blais is a full-time investor who specializes in quality gold and silver stocks. He writes on his blog, Epiphanies on Gold and Silver.

Disclaimers: Neither Dave Blais or Keith Schaefer are investments advisors; no part of this article should be considered personalized investment advice. As always, investors should consult with a licensed financial planner for help on their particular investment situations.

In Part 2 of his story on the Natural Gas Bull ETF, Guest Writer Cory Mitchell tells you historically WHEN the best time is to make this trade to maximize profits… and it’s coming up very soon.  He also explains what happens to this short trade if natural gas prices start to rise (Hint: It’s better than you think.)

- Keith

By Cory Mitchell, CMT

In Part 1, I explained The Best Trade in Natural Gas—shorting the Horizons BetaPro Natural Gas Bull ETF, symbol HNU on the Toronto Stock Exchange.  With very little volatility, investors who shorted this ETF in June 2008 would be up more than 99% now—in fact, there is almost no time in the past four years when this trade would not have been profitable.

Most retail investors look to ride a major trend to profits, and the downward slope of natural gas prices for the last three years have provided very steady capital gains.

So when is the BEST time to make this trade—shorting the HNU:TSX?

Charts suggest that the Monday of the last week of January has been a historically good entry point for short positions.  Here is what happened the last three years:

1. Monday, January 25, 2010—if you shorted and held you would have never seen a loss and would have made 88.95% between that date and December 2, 2011(closing prices).
2. Monday, January 24, 2011 was a steep drop day.  But if you sold on that day, the price never moved above it again, representing a 63.56% gain as of the close on December 2.
3. In 2009 the ETF did manage to move a bit higher after the last week in January, but by mid-February—only three weeks later– the ETF was dropping once again, never to reach those levels again.

Therefore, the first Monday of the last week in January has been a solid entry point, yet there is possibility that it could fluctuate and move higher from there in the short-term.  History indicates this is likely a high probability short position entry point, although history does not always repeat itself so retail investors must be vigilant on managing their own risk and not taking positions which they cannot afford to lose on.

What Happens if Natural Gas Goes Up in Price?

Natural Gas has been sliding this year, as mentioned, down 22.77% YTD as of Friday, December 2.  Therefore, if natural gas begins to rise over the long-term will HNU rise?

Given the structure of the ETF, this is extremely unlikely over the long-term.  Even if natural gas rises the ETF will continually be paying a higher price for new contracts than it receives for expiring ones.  The spot price at expiry will theoretically need to be higher than the futures price paid every time a contract is rolled in order for this ETF to appreciate long-term—a highly unlikely scenario.

The potential exists for a “backwardation” market condition to develop.  This would aid HNU in recovering some of the excessive losses it has seen since its inception.

Backwardation occurs when contracts in the future are priced lower than the current spot rate and then rise as they near expiry to converge with the higher spot price.  This would occur for example if short-term demand is higher than anticipated demand in the future. The current price is driven up, but contracts for future months are priced lower because demand is expected to decline by then.

This allows the leveraged long position ETF to profit when the spot price increases, remains flat or even if the spot price declines slightly–because the ETF will purchase contracts which expire in the future for cheaper than the current spot price (how much they sell expiring contracts for).

How To Release The World’s “Trapped” Oil

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Sometimes as much as 90% remains... despite using today's most advanced recovery technologies.

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You see, its patented technology literally extends the life – and profits – of oil wells.

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I hope you’re still with me!

As the contracts near expiry, its value will increase to the current price, at which point the position is rolled into another contract which is priced lower than the current spot price.  This allows the fund to purchase more of the new contract which is likely to provide a positive return even if the spot rate remains flat.

Backwardation rarely occurs in natural gas, which is called a “non-perishable commodity,” since there are storage and insurance costs for holding the commodity for delivery in the future.  This is why futures contract far away from expiration are priced higher than the spot price—it compensates the seller and holder of the commodity for costs incurred until delivery.

Sustained backwardation is really the only way HNU can recoup losses, and this scenario is highly unlikely. Therefore, it is very implausible HNU will be able to sustain an uptrend even if natural gas were to begin a long-term uptrend.

The daily objective of the fund means it is more suited to day traders, and long-term short sellers than bullish investors.  The odds are stacked against the bulls due to the structure of the fund and contango.  While bullish investors may be able to exit at a better price on daily gyrations, it is probable that this ETF will continue to decline, as it has done since July of 2008.  That provides an opportunity for those open to short selling.

We are approaching a time which was a great entry point in 2009, 2010 and 2011.

2008 saw a sharp rise in natural gas between January and the end of the July. This was the only time the ETF rallied—right after its inception.  It responded well to the bull market then mainly because during the first several months, contracts did not have to be rolled.  Once the contracts began to roll, the losses mounted as natural gas began its long-term decline.  If such a sharp rise occurred again, HNU.TO would likely rise, but the effects would be more muted than in 2008 because of the contango effect and the inefficiencies mentioned in Part 1.

Conclusion

HNU is a product long-term investors should avoid buying as the ETF does not accurately reflect the movement of natural gas beyond a single day.  The likelihood of a long-term rise in the ETF which will allow investors to recoup losses, even if natural gas begins a bull run, is slim.  The structure of the ETF is not favourable to long term appreciation.  In order for long-term appreciation to occur, conditions would need to be perfect, and need to run counter to the norms of the non-perishable commodity.

This makes the ETF a prime candidate for taking a short position as the inefficiencies of the fund create profits for further downside.  Couple this with a weak natural gas price and late January of 2012 begins to look like a good short-entry point.

- Cory Mitchell, CMT

EDITOR’S NOTE:  Several readers emailed in after reading Part 1 asking, why short the HNU ETF — why not buy the HND:TSX, the natural gas down ETF?  The answer is simple. In terms of being able to capitalize on a trend it has been less reliable.

Since March of 2009 HND has continually pulled back to former price lows (support).  HNU has not done this; very rarely on a long-term basis has HNU moved higher to test old resistance levels.  This makes HNU far more consistent in making new lows (good for shorts), than HND is at making new highs (tricky for longs).  For trend followers and investors who don’t want to have to babysit a position, the short in HNU is likely a better option.  HND provides great profit potential as well, but entries and exits are harder to pick as the movement is far less uniform than in HNU over the long-run.

Disclaimers: Cory Mitchell nor Keith Schaefer currently hold a position, short or long, in TSX:HNU. Neither Cory Mitchell nor Keith Schaefer are investments advisors; no part of this article should be considered personalized investment advice. As always, investors should consult with a licensed financial planner for help on their particular investment situations.

I asked Cory Mitchell to explain two scenarios that could play out in the global energy markets, and what it means for energy investors. Here’s Part 1 of his story.

- Keith

The Macro Dilemma
by Cory Mitchell, CMT

Energy investors need to be aware there are two massive macro forces in our global markets and economies battling it out.  One is obvious (and positive!), and one is not—it’s negative.  But the new global credit crunch has brought this dilemma for energy investors into sharp focus:

1.   Stagnant or declining oil production, which should mean oil prices—and oil stocks—are going higher.

But as I’ll show you…

2.   If oil production declines, it will have a negative on global debt and GDP—declining oil production will in turn lead to a long-term decline in the global economy – and a declining economy should push the price of oil down.  The lack of continued growth in oil supply has been a constraint on global growth since 2004, says Canada’s Sprott Asset Management.

One scenario points to a higher oil price, and another to a lower price—yet they are two sides of the same coin.  And while it’s counter-intuitive, lower oil production can potentially lower oil prices by constraining demand. As these contrasting forces play out now and in to the future, oil markets are likely to remain volatile.

The volatility created by this global battle will present opportunities for energy investors as the macro forces play out.

Economic Relationships with Oil

Oil production (and consumption) drives GDP and debt.  While debt is often viewed negatively, it is what allows our economy to expand.  When a consumer goes to the bank and gets a loan, money is created.

This money is then spent and deposited into someone else’s bank account, allowing the bank to grant another loan and so on.  This is healthy for the economy as long as the process is not taken to extremes and leveraged too highly, like what occurred in the 2008 “credit crisis.”

US debt had been steadily rising but has now plateaued, as shown in Figure 1. The problem is, debt—and thus the economy—do not expand if oil production does not expand.

Figure 1. US Government and Non-Government Debt:

*Source: http://www.theoildrum.com/node/8268

Figure 2 shows the high correlation of oil production and GDP.  Oil production levelling off corresponds to the flattening in debt (above) and GDP that we are currently seeing.  Oil production levelled off in 2005 and GDP is failing to get above 2008 levels after a significant decline.  The plateaus in oil production, debt and GDP may be short-term, or may indicate a long-term lack of growth or decline in global economies.

It’s interesting to note that oil production and demand has increased steadily by 10 million barrels of oil per day per decade since 1970—just as the world experienced the largest debt increase in global economic history.

Figure 2 World Oil Production and GDP (Crude Production in blue and scale on the right, GDP in red and scale on the left):

*Source: Economagic

Figure 3 shows the high correlation of oil consumption to GDP.  The relationship of oil production to these major economic factors—debt and GDP—are unavoidable.  As goes oil production so goes the global economy.  The major issue presented is that oil production has levelled off.  If oil production cannot increase the world has reached “peak oil” and by extension, peak debt and peak GDP.

This means investors need to look for places which still exhibit growth prospects and may even benefit from peak oil over the next several years to decades.

Figure 3. Oil Consumption vs GDP:

*Source: Gail Tverberg,  The Link Between Peak Oil and Peak Debt

Issues the Relationship Presents

“Peak oil” occurs when global productions hits maximum output and can no longer continue to increase, leading to a long-term decline in supply.  Oil is what allows economies to operate, and without it to fuel many projects — well, companies, consumers and banks would have no need for debt.  Debt would dramatically drop, forcing down GDP in the process.

Therefore, peak oil and peak debt will create peak GDP.

When peak oil and peak debt (and by extension peak GDP) will exactly occur is unknown, but global production has levelled off and the idea that we are rapidly approaching a global peak oil production is becoming more prominent in the media.  Canada, however, is continuing to see its oil production rise—which is providing a very interesting opportunity for energy investors around the globe.

With debt and oil production levelling off, I believe that at some point the world will hit a “growth ceiling,” until some new technological advance drives us forward once again.  This has happened throughout history, when there have been moments of radical growth following a new technology or an increase in productivity.  Then growth levels off or declines until the next big idea comes along.

That big idea may or not be here yet — shale gas, hydrogen and electricity are some the alternatives currently being explored; though the transition away from oil will take at least 30-50 years according to Vaclav Smil in the book, Energy Transitions: History, Requirements and Prospects.  That’s not hard to fathom, given the vast infrastructure aligned with our dependence on oil.  At this time, creating or extracting an alternative fuel and transporting it stills relies on oil.

In conclusion, I see the combination of (at least short term) peak oil and peak debt, which should cause lower demand and lower oil prices, continuing to do battle against the idea that lower oil production should obviously mean higher oil price.

To me, this means the oil sector will continue to be a hot bed of macro volatility and investor opportunity.  And in my next article, I’ll explain how energy investors can best profit from the volatility created by these two forces.

- Cory Mitchell, CMT

Intermediate and junior oil service stocks have been pummeled by as much as 50% or more in three short months—even as all fundamental data showed a booming sector—both now and into Q4.

Canadian analysts say the market is either discounting a much larger correction in activity for 2012 or this is a great buying opportunity for investors.

National Bank summed up what the analyst group think with these two paragraphs:

“If hydrocarbon prices rebound to 2011’s average levels, the fundamentals for service companies will remain intact and 2012’s activity levels will likely be record-setting; therefore, these prices may currently represent a once-in-a-decade entry opportunity.

On the other hand, if the market is correct, service companies’ 2012 EBITDA will be approximately 25%-50% lower than analysts’ current estimates, and this would represent the second biggest pullback ever since 2009’s 38% decline.”

Rig counts in both Canada and the US are peaking at 4-5 year highs, and haven’t fallen yet.  The number of wells being drilled in Canada in Q3 soared higher than anyone expected, trying to make up for a very wet Q2 that prevented thousands of wells from being drilled.   Wells drilled in August and September were the most since 2006.

The number of operating days jumped 39% in Q3 over Q2, due to more intensive horizontal drilling, which is now over 60% of all wells drilled. As a result, service rig activity is high and rising.  Deep horizontal drilling rigs are basically at maximum capacity now, which the industry normally doesn’t see until winter.

So while the business was on fire in Q3, the stocks were getting doused with water.  That’s what has analysts – and investors – befuddled.

Valuations were lowered so hard and fast that four Canadian firms issued reports early last week saying the sell-off in service stocks was overdone, and valuations had improved enough to where they thought investors should be buying—at least a bit.

And investors were listening.  Canadian fracking stocks were up 15% or more in the shortened (Canadian) Thanksgiving week, on great volume.

Said RBC Dominion, Canada’s largest brokerage firm:

“Our coverage universe on average is now discounting 2012 results that are ~18% below our current estimates, based on a return to historical trough valuation multiples.”

“While activity levels for 2012 will become clearer once E&P budgets begin to be announced, starting with Q3/11 results, we view the discount for certain companies as particularly pessimistic in the current oil price environment.”

Of course, the market isn’t discounting the current oil price environment—it’s discounting much lower oil prices, like the $65-$70 oil that oil producers’ stocks were pricing in last week and corresponding major drop in capital spending that goes along with that.

I attended an oil and gas conference recently in which one of the presenting CEOs was asked—at what oil price do you cut spending?  He really did not want to answer, but it finally came out–$80/barrel.  So that’s why this current price level is important to hold for services companies.

The four analyst reports I read suggested stocks were now pricing in a reduction in 2012 activity that ranged from 18%-30%–which usually means a 35%-50% decline in share prices.  That is already priced into the services stocks and then some, creating this buying opportunity, they say. (FYI, frackers have more leverage to producers’ spending levels than drillers, which gives their stocks bigger swings; they’re more volatile stocks.)

Analysts outlined several factors that they think could make this downturn in the oil services cycle different than before.

One factor is…well…it has been different before. Raymond James, a brokerage firm on both sides of the 49th parallel, says that between June 2009 and September 2010, the oil services stocks lost 38% of their share value—while the rig count kept going steadily higher, without even pausing.

That is the only time the market priced in a downturn in activity, and it didn’t happen.  Raymond James pointed out that the rig count in both Canada and the US has now plateaued, “almost as if it’s trying to decide if the hitherto sound fundamentals or the forward-looking bearish technicals will win the day.”

The US onshore rig count stopped going up in August, and the Canada followed suit in mid-September.  But they haven’t fallen, and Raymond James says it’s highly unusual for oil to go down 5 months like it has and not see a corresponding drop in rig count.  It’s definitely a chin-rubber.

Another point is that for the first time ever, North American rigs are drilling mostly for oil, not gas.  Previous cycles have all been predicated on the continental natural gas cycle—which is generally more volatile than the global oil market.  Really. ;-)

Even the natural gas rig count in the US is up for the year right now, despite very low prices and a bearish outlook.

Why? I would suggest it’s because gas rigs are now drilling for Natural Gas Liquids (NGLs) like ethane, propane, butane and condensate—and they can afford to sell the regular, dry natural gas at a low price.  NGLs receive world pricing, and a lot of US produced NGLs end up in Latin America now.

The point is that the underlying commodity cycle for the services sector is different in North America now.

Toronto-based Cormark Securities mentioned several other items in their report:

More long term contracts for drillers and frackers (or “pressure pumpers”)—the drilling fleet is 25% under contract, while pressure pumpers are enjoying >60% of capacity contracted in the US and ~50% in Canada

Large joint ventures with National Oil Companies (NOCs) and other International Oil Companies (IOCs) have given US & Cdn E&P companies $21 billion to spend since early 2010 (they listed 21 different deals)

Land sales.  The industry has spent $3.4 billion on new land leases, with most of it in areas that already have excellent infrastructure, meaning access is easy to get in and the oil/gas is easy to get out (I would add that for Canada, if the newly tested Duvernay formation gets deemed commercial in Q1 2012, the entire services sector in the Great White North will continue to laugh all the way to the bank.)

Will this downturn cycle really be different for Canadian and US service companies?  It has happened once before.   Or are energy stocks – both the producers and the service companies – foretelling of lower oil prices and reduced spending in 2012?

RBC says investors should stick with the deep drillers; the trend is to deeper, longer horizontal wells.  Cormark says go with the defensive large cap names with good liquidity.  National Bank says go with geographic diversification and technological sophistication.

No matter the choice, investors will need to be nimble in this market.

I asked my good friend Dave Blais, who trades gold and silver stocks full time, to provide an update on what he sees happening in the gold market, in follow up to the last piece he penned for OGIB readers several weeks ago.

The frustrating under-performance of the precious metals shares – in particular the gold mining shares – may be finally ending.  In fact, the stock charts are telling me the gold shares are now basing for what could be a large move up.

Certainly for the past year or more, owning stagnant gold mining shares has been a disappointment for many investors as they watched the price of gold bullion soar.

In recent months especially, the gold shares as a group have simply not played their traditional role as a leveraged play on the metals themselves. On the contrary, until very recently many gold mining shares have been acting weak, while gold itself bolted upward.

Only a small subset of the gold shares performed reasonably well by mirroring – or in some cases somewhat bettering – the action in the metal. This means successful investors have had to be very selective in which gold mining stocks they owned in 2011.

Things may be about the change – the gold shares may be shaking off their lethargy, getting ready to make a big move. A rising tide may be starting that will lift all – or at least most – boats.  I think the tide is coming in.

What’s more, the base for this potentially big rise may be forming — right now.

If so, sometime in the next few weeks, the gold shares may begin a profound rise.

This scenario fits my theory where I had been looking for a temporary top in gold to happen on either side of Labour Day.  As I explained in my last article – this has been the historical tendency when gold has had an outsized summer run like we just got.

As expected, we did get strong corrective action in gold – shortly before Labour Day gold dropped more than $200 in a few days. And then for good measure, gold rebounded, made a new temporary high and gold corrected strongly again shortly after Labour Day, diving more than $100.

However, when gold had these most recent corrections on either side of Labour Day, we saw something different happen with the gold shares that we have not seen in a very long while –when gold corrected, the gold shares were consistently stronger than the metal.

Even more surprising, when gold had its more than $100 dollar drop just after Labour Day, the shares actually rose.

And then in the last several days, the HUI, an index made up mostly of unhedged gold miners, did something remarkable – it broke out of a multi-month consolidation while gold was well below its recent highs, a very bullish sign.

Based on the very recent potential breakout action in the HUI, I scaled in modestly to some of the most promising precious metals shares I am tracking. I will scale in more if the HUI can hold above the breakout over the next few days and weeks.

We may be at a very exciting juncture that bears close watching. A few weeks does not necessarily make a trend, but make no mistake – the very recent gold stock stock action is very impressive.

If this breakout in the gold stocks holds and builds strength over the next several days and weeks, we very well may have a major breakout on our hands, portending significant gains ahead.

By Dave Blais

I feel lucky today to introduce Dave Blais, a good friend I’ve known for 15 years.  Like me, he has a journalism degree, and also like me, recently left a six-figure salary to trade the markets full time.  But while my passion is junior oil and gas, his is gold and silver stocks.  Throughout one of our recent chats, I continually exclaimed to him – Dave, that’s a great story—I don’t think that idea is out there in the market! I have great respect for Dave’s insights, and the fact he backs up his insights and philosophies with his own money.

I hope I can convince Dave to write periodically for our readers, and I specifically chose what I thought was his most controversial belief – that history suggests the gold price is topping out in the very near term.

_____________________________________________________________________

Gold has been on an upward tear lately – no surprise given the uncertainty over how the western world will deal with its debt. What could be a surprise for investors (but mostly traders) is that history suggests the odds are high that gold will top for the year sometime in the next three weeks.

A feature of the current gold strength is it is happening in the heart of summer — a time when gold is usually weak. Though rare, this out-of-season strength in gold has happened before. When it does, something interesting occurs – gold makes a top that will not be bettered for the rest of the year, in August or early September.

In the last 30 years, gold has had only two summers with the type of outsized gains gold is making this summer (a rise of about 20 percent or more). In both cases, gold topped out for the year on either side of Labour Day.

In 1982, gold had a surprisingly strong summer – rising more than 50 percent – and gold topped for the year in early September. The news then driving the gold price was the threat of a Mexican debt default … sound familiar?

In 1990, gold had another unusually strong run in the summer and was up almost 20 percent, which is closer in magnitude of the current rise (up about 22 percent when gold briefly topped $1800). That summer run in 1990 topped out in late August, and gold did not exceed that top during the rest of that year.

There are other factors hinting gold will need to take a breather soon.

Of note, the gold mining shares are not confirming this rise in gold. Take the bellwether gold mining stock Newmont Mining for example. As of this writing, Newmont is still well below the high of $65.50 it made last year, even as gold is hitting new record highs day after day. This is a potential warning called “divergence” that should not be ignored.

Overall, Canaccord Genuity research shows that the senior and intermediate gold stocks in their coverage universe are discounting a gold price of $1,409 per ounce.

Then there is the curious chart for gold that is making what looks like a “blow-off” top.

The current chart formation for gold is eerily similar to that of silver’s chart when it went into a terminal rise earlier this year. That steep rise in silver quickly gave way to a punishing decline that knocked some 30 percent off the silver price in a matter of days. In turn, the stocks of silver miners were pounded.

These types of blow-off tops are usually not sustainable – and they don’t tend to end well because of what causes them. The rapid rise we are seeing now appears to be fuelled in part by a “short squeeze.”

Fundamentals like the debt crises in Europe or the recent downgrade of US debt can explain some of the factors behind the rise – but the news is not the sole cause of this fast, wild part of the current rise.

Wrong-footed traders who made a mistake by going short (betting on a decline in price) in a big way– are being forced to buy back gold to close (or “cover”) their short positions that have gone horribly wrong as gold relentlessly rises. Their urgent buying of gold to close their short positions (and cut their losses) causes the gold price to rise further, causing more shorts to cover in panic, creating a feedback loop – and a price spike  – that may quickly exhaust itself.

That a short squeeze has been evident in the gold market lately – in particular, after gold recently broke above $1680 – has been noted by some market watchers who monitor the trading of gold future contracts. Ed Steer, who publishes Ed Steer’s Gold and Silver Daily for Casey Research, commented in his August 13 bulletin: “the open interest numbers were indicating for the reporting week, the rally in gold was pretty much all caused by short covering.”

Short squeezes tend to end abruptly when the short covering finally exhausts itself.

If gold does turn tail soon, how far could it fall? A good target for a drop is the area that has held anytime gold has declined during the last two and a half years – its 150-day moving average. Currently gold’s 150-day moving average stands just below $1500/ounce.

History is a guide, not a bible.  But there are some recent and longer term charts that suggest the gold price could top out in the next few weeks.

And of course, long time gold followers know it’s just at times like these, when excitement is running high, and everybody thinks they know what to expect that gold turns tail, and breaks the hearts – and wallets – of the unwary.

By David Blais

So what do we retail investors do now?

Gut wrenching volatility in the markets due to gut-less politicians has left investors dazed – do we still buy the dips or this 2008 all over again?

I was a buyer on Thursday and Friday of my favourite oil producers and energy services companies.  I see this steep market downturn as a crescendo of fear that had been building up in the markets over politics mostly – NOT as any kind of actual drastic economic downturn.

Now, I didn’t waste all my bullets as I may be able to buy them lower in the next month, i.e. there could be a reset of valuations (Lord, please let there be a reset so we can get on with making money again!) but the many investors with lots of cash around would welcome that.

And the reality is that in my specialized sector, junior oil and gas valuations were already hit so hard in June that many of the stocks that I follow barely moved, telling me the reset in this sector is almost complete.

I’ll tell you more about these purchases in a minute.

But first, I see that the economic numbers – especially when you look globally – are not that bad.

Credit Suisse reports that global emerging markets  now account for 49% of global GDP – and with estimated trend growth of 9%, 7.5% and 4% in China, India and Brazil, those three economies alone would add 1.8 percentage points to global GDP if they grow at trend.

You don’t read stuff like that in our financial pages.  Our financial media is very biased towards shrill negative US and European bad news.  (And most news reporters have never spent any time in business, doing real business – never forget that as you read the media.  They are unionized staff who have not been trained to think like entrepreneurs so they don’t see solutions, only problems.  My degree is journalism ;-).)

US GDP is still positive, and most forecasters are now just calling for reduced growth, not recession.  Of course, there could be another recession in the US, though I think investors will do better than workers as this will guarantee North American interest rates stay at zero for another 18 months.  The market loves cheap money as much or more than a strong economy, and this will fuel stock market participation.

I think it will also help fuel corporate growth, and here’s why – now corporate debt is more attractive than sovereign debt.  So cheap corporate debt – already very cheap with 10 year + notes going out at 3% – will continue to allow whatever low cost growth consumer spending will support.

This mini-crash was mostly due to investors’ uncertainty that political leadership and un-elected autocrats could contain the European debt problem. (Being a politician isn’t easy as you are elected on your integrity (or your party leader’s integrity) but your job is to be a professional compromiser.  Whether it’s getting a business deal done or passing laws, you have to compromise with the other side to get a win-win.  But the people who elected you don’t see you that way.  When was the last time you saw an election sign saying “I’ll compromise for you!”).

I find it funny that the common man has reduced his credit and increased his savings over the last three years (especially in the US), but big banks have continued to lend weak states like Greece et al hundreds of millions or billions of dollars.  They remain vulnerable to collapse and as a result will likely have to reduce lending to their customers even more.

A perfect example of this is The Royal Bank of Scotland (RBS), whose collapse in 2008 sent junior market darling but heavily indebted Oilexco (a $20 stock at the time) into bankruptcy.  Greece owes RBS just under US$1 billion.

This reduced bank lending in the coming year will reduce consumer spending, but it won’t kill it.  I believe a good chunk of that is now priced into the market (worst case we’re at 9x PE for the S&P 500, now is 11.7x).

To me, worst case is that austerity measures in the western world remain a drag on overall equities for several years – but emerging markets continue to be strong, which will keep the oil price at a level that will reward growth in both producers energy services companies.

The market just wants clarity.  Short term, it doesn’t even care if it’s the perfect solution.  It knows everybody has to take a haircut on this debt, so just tell us the number for each party and let’s get back to business.  The global economic backdrop is strong enough that I believe these political crises that spill into the stock market are buying opportunities – though I confess I’m a lot more selective than I was six months ago.

I see two possibilities out of this week’s drama, and both are positive for investors who bought stock the last two days.  One is that the European debt problem here is so big and so immediate and so PUBLIC that some kind of concrete, credible action will be taken to resolve the issue.  That would create a positive shift in market sentiment, even if it meant significant short term economic pain.

But some kind of action must be taken now, and even if it’s NOT completely credible, I see that action (Italian PM Berlusconi’s promise of a balanced budget and tackling welfare and labour reform would count as this) being rewarded by the market.
This would mean the index charts will look like a bouncing ball from these levels, and you use these instances to buy stock in your favourite companies.

So let’s talk about my favourite companies – what did I buy this week?

I bought two types of stocks.  One was energy services – these are the companies that do the drilling, the fracking, supply most of the hardware that producers need.  The global shift to shale oil and gas production and horizontal drilling is still in its infancy.  In North America it’s really only become mainstream in the last 5-7 years.

And the energy services sector is still catching up to producers’ demand for their products and services. Calfrac (CFW-TSX) is one of Canada’s largest fracking companies, (but was NOT a company I bought or own), and they announced their Q2 numbers this week and they beat The Street’s consensus cash flow by 74%!  Canadian brokerage firm Raymond James says Calfrac is growing its capacity 48% this year – the demand is so strong for fracking by the energy producers. Their main growth was in the US, in the face of a very weak US economy.  That’s very bullish for the sector. Service companies also have pricing power – sometimes by as much as 5% per quarter Raymond James said in a report earlier this year.

The technology innovation that is coming out of the energy services sector — steadily — is astounding.  There are companies that have technologies or tools that can get more oil and gas out of the ground or reduce time and costs, which increase profits and stock prices for producers.

These companies have huge sales backlogs now, and strong pricing power.  Even if oil goes to $50/barrel (which it’s not, it’s going higher folks), the demand for these innovative services would not decrease.

The second type of stock I bought has yield.  Both producers and service companies pay dividends, and with all this negative economic chatter, I believe interest rates will stay near zero for another two years, insulating yield stocks.  Many dividend stocks dropped 10%-20% in intraday swings, and I was able to scoop up a juicy 10% yield! I missed another because I couldn’t end my phone call at the time!  Even big companies like Pembina Pipelines (PPL-TSX) had a 20% swing Friday.

The market may not have bottomed yet. Interbank lending rates are spiking (the TED spread) and PE levels for the S&P 500 are still, at 11.7x, above what they are at market bottoms (8-9x).  Political indecision in Europe and the US could endure.

But this is not 2008.  And there are great companies growing quickly with HIGH profit margins that went on sale this week which I believe I will profit from handsomely in the coming quarters.

-Keith

P.S.  In my newest video, I explain why the Global Shale Revolution has the new energy services sector booming… and why energy services stocks aren’t actually dependent on the price of oil or gas to deliver huge profits for investors (unlike most oil & gas stocks). Click here to watch.

Investment Profile and Business Overview (ticker: BDI on the TSX)

The Black Diamond Group (BDI) is one of the most boring companies I’ve ever come across.

They make & rent remote camps for the oilsands workers – from dining rooms to toilets – and supply the temporary office space. There’s no technological edge here. And they do supply some basic well site services as well. Boooooring. No sex appeal. ZZZzzzzzz.

But what a great stock chart.

It’s up 500% in two years, from $6-$30 per share. They pay a steady and growing dividend. Q1 2011 revenue was up 80% over a year ago, as was profits. They have $87.6 M annualized (from Q1) EBITDA of $4.71/share, which equals 6.25x cash flow. BMO has them at 7.4x Price to Cash Flow (Cash flow is slightly different than EBITDA) their estimate, but average in BMO coverage universe is 8.1x P:CF

$2.11 annualized earnings – 13.7x – BMO average is 16.4x – You could argue the stock is still cheap.

When oil looks like it will be trading lower for awhile and gas has a glass ceiling at $5.25, the only sector in the energy patch with pricing power – and therefore earnings power – is the energy services sector.

My colleague, Michel Massaad, who writes his own energy blog at www.beatingtheindex.com, has interviewed management and written up a profile of the company for OGIB subscribers. Neither one of us owns stock in Black Diamond.

Trading Symbols: BDI-TSX
Share Price: $30.50
2011 Revenue: $140.0 million
2011 EBITDA: $50.0 million
Shares Outstanding: 18,500,000
Market Cap: $564,250,000
Dividend: $1.14 per year paid monthly
Yield: ~3.75%

Positives for the Stock:
Provides exposure to the resources sector (oil sands, conventional oil and gas activities, mining) while shielded from the volatility of commodity prices.
Low payout ratio – 25% for Q1 2011 — 25% of the company’s Q1 net income funded the dividend payment for the quarter.
Significant insider ownership – 17%
Significant institutional ownership – 50%
Stock Chart – steady rising trend line
Negatives:
A sharp drop in commodity prices for an extended period of time will hurt the company’s long term contract portfolio
No technology edge – aggressive pricing by the competition could reduce profitability
Any regulatory changes in the oil sands sector could impact new or existing projects
75% of the company’s revenue is out of Western Canada.
Poor liquidity for buying and selling shares
Business Overview

Black Diamond has three business segments:
1. Energy Services
2. Workforce Accommodations
3. Space Rentals

While each division is independent with its own fleet and equipment geared towards answering a specific need, it is not uncommon for all 3 business segments to end up working on the same site cross selling to the same customer. For instance, the Energy Services division would not be the only one to generate revenue from the oil sands sector. All 3 segments are geared towards the energy sector by design and the company is working on expanding its business into the resources sector as a whole which includes mining and forestry

Let’s take a closer look at each of the 3 business segments…

1. Energy Services

Canadian E&P spending (energy producers) is forecasted to increase by 16% to $44 billion this year as companies bankroll projects on the back of high oil prices. Black Diamond exposes investors to all the hot energy plays minus the risks E&P companies take on. The company believes growth in these areas will continue as long as oil prices remain in a sustainable range.

Think of the Energy Services segment as a mobile Canadian Tire store – for our American readers, that would be Lowe’s – which will supply your operations on the ground with almost everything you need.

Surface Equipment Rentals

Black Diamond offers a full range of surface rental assets that would typically support a drilling or completions operation. This is the boring stuff, but is the guts of any well site or oilsands operation – tanks, pumps, water storage, steel walkways etc.

The shale revolution means a lot more horizontal wells. These wells are getting longer and are using more water per well – which means more tanks and containment systems from companies like Black Diamond.

Remote Camps

Energy Services provides housing for drill camps, geologist/engineer quarters and staff quarters in temporary and remote sites. This is different housing than their workforce division or space rental (office) divisions.

Related Services:

And of course, if you want Black Diamond to install and set them up and take them down, that costs extra – just like a drayage company at a convention centre.

The Energy Services division generated 13% of Q1’s gross revenue, and this figure should grow as demand from shale oil and gas plays grows on the back of horizontal drilling and multi stage fracking completion requirements.

When a company can’t count on a technological edge in its services, its profits are as strong as its sales team — which is one of BDI’s strong points. The company has been a first mover when it comes to securing long-term strategic partnerships with 2 first nations in B.C. with lands in the following hot plays – the Montney and the Horn River shale gas plays.

Exploration and production companies need access permits to work on traditional native land. The band can expedite your access permit if you choose to work with them as a preferred partner for your accommodation/equipment needs. The partnership between Black Diamond and the native bands is either through a royalty structure or a 50/50 ownership. So even if a competitor is selected for a services contract in this area they still need to hire the First Nations partnership – which means BDI will still get paid since they own half of the equipment in use.

This move has lead to capturing more than 70% market share in the Horn River natural gas shale play which is buzzing with infrastructure and pipeline projects in anticipation of higher dry gas prices once the Kitimat LNG export facility becomes operational.

These partnerships are not only expected to deliver strong monthly revenues from large and flourishing activity area, they are primarily long term solid relationships with the local community as it provides them with jobs and sustainable benefits in the long run.

Part of its strategy in geographically diversifying its revenue sources, Black Diamond is expanding its business into the US in North Dakota and Montana where there is a chronic shortage in accommodation and service rental equipment. Drilling continues to grow in the Bakken shale oil play thanks to sustained high oil prices.

Editor’s Note: In Part 2, we review Black Diamond’s other business segments: Workforce Accommodations and Space Rentals… along with a full valuation on the company’s stock. The company recently closed a private placement that gives it extra financial flexibility.

Part 2:  The Technical Outlook — and Conclusion — for Bankers Petroleum Stock

While the fundamental aspects of the company provide some measure of safety and understanding of future price potential, the technical aspects of the actual stock price provide additional insight for potential price targets and also when to enter.

Figure 1 is a daily chart of BNK-TSX and shows that since 2010 the stock has been within a large price range between $5.48 and $9.92.  This price range is marked by horizontal pink lines.

Figure1.  BNK-TSX Daily Chart with Volume and On Balance Volume (OBV)

This price range indicates the stock has struggled to move down to $6 since early 2010; at a current price of $5.97 (July 11, 2011 Close price) this potentially provides a buying opportunity.  Note the Volume indicator at the bottom of the chart.  There are four volume bars labelled 1,2,3 and 4.  These represent the times over the last 2 years volume has exceeded 10 million shares/day.  Each time this has occurred a major price reversal has taken place (within the range).

Based on this, we are currently at point 4, marked by a “?” as the future direction is not certain.  Yet the evidence points to an upside move.  Massive selling volume entered the market at point 4 (July 6, 2011) and even on that volume the price could not make it the bottom of the range.  This is a sign of a potential turning point.  Historically a price reversal has occurred within three weeks or less following a volume spike, but price could drift lower within that timeframe.

The price target is near the range high: $9.00 conservatively over the next two to eight months.  This target is slightly below the most recent price high seen in April, 2011.  A slightly more aggressive target would be right near the range high at $9.50.  The potential exists for higher price movement, especially if the stock moves above $10.  Using multiple exits may be useful, for example selling part of a position at $9.00 and holding the rest if the stock moves higher.

A move above $10 provides a technical price target of  $14.00.  This is attained by taking the difference between the high close price and the low close price of the range, $9.85-$5.51=$4.34, and then adding that to the breakout price (old high) of $9.85, providing us a precise price target of $14.19 (It is common to round down when using this method).

If the price drops below $5.50 it is an indication the stock may go lower.   Just as a potential move above the current range (above $10) is likely to spur buying, a move below the range is likely to bring in sellers as all gains since 2010 would be erased and anyone who bought the stock over the last 18 months would be in a negative position. Therefore stops can be placed in the $5.50-$5.00 range to limit potential risk in case of unforeseen bad news.

An additional note in regards to the chart is what is called “divergence.”  Divergence is when an indicator is moving in a different direction than price.  The On Balance Volume (OBV) in Figure 1 is an indicator which measures buying volume versus selling volume.  The OBV indicator shows that buying volume has been trending higher while price has been range bound.  Even though OBV is moving slightly lower now, the fact OBV is moving higher overall is an indicator of buying interest and that a reversal will occur at some point in price as long as the OBV overall trend  continues upward.

One last thing to consider is the massive short position against this stock – it is roughly 10% of the share float, or 25.5 million shares as of June 30.  This up from 17 million shares short as of May 31.  Currently it is ranked in the top 20 most shorted stocks on the TSX.  There seems to be no correlation between stock performance and being on this list.

The new short sale report from the Toronto Stock Exchange for July 15 will be released by Friday, July 22, so we can see if the short sellers have reduced their position on the recent news and accompanying sell-off.  If the short position has been reduced I believe this to be a positive.  If the short position increases there is a danger that a group of traders know, or think they know, something that could hurt the share price which the general investment community has not clued into yet.

Looking at the volume since the announcement, I don’t believe that short shares could have been reduced by more than several million.  Therefore, best case, the short shares would be about 18-20 million.  Alternatively, it may have increased.  “Days to Cover” the short position is at least ten trading days.  Days to Cover is the approximate minimum amount of time it would take for the short sellers to exit their position assuming normal trading conditions.  If the stock begins to rise before they exit, the potential exists for a “short squeeze,” where the shorts are forced to buy back their position, often causing a sharp short-term rise in the share price.

Interesting though is the put/call ratio, which is in startling contrast.  Since March there have been 6,116 puts and 22,198 calls.  This places the put/call ratio at 0.276 over that time frame (which is the major portion of the decline).  This could be interpreted as a hedge against the short, or a bullish signal in traditional terms.  It also could be looked as a contrary indicator as the ratio is quite low.  Therefore we have contrary indicators that conflict, and if we look at the positions in the traditional way, they still conflict.

Short sellers generally do better research than investors who go long.

Conclusion

While recent news caused a selloff in the stock, the company says it has the capacity to fix the issues.  The main issues going forward will be to continue to acquire service rigs to avoid shut-in production which we saw in the recent quarter.  The company is acquiring these but may need to increase that number.

Also, if inventories continue to increase it could hurt short-term performance due to reduction in sales.

Recent Gorami wells are doing well and show promise for the field area.  Bankers will need to ramp up re-activations in Q3 and Q4 to hit their projection.   Investors should also be aware there is likely a large and expensive environmental issue at Patos Marinza that somebody will have to pay to clean up at some point.

Technically the stock is at the low of a price range, which historically has been a buying opportunity providing   a target of $9.00-$9.50.  OBV is diverging with price, indicating a reversal.  If the stock moves above $10 the price could reach $14.00 while a move in the stock price below $5.50 is a warning of major investor concern.

– Cory Mitchell, CMT

Disclaimer: The information provided is as of the date above and subject to change, and it should not be deemed a recommendation to buy or sell any security. Much of the fundamental information is based on company statements and therefore are dependent on company honesty. Trading involves substantial risk and may not be right for everyone. Certain information has been obtained from third-party sources we consider reliable, but we do not guarantee that such information is accurate or complete.

Cory Mitchell owns zero Bankers Petroleum. Keith Schaefer owns zero Bankers stock. Neither the author nor the publisher have any affiliations or associations whatsoever with the company.
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