March Madness

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(Disclosure: The following represents my opinions only. I am not receiving any compensation for writing this article, nor does Hydra Capital have any business relationship with companies mentioned in this post. I am long ATU.V, CRE.V, MAI.V, NLC.V, NRN.V, GILD, and TXP.TO)

If I’ve used this title before, then I used it too soon, because THIS is March Madness. Unless you’ve been in a cave harvesting bat guano for the last two weeks, you’ll know that volatility is off the charts and that the market is in coronavirus crisis mode. The U.S. indexes are down about 12-13% from their teflon-market-priced-for-perfection highs and all anyone can think about is coronavirus. When the market first really got wind of this virus, I was travelling in Mexico and I noticed that the market pretty much brushed it off in a couple/few days. At that point I wondered if the market was whistling past a graveyard and ended up getting stopped out of a lot of “non-core” positions soon after. Since then, things haven’t improved much unless you’ve been shorting things, aside from gold, which although volatile, has been expressing its crisis-weathering properties, closing at a new 52-week high on Friday. Gold stocks have been even more volatile as liquidity concerns sent people selling everything initially, only to return in full force soon after. I’m torn on gold stocks at the moment, but still have a modest collection of them, alongside some long-tail calls on the GLD. I’m probably at 50% cash given the uncertainty out there and am keeping a very close eye on gold and the gold stocks.

Not much has survived the carnage. Touchstone (TXP.TO, last at $0.70) and Altura (ATU.V, last at $0.205) are my two sacred cows right now, alongside of a collection of small caps that all have their own unique stories. Touchstone was actually up 3 cents on Friday and probably falls into the category of “not really impacted by coronavirus” stocks. The company raised the cash that it needed to drill its Royston and Chinook prospects (this is why the “take the money” mantra of brokers is not entirely self serving, because you never know what’s around the corner) and is testing the next zone in its Cascadura well this weekend, so results should be out very soon there. I see little reason to sell this one given that I’ve raised cash by getting stopped out of a lot of things that are more “market” driven as opposed to “catalyst” driven.

As for Altura, the company reported its reserves on Thursday, which included an update on operations at Entice, where the company said it was production testing its first well. It sounds to me like they want to “see what it does”, so to speak, over a longer period of time so that they know what they are dealing with in terms of potential economics. Altura is never promotional without reason, so in the meantime I take comfort in the fact that (1) they are doing a long-term production test (because you wouldn’t keep testing for a month if it was 100% water) and (2) they have called it a “hydrocarbon accumulation”. The real questions are to do with fluid rate and oil cut now, and it has been shown that oil rates in the Pekisko formation can trend higher in the early months, so I understand why they might like some more observation time before talking about it (link to an example of that from Pine Cliff here… not a totally comparable play, but also not that dissimilar). At the end of the day, water is an operating cost, so hopefully the well has a good oil cut at this location. If not, the deal ATU did earlier this year has provisions for a second well that could be drilled elsewhere in the 89-section land block. Basically it’s wait and see. In the meantime, counting Entice at zero (for lack of information right now), ATU trades right at its PDP (proved developed producing) NPV10, at about one-third of its 1P NAV, and one-fifth of its 2P NAV. This is just the nature of the Canadian energy sector right now. I think that private equity will start to come in to rectify the absurd valuations in the oil and gas sector unless the market does, and I’m a patient guy when it comes holding this one as it is my only current exposure to Canadian oil and is extremely well managed. Altura’s balance sheet and low cost structure means that it can hibernate somewhat during the bad times and then re-emerge with the climate is better. It’s practically an oil storage project where you drill wells when you need/want them instead of keeping it above ground in tanks. Oil is going to get hit here, but the stocks are trading like they are all going to zero, which they are not (to be clear, some will go to zero… now is not a time to be in a debt-heavy story given that deep troughs make lenders nervous, sometimes at exactly the wrong time). The decline rate on U.S. shale plays is so great that any prolonged oil price weakness will have a profound impact on supply in a relatively short time period. Demand is another question, but that tends to snap back a lot sooner than supply.

Although reduced, I’m still holding Neo Lithium (NLC.V, last at $0.72) and Critical Elements (CRE.V, last at $0.38) because the electrification theme is coming like a tidal wave and both companies appear to have quality (albeit very different) lithium projects. Northern Shield (NRN.V, last at $0.09) put out some encouraging early observations (thick intervals of veining and alteration) from its Shot Rock property in Nova Scotia during the chaos, which a few people seem to have noticed, but it’s early days there with assays from the first holes still pending. It’s hard to say where exactly they are in the system, but there are very clear indications that they are in an epithermal environment that they know has already produced samples up to 5 g/t Au at surface, with most being lower than that. It really comes down to the assays on the early holes and what the rock tells them about how high they are in the system, as these systems are zoned vertically. I’ve still got some Minera Alamos (MAI.V, last at $0.27) on the books as a pre-production gold story alongside of an eclectic handful of gold exploration target/existing deposit stories.

A few words on the market of the last two weeks. Once the market clued in that coronavirus was indeed ‘coming to a theatre near you’ and went into panic mode, the Fed did an emergency rate cut of 0.5% and the U.S. 10-year yield promptly fell under 1%. Now the market seems to be pricing in an additional 0.5-0.75% of rate cuts in short order (the next FOMC meeting is scheduled for March 17-18). Listen, the fact that the 10-year yield is under 1% is telling you that the market is in distress. That’s the biggest market in the world taking less than 1% on its money instead of risking it on the S&P, which has a dividend yield of 2% (i.e., why take the equity risk?). Yes, stocks are down 12% from their highs, but man, they were priced for perfection up there and I’d argue that if you look at a longer term chart of the indexes, it shows that there’s a lot of air under valuations right now. Sure the coronavirus might fade away like SARS or the bird flu, but it also might not. The WHO does not have divine knowledge, but they are clearly concerned (especially in countries with weaker healthcare systems), which should at least give people some pause. Some folks have taken solace in the fact that the coronavirus appears to be most dangerous to older people with pre-existing health conditions, but that’s little consolation for anyone who is in, or knows someone in, that cohort of the population. In countries with weaker healthcare systems, the potential for elders to succumb to this illness may be particularly disruptive. Maybe it doesn’t spread as well in warm climates or during the summer, but who knows? Is a 12% market correction really pricing in something that could ripple around the world for a year? As for the Fed cut or cuts, I’m not sure what they will do to alter consumer and industry behaviour. They will buy valuable time for those carrying high debt loads during a time of uncertainty, but how do you fill the money hole that forms when cities shut down the way that Beijing and Shanghai did?

China seems to have gotten a better handle on things now, but let’s just say that I have a lot more faith in their ability to successfully execute a mass quarantine like that than I do in most other countries. Look at Italy. They’ve shut down schools, made “red zones” where travel in/out is prohibited/heavily restricted, and have sports games being played without fans. Is the market here ready for NHL and NBA games to be played without fans in the stands? Think about what this means for hotels, restaurants, drivers, you name it. Actual and effective quarantine and travel restrictions would have a significant short term (rolling?) impact on pretty much every aspect of life as we know it right now; and who really knows what that looks like globally? Does a 12% correction from the heavenly heights price all of that uncertainty in? I’m not sure, but I don’t think so. Fear is still ramping up, and that’s largely because this coronavirus is a “novel threat” and there’s been research done that shows that humans respond much more strongly to novel threats (new viruses, terrorism, climate change) than they do to familiar ones (the flu, flying on airplanes, heart disease). It’s human nature. Will it blow over? Yes, eventually. Will it suck? Yes, probably for a lot of people. How big will the impact be? I have no idea. If people can just wash their hands, not go to work sick, and generally be smart about trying not to catch or spread what they might think is “just a cold” we will be much better off. I’ve seen calls for Hong Kong-like action where the government simply mails a cheque to everyone to help them afford food, rent, and necessities if required to stay home due to illness and/or lost work, but how this plays out is really in the hands of the people, so to speak. In the near term, there are two trials that should wrap up soon on one of Gilead’s antiviral drugs (Remdesivir) in “Asia”, with results expected in April. Should Gilead’s antiviral trials show that a therapeutic treatment is possible, I would think that would do a lot to assuage the fears of the market… but in the meantime there will just be progressively larger numbers of cases reported around the world for people to focus on. I think that governments are going to have to throw a lot of money at this (if people can’t stay in quarantine without fear of not making rent, this isn’t going to work); hence my close eye on gold and gold stocks because even in the worst times, the market still likes to rally around a winning trade.

​For some perspective, I found this article to be a good read for anyone looking to calm their nerves. I had no idea that the Swine Flu (aka H1N1) is estimated to have infected some 61 million people, hospitalized 275,000 and killed nearly 12,500 people in the U.S. from 2009-2010. You only ever get a statistical estimate on something like that because you simply can’t ever test everyone. Perception and reality are two separate things. While there is risk here, it is low, but it is being perceived to be high because it is novel. That’s the impact that’s more important than anything right now, because there are said to be only two factors that drive markets… fear and greed.

Time will tell how this all plays out. Stay healthy, wash your hands (properly) often, and stay home if you’re sick… because even if it’s not coronavirus, no one wants your cold or flu right now!