Friday, December 25, 2015

Some readers were having trouble  viewing the ten-year-forward graphs. I reset them. You can now view them as normal web pages at here1 and here2

No more blogging till after New Year's. When I get the December update, I'll go through the full list with my picks for long and short.

Wednesday, December 23, 2015

Post Number 12: The Bottom in Oil

Back on December 14, I wrote:

"It is unrealistic to think that the Saudis and their Gulf allies will give on output without getting something in return. Since it is highly unlikely that the other OPEC members will cut output, this "something" has to be political. It will be tied up with the battles raging in the mideast. When it looks like there may be progress on those, we can start thinking about a firming of oil prices."

That time is now. The politics in the mideast are breaking the Saudis' way, and I believe understandings have been made.

- Iran has substantially cut back its support of the Houthis in Yemen. Apparently they are resigned to let the old Saudi-friendly regime retake control. It's possible that they simply are facing up to the reality that they could not win, but some kind of understanding is also possible.

- A potent anti- ISIS coalition has been formed in Iraq and is forming in Syria. The Iraqi army, the Iranians, the Russians and the US are on the same side, and are coordinating their efforts. This is already getting results in Iraq.

- Turkey looks like it may be getting onboard via closing its border with Syria. If so, there will soon be progress in Syria as well.

- The recent resolution of the UN Security Council on the issue is important. Not because the UN can or will do anything; it cannot. But it shows that the major geopolitical players are united on the importance of settling the issue. This is realpolitics, not symbolism.

So I believe we are at or near (in terms of time) of a bottom in oil. How to play this? I am trading oil futures from the long side. My idea is that there will be a good two-way market for awhile with an upward bias. This is buy the dip tactics. Here are some other ideas for readers who are not active traders.

- Do not buy the usual ETFs like USO or OIL. The contango will kill you. Instead, open a futures account and buy a deferred contract. Dec 2016 or even Dec 2017 are the cleanest ways to play this.

- The equities of E&P companies would also be good. You should be aware however, that these companies are already trading with implied oil prices that are higher than the current strip. So if oil just stays where it is, they could be in serious trouble.

- I would still stay away from natural gas producers. Although NG may get a bounce when the weather turns, there is an ocean of LNG lapping at the shores of the market. This is very bearish for international prices. See my post of December 14 for a little more color.

- The key risk here is that we run out of storage, and the spot price collapses further. If this happens, I do not believe the one or two year forwards will fall too much. They will be dominated by longer term considerations. Nonetheless, they will fall. Either keep this in mind when sizing your position or use appropriate money management techniques.

Monday, December 21, 2015

More off Topic on Quantum Computing

More off Topic on Quantum Computing

The last post on quantum computers got more hits than all my previous posts combined! That shows pretty starkly that people are not interested in commodities. So I'll do one more post on the subject, than go back to what I actually know best.

I read through Google's paper on the D-Wave benchmarks The results really do seem good. Compared to a classical computer running the same type program, the quantum machine was many orders of magnitude faster. Probably more important, the running time increased more slowly than the classical machine as the problem got larger. So far, so good.

Now, the benchmark problem can be solved at about the same speed with special purpose algorithms aimed at that problem. It could be solved even faster with special purpose classical hardware. This type of attack, building the hard and software for one purpose alone, was pioneered by Alan Turing when he built the (possibly) first computer in order to break Nazi codes in WWII. But that's not really a fair comparison. Longer term, it's almost always cheaper to solve problems with a general purpose machine.

It's also important to know that D-Wave is something of an outlier in the world of quantum computer research. Most of the research is going into quantum gate (or circuit) machines. These are truly general purpose, with their qubits a rough analogy to traditional computer bits. IBM, Google itself and many academic institutions are doing this research. Depending on who you ask, these are between eight and twenty years away. A very few people think they will never be practical. There has been a noticeable increase in research funding in the last year or so, which may be telling you something.

A number of the academic researchers dislike the D-Wave approach (also called the "adiabatic" approach). They have two issues. First, there is theory that limits the speedup that adiabatic machines can achieve. This has to do with the speed which the quantum state can be changed without ruining the whole system. Second, D-Wave made the design decision to emphasize the quantity of qubits over the quality. Some think that they will have to reengineer the qubits from the ground up to make it practical.

It's hard to know what to think about this. However, I note that some of these same critics were pooh-poohing that D-Wave ever had any quantum effects. It is now clear that it does. Also, I seem to remember the same type of objections when computers first became widely useful (Yes, I am that old). They argued that IBM was sacrificing quality of design for larger and cheaper. This was especially true for software. Guess who won?

Math geeks only: This also reminds me of the solving of the Poincare Conjecture a few years back. The mainstream math community had a program in place that was working to solve it along established lines. Along came G. Perelman who was an expert in Alexandrov spaces, something of a mathematical backwater. But it was just what was needed to solve the problem!

OK, can one make a buck on any of this stuff? In the last post I mentioned a back door to buying D-Wave. That's probably still the cleanest way. However, Google is quite active in both quantum gate and adiabatic hardware, so that would be an alternate way. IBM appears to be concentrating on gate machines, so the payoff may be further down the road. Microsoft is working on an even more speculative approach, using the topology of certain two-dimensional particles to provide an ultra-stable qubit system.

There are also a fair number of private companies who are doing research in the area, particularly in software that could run on future machines. These might be interesting for angel investors who understand what they are getting into and can afford to lose the entire investment. The hope is that the patents will eventually be bought by some of the big boys once a useful gate machine is developed.

Ok, that's all on this. Next post: back to commodities.

Monday, December 14, 2015

Off Topic

Off Topic  - Investing in Quantum Computing

I know this is a commodity blog, but there was important tech news last week. Google announced that they have definitely achieved quantum calculation with their D-Wave II computer. To my knowledge, this is the first quantum computer that has been used to solve a real life problem.

This is a subject dear to my heart because I wrote my doctoral dissertation on a closely related subject: optimizing a function over a countable set with many local maxima (really).

Here's a little background: A quantum computer can be vastly more powerful than a traditional (classical) one. The quantum machine uses the superposition of and between its bits to do much faster calculations over a much larger set of states. No one to my knowledge has replicated a classical computer with quantum bits. However, D-Wave has created a computer that uses the structure of a particular type of problem (optimising a function over a.....) to solve it quantum mechanically.

An important thing to know is that this type of problem is extremely important in real life. Google is undoubtedly interested in its applications to machine learning. Other D-Wave partners include Lockheed, NASA, I-Q-Tel (the venture cap arm of the DoD), and Goldman. This could be used to schedule trucks and airplanes, plan optimal routes, price complicated derivatives, aim interceptors at incoming targets, decrypt current codes. And as they say in marketing: a whole lot more.

Several other companies are working on quantum computing: IBM, Microsoft, Google itself, and probably a bunch I don't know about. However, this is the first clear success. My guess is that they are first to market because they concentrated on a machine that does only one thing. The others appear to be working on more general devices. Microsoft is working on a potentially breakthrough topological machine.

D-Wave claims to have a lot of patents around its technology, but I have no way of knowing what these are and whether they will hold up.

Can you invest in this? Surprisingly you can. An early angel of D-Wave is Harris & Harris, a publicly traded microcap venture/angel firm. They claim to own "between 2.5% and 5%" of D-Wave. Most of their investments are in biotech, and I think they got into D-Wave via its potential for computational biology. The firm's financials are poor. They are losing money and bleeding cash from operations.

Here's my speculative back of the envelope: EV of Harris & Harris is $60 million. If their other investments are worthless and they own 4% of D-Wave, that puts the breakeven value of D-Wave at $1.5 billion. Seems like a decent punt to me. (Note: I am not saying their other investments are worthless. This is for calculation only.)

- This is very very very speculative.
- Given the national security implications, it may not be monetized in the usual sense.
- H & H may simply use the investment as an advertisement to attract more money to blow on bad investments.
- I may not know what I'm talking about.

Monday, December 7, 2015

Thoughts on OPEC and Energy

Post Number 11 - Thoughts on OPEC and Energy

So OPEC has met and couldn't do anything to goose the crude market. Here's my take on the situation:

- Most commentators got this right. It is unrealistic to think that the Saudis and their Gulf allies will give on output without getting something in return. Since it is highly unlikely that the other OPEC members will cut output, this "something" has to be political. It will be tied up with the battles raging in the mideast. When it looks like there may be progress on those, we can start thinking about a firming of oil prices.

- US shale may be declining, but US deepwater Gulf of Mexico is increasing. Gulf production may even be profitable at prices near here. Remember, a big part of the cost of producing in the Gulf is buying the acreage rights from the government. This is done in an auction. At lower oil prices, there will be lower bids and thus lower costs.

- The big story to my mind is LNG. There is an ocean of LNG capacity being built in Australia, the mideast, Russia, the US and soon the Mediterranean. I do expect that this will find markets. Many nations want to use more NG to reduce pollution, both the global warming and the smog types. Nonetheless, world prices will come down hard. Remember that the cost of producing NG is extremely low, especially where the only alternative is flaring. Liquefaction and transport do cost money, but much less than current prices. This will also eliminate a manufacturing advantage that the US has. As if US manufacturing doesn't have enough problems....

So how to play this? You could short nearby crude and roll every month to pick up the carry. I know that sounds like picking up pennies in front of a steamroller. But with a small position, it does make some sense. I would not short US natural gas. The nearbys are vulnerable to a turn in the weather. The more distant positions do have room to fall, but I don't see a catalyst at this time. Better to wait for a rally in the spring.

A trade that may be interesting is long Travelcenters of America (TA). This is a gasoline and diesel marketing company. The thesis is that low fuel prices will lead to continued volume growth. It is trading at a PE of about 6. I don't have it, and don't want to do the work. If any you out their have researched it, give me an email.

Wednesday, December 2, 2015

Dean Foods (DF)

Post Number 10: Dean Foods (DF)

In Post 8 I discussed why I was bullish on milk volumes and that I was particularly looking for a turnaround in fluid milk sales. Dean Foods is the largest company in the space, and I now am long. Here is some more on the financial aspects of it.

DF has suffered majorly from the decline in milk volumes. For awhile it was overridden by their WhiteWave brands, but they were spun off three years ago. The remaining company simply had to cut costs hard, and management must be given credit for doing this. Operating expenses have fallen by over a quarter. Of course milk costs have gone down as well, but so have selling prices. Even so there is reason to be optimistic on margins. Dean has an active branding program which is showing some signs of success. The boutique milk types like flavored and lactose-free will also help here. Most important, Dean has a lot of operating leverage to volume improvement. Here's a simple spreadsheet that illustrates DF's upside to a turnaround in fluid milk consumption. I have assumed that volume grows by 1% per year and margins increase by two percentage points as the branding and specialty milk initiatives pay off. I also assume that temporary cash items like changes in receivables will be zero. They were strongly positive in 2015, which is why 2016 FCF will be down.

Income Statement
Cost of revenue

Gross profit
Gross Margin
Operating expenses
Operating income
Interest Expense
Other income (expense)

Income before taxes
Provision for income taxes
Net income from continuing operations
Net income from discontinuing ops


Net income
Earnings per share, Diluted
Shares outstanding, diluted
Free Cash Flow Calculation

Net income
Depreciation & amortization
Investment/asset impairment charges
Stock based compensation
Prepaid expenses
Income taxes payable

Other working capital
Other non-cash items
Net cash provided by operating activities
Investments in property, plant, and equipment, net
FCF per share, diluted