Trade Update - UYG, SSO

The markets were up again, so I sold my UYG for a very nice 30% gain in 1 week. While that sounds sweet, I had such a small amount invested in it that it really didn't do much for my portfolio.

SSO finally climbed back up to my purchase price, and I exited my position. At one point on Friday I was down a whopping 40% on this trade, and that scared me enough to get out while I could today without a loss. I can't tell which way the markets are going to go. Is this just the beginning of a much larger rally? I'm too chicken to take any chances, especially after having being down so much, and now with the markets being up 4 days in a row. So I'm happy to get out now even if it continues to rally.

Trades (Nov.26):
Sold UYG @ 6.00 (bought on Nov.19 @ 4.62), a 30% gain.
Sold SSO @ 5.80 (bought on Nov.12 @ 5.65), a 2% gain.

P.S. I should note that with the current crazy commissions I'm paying, you can usually subtract about 5% off the posted trade gains to arrive at what I really made. E.g. I actually took a very small loss on the SSO trade. The variations in the CAD/USD exchange rate over the length of a trade also affects what I really make on these ETFs that trade on the american exchanges.

Bounce

Well the markets finally bounced, with big gains at the end of Friday and today, Monday. You could make a killing in this volatile environment if you could time the bottoms and tops. For example, UYG is up 50% from its lows 2 days ago (Friday), mainly due to bank stocks surging today. Unfortunately, since I bought back on Wednesday, I was already down about 28% by the time it hit the lows on Friday, so the huge +52% gain from there only brings me to about +10% as of today. So I need the rally to continue in order to actually make any reasonable amount of gains on it.

Ouch!

Ouch! The market plummeted again today. S&P down almost 7%. UYG down 19%. I should've known not to try to catch a falling knife. Oh well.

And Oil finally went below $50. I should've stuck to my plan to wait until oil went this low before buying more DXO, but even when blogging about it I couldn't force myself to stick to the plan.

I'm sure tomorrow will be interesting.

Trade Update - UYG, DXO

The market has continued to drop, and so has oil. I made a bit of a gamble trade today, buying UYG (2x financials) at 4.62 at the end of the day, after it had dropped 20% today alone, and is down 50% from 2 weeks ago. It feels wrong to me buying long ETFs when the market is crashing, and I may regret this (I feel like I'm starting to rationalize like I was in the dot-com bust). It could easily plummet a lot more this week as the DOW breaks the 8000 mark, but again, I'm still just looking for a short-term bounce to make a quick 20% after such a large drop.

I also bought some more DXO (2x oil) at 3.68 today while oil was down around $53, to add to what I bought at 4.85 when oil was $59. I don't know why I can't be more disciplined and wait for oil to drop to $50 so I don't spend all my cash too early... I got too impatient and gave in. This trade doesn't worry me at all though. Who cares if oil goes to $40 short-term. In a few months it will be back up. I won't lose money on this trade; I just may not make as much as I could have if I waited to buy in lower. I plan to make a minimum of 100% on this within a year.

I'm still holding my SSO even though it's down 15% now.

Trades:
-bought more DXO @ 3.68
-bought UYG @ 4.62

Trade Update - SSO

Yesterday I bought some SSO (2x S&P500) at 25.65. Why? The S&P was around 870, almost at the lowest point it had reached in recent times back on Oct.27. There has been a lot of recent market negativity and continued bleak news reports, but it was the 3rd day in a row of quite significant market losses. With that alone I thought/hoped it was due for a short-term bounce, possibly before the end of the day. Also, I noticed theMarketSpeculator was buying too, which gave me some confidence.

Well, it continued dropping yesterday after I bought. Then the markets dropped more today -- at one point I was down 10% on the trade. But the markets took off like crazy out of nowhere at 1 pm and finished up a whopping 6%. DOW ended +550 at 8835, the 3rd largest 1 day point gain. What's crazy is that from 1pm to the 4:30 close the Dow gained almost 1000 points from it's midday low! Talk about volatility. Within that time frame my SSO holding went from being -10% to +9% ($28.10 close)-- almost a 20% swing in 3 hours. crazy.

Side note: I never know where I should place stops. I didn't place a stop on this trade and I'm glad I didn't. If I had placed one at say 10% below my entry, or at a support level around $24, I would've been stopped out at the lowest point today right before it took off.

I may place a stop now around break-even, and don't know when I'll sell.

Trades:

Nov.12,2008 - bought SSO @ 25.65

P.S. Google Finance links are now broken for many ProShares ETFs that moved to another exchange. Yahoo Finance works. Hopefully Google will fix it soon.

3x Leveraged ETFs

I knew these were coming down the pipe, but my brother just notified me that eight 3x Leveraged ETFs from Direxion are now available -- the first of their kind. Crazy!

See this SeekingAlpha article for the details.

So for example, instead of buying DIG for 2x performance of an energy index, you could buy ERX for 3x the performance.

Since the 3x performance is applied daily, some weird, unintuitive behaviour can occur over multiple days (usually in a bad way)... but that's for another post. In the meantime, proceed with extreme caution! It'll be interesting to watch these to see what kind of volume these get and how they perform over time.

Trade Update - DXO

Well, what people were saying actually came true for once: that when Europe cut rates today, that would boost the dollar, and oil would drop. I was a little worried with oil at $70 2 days ago, but sure enough oil has dropped to $60. DXO went under $5, so I bought a whole bunch. Unfortunately, now I have to sell a bunch of my Sprott funds to pay for the trade :(

Oh, and Please stay above $60, oil, so I can sleep the coming nights :)

Unrelated note: I plan to do a couple of posts on ETFs, ETNs, ETFs vs ETNs (now that I finally understand much better), some info on changes in the Sprott funds, as well as talk about something most people have never heard of: MICs.

Trades:
Bought DXO @ 4.85. Will be selling an equivalent amount of my Sprott Canadian Equity fund to pay for this.

Shift Investments to Oil? Part 3

In Part 1, I talked about the various leveraged commodity ETNs and their potential gains. It looked like the ETN for Oil, symbol DXO, had the greatest potential, since oil has moved by a larger amount than the other commodities. Going forward, it seems to me that this will continue. For example, it seems easier or more likely for the price of oil to double from $60 to $120, than for, say, the price of gold to double from $720 to $1440. While both may move up, it seems that the potential for oil to move up more is greater.

In Part 2, I talked about the argument for the price of oil going up, and why oil was such a great investment in the long run.

In Part 3, the last post on this, I'm only going to talk about DXO and its risk/reward to help determine if it is a good investment.

I put together a chart showing some observed values of DXO at certain prices of Crude Oil.




One thing that is interesting is that the DXO line is a curve, not a straight line that follows "y = 2x + c". After reading up on how the ETN gain is calculated (which appears to be monthly), it seems this effect is due to compounding over time. For example, say the price of oil keeps going up 10% each month, compounding, for 7 months. This ends up being a 95% gain (1.10^7 - 1)*100%. You might expect the 2x ETN to gain double that, or 190%. However, if the 2x ETN goes up double the amount that the price of oil went up each month -- that is, 20% each month -- for 7 months, this works out to (1.20^7 - 1)*100%, or a 258% gain in the end. Notice this ends up being over 2.5x the oil price's percentage gain over the same 7 month period. Because the compounding effect varies a lot depending on whether the commodity is trending or whipsawing back and forth a lot over the year, we can't totally rely on the chart above for a prediction of the ETN price based on what the price of oil is, but it should give us a rough idea.

Reward:

Looking at the chart, we see we can make HUGE gains if oil goes up even a small amount. For example, with oil at $64/barrel right now, DXO is around $5. If oil reaches $88/barrel, DXO should be around $10. That is a 100% gain. If oil reaches $105/barrel, DXO should be around $15. That's a 200% gain, or an increase of 3x in your investment! And imagine if you were to get into DXO at a price below $5? How long until oil is over $88/barrel again?

Risk:
The bad news is that a small drop in oil price is a huge drop in DXO. Extrapolating the price data, if oil were to go down from its current $65/barrel to $50/barrel, DXO could drop to around $2.70 -- you'd lose almost 50% of your investment right there. If oil were to go down to $30/barrel, DXO could be around $0.80 -- meaning you've lost... well, most of your investment. So you will lose a lot with any drop in the oil price.

The good news is that oil is not like the stock of some company, where the company could go bankrupt and the price goes to zero. Oil cannot go to zero. We know oil is going to be in demand for a while yet, and as pointed out in the last post, all signs point to an increased oil price in the long term. So as long as you're willing to hold on, the risk of losing any money in this investment seems extremely low, as oil will eventually rise above its current price.

So, can you handle losing 50% or more of your investment for a few months... a few years, in the unlikely event it takes that long?

I guess one other risk I should mention is the risk that the ETN could shut down if the price gets too low, and you'd end up losing most of your money. I read somewhere that this happened to some ETFs (I'm too lazy to find the links for this).


The question for me is really just how low will oil go in the short term? While it's hard to imagine oil at $20 again, you only have to go back to 2003 to see oil in the $20's. That's scary to me. Losing 50% of an investment with a small drop in oil is scary to me. So what's a good entry point? Should I really care, especially if I believe that oil is guaranteed to go over $100 at some point in the future? Imagine what will happen when we see some of the production numbers and decline rates from the big reserves a year from now?

Another random thought: What effect is the election result going to have tomorrow?

I don't really know how to summarize this post. DXO's risk/reward ratio looks great if you're planning 5 years out from now, but in the short-term the risk is quite high. But again, the type of risk is mainly that you'd lose money on paper, and only temporarily too, and as long as you hold on you'd be virtually guaranteed making money on the investment. There is still some risk of you actually losing money; this would happen if the ETN shuts down while at a low price, or if you are forced to sell due to some other personal financial situation. So I wouldn't put your life savings in something like this, but the risk/reward ratio is too good to pass up not investing in this.

So what am I going to do? I'll strongly consider selling some of my Sprott funds and buying DXO at $4, meaning oil has to touch below $60 again, which I think it could do this week. If it doesn't look like that will happen, I may buy at $5. If oil drops even further to $50 (and thus DXO goes under $3), then I'd probably actually borrow some funds and buy a whole lot more, as crazy as that may sound.

Shift Investments to Oil? Part 2

The main arguments for the price of oil going through the roof are:

1) Decreased Supply due to Peak Oil. If you haven't heard about Peak Oil Theory, read through the Wikipedia entry and Eric Sprott's Market at Glance articles.

2) Increased Demand. World demand for oil is expected to increase about 35% by 2030. China's consumption has been increasing about 8% a year.

I was going to post a few choice quotes from Eric Sprott in regards to oil from the recent Sprott Webcast, but since everything he talks about is quite interesting and you probably won't watch the webcast, I'm just going to post the whole transcription of the part of his speech on Oil here and bold some notable parts.

Sprott Webcast, Eric Sprott from 30:30 - 36:30 :

Peak Oil. Okay. I just like going to this chart, which shows the rate of discovery and the rates of production. As you all know, M. Hubbard King back in 1956 was working with Shell Oil, said that in 1970, U.S. conventional production lower 48 states would peak. Sure enough, 14 years later after making the prediction, it peaked, and it's gone down ever since. And the same petro-physicists... have suggested that in this decade, oil peaks and forever goes down. And the data on conventional oil production -- when I say conventional, I'm excluding tarsands and ethanol and other forms of energy that don't come from normal hydrocarbons... -- but the data tends to suggest that in December of '05 we *have* peaked: that conventional production of oil in the world is going down.

I wanted to give you some examples here. And probably the most glaring example: There's a field in the gulf of Mexico called the Cantarell, and in 2004 it produces 2.4 million barrels. It was just announced that their production in August (2008) -- I've heard 2 numbers, either 974,000 or 950,000. It doesn't matter much. But from '04 to '08 it fell by 1.4 million barrels.

Now, you live in Canada. You know what it costs to produce a tarsands plant to produce 100,000 barrels a day. It probably costs at least -- It's $10 to $15 billion -- to get 100,000 barrels a day. And it takes you 5 years and stresses the system out. Imagine if we were building 15 plants today just to offset this one field. And that is going down *so* fast.

And most of the prognosticators on oil that the general public is forced to listened to have massively had their head in the sand on oil production and what's likely to happen. And I will forewarn you, that the International Energy Agency back in May said, "Uhh, we're going to look at our formula again on oil production. In November, we'll probably come out with a new forecast, because we may have the depletion rates wrong." And I know what the forecast is going to be, because they do have the depletion rates wrong. When you see a field like Cantarell falling 36% year over year... Imagine if all fields fell at 36%. But even that one, because it's one of the biggest in the world.

And of course one of the bigger fears is Ghawar field [the largest oil field in the world] in Saudia Arabia that produces over 4 million barrels a day. And the same guys who predicted -- I can tell you they predicted back in 2001-02 -- they all talked about Cantarell. I talked about Cantarell back in 2004 and said it's likely to be a problem. But they all talk about Ghawar too. Ghawar's 4 million barrels a day. And they sustain production by pumping in 6 million barrels of water every day to keep production up. Well you know what? Someday that water's going to get up there and you're going to be producing water, not oil. And when it declines, I'd predict it'll decline real fast.

And we all know how difficult it is. We have investments in oil and gas stocks in Canada. We don't use the word 100,000 barrels a day. We're happy if -- If a guy has a well in Canada that produces 1,000 barrels a day, we're kind of happy. A thousand. What does *that* do for you? We have 86 million barrels a day of [worldwide] production, and I think the accepted decline rate today is around 8%. So we have to find 7 million barrels of oil -- new oil -- a year. Well hey, I would certainly predict that we won't.

We have other charts of different countries and their production, and you can see most of them have [gone down] -- Oh hey, there's one that's going up! [said with mock surprise]. Oh, that's 'cause it's consumption - sorry! (Laughter from audience). [Displayed is a chart showing China's consumption over the last few decades, which looks like it has been roughly doubling every 10 years, 4 million barrels per day in 1998 vs almost 8 million barrels a day in 2008].

I don't often talk about consumption. I really don't. I just look at supply and say it's a problem. God forbid that *that* [pointing to China consumption] keeps going. I mean that is a big problem. I don't even talk to it, because I just don't think it can. In fact, if I had to make a prediction, U.S. consumption has to fall by probably 50% in fairness to the world. I mean, here we have 4-5% of the population and it consumes 30% of the world's energy? I mean, it's just anomolous. It's ridiculous. And I'm sure you're going to hear some thoughts about that from some people who need oil, who have bigger populations. And I don't know, maybe the mechanism is just jacking the price up by -- I have no idea what it is -- but this is a problem.

So, we are great believers in peak oil, and that the price of oil, certainly over the longer run, will do *nothing* but go up. Forever. It's a forever trade, trust me, [at least] in your lives. See, I'm probably the oldest guy here...
But it's going to be a problem. I mean, you go and try to find some oil. Look at Pearl Petro-Can in their UTS project, when they said that the cost, which was estimated at $19 billion last year, against which they've already spent something, has now gone to $28 billion. That's what it costs to get oil out of the ground. They probably won't even break even at $100 oil with those kind of costs. And that is just this year's estimates, don't forget. We [still] have next year's estimates.

I like near the end when Eric says that over the longer run, the price of oil "will do nothing but go up. Forever. It's a forever trade...".

"Hold on," you say. What about the decrease in demand with this whole world recession we're entering, which has already caused the price of oil to drop from $145 to $60? Eric gets asked that question later on, and this is what he says (at 47:45 - 49:00):

That's a great question. The question was, "How does demand destruction affect the oil price". You know, we're not naive. We're the guys predicting the economic contraction, so we all know there will be some demand destruction in energy. One of the great things about energy though, is demand is incredibly inelastic. You know, we all have to heat our homes, we all theoretically have jobs and we have to work, the subway has got to run. There's only so much you can cut back on. So I think that energy is one of the most inelastic demand cycles you can be involved in. There is some demand destruction going on now, and I've always imagined that we will see that, but ultimately when this Peak Oil cuts in, it will way more than offset any
demand destruction. So that's our thesis.

Makes sense to me.

I feel like I'm reading too many articles that make it seem obvious the only way for oil to go is up. Long-term, there aren't many people who see oil not going up. Criticisms of the Peak Oil Theory are far and few between (there's one small section on the Wikipedia entry). Am I being deluded by Peak Oil proponents? Could oil drop to $20 due to new discoveries and weakened demand in this recession? I can't really find any articles from this year predicting that oil would go that low and stay there for very long. So with oil being around $65, it seems like one of the best 'guaranteed' good investments in a long-term horizon -- something that would be good for an RRSP.

So we now see that Oil is a great place to be long term, and next post I'll show how an investment in DXO can reap huge rewards with even a mild increase in the oil price.

Shift Investments to Oil? Part 1

I've been thinking a lot about what to invest into next, from the point of view of "where can I make the greatest amount of money (both short-term and long-term), with minimal risk." And I'm coming to the conclusion that the place to be is: Oil.

Commodities vs Stocks:

From the risk perpective, I've been looking at ETFs comprised soley of commodities -- that is, the commodities themselves (e.g. oil, gold, corn, wheat) that trade on the futures exchange, not stocks of companies that are involved with such commodities (the latter of which most commodity-related ETFs actually hold, e.g. DIG). The risk of a further drop in the stock market is quite possible, and it's even more possible that after a brief rally, the recession/depression in the U.S. keeps the markets from gaining that much for the next few years. We've already seen gold stocks lose 50% of their value while the price of gold has gone up, so in a volatile market in the middle of a recession, stocks are a risky place to be. The prevailing consensus is that most commodities can only go up in the long term, especially energy and agricultural related commodities due to the double-whammy of increased consumption (due to world population increases and the rapid development in countries like China and India) and declining production (running out of resources, getting harder and more expensive to grow or extract resources).

Now, unless you're buying actual futures contracts, which often have a leverage of 10:1, it used to be that stocks related to the commodities would go up by a much larger percentage than the percentage increase in the commodities themselves. So while I'm interested in commodities, I still want something that will increase a lot when the commodity goes up. We'll get to this later...

Which Commodity?

While Sprott and others believe gold will go to $2000, there seems to be some risk that that may not happen, or it may take a while. I've noticed the guys at Sprott seem to talk more about energy and oil than gold. I'll be pointing out some quotes from the recent Sprott Webcast that talk about the Oil situation a little later in this post. There seems to be less downside risk in Oil to me, but maybe I just haven't read enough views about how bad the current and upcoming (short-term) decrease in demand could affect things and how low oil could go. Then there are other commodities, such as agricultural ones, which don't get much attention and which I honestly haven't looked into that much. World population and increased standard of living in China in India are going to mean we'll need more and more food (whether to feed the people or to feed the animals that the people will eat!). It's hard to say which commodity has the most potential and least risk, but lets see what's happened with some of the commodity ETNs the last little while...

Commodity ETN potential performance:

The only 2x leveraged pure commodity ETFs I know of are the ones from from Deutsche Bank (who is known for their PowerShares series of ETFs). Their pure commodity plays are actually ETNs (Exchange-Traded Notes), which don't seem much different from ETFs to me. Their list of commodity ETNs can be found here. They haven't been around that long, but most began trading just before the peaks in commodities that occurred around March 2008 or end of June 2008. Let's look at the difference in price now from their peak, in order to see the potential gains we would make if they went back to their peak price...

Gold 2x ETN: DGP (comprised of Gold futures):
- Current price: $12-14 Peak Price: $28 Difference: 2x

Agriculture 2x ETN: DAG (comprised of corn, wheat, soybeans, and sugar futures)
- Current price: $8-11 Peak Price: $29 Difference: 3-4x

Base Metals 2x ETN: BDD (comprised of Aluminum, copper, and zinc futures)
- Current price: $7-8 Peak Price: $28 Difference: 4x

Oil 2x ETN: DXO (comprised of Oil futures)
- Current price: $4-6 Peak Price: $29 Difference: 5-7x

Commodity 2x ETN: DYY (just a mix of everything, specifically: wheat, corn, oil, heating oil, gold, and aluminum)
- Current price: $8-10 Peak Price: $35 Difference: 4x

So any of these look pretty good -- a chance to make 2 to 7 times your investment if the commodities go back to their peaks. Now you could argue that that scenario is unlikely, as the commodity boom was fueled by a lot of speculative traders. However, Sprott and others are arguing that the commodity boom will continue, especially with oil and gold having nowhere to go but up.

Looking at the above numbers, we can see that oil has had the greatest drop, and maybe the greatest potential to reach it's previous highs again. Can you imagine making 500% (6x) your investment in a few years if oil hits the $140's again? What is the risk? Could Oil go back down to $30 or $20 again?

Anyway, that's all for this post, which just touched on the potential for gains in the commodities -- specifically oil. In the next post, I'll mainly talk about what Eric Sprott talked about in the latest webcast, and then look in more detail at investing in DXO.