Hoisington Investment Management: Quarterly Review and Outlook, Second Quarter 2014

By John Mauldin

This week’s Outside the Box is from an old friend to regular readers. It’s time for our Quarterly Review & Outlook from Lacy Hunt of Hoisington Investment Management, who leads off this month with a helpful explanation of the relationship between the U.S. GDP growth rate and 30 year treasury yields. That’s an important relationship, because long term interest rates above nominal GDP growth (as they are now) tend to retard economic activity and vice versa.

The author adds that the average four quarter growth rate of real GDP during the present recovery is 1.8%, well below the 4.2% average in all of the previous post war expansions; and despite six years of federal deficits totaling $6.27 trillion and another $3.63 trillion in quantitative easing by the Fed, the growth rate of the economy continues to erode.

So what gives? We’re simply too indebted, says Lacy; and too much of the debt is nonproductive. (Total U.S. public and private debt rose to 349.3% of GDP in the first quarter, up from 343.7% in the third quarter of 2013.) And as Hyman Minsky and Charles Kindleberger showed us, higher levels of debt slow economic growth when the debt is unbalanced toward the type of borrowing that doesn’t create an income stream sufficient to repay principal and interest.

And it’s not just the US. Lacy notes that the world’s largest economies have a higher total debt to GDP ratio today than at the onset of the Great Recession in 2008, and foreign households are living farther above their means than they were six years ago.

Simply put, the developed (and much of the developing) world is fast approaching the end of a 60-year-long debt supercycle, as I (hope I) conclusively demonstrated in Endgame and reaffirmed in Code Red.
Hoisington Investment Management Company (www.Hoisingtonmgt.com) is a registered investment advisor specializing in fixed income portfolios for large institutional clients. Located in Austin, Texas, the firm has over $5 billion under management and is the sub adviser of the Wasatch-Hoisington U.S. Treasury Fund (WHOSX).

Some readers may have noticed that there was no Thoughts from the Frontline in their inboxes this weekend. As has happened only once or twice in the last 14 years, I found myself in an intellectual cul-de-sac, and there was not enough time to back out. Knowing that I was going to be involved in a fascinating conference over the weekend, I had planned to do a rather simple analysis of a new book on how GDP is constructed. But as I got deeper into thinking about the topic and doing more research, I remembered something I read 20 years ago about the misleading nature of GDP, and I realized that a simple analysis just wouldn’t cut it.

Rather than write something that would’ve been inadequate and unsatisfying, I decided to just put it off till next week. Your time and attention are quite valuable, and I try not to waste them. But there will be no excuses this weekend.

The conference I attended was organized by Great Point Partners, a hedge fund and private equity firm focusing on medical and biotechnology. I really had not seen the program until I arrived and did not realize what a powerful lineup of industry leaders would be presenting on some of the latest technologies and research. The opportunity was too good to pass up, as it is so rare that any of us get to sit down with people who are responsible for the science we all read about.

I had breakfast with a small group of 11 readers/investors one morning and learned a lot by asking them what their favorite investing passion was. Although everyone had concerns, they all had areas in which they were quite bullish. I find that everywhere I go. It was interesting, in that they all expected me to be far more negative about things than I am. I guess when you write about macroeconomics as much as I do, and there’s as much wrong with it as there is, you kind of end up being labeled as a Gloomy Gus. I am actually quite optimistic about the long-term future of humanity, but I’ll admit there will be a few bumps along the way. Given how many bumps there have already been, just in my own lifetime, and given that we seem to have gotten through them, I can’t help but be optimistic that we’ll get through the next round.

It was a fascinating weekend, made all the more so by my very gracious hosts, Jeff Jay and David Kroin, Managing Directors of Great Point. They and their staff made sure I could enjoy my time on Nantucket Island. It was my first visit to the area, and I hope it won’t be the last.

Last night I had dinner with Art Cashin, Barry Ritholtz, Jack Rivkin, and Dan Greenhaus. It was a raucous, intellectually enlivening evening, and our conversation ranged from macroeconomics to our favorite new technologies. Jack Rivkin is involved with Idealab, and one of his favorites is that he sees the eventual end of Amazon as 3-D printing becomes more available. Given how Bezos has adapted over the years, I’m not so sure. Jack and Barry will join me in Maine in a few weeks, where we will again join the debate about bull and bear markets.

Now let’s go to Lacy and think about the intersection of velocity and money supply and what it says about future growth potential. I have two full days of meetings with my partners and others here in New York before I return to Dallas, and then I get to stay home for a few weeks. There are lots of new plans in the works. And lots of reading to do between meetings. Have a great week!

Your hoping to be able to stay optimistic analyst,

John Mauldin, Editor
Outside the Boxsubscribers@mauldineconomics.com

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Hoisington Investment Management – Quarterly Review and Outlook, Second Quarter 2014

Treasury Bonds Undervalued

Thirty year treasury bonds appear to be undervalued based on the tepid growth rate of the U.S. economy. The past four quarters have recorded a nominal “top line” GDP expansion of only 2.9%, while the bond yield remains close to 3.4%. Knut Wicksell (1851-1926) noted that the natural rate of interest, a level that does not tend to slow or accelerate economic activity, should approximate the growth rate of nominal GDP. Interest rates higher than the top line growth rate of the economy, which is the case today, would mean that resources from the income stream of the economy would be required to pay for the higher rate of interest, thus slowing the economy. Wicksell preferred to use, not a risk free rate of interest such as thirty year treasury bonds, but a business rate of interest such as BAA corporates.



As chart one attests, interest rates below nominal GDP growth helps to accelerate economic activity and vice versa. Currently the higher interest rates are retarding economic growth, suggesting the next move in interest rates is lower.

To put the 2.9% change in nominal GDP over the past four quarters in perspective, it is below the entry point of any post-war recession. Even adjusting for inflation the average four-quarter growth rate in real GDP for this recovery is 1.8%, well below the 4.2% average in all of the previous post war expansions.

Fisher's Equation of Exchange

 

Slow nominal growth is not surprising to those who recall the American economist Irving Fisher’s (1867-1947) equation of exchange that was formulated in 1911. Fisher stated that nominal GDP is equal to money (M) times its turnover or velocity (V), i.e., GDP=M*V. Twelve months ago money (M) was expanding about 7%, and velocity (V) was declining at about a 4% annual rate. If you assume that those trends would remain in place then nominal GDP should have expanded at about 3% over the ensuing twelve months, which is exactly what occurred. Projecting further into 2014, the evidence of a continual lackluster expansion is clear. At the end of June money was expanding at slightly above a 6% annual rate, while velocity has been declining around 3%. Thus, Fisher’s formula suggests that another twelve months of a 3% nominal growth rate is more likely than not. With inflation widely expected to rise in the 1.5% to 2.0% range, arithmetic suggests that real GDP in 2014 will expand between 1.0% and 1.5% versus the average output level of 2013. This rate of expansion will translate into a year over year growth rate of around 1% by the fourth quarter of 2014. This is akin to pre-recessionary conditions.

An Alternative View of Debt

 

The perplexing fact is that the growth rate of the economy continues to erode despite six years of cumulative deficits totaling $6.27 trillion and the Federal Reserve’s quantitative easing policy which added net $3.63 trillion of treasury and agency securities to their portfolio. Many would assume that such stimulus would be associated with a booming economic environment, not a slowing one.

Readers of our letters are familiar with our long-standing assessment that the cause of slower growth is the overly indebted economy with too much non productive debt. Rather than repairing its balance sheet by reducing debt, the U.S. economy is starting to increase its leverage. Total debt rose to 349.3% of GDP in the first quarter, up from 343.7% in the third quarter of 2013.

It is possible to cast an increase in debt in positive terms since it suggests that banks and other financial intermediaries are now confident and are lowering credit standards for automobiles, home equity, credit cards and other types of loans. Indeed, the economy gets a temporary boost when participants become more indebted. This conclusion was the essence of the pioneering work by Eugen von Böhm-Bawerk (1851-1914) and Irving Fisher which stated that debt is an increase in current spending (economic expansion) followed by a decline in future spending (economic contraction).

In concert with this view, but pinpointing the negative aspect of debt, contemporary economic research has corroborated the views of Hyman Minsky (1919-1996) and Charles Kindleberger (1910-2003) that debt slows economic growth at higher levels when it is skewed toward the type of borrowing that will not create an income stream sufficient to repay principal and interest.

Scholarly studies using very sophisticated analytical procedures conducted in the U.S. and abroad document the deleterious effects of high debt ratios. However, the use of a balance sheet measure can be criticized in two ways. First, income plays a secondary role, and second, debt ratios are not an integral part of Keynesian economic theory.

We address these two objections by connecting the personal saving rate (PSR) which is at the core of Keynesian economic analysis, and the private debt to GDP ratio that emerges from non-Keynesian approaches. Our research indicates that both the “Non Keynesian” private debt to GDP ratios, as well as the “Keynesian” PSR, yield equivalent analytical conclusions.

The Personal Saving Rate (PSR) and the Private Debt Linkage

 

The PSR and the private debt to GDP ratio should be negatively correlated over time. When the PSR rises, consumer income exceeds outlays and taxes. This means that the consumer has the funds to either acquire assets or pay down debt, thus closely linking the balance sheet and income statement. When the PSR (income statement measure) rises, savings (balance sheet measure) increases unless debt (also a balance sheet measure) declines, thus the gap between the Keynesian income statement focus and the non-Keynesian debt ratio focus is bridged.



The PSR and private debt to GDP ratio are, indeed, negatively correlated (Chart 2). The correlation should not, however, be perfect since the corporate sector is included in the private debt to GDP ratio while the PSR measures just the household sector. We used the total private sector debt ratio because the household data was not available in the years leading up to the Great Depression.

The most important conceptual point concerning the divergence of these two series relates to the matter of the forgiveness of debt by the financial sector, which will lower the private debt to GDP ratio but will not raise the PSR. The private debt to GDP ratio fell sharply from the end of the recession in mid-2009 until the fourth quarter of 2013, temporarily converging with a decline in the saving rate. As such, much of the perceived improvement in the consumer sector’s financial condition occurred from the efforts of others. The private debt to GDP ratio in the first quarter of 2014 stood at 275.4%, a drop of 52.5 percentage points below the peak during the recession. The PSR in the latest month was only 1.7 percentage points higher than in the worst month of the recession. Importantly, both measures now point in the direction of higher leverage, with the PSR showing a more significant deterioration. From the recession high of 8.1%, the PSR dropped to 4.8% in April 2014.

Historical Record

 

The most recently available PSR is at low levels relative to the past 114 years and well below the long-term historical average of 8.5% (Chart 3). The PSR averaged 9.4% during the first year of all 22 recessions from 1900 to the present. However this latest reading of 4.8% is about the same as in the first year of the Great Depression and slightly below the 5% reading in the first year of the Great Recession.



In Dr. Martha Olney’s (University of California, Berkeley and author of Buy Now, Pay Later) terminology, when the PSR falls households are buying now but will need to pay later. Contrarily, if the PSR rises households are improving their future purchasing power. A review of the historical record leads to two additional empirical conclusions. First, the trend in the PSR matters. A decline in the PSR when it has been falling for a prolonged period of time is more significant than a decline after it has risen. Second, the significance of any quarterly or annual PSR should be judged in terms of its long term average.

For example, multi-year declines occurred as the economy approached both the Great Recession of 2008 and the Great Depression of 1929. In 1925 the PSR was 9.2%, but by 1929 it had declined by almost half to 4.7%. The PSR offered an equal, and possibly even better, signal as to the excesses of the 1920s than did the private debt to GDP ratio. Both the level of PSR and the trend of its direction are significant meaningful inputs.

John Maynard Keynes (1883-1946) correctly argued that the severity of the Great Depression was due to under-consumption or over saving. What Keynes failed to note was that the under consumption of the 1930s was due to over spending in the second half of the 1920s. In other words, once circumstances have allowed the under saving event to occur, the net result will be a long period of economic under performance.
Keynes, along with his most famous American supporter, Alvin Hansen (1887-1975), argued that the U.S. economy would face something he termed “an under-employment equilibrium.” They believed the U.S. economy would return to the Great Depression after World War II ended unless the federal government ran large budget deficits to offset weakness in consumer spending. The PSR averaged 23% from 1942 through 1946, and the excessive indebtedness of the 1920s was reversed. Consumers had accumulated savings and were in a position to fuel the post WWII boom. The economy enjoyed great prosperity even though the budget deficit was virtually eliminated. The concerns about the under employment equilibrium were entirely wrong. In Keynes’ defense, the PSR statistics cited above were not known at the time but have been painstakingly created by archival scholars since then.

Implications for 2014-2015

 

In previous letters we have shown that the largest economies in the world have a higher total debt to GDP today than at the time of the Great Recession in 2008. PSRs also indicate that foreign households are living further above their means than six years ago. According to the OECD, Japan’s PSR for 2014 will be 0.6%, virtually unchanged from 2008. The OECD figure is likely to turn out to be very optimistic as the full effects of the April 2014 VAT increase takes effect, and a negative PSR for the year should not be ruled out. In addition, Japan’s PSR is considerably below that of the U.S. The Eurozone PSR as a whole is estimated at 7.9%, down 1.5 percentage points from 2008. Thus, in aggregate, the U.S., Japan and Europe are all trying to solve an under-saving problem by creating more under-saving. History indicates this is not a viable path to recovery. [reference: Atif Mian and Amir Sufi,. House of Debt, University of Chicago Press 2014]
Japan confirms the experience in the United States because their PSR has declined from over 20% in the financial meltdown year of 1989 to today’s near zero level. Japan, unlike the U.S. in the 1940s, has moved further away from financial stability. Despite numerous monetary and fiscal policy maneuvers that were described as extremely powerful, the end result was that they have not been successful.

U.S. Yields Versus Global Bond Yields

 

Table one compares ten-year and thirty year government bond yields in the U.S. and ten major foreign economies. Higher U.S. government bond yields reflect that domestic economic growth has been considerably better than in Europe and Japan, which in turn, mirrors that the U.S. is less indebted. However, the U.S. is now taking on more leverage, indicating that our growth prospects are likely to follow the path of Europe and Japan.



With U.S. rates higher than those of major foreign markets, investors are provided with an additional reason to look favorably on increased investments in the long end of the U.S. treasury market. Additionally, with nominal growth slowing in response to low saving and higher debt we expect that over the next several years U.S. thirty year bond yields could decline into the range of 1.7% to 2.3%, which is where the thirty year yields in the Japanese and German economies, respectively, currently stand.

Van R. Hoisington
Lacy H. Hunt, Ph.D.
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The article Outside the Box: Hoisington Investment Management: Quarterly Review and Outlook, Second Quarter 2014 was originally published at Mauldin Economics

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Fundamentals Rendered Irrelevant by Fed Actions: Probability Based Option Trading

The fundamental backdrop behind the ramp higher in equity prices in 2013 is far from inspiring. However, fundamentals do not matter when the Federal Reserve is flooding U.S. financial markets with an ocean of freshly printed fiat dollars.

As we approach the holiday season, retail stores are usually in a position of strength. However, this year holiday sales are expected to be lower than the previous year based on analysts commentary and surveys that have been completed. This holiday season analysts are not expecting strong sales growth. However, in light of all of this U.S. stocks continue to move higher.

Earnings growth, sales growth, or strong management are irrelevant in determining price action in today’s stock market. In fact, the entire business cycle has been replaced with the quantitative easing and a Federal Reserve that is inflating two massive bubbles simultaneously.

Through artificially low interest rates largely resulting from bond buying, the Federal Reserve has created a bubble in Treasury bonds. In addition to the Treasury bubble, we are seeing wild price action in equity markets as hot money flows seek a higher return. Usually fundamentals such as earnings, earnings estimates, and profitability drive stock prices.

However, as can be here the U.S. stock market is being driven by something totally different......Read "Fundamentals Rendered Irrelevant by Fed Actions: Probability Based Option Trading"



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Why Investors Must Be Cautious At These Prices

Last week on October 8th the financial market experienced a broad based sell off. Every sector was down with utilities being the only exception.

The individual leadership stocks, which are typically small to mid-cap companies (IWM – Russell 2K) that have a strong history and outlook of earnings growth, were hit hard as well.

Whenever the broad market experiences a price correction, one of the most important factors I analyze is how well leading stocks hold up and show relative strength to the broad market.

So, where does this leave us going forward?

When stocks that have been leading the market higher and only pausing during market corrections in the S&P500, Dow, and NASDAQ, it’s a positive sign. This tells us investors and big money continues to flow into the risk on assets (stocks).

Conversely, when these leading stocks/sectors begin succumbing to the selling pressure of the broad market, it quickly grabs my attention and tells us it’s time to be aware that a major top may be forming.

It looks as though the broad market rally is just barely hanging on. If the leading stocks and sectors begin breaking below their 50 day moving averages, my proprietary SP500 Market Timing & Trading System will shift to sell mode and things could get ugly for those who do not know how to trade a bear market.

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COT Market Summary for Tuesday October 8th - Crude Oil, Natural Gas, SP 500, Gold and Coffee

November crude oil closed higher on Tuesday as it consolidates above the 10 day moving average crossing at 103.07. The mid range close sets the stage for a steady to higher opening when Wednesday's night session begins. Stochastics and the RSI are bullish signaling that sideways to higher prices are possible near term. Closes above the 20 day moving average crossing at 104.41 are needed to confirm that a low has been posted. If November renews the decline off August's high, the 50% retracement level of the April-August rally crossing at 98.71 is the next downside target. First resistance is the 20 day moving average crossing at 104.41. Second resistance is the reaction high crossing at 108.15. First support is the 38% retracement level of the April-August rally crossing at 102.43. Second support is the 50% retracement level of the April-August rally crossing at 98.71.

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November Henry natural gas closed higher on Tuesday and above the 20 day moving average crossing at 3.654 confirming that a short term low has been posted. The high range close sets the stage for a steady to higher opening on Wednesday. Stochastics and the RSI are turning bullish signaling that sideways to higher prices are possible near term. If November extends today's rally, September's high crossing at 3.892 is the next upside target. If November renews the decline off September's high, the 75% retracement level of the August-September rally crossing at 3.436 is the next downside target. First resistance is today's high crossing at 3.730. Second resistance is September's high crossing at 3.892. First support is the reaction low crossing at 3.450. Second support is the 75% retracement level of the August-September rally crossing at 3.436.

The December S&P 500 closed lower on Tuesday as it extended the decline off this month's high. Today's low range close sets the stage for a steady to lower opening when Wednesday's night session begins trading. Stochastics and the RSI remain neutral to bearish signaling that sideways to lower prices are possible near term. If December extends the decline off this month's high, August's low crossing at 1621.00 is the next downside target. Closes above the 20 day moving average crossing at 1687.11 would confirm that a short term low has been posted. First resistance is the 20 day moving average crossing at 1687.11. Second resistance is August's high crossing at 1726.50. First support is today's low crossing at 1651.00. Second support is August's low crossing at 1621.00.

December gold closed lower on Tuesday and the high-range close sets the stage for a steady to lower opening when Wednesday's night session begins trading. Stochastics and the RSI are neutral to bullish signaling that sideways to higher prices are possible near term. Closes above the 20 day moving average crossing at 1324.30 are needed to confirm that a short term low has been posted. If December renews the decline off August's high, August's low crossing at 1271.80 is the next downside target. First resistance is the 20 day moving average crossing at 1324.30. Second resistance is the reaction high crossing at 1353.80. First support is the reaction low crossing at 1276.90. Second resistance is August's low crossing at 1271.80.

December coffee closed higher on Tuesday. The high-range close set the stage for a steady to higher opening on Wednesday. Stochastics and the RSI are turning bullish signaling that a low might be in or is near. Closes above the reaction high crossing at 11.92 are needed to confirm that a low has been posted. If December extends this summer's decline, monthly support crossing at 10.21 is the next downside target.

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The Energy Report: Micro-Cap Oil Stocks that Hit the Jackpot

The Energy Report: With oil prices firming up over the past couple of months and the spread between West Texas Intermediate (WTI) and Brent Crude narrowing, what are your price expectations for the remainder of 2013 and into next year?

Phil Juskowicz: While I don't spend a lot of time predicting commodity prices, I personally see relatively stable short-term oil prices. Intermediate or long-term prices may weaken, assuming no supply disruptions arise from political upheavals, while gas prices may strengthen based on supply/demand fundamentals. We've seen continued oil supply growth and the short term market seems to be pretty range bound, having developed a good base around the $100 per barrel ($100/bbl) level.

TER: Where do you see some of the best investment opportunities in the oil and gas business?


PJ: Micro-cap exploration and production (EP) stocks have severely underperformed the SP Small Cap EP Index since the second half of 2011 (H2/11). However, the definition of "small cap" depends on who you're talking to. The Small Cap EP Index consists of companies around the billion-dollar range like Approach Resources Inc. (AREX:NASDAQ) and Northern Oil Gas Inc. (NOG:NYSE). Casimir has a micro-cap EP index, which is comprised of companies with market caps up to $500 million ($500M) with some names under $100M. That index level started to diverge in H2/11. Both of these groups consist of relatively equal gas/oil weightings, so the performance should not, in our opinion, be attributed to the relative strength of oil prices over gas that commenced around that time. As a result, we believe that there are attractive investment opportunities in the micro-cap EP universe.

Casimir Micro-Cap EP Index (White) vs. SP Small-Cap EP Index (Yellow)


Casimir Micro-Cap EP Index composed of: AMZG, ANFC, CAK, CPE, CXPO, EGY, EEG, ENRJ, ENSV, FEEC, FXEN, GMET, GNE, HDY, HNR, IFNY, IVAN, LEI, MCEP, MILL, MPET, MPO, OEDV, PHX, PNRG, PSTR, RDMP, SARA, SSN, STTX, TAT, TENG, TGC, TPLM, USEG, WRES, ZAZA
Source: Bloomberg; Casimir Capital

TER: How do you choose the companies in your coverage list?

PJ: We look for small companies that have largely flown "under the radar screen" and are underfollowed. The companies we cover have strong management teams and operate in premier areas with good assets that have substantial cash flow potential.

TER: Do you cover any service companies?

PJ: Enservco Corp. (OTCBB:ENSV) is on our "watch list". The company is the only nationwide provider of hot oiling, well acidizing and frack heating services generally used to coax oil out of the ground, for example to counter paraffin buildups. Enservco experienced healthy margins in Q2/13 despite it typically being a seasonally weak time for heating services. The company continues having to turn customers away in some areas while it builds out its fleet. Management, in our opinion, has a track record of building successful companies and its regional staff has strong relationships with EPs. The company is also expanding into other basins and successfully tapping into new revenue sources.

TER: Why aren't competitors seeing the opportunity here and moving in to get a piece of the action?

PJ: There are regional pockets of mom and pop shops that will do some of these services, but, a nationwide company like a Noble Energy Inc. (NBL:NYSE) might turn to Enservco because it already has a reliable relationship with Enservco's staff in different areas. Enservco's services account for a very low percentage of total well drilling and completion costs (it might cost around $100,000 to service a $7M well) so customers are not as likely to conduct competitive bidding processes. Instead, they choose to use a company with which the frontline managers already have existing relationships.

TER: So it has developed a national reputation, which is its competitive strength.

PJ: And it's building out the capacity as we speak. Enservco is expanding its already large presence in the Marcellus Formation. In its Q2/13 conference call, management said they were starting to see the Utica play out a little bit. The Utica underlies the Marcellus in a lot of areas and Enservco gets some economics of scale there. [See map] Furthermore, management has been getting the word out more and also may be contemplating a reverse stock split and listing on another exchange.


Source: Marcellus Coalition

TER: What EP names on your coverage list look interesting?

PJ: We like Miller Energy Resources (MILL:NYSE; MILL:NASDAQ), which, in late 2009, captured former Pacific Energy Resources Ltd. assets out of bankruptcy that were valued at $500M for an outstanding $4.5M. Miller's entire enterprise value, meanwhile, is just $240M. Moreover, its infrastructure assets were valued by third parties on behalf of its lender at $190M. What makes these assets most attractive is the fact that recent well results indicate that original estimates by Forest Oil (which sold the properties to Pacific in 2007) may in fact be correct, which would mean that these Alaskan assets could contain 100200 million barrels (MMbbl) of recoverable oil reserves. Proved oil reserves presently stand at 8.61 MMbbl.

TER: How was Miller able to buy $500M worth of assets for less than 1% of their value? Even in bankruptcy, you'd think that there'd be buyers willing to pay more than that.

PJ: David Hall, a Miller Energy executive who had worked on the assets even before Pacific bought them from Forest Oil in 2007, was following the Alaskan bankruptcy proceedings. He got in touch with the CEO of Miller, Scott Boruff, and told him about these assets that were becoming available.

TER: Why does Miller believe that the original estimates of recoverable oil reserves may, in fact, be correct?

PJ: The thesis is that Forest Oil used the wrong completion techniques, which is why well performances had dropped off. The completion techniques Forest Oil used were in fact different from techniques used for other assets on the McArthur Trend. David Hall believed that workovers on existing wells, for example, replacing some electric submersible pumps and making changes to completion techniques on new wells, could improve production. Low and behold, that's exactly what's happened.
In addition, Miller just started doing sidetracks of some of these old wells. It posted a 21-day production test of its RU-2A well several weeks ago at 1,314 barrels per day, which would indicate that that the oil's there and it's recoverable. Management has been doing a good job of utilizing preferred equity to have substantial capital expenditure programs without diluting the common shareholders. To top it off, it has about 600,000 undeveloped acres that it's just starting exploration on as well.
TER: What other names look interesting?

PJ: I like Trans Energy Inc. (TENG:OTCBB), which is a pure play in the Marcellus Shale. The company holds about 20,000 net acres in the Marcellus, a substantial portion of which are in the core, liquids-rich part of the play. Operators, including Range Resources Corp. (RRC:NYSE), EQT Corp. (EQT:NYSE) and Gastar Exploration Ltd. (GST:NYSE), continue to increase their return assumptions for acreage adjacent to Trans Energy's. The company's production is set to ramp up as soon as Williams Companies Inc. completes the construction of certain infrastructure. Trans Energy's acreage is in northeast West Virginia, on the southwest Pennsylvania border. There's been a lot of success coming out of that area.

TER: What sort of strategy would you suggest our readers consider?

PJ: I think the micro-cap space, in general, is less correlated to the market's vagaries. Perceived changes in foreign interest rates, for example, have a larger effect on large-cap names. Micro-cap pricing is determined more by company-specific dynamics, such as anticipated future cash flows. Plus, a lot of micro-cap names and EPs in general seem to be more active on hedging, and therefore should be less susceptible to changes in commodity prices. As a result, investors that exercise due diligence should be rewarded for accurate cash flow predictions. If you want to find companies where your hard work can actually pay off, then the micro-cap space is a good place to look.

Micro caps seem to be getting more active in reaching new investors, and some of the management teams have regrouped from previous lives and are starting up very successful new companies. I think Bonanza Creek Energy Inc. (BCEI:NYSE) is a great example of management hailing from one company and getting back together and starting all over again.

TER: Thanks for talking with us today and giving us some interesting input, Phil.

PJ: I appreciate the opportunity.

Philip Juskowicz, CFA is a managing director in the research department at Casimir Capital, a boutique investment bank specializing in the Natural Resource industry. Juskowicz began his career at Standard Poor's in 1998, where he was one of the first analysts to recommend Mitchell Energy, credited with discovering the Barnett Shale. From 2001-2005, He worked with a former geologist in equity research at both First Albany Corp. and Buckingham Research. At Buckingham, Juskowicz was promoted to a senior oilfield service analyst position, leveraging his extensive knowledge of the EP space. From 2006-2010, he was an insider to the oil and gas industry, serving as a credit analyst at WestLB, a German investment bank. In this capacity, Juskowicz was responsible for $500M of loans to energy companies and projects. He earned a Master of Science in finance from the University of Baltimore.

Here is our complete disclosure

Come Monday morning....will you be trading with us or against us?

Did you make it to John Carters webinars this week?

If not it's not to late to see what you missed, here is a replay of one of the webinars.

What's next? Some of us are starting John's training classes this Saturday. And we'll be putting these methods to work first thing Monday morning. Click here to sign today

The week got started when John showed us some live trades that proved that his methods of trading were working for anyone and everyone.....no matter how much money they had in their trading account.

Here's just a sample of what the webinars covered.......

*   The difference between trading for income vs. growth

*   Why attempt to double your account "before" it goes to zero in 12 months or less

*   How to control risk while being an aggressive trader

*   What Stops to use and when

*   The mindset of an aggressive trader

Click Here to Register for classes starting on Saturday

Come Monday morning.....will you be trading with us or against us?

See you in the markets!

Ray C. Parrish
President/CEO The Crude Oil Trader

Gold vs. S&P 500 – Where is the Value?

This past week we received the final 4th Quarter GDP number which came in at 0.39%. The total 4th Quarter growth was terrible, plain and simple. Based on the performance in the equity markets that we have seen thus far in the 1st Quarter of 2013 investors would expect strong GDP growth. However, the only thing spurring stock market growth is the constant humming of Ben Bernanke’s printing press.

The real economy and the stock market are no longer strongly correlated. Essentially, they are meaningless. How do you evaluate risk when Treasury linked interest rates are artificially being held down by the Federal Reserve? How do you evaluate earnings growth estimates when most government based statistics are manipulated or “smoothed” to perfection?

My final argument to anyone who is a true believer that the stock market is representative of the economy is a very simple premise. If the stock market is the economy, how does the stock market evaluate small business earnings growth when most small businesses are not publicly traded? It is a simple question, but I have yet to find a sell side analyst that can work around it with facts......Read More.



Here's 2 Energy Sectors You Should Invest in This Year