Thursday, July 24, 2008

A situation similar to CQM.H , but not a given........

As we wait for the Forest Oil and Junex drilling results over the next few weeks that will provide the next leg up for the Utica plays, I've identified a situation that is similar in several respects to the Canadian Quantum (CQM.H) situation I uncovered in May. The one difference, and it is a big difference, is that this 10 bagger potential is not guaranteed like the CQM situation at $.30 was. The company is Lariat Energy (LE.V), a company that had no properties, no debt, and minimum working capital at the time I identified CQM on May 31st. Like CQM.H, their outstanding shares are microscopic, with the currently free trading shares standing at a tiny 3.3 million. They did a PP in early June that closed last week and are doing a 15 million PP now to get the approximately $10-$15 million needed for their share of the well costs. They have put themselves in a position to earn 25% of a potential 585 million recoverable barrels of oil in the North Sea.

The thing that really jumped out at me was that the other 25% of the farm-in is with BFW Capital Management, a private company headed by former Talisman CEO Dr. James Buckee. This brings instant credibility to the play and is what has led me to puchase 20,000 shares in the last week in the $1.20 range. The operator with 50% interest is Bridge Resources. A report by Blackmont in June put the risked (not the unrisked mind you) value of Bridge's 50% share at $220 million. Using their metrics, they would value Lariat at approximately $110 million risked value, or nearly $4/share after taking into account the recent PP financings. On an unrisked basis (meaning if this well is successful), the value could be over $15. Unlike CQM, success is not guaranteed so a 10 bagger is not "in the bag". However, a $4 price target is reasonable in the next few weeks considering the well will spud next week (around August 1st) and it will only take 20 days to drill the target.

ENG with only a 10% interest and less recoverable barrels reached a $160 million value pre-drilling results with over 30 million free trading shares. With LE having only 3.3 million free trading shares until the middle of November, the spike on a successful test will be extraordinary. Even before results are announced, an ENG pre-drill valuation would give Lariat a $5 share price.

The current market will probably not reward LE the same value ENG received pre-drill results but a $4 price is certainly within reach. Again, I own 20,000 shares so I have a vested interest in this play. A warning.....the microscopic 3.3 million outstanding shares through the middle of November will make it difficult to accumulate a large number of shares without moving the share price up appreciably. Investors with a speculative bent may want to dip their toes in this play as the risk-reward appears extremely favorable and the pay-off will be known in less than a month.

For those who want more information, including those geo's out there, a presentation can be viewed here.

Note: right click the link to open it in a separate window.

Sunday, July 13, 2008

One more final word on gold from Uncle Jim

I don't want to use this blog to comment daily on gold since there are many more qualified than I but I'll leave you with this from Jim Sinclair tonight:

Posted On: Sunday, July 13, 2008, 5:41:00 PM EST

Gold In The Coming Weeks

Author: Jim Sinclair

Dear CIGAs,

Gold is headed to and through $1200. This is the Mantra and truth. All "smoke and mirror" reactions are buys. That is the entire review. I do not think this, I know this.

Why, you ask?

History was made last week but so few understand it and less understand how to protect themselves.

The events of last week are so serious that saving newspapers for generations to come will amaze people who read them in the future. Some of the questions you will hear are:

  • How in the world did people see the great dollar-destructive inflation coming?
  • How could they possibly stay in the dollar?
  • How could people have not bought gold?
  • You have to be kidding. Funds were short up to their eyeballs in junior gold shares. These juniors are the only means of getting new reserves. Why did investors in juniors fail to take definitive action to stop the lending of their shares to the shorts?
  • Why didn't everyone keep their hard earned dollars in gold?
  • Why were the OTC manufacturers not arrested for first degree financial murder?
  • Why did so many educated people fail to see "This was it"?
  • Why did so many educated people not understand the unwinding of the entire financial system was accelerating?

The facts of the debacle:

  1. The largest bank failure in US Financial history occurred because of OTC derivative losses.
  2. The two giant real estate financiers, Freddie and Fanny, are balance sheet insolvent. In English this means both companies are busted, all because of OTC derivatives.
  3. The damage to the financial system’s estimated size is predicted to be $1.6 trillion dollars. This number shocks people, but it is still far below the real number. Once again we should all give thanks to the OTC derivative Geeks.

Freddie and Fanny are to be rescued by smoke and mirrors designed to look like private sector investments.

This weekend the US Treasury and The US Fed are calling all banks and financial institutions that have populated the Begging Bowl Fed Loan Window to stay solvent to buy the multi-billion dollar bond issue scheduled to be auctioned on Monday. That is a joke as these institutions will have to buy them for their own account if they don't have insane clients to stuff with this paper. The question is where are these busted financial entities getting the funds for the bail out? Are these funds coming from the various Federal government entities that can buy any US security or bond?

I am offering a special award for the CIGA able to name the most Federal Entities that are by law allowed to purchase US securities and US Bonds.

The award is an air blast ping pong ball gun you can fire at financial TV when some damn fool is telling the public when gold or energy reacts that they are both all washed up. Your family and/or office associate will be pleased if you stop yelling at the screen and simply took aim at the idiot talking head.

Saturday, July 12, 2008

Please read this to understand the current situation

This is from a poster on the CWEI Investor Village board today. I read this after my earlier post but reinforces my comments:

Recs: 82 The Fed, The Treasury, Debt Creation, Money Creation, & FNM/FREPlease pay attention. This might be the most important post you read for a while (even though it does not involve energy directly).

The level of understanding about how our capital markets work in this country (including these talking heads on CNBC and in the media) is pathetically inadequate. For those here, I'm going to try and correct that. The basis of my understanding of this subject did not come from a book. It came from working at Salomon Brothers during the 1970's (a firm - now part of Citibank - that dominated the taxable fixed income markets during that period). I started out as a money market and government securities salesman. My next to last job there (before I left to start my own firm) was as their global money market and government securities sales manager. As a result, I think I know what I'm talking about.

Following the concept of KISS (keep it simple, stupid), I'm going to try and walk you thru what exactly is going on right now as it pertains to Freddie Mac and Fannie Mae. I'm going to go slowly and keep it as simple as I can (at the possible cost of exact technical correctness). Hopefully I will be able to tie everything together at the end in a way that makes this complicated financial situation understandable.

(1) What role does the Treasury Department play? - It is the role of the Treasury to make sure that the U.S. government has enough money to fund the obligations of the U.S. government. Whether the government is running a fiscal surplus or deficit, it is their responsibility to determine how much money should be raised and when. It is also their responsibility to determine what the maturities of this debt should be. The amount of each offering is set by the amount of debt maturing (thus requiring refinancing) as well as any additional debt that may be needed above and beyond that (i.e. to fund that year's deficit). If you check, this is done thru weekly Treasury Bill auctions, quarterly refundings and other periodic treasury auctions such as the monthly two year note. These auctions are not conducted by Treasury. They are conducted by the Federal Reserve Bank of New York thru their network of recognized government securities dealers. The important thing to note here - these Treasury financings have absolutely no impact on the money supply. They simply determine how much Treasury debt is outstanding (i.e. the national debt).

(2) What role does the Federal Reserve play - Besides facilitating the Treasury's effort to fund the operations of the government, the FED is charged (along with many other things) with determining how much money is in the system. So how does the FED expand or contract the money stock? SIT DOWN AND PAY ATTENTION. All they have to do to create more money is to buy a Treasury bill, note, or bond from one of the recognized government securities dealers (i.e. $1MM treasury security goes to FED, $1MM is released into the system as payment). IT IS JUST THAT SIMPLE. It is from this money stock creation/contraction (that can be raised or lowered at will by the FED simply by buying or selling treasury or GSE agency securities), that then gets circulated throughout the financial system, that is the starting block for determining such things as M1, M2, and M3. POINT TO REMEMBER - only the FED can monetize debt and THIS IS HOW THEY DO IT.

(3) With (2) above in mind, The FED right now has a portfolio of around $800B (my numbers are probably off, but the magnitude isn't). That means that they have created $800B of "money" (which gets multiplied many times over as it winds its way thru the banking system thru the mechanism of bank deposits and bank loans (less reserve requirements)). Up until the Bear Stearns bailout, all of this $800B of "money" was backed by a portfolio of U.S. Treasury and Agency securities. With all of these "clever" new financing vehicles that were created by the FED to bailout Bear Stearns and to keep the IB's and money center banks afloat, roughly have of this $800B AAA+ portfolio has been loaned out thru the Discount Window in exchange for toxic waste garbage (sub prime MBS, etc.). [It should be noted here that the FED does not own this garbage. It is simply financing it for the street since no one else will. The hope is that they will be able to get their original securities back (and get the garbage off their books) when the credit markets normalize.]

What role does FNM and FRE play? - These two GSE's are the only reason that we have a functioning 30 year fixed rate mortgage market. Reason? As government sponsored enterprises, they have long enjoyed a competitive advantage in terms of how they can fund themselves. They have historically paid only a slight premium over the level of treasury (i.e. risk free) interest rates (for any given maturity) for their money. As a result, they have been in a much better position than any private sector mortgage provider to be able to "lend long" and "borrow short". It should also be noted that FRE/FNM are the bedrock of the secondary mortgage market in the country (since they own roughly half the residential mortgages in the country and process many others in one way or another). I haven't looked in a long time, but it is my guess that the average duration of FRE and FNM's 5T of debt is under 3 years (REMEMBER THIS POINT).

So let me cut to the chase and try to tie all of the above together as it pertains to the current crisis that FNM and FRE and the FED and the Treasury now face and what options the government really has at its disposal to attempt to solve this problem.

So as we sit back this weekend and try to figure out what the government's options are in regards to Fannie Mae and Freddie Mac, let's look at some of the options being proposed by some of these financial, talking head bozos on CNBC and elsewhere:

(1) Open the Discount Window - This ranks as the dumbest idea ever. Why? Simple. The FED's balance sheet is only $800B. Half of that has already been exchanged for toxic waste to keep Wall Street afloat. They are probably going to need the other half when Lehman Brothers or someone else starts to seriously sink (which will most certainly happen). In addition, how is opening the discount window going to solve the GSE's problem of rolling over their $5+ TRILLION in debt when it matures? Keep in mind that this massive debt also has a very short duration. The ONLY way the FED could do this would be to MONETIZE whatever the $ amount the GSE's came to the discount window for by going into the market and buying massive amounts of treasury securities. We're talking potentially TRILLIONS here since this action (i.e. the GSE's going to the discount window) would in all probability shut them out from issuing any additional debt into the debt markets at anything close to a reasonable spread to treasuries.
LESSON LEARNED - No way is the FED going to open the discount window to the GSE's.

(2) Nothing changes - business as usual. According to Paulson, the government has no current plans to "takeover" the GSE's. They're just going to monitor the situation closely. This might work. It might not. HERE'S THE TEST the GSE's have to pass. As long as they can continue to issue debt on a timely basis and in the amount that is required to fund their business at a REASONABLE INTEREST RATE SPREAD over treasuries, then things will be okay (no matter what the financial media says). If they can't, then the sh#t will truly hit the fan. Here's an example of what I'm talking about. Let's say that 5 year FNMA paper historically has traded at 50 basis points over 5 year treasuries. If that spread blows out to 150 -200+ basis points because the bond market vigilantes no longer trust the implied government guarantee that historically has supported it, then the game is over. The government will then have to step in.

(3) The government steps in - The options here are numerous.

(A) The government puts an explicit government guarantee on all of the GSE's outstanding debt. The benefit to this is that it will insure that the GSE's can continue to fund themselves in the debt market (which is ABSOLUTELY crucial). The downside is that it will officially add this debt to our national debt.

(B) Congress authorizes the Treasury to raise $100B (for example) in additional debt and to invest those funds into the GSE's (in some form or fashion, you're guess is as good as mine). The good news is that this will preclude all of the GSE's debt from landing on the national debt. The bad news is how big are the real losses that the GSE's will face going forward? Will this $ amount (whatever it is) be enough? Will they still be able to fund themselves at a reasonable spread over treasuries?

(C) Some sort of convoluted public/private bailout scheme that might be attempted by the government in order to save face. This could come in many forms, and I'm not smart enough to figure out which ones (if any) might make sense.

The bottom line to all of this is that whatever happens in regards to FRE/FNM, it won't be a quick easy fix. The problems the government now faces in this regard makes the Bear Stearns bailout look like a walk in the park.

In conclusion, I saw something like this coming. That is why I'm so heavily overweight in gold stocks (38% of my portfolio). Having said that, I never dreamed that the GSE's fall from grace would either be as swift or as stunningly complete as it has turned out to be. We could very easily be looking at a "Black Monday" market situation if the government doesn't get its act together quickly.

JMO. I hope this helps others here understand exactly what is going on in terms of the GSE's.

Time to buy insurance to protect your shale investments

I had planned a report on a Montney shale play I recently researched and took a position in (Canadian Spirit SPI.V) but I believe there is a more pressing issue. If you don't have downside protection for your portfolio, I would strongly consider doing so next week. I am not recommending selling any shale plays as they will do just fine over the next 6 months. As I mentioned, I recently took a position in Canadian Spirit. I am recommending that investors look into DGP which is traded on the NYSE. DGP is a double-leveraged Electronically-Traded Note tied to the price of gold (so you get twice the move, both up and down when gold moves). It's like GLD on steroids. I believe the US FED will need to take over both Freddie and Fannie very soon which will put tremendous pressure on the USD. This will also pressure stocks but will ignite the gold price which is finally behaving in it's traditional role as a hedge against troubling times. The shale gas plays may feel some of the pain of the overall market but a 5-10% position in DGP may offset any losses until such time that the Forest Oil news arrives.

I have been following the gold market daily since July 2005 and feel now is the time to enter a position to protect one's investments. There will be a battle at $1,000 but the battle will be won by gold longs and I can see $1,250 by year end. This will mean a 60% return on the DGP. Consider it an insurance policy on your shale gas investments. With this policy in hand, you may be less likely to get out of your shale gas position if the market takes a major turn for the worse.

Friday, July 4, 2008

Contact/Triangle - From Canaccord Today

Contact Exploration* (CEX : TSX-V : $0.52), Net Change: -0.02, % Change: -3.70%, Volume: 109,300
Triangle Petroleum* (TPLM : NASDAQ : US$1.35), Net Change: -0.03, % Change: -2.17%, Volume: 28,400

On board and ready to go. Led by the Utica in Quebec, Bakken in Saskatchewan and the Montney in northeast B.C., Canadian shale plays have caught fire in 2008 thanks to an increased natural gas price, better technology and the huge success of the Barnett shale play in Texas. Relatively unknown to most investors, and definitely not caught up in the excitement yet, is the
shale gas plays developing in the Canadian Maritimes that some industry players believe is more prospective and potentially larger than a couple of the other Canadian shale plays mentioned above. Of course, until proven, predictions are just that, predictions. While all the junior Canadian shale gas players have seen there stocks come off substantially in the last couple
weeks, as drilling and news picks up the excitement for the sector should gain traction again. There will be an extremely large amount of drilling on all the big Canadian shale plays this summer and by the end of the year the market should have a much better grasp on who the winners are. On Thursday, Contact Exploration, which holds highly prospective land in New Brunswick near Corridor Resources (CDH), announced Thursday that it has elected to participate on a working interest basis in the Windsor Shale prospect in Nova Scotia. Contact originally identified and acquired the Windsor Shale block in 2002 and subsequently farmed out a 70% working interest to Triangle Petroleum. Contact retained the right to participate with a 30% working interest or to convert its working interest to a 5% Gross Overriding Royalty. On Thursday, Contact said it has notified Triangle, the operator of the property, that it will continue as a 30% working interest partner. The junior oil and gas company will participate retroactively on the already drilled Kennetcook #2 well and the 3D seismic data that was procured by Triangle last fall. Expenditures for the retroactive participation in the Kennetcook #2 well and seismic will be approximately $3 million.

The Kennetcook #1 well was carried at no cost to Contact by Triangle as part of the earning process on the block. The next well on the prospect is expected to spud in late July and is a 3,000-meter (10,000-foot) vertical test that targets the deeper and considerably thicker shale package, in an undrilled fault block north of Triangle’s first two vertical test wells. This next well is one of six new delineation wells that comprise the second phase of Triangle’s three-phase strategy for developing natural gas from shale in Eastern Canada. At least one horizontal well is expected to be drilled as part of the second phase. On May 19, independent resource evaluator Ryder Scott estimated 69 Tcf of original gas-in-place for the Horton Bluff Shale on the Windsor

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