Trader’s Narrative

Sprott, a young Canadian asset management firm, is going public next week. This might be a market tell. Or it may be nothing.

The reason why I bring it up is not because of Sprott’s size or significance to the market. It is after all tiny, managing only $7 Billion - in the world of asset management that doesn’t even register as a blip on the radar.

Rather, it is that Sprott has been at the forefront of the commodity boom, riding the rise of oil, gas, and even obscure natural resources like molybdenum to earn management fees. The owner and main portfolio manager, Eric Sprott, is an unapologetic believer in “peak oil” and a huge gold bug.

What makes me question the IPO is its potential significance as a market tell for the whole commodity boom. There is no question that Sprott is an astute manager and market timer. The track record of his various funds attests to that. The natural corollary is then, why is he selling now?

If he thought that the commodity boom would be continuing or even accelerating, wouldn’t he want to keep as much of the company and the profits for himself?

The only logical reason to sell is if the commodity boom is about to come to an end.

Consider these other examples:

Sam Zell, probably the keenest real estate investor today, sold Equity Office Properties in February 2007 to Blackstone after a protracted bidding war between the winner and Vornado REIT. You get one guess on when the REITs in the US topped out.

Or take the June 2007 IPO of Blackstone Group (BX), one of the largest private capital managers in the US. Timing when to take companies public, when to take them private, and valuation is their bread and butter. Do you think they might know something you don’t?

Blackstone’s IPO marked not only its own share price but also the top for private equity deals:

For more examples, check out: Don’t buy what Wall St. sells

Of course that doesn’t mean that by default all IPOs are to be shunned. But in the case of Sprott there is a more fundamental reason. It is extremely expensive! The IPO values Sprott Asset Management at $1.5 Billion - twice as much as other Canadian boutique asset managers. Finally, Sprott is selling right at the top. The TSX is at a triple high above 14,500 and the energy sector is rather stretched to the upside as well.

Given the cyclical nature of the natural resource sector, my hunch is that sooner rather than later this sector will revert to the mean. Peak oil is a meaningless concept that has been bandied about for the past 50 years. Every time oil prices go up it finds a new following and every time oil prices return to earth the peak oilers somehow melt into the scenery quietly. The reason why Hubbert’s theory has been proven wrong again and again is that new advances in science and engineering processes move the line in the sand. In effect making it an anachronism.

In any case, for those interested, watch for Sprott’s IPO on May 15th. It will trade under the symbol SII on the Toronto Stock Exchange.

Wall Street has a knack of bringing new financial products online just as the demand for them is at its zenith. In Wall St. parlance: when the ducks are quacking, feed them.

I’ve already mentioned several examples of this: Don’t Buy What Wall St. Sells

Here’s another:

On May 4th 2007, the iShares FTSE NAREIT Mortgage REITs Index Fund (REM) started trading around $50.

It then promptly lost half of its value in the next few months (at its lowest point):

I pleaded the same case when Blackstone (BX), the private equity outfit went public in late June:

I’m not saying that these firms are bad investments. On the contrary, they create a lot of value. But buying here and now at these prices? I’m not sure that’s wise.

Seeing as how it is their job to know when to sell what, it makes perfect sense that they would flip their shares to the public when they knew they would get the highest price for them. Blackstone fell from a high of $38 to a recent low of $22.

Now that all things related to mortgages are avoided like the plague, it would take a smart contrarian to buy the mortgage ETF here.

Any one else find it ironic that a private equity firm is going public?

No? Well, it must just be me.

Late yesterday the upcoming IPO of Blackstone Group (BX) was priced at the higher range: $31. Trading will start sometime today in New York.

One of the concerns is that as a public company they will not get preferential tax treatment (15%) but instead be taxed at 35%. That can’t be good for earnings, nor for valuations.

But the Chinese don’t seem to mind. They’ve sunk a few billion into this firm. Of course for the Chinese government a $3 B investment is chump change. The sort of money most people would find under their couch cushions.

But remember, the Chinese bought before the IPO (and they’ve already made money since BX is valued at $34 billion now). I’m not sure you want to buy what these guys are selling. After all, their bread and butter is taking companies public when the ducks are quacking. Are you sure you want to sit on the other side of the table? And play the part of ducks?

Take a look at Fortress Investment Group (FIG). Since its IPO its floundered. Sure it was horrible timing going public just before a market rout, but while the market recovered and then some… FIG just flops around:

I’m not saying that these firms are bad investments. On the contrary, they create a lot of value. But buying here and now at these prices? I’m not sure that’s wise.

Of course, the two giants (Carlyle and KKR) in the sector still haven’t moved for an IPO - although there are some rumous. When and if they go public then we’ll have a perfect storm of a signal.