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.

Let’s take a look back at my previous commentary on Canadian REITs’ oversold condition on June 27th, 2007. Yup, it is report card time!

Unlike many other trading bloggers who let previous calls drift into the ether I like to keep myself honest by reviewing past calls and analysis. Both to be transparent and to give myself and others another chance to learn (from my mistakes).

…we could be seeing a major trend change with REITs. But even so, they aren’t going to go straight down. I think this technical oversold picture in the short term is still actionable.

So how did I do?
My thesis was that it was yet another correction within a long term uptrend. I was right about an “actionable” short term oversold condition because we did see REITs bounce into July. However, the index failed to ricochet off its 200 day moving average as it had so many times before. So I was wrong in the sense of not seeing a trend shift taking place right under my nose.

Thinking back, I don’t think I did anything necessarily wrong. I prefer to be proven wrong by price action than trying to simply ‘guess’. I think it is always wiser to continue to do what has worked, until it proves you wrong. As long as you are practicing smart money management you’ll be ahead.

Weinstein’s Stage Analysis
If you’re not familiar with Stan Weinstein, what are you doing still reading this? Go and buy his classic book on technical analysis (on your left). Then you’ll have a great grasp of basic TA and understand what follows.

According to Weinstein, stocks follow 4 stages. From his definition, last summer the Canadian REIT sector had all the indications of Stage 3 - topping. It is now in Stage 4 - decline. Simple to see that in the chart: lower highs and lower lows.

As well, in mid-July 2007, the Canadian REIT index’s 200 day moving average plateaued. No surprise really since the index had been going downhill since late February 2007 (red arrow).

It isn’t just coincidence that since that same point in time, the Canadian REIT index has been trading consistently below its long term moving average. Something that it hasn’t done in years. This definitely denotes a major shift in REITs.

Way before they actually did, I correctly surmised that the Fed was going to have to start cutting rates. But my misstep was in not realizing that there were greater forces at play. So much so that a major campaign of tax cuts has not been able to withstand the tsunami of the credit crisis.

On a positive note, the index seems to have found footing recently along with the rest of the market, lifting off from a double bottom formation. If it continues to rise, its next challenge will be meeting the long term moving average from below as it is hurtling down towards it.

I find myself unable to resist the temptation of picking up some Charter REIT (CRH.un); a tiny real estate investment trust that has a 15% yield. Other than that I’m just going to hang on to my long term holdings.

Lesson learned:
When Sam Zell sells, real estate has peaked.