Dow Jones Industrial Average 10,785
Value Line Arithmetic Index 1,759
30-Year Treasury Index 4.64%
The Big Picture for Stocks The 2002-2004 bull market is probably in the rearview mirror.
Technical Trendicator (1-4 month trend):
Stock Prices Down
Bond Prices Down
Two of our energy stocks got a boost this week — Canada Southern and Teton Petroleum. Canada Southern (CSPLF, 6.80) announced Thursday night that the well they are drilling in the Yukon Kotaneelee field has encountered the gas bearing zone (the "Nahanni" formation) which it failed to hit last month, sending the stock south. This brightens the outlook for this company, which was reflected in the stock's price on Friday. It now appears likely that they will have a producing well. Whether it is a good well or not depends on several factors, including whether the section of the zone that they are in has too much water, whether the area is fractured enough to allow the gas to flow to the well bore, and whether there are mechanical problems as they now drill ahead horizontally into the zone. Horizontal drilling technology significantly increases the chances that a well like this will be good. A horizontal well can contact more of the pay zone than a vertical-only well. And it can stay high up in the zone to minimize the water problem. This is only the sixth well in this field in which two of those six wells were among the top ten gas wells ever in north America.
It is very difficult to guess where this stock may go from here. This a very expensive well and if it is not a good one, shareholders will be disappointed. But in addition to the well in the Yukon, they have a deep gas exploratory well nearing completion in British Columbia on the so-called Mike/Hazel prospect, as well as a nearby oil well at a shallower depth. There is certainly a chance that nothing good will come of these wells. But they have spent a lot of money on 3-D seismic at Mike/Hazel which they related in their 2003 annual report as very promising. The likely scenario is that the news in the next month will be positive. And there is a chance that this drilling could transform this company — and that the stock could rocket higher. If you happen to have a lot riding on this stock, you might trim it back if we see prices approach $10. But if the news is good, hope for much higher prices than that. We put the stock on our list at $4.60 a year and a half ago.
Teton Petroleum (TPE, 2.25) is another very interesting situation. This company is a Denver based company that formerly had all its activities in Russia. But last year they sold all their Russian oil properties and went entirely to cash. We put the stock on our Special Situations list at a price of $1.55, which was below the value of their cash! They are now going forward to re-start the company by buying reserves, primarily in the Rocky Mountain region which is the hottest area in the country for oil and natural gas production.
Potentially, a company can leverage a good balance sheet and boost their share price and create real value to shareholders over time. It works in the oil business just like any other business, but here is how it could work for a company like Teton. You buy oil and gas assets for a third or less of what they could be expected to bring in gross cash flow, but of course you have the expense of getting an uncertain quantity of the stuff out of the ground. But just as the stock market will pay for future growth potential of a business, the stock market may pay more for your stock than you paid for the assets. Then if the market price of your stock goes up, you can buy more assets by issuing stock rather than cash. And if successful in producing the oil or natural gas, this process can continue. You can turn a small company into a much bigger one. That is textbook capitalism. And it is why a small company has so much leverage to grow, but with more risk.
Teton has announced two deals recently. The first one was announced in an 8-K filing on January 10. This deal is still pending due diligence. The second deal (which was announced last week) is a 25% interest in a partnership in the so-called Piceance Basin in the Rocky Mountains. In the announcement, the company said that the partnership potentially could drill as many as 600 wells on the property! The management of this company is experienced in evaluating oil and gas properties, and it appears that their Piceance Basin deal may be a real winner. Below is a link to their news announcements:
Both Teton and Canada Southern have the potential to become bigger companies. Both have good balance sheets and promising prospects. These are the type of stocks that have the potential to triple in value in a matter of months. Will that happen? Don't bet the farm. But don't be surprised if it happens. The recipe is there.
We have a lot of our Special Situations stocks in natural resource companies — mostly natural gas and precious metals, but also other commodities such as molybdenum and uranium. There is substantial growth potential in this segment of the economy. There is a worldwide commodities bull market in progress. We attempt to invest in companies that have assets in the ground worth significantly more than the stock price. Hopefully, time will reward this strategy.
The Stock Market
The chart below shows mutual fund cash as a percentage of assets. (Source: Merrill Lynch). Note that the bull market of the 1990's was marked by declining cash as a percentage of assets in mutual funds. Then note how the chart hit bottom in 2000, rallied, and then tested the lows. Then recently it has started to turn up again. The picture of this chart is that of a saucer bottom — the most reliable chart pattern to mark a bottom in my experience.
This is very bad news for the stock market. The mirror image of the 1990's bull market could be in store. A period of rising cash would almost certainly mean dropping stock prices.
Accordingly, I am adding a short position of the iShares S&P SmallCap 600 Index (symbol IJR) to our Special Situations list. It will go on the list as of the opening on Tuesday morning.
Note: We are long both Canada Southern and Teton Petroleum in accounts that we manage.