Drilling Rig Market

Noble Corp's acquisition of Frontier Drilling and subsequent lease deals with Shell have provided invaluable insight into the state of the offshore drilling industry.

Eyeballing the dayrates, it looks like rig rates in the Gulf of Mexico have fallen 25%. But elsewhere, the drop is much less, maybe 10-15%. The rig companies have all fallen much farther than that. In addition, Seadrill is still not on the radar of the MSM. They are not yet listed along with Transocean, Noble, and Diamond Offshore. In my opinion, this is a golden opportunity to buy more.

Go, Mr. Bond, go! I've been called "too bearish" by friends. To me, that term doesn't make sense. Markets are like see-saws. If you're bearish on the equity market, you are probably de-facto bullish on the bond market. Dave Rosenberg (the only bond bull besides myself that I know) is calling for 880 on the S&P if it breaks 1050. And 2.5% on the long bond is possible in the next few years. Back to the S&P 500. The head and shoulders pattern is complete (barring a late-day rally), as it has sliced through all the way down to 1045.

Trades at day's end:

Sell to close 10% position in EDZ @ $49.02, +19.4%.

I looked at closing either this position or the SPY 108 put. They both have roughly the same profit if I sell them now, but the SPY put has more upside because it has more leverage. Part of me really wanted to ride this thing down more, but EDZ is not a long-term holding. A week is perfect.

Buy to open 10% position in SDRL @ $18.09.

See drilling market analysis above. In a couple of years when SDRL is paying out $0.75-$1.00 per quarter, I will look back and wish I had bought more.

Seadrill

Great news for Seadrill! A Louisiana judge has blocked Obama's drilling moratorium as "arbitrary" and overturned it. Obama immediately promised to appeal. He may win, but that will take time. In the meantime, this is very good for Seadrill, because they have 10 rig contracts expiring by the end of the year, but only 2 in the first half of 2011. The more time Seadrill gets to rework contracts before the market is flooded temporarily the better.

Rig leases can be terminated according to force majeure provisions including, but not limited to government interference with drilling. This has threatened to dump 33 deepwater rigs and drillships on the market very quickly.

Trade!

Long 10% position in EDZ at $41.06.

This is a balls to the wall, take no prisoners position. But the set up is favorable. All the technicals are there, with the charts looking beautiful. Yesterday's market fade on low volume confirms there is no follow through. China has just screwed themselves as their manufacturing profit margins are 1.8%. The yuan jumps up 0.4% but commodities advance 2%. This is a noose that will choke them to death. Dave Rosenberg said today for the second time that a hard landing in China could be the greatest threat to the global recovery going forward. And Russ Winter has already taken this same position.

Now that I'm "all in" it's time to kick back, order a margarita, and enjoy the show.

Trade!

Buy 1% position EWA Jan11 16 puts @ 0.65.

This is how I've decided to play the China bounce today. I was itching to buy the FXI puts, but they are much more expensive. The IV on FXI is 40+, compared to 32 for EWA.

Today's rally has insanely low volume, and I can't help thinking that GS and the big boys are disappointed with their attempts to get more people into the water with their bullish sales story on China, complete with ridiculous Yuan appreciation targets.

Nouriel Roubini, on the other hand, says the yuan is more likely to fall versus the dollar than rise if the euro keeps falling.

I am tempted to put in a big position in EDZ later today, and will update if I pull the trigger.

Mainstream Media Misreporting

According to the mainstream media, China is going to revalue the Yuan.


Yuan Unshackled May Strengthen China Shift to Domestic Demand
Beijing cautious despite end to peg

China to ease yuan-dollar peg; any weakening to be gradualChina loosens its currency chokehold


But not according to China's own press release, which stated that
"the exchange rate floating bands will remain the same as previously announced in the inter-bank foreign exchange market" and "the basis for large-scale appreciation of the RMB exchange rate does not exist." (Bloomberg)

Translation: the currency band won't change and neither will the currency be revalued. So how's it going to change? Answer: it's not.


Either the MSM is so stupid that they believe the popular myth that China will revalue this year, or they are setting China up to be the bad guy when there is no change in exchange rates in the future.  

Chinese Real Estate Ponzi Scheme

From the israelfinancialexpert blog comes a fascinating expose of the ponzi scheme that the Chinese real estate bubble has become. I'll let the following excerpt speak for itself.

So many ordinary households pledge their inflated house and get a loan from the bank, then lend the money to a shark loan operator with 20-150% annual interest rate, this shark loan operator then lends this aggregated loan to real estate developers, speculator, or some SME which have to pay back the bank. ( China’s banking system operates at a roll over loan base on a year on year base, so many Chinese SME will borrow at shark loan market rates to pay back the bank, then days later, use the approved new bank loan to pay back. And it is very common practice, given the dire situation for many SME exporters due to razor thin profit margin combined with rising labor costs, in reality. Furthermore, in recent years, many SME’s totally stopped old business of exporting , since the high return of real estate flip flop drove more and more capital into this historical bubble, thus further inflating the housing market.

The parallels with liar loans, ARMs, subprime mortgage lending, and using houses as ATMs are unmistakable. This kind of ponzi scheme cannot last without ever increasing supplies of money and credit from the central bank. If the blog is correct that 85-90% of some cities are participating in the lending schemes, then the saturation point is close at hand. Even so, the government could extend the bubble further. However, they will have to worry about general price inflation at some point. Then the people who have been left out of the real estate lottery will become restless.  Recently, the government is acting as if they are concerned about a hard landing. They should be. Nothing makes people angry and desperate like being cheated out of their house for a few interest payments.

The details of the scheme are telling. In 2008, the government kept property development companies in business by preventing the lowering of property prices. If this strategy is applied again, it means that markets could disappear overnight. The loan shark ponzi schemes are very troubling. In simplest terms this means that massive increases in credit are issued from state run banks to homeowners who then lend to development companies to build more homes. I can not think of a more self-defeating process in the long run.

So, now I have to figure out how to play this. The report also says that inflation is much higher than the government's official numbers. So that means that renewed tightening is much more likely. And higher interest rates are usually very bearish for equities. So I will watch FXI. But that's not a sure thing, as the government's solution might be to blow a new bubble in equities to replace real estate. A hard landing a China could also depress commodity prices, but inflation in China might increase demand short-term if inflation gets out of control. All these ideas bear careful watching, but it seems pretty clear to me that the real estate bubble is on its last legs. The time is ripe for a big pop.

Trade

Buy 1% position in BP Jan11 47 calls @ $1.11.


Sentiment is universally negative on BP. I think the 39% chance of bankruptcy priced in by the credit default swap market is ridiculously high.


$47 is the halfway mark between the current price and the yearly high. I think that BP will be able to do some damage control. Anything they are able to do will help their stock price now.

Trade!

Buy 1% position in SPY Jul 108 put @ $1.70.

All the short-term indicators are in my favor. Russ Winter and Dave Rosenberg say this last week is a gift for the bears and a sucker's rally, respectively. The McClellan oscillator just hit the highest value this year, showing an extremely overbought market running on momentum. The chart is also favorable, and it looks like the S&P 500 is putting in a head and shoulders position. There is a possibility of a breakout and a double top being put in, but if the market doesn't beak out from here, it is an extremely bearish sign.

I was trying to find more stuff to short, but I already have options on SPY, FXI, and EWA. The other charts, like KBH and ANF are way in the gutter already. I'll just have to keep looking, and maybe I'll roll over EWA.

trade

sold 20% position in gold @ $1,227/oz., +7.7%

Rosenberg has now warned 3 times in the last month that gold is frothy. I will look to buy back in at the $1100-50 range.

Trade

Bought 10% position in SDRL @ $19.63.

This is just a deep value play, pure and simple. The forward dividend is $2.40, so the yield is 12%. Revenue per share is $17.11, and the operating margin is 40%+. Going forward, this will improve, as new contracts signed in Q1 2010 will have a margin of 64%! EBITDA per share is a whopping $8.44.

These numbers are unreal. You can't find a cash cow like this anywhere. I even expect the dividend to go up from here.

The Macondo oil spill has gotten people frightened, and rightly so. However, Seadrill has limited exposure, with only one rig in U.S. waters. Other rigs are spread across Norway, South America, Africa, and Asia. This geographic diversity is a strength for Seadrill. So to is their status as a Norweigian company. Norway has a reputation for stringent regulation. The youth of Seadrill's fleet is just one more thing in their favor.

At this point, I think I'm going to treat SDRL as an income play, not speculation. This means that I will start to rotate out of my other income play, 30-yr Treasuries and into SDRL at these prices.

Waiting for an Opportunity

I just can't seem to catch a good bounce to short this market. That's what I'm waiting for. But the bad news keeps coming. And when it's not bad, well, the market makes the news anyway.

The new Hungarian government today uttered the "D" word and spooked the euro into an all-time low against the Swiss franc and a under $1.20/dollar. Default would be a shockwave after 2008's $24.1 billion IMF bailout.

Payrolls disappointed, barely positive except for temporary census workers. No wonder bonds look good.

The Daily News ran a story yesterday about Los Angeles county. Property taxes revenues are set to fall by $700 million, or 15% of revenues. How does the county pay its bills after a hit like that?

But I can afford to be patient. Treasury bonds are skyrocketing, up 2.5% today. At the same time, gold is holding steady and consolidating its gains. And my EWA put is in the money and trades exactly like a short. Another break down in EWA and I will close it. The thing I'm most itchy to pull the trigger on is a long-term call on IAG or ABX.