A Tale Of Two Trades

It was the best of trades. It was the worst of trades. Separated in time by seven years.

During the oil price crash of 2008, and again during the most recent oil price crash, I attempted to time the bottom of the market with a purchase. In late 2008, oil prices were in freefall after the price of West Texas Intermediate (WTI) had briefly reached $147/barrel in July. By December the price had fallen into the $30s, and I remember asking myself how much conviction I had that this was only a temporary price dislocation. I was convinced that while the market had overshot to the high side at $147/bbl, it had also overshot to the low side when it went below $40/bbl.

At the time I considered buying oil futures, but I finally decided to buy one of the beaten down names in the oil and gas sector. Shares of the Brazilian oil company Petrobras (NYSE: PBR) had fallen by 75% from their summer highs, and I thought they would rally when oil inevitably recovered. I pulled the trigger on the trade just barely above its 52-week low, and then watched those shares rise by 200% over the next 12 months.  

My conviction was rewarded and the notion that I should act decisively on my convictions was reinforced. Those lessons were in my mind in mid-2014 when I once again saw oil begin a steep decline from over $100/bbl.

In early 2014 I had felt like oil prices were due for a decline. That was in fact one of my 2014 predictions. The bull market in MLPs had also been especially strong for many years, with the sector broadly outperforming pretty much every other asset class. So I was looking for a correction in energy prices, and hoping to buy MLPs at a discount.

I wasn’t sure how far prices might fall, but during the previous plunge I became convinced that oil prices were in unsustainable territory when they reached the $40s. That happened again during the first week of 2015. However, I was a little concerned this time around that high crude oil inventories could keep prices depressed for a while, so I hesitated. I waited until April, and with crude oil prices in the lower $50s, I pulled the trigger again.

Once more, I was convinced that oil prices were at unsustainably low levels. MLPs had also suffered a sharp correction, so this looked like the opportunity I was after. I am generally a pretty risk-averse investor, but I was sure that the long-term price of oil would be significantly higher, and that MLPs were going to recover soon. So I bought the UBS ETRACS 2x Monthly Leveraged Long Alerian MLP Infrastructure Index ETN (MLPL). It would be my biggest financial mistake of 2015.

Units initially rose, but after OPEC reiterated its strategy of defending market share at the June 2015 meeting, oil prices made another move lower, reaching the $30s by August. Midstream MLPs traded down almost in lockstep with oil prices. I was down 30% by mid-August.

My conviction hadn’t changed. I still believed oil prices were unsustainably low. But I finally decided to take a tax loss on the investment in November. My total loss was 40%, and I only sold then because I wanted to offset gains from the rest of my portfolio. I was sure I was selling at the bottom, but MLPL would go on to decline another 45% before it was finally redeemed by UBS on Feb 1.  

The lesson that was reiterated for me here was that just because there’s blood in the street, doesn’t mean it can’t get a whole lot bloodier.

Still, I couldn’t help but think that the energy sector, and especially the MLP sector, was grossly oversold. It would have been interesting to see how MLPL would have fared had it not been taken off the market.

It just so happens that I was browsing through the performance of MLP ETNs, and I saw that the top performer in that category year-to-date is UBS E-TRACS 2x Leveraged Long Alerian MLP Infrastructure Index (MLPQ), which appears to be MLPL reincarnated. MLPQ opened up a week after the MLPL closed, and it is up 71% in the two months since it opened for business.

That’s the kind of performance I had in mind when I first bought MLPL. I knew the downside risk was high, but thought we were close to the turning point for the sector. I was wrong about that. It now looks like we may have seen the bottom in February of this year. I was too early, and that was costly.

Sometimes you get lucky. Sometimes you don’t. And sometimes you have to be reminded that market timing is really hard.     

(Follow Robert Rapier on Twitter, LinkedIn, or Facebook.)


Portfolio Update

A Telling Shrug to Kinder’s Bad News   

The latest confirmation that the MLP bear market is well and truly over comes courtesy of Kinder Morgan (NYSE: KMI). Kinder inaugurated the first-quarter reporting season by lowering its three-month old distributable cash flow forecast by 4%, citing in particular reduced gas gathering volumes in the Eagle Ford and the effect of recent coal bankruptcies.

It also canceled two pipelines that had run into fierce local opposition, the $3.3 billion Marcellus to New England project that failed to secure sufficient commitments from producers and the Palmetto, a $1 billion refined products pipeline across the Southeast that had been effectively blocked for at least the next year by Georgia state officials.

This is the sort of news that could have easily pushed the stock down double digits during the panic that prevailed between August and February. Today, though, it has KMI shares down less than 3%, perhaps because investors liked the news that Kinder is now budgeting growth capital spending of $2.9 billion this year, down from $3.3 billion six months earlier.

The stock now trades higher than it did on the eve of the Dec. 7 75% dividend cut, but still well below its price at the end of November. And Kinder made clear on yesterday’s conference call that the company isn’t likely to boost its dividend again or buy back a significant number of shares until 2018 at the earliest. So it would be unfair to slander the current shareholder base as incorrigible optimists. Realists with low near-term expectations seems closer to the mark. Growth Portfolio pick KMI is a Hold.

— Igor Greenwald

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