By Jack Barnes
The hedge fund industry has many distinct investment styles. One of them is called "Global Macro." It is the economic study of world events, with an eye toward making a profit from these events.
The Global Macro crowd looks for trades around the world, where they can be long one commodity and short a different commodity - due to weather conditions for example. The idea is to look for trades based on causation, not just correlation.
Here is an example of a global macro trade. If it is dry in Brazil during planting season, you want to go long on palm oil futures in Indonesia, because soybean crop yields will be late to market in Brazil. Palm oil will replace soybean oil in the kitchens of homes in Asia when this happens.
Here's another example: The Rains in Australia have forced the coal buyers of China and Asia to search the world for available supply of coking coal. And British Columbia, Canada is to coking coal what Indonesia is to palm oil.
That brings us to Teck Resources Ltd. (NYSE: TCK) - Canada's largest diversified mining, mineral processing and metallurgical company. Teck sports a $37 billion market cap and an enterprise value of $41.9 billion. The company's stock has risen by 63% in the last year compared to an 11% change in the Standard & Poor's 500 Index. Teck generated $8.7 billion in revenue in the last year.
Teck produces copper, zinc, molybdenum and coking coal for the manufacturing of steel. It is this last part that has caught my interest this week. The last time Australia had flooding in the coal region, spot prices for coking coal hit $300 per ton.
Teck has interest in six metallurgical coal mines in British Columbia and Alberta. It is the second-largest exporter of seaborne hard coking coal. It produces primarily hard coking coal and will be essential in replacing lost incremental world supply.
Teck also will see a significant increase in revenue from its coal operations, since coal contracts are now renegotiated quarterly. The impact of the rains will be felt for the next year. That will give the company a chance to book the majority of the available leverage via their own contracted relationships.
The Australian rains have flooded an area the size of France and Germany combined. This region currently has 70% of its production in Force Majeure conditions, which means the coal companies do not have to supply their agreed contracted volume due to conditions beyond their control.
This is causing the Baltic Dry Index to drop significantly, as ships are parked with no load scheduled. Currently the BDI is at 20 month lows as demand craters for ships.
This has Asian steel mills desperately seeking new supplies to last them until the Australian pits can be drained and returned to operating conditions. That is going to be a multi month process, as employees also have to focus on repairing and fixing the damages done by the rains to their own homes.
So let's give Teck a quick review:
- It's the second-largest international seaborne shipper of hard coking coal exports.
Force Majeure is affecting its competitors due to Australian rains.
It's Canada's largest diversified metallurgical company.
And the realizable leverage to quarterly coal rates will be extremely beneficial.
Teck is one of those rare investments where weather events around the world will have a significant and long lasting impact on a company's profits. It only has to book the gains that are coming to its core market. I love to find leverage on a story - Teck has it.
Action to Take:
Teck is a highly liquid stock and is trading near its 52-week high. My suggestion would be to purchase half of your position now at market. I would then look to write some naked puts on TECK 2%-5% below the current market price. Currently the stock is trading around $63 dollars per share. It closed Friday at $62.42. The Teck 60 puts for February 2011 are currently bid 2.40 x 2.45. I would look to write a contract for every 100 shares you want in Teck that you didn't buy at market already: TCK Feb 2011 60.000 put (TCK110219P00060000)
We can generate a nice stream of regular cash flow, by selling Teck naked puts slightly out of the money from where it is trading. We will be paid to provide someone else with insurance on Teck, or to allow someone to bet against Teck.
In either case, we don't care. We are being paid cash to wait to enter a stock we already want to own. This allows us to build up a cash hoard to increase the overall size of the position when we do buy the last half of this entry. If the stock goes down below our 60 strike, we will have a discounted entry into the stock for the second leg. If it rises from here, we are paid cash to wait for our entry.
Disclosure: Jack Barnes holds no interest in in Teck. And he is not related to the TD analyst by the name of Greg Barnes who is following Teck and just raised its rating due to the weather conditions.