Short selling update July 2014

So far I have shorted the common shares of more than 80 stocks this year.  On common shares, I have been profitable overall despite a rising market.  Unfortunately, losses on put options (mainly YONG) have more than wiped out the gains on my common stock shorts.

I think that I’ve gotten fairly good at spotting bad stocks.  My CAPS account is a reflection of that.  (*CAPS does not consider the mechanics of borrowing shares.  It’s unrealistic.)  Unfortunately, I’ve been losing money on put options this year.  Part of this may be because I mainly short small cap stocks which are too illiquid to buy put options on.  As well, many of my shorts are volatile so the put options would be neither cheap or attractive.

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See below for commentary on certain positions.  Keep in mind that due to the sheer number of positions, my research on short positions is typically very shallow.

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Most of the time nobody will explain the game to you

In many areas of life, the sharpest people in a given field often won’t explain the tricks of the trade to the general public.  Sometimes it’s the case that the publicly-available information on a subject is second-rate.  Take Warren Buffett for example.  His derivatives deals are brilliant because he is getting paid to borrow money.  Of course, he does not fully explain his deals because he doesn’t want others copying his trades. In shareholder letters, he does not explain how his counterparties were inappropriately modeling equity-equity correlations.  He only discussed the trades on a superficial level because GAAP accounting of the derivatives were causing people to misunderstand Berkshire’s intrinsic value.  Buffett likely avoids explaining Berkshire’s credit default contracts for similar reasons.

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CACC Part 4: Will subprime auto lending end badly?

I think that the word “subprime” has an undeserved reputation.  The US subprime housing crisis was a very unusual situation caused by extreme levels of loan fraud and loans designed to blow up (e.g. ARM, negative amortization mortgages, etc.).  These excesses do not exist in other areas of subprime lending.  During the housing bubble, lenders did not verify income and allowed unemployed individuals to buy millions of dollars of housing.  In the current auto market, the lenders actually check that the information given to them is correct.  According to CACC’s training website, 75% of loan applications are initially rejected due to problems with the loan application (e.g. a utility bill to verify residence is too old).  The subprime lenders tend to perform the most loan compliance work (out of necessity) while prime lenders have fewer stipulations, looser loan compliance, and less onerous paperwork.

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Silver Standard sells shares of Pretium in secondary offering

Here is Pretium’s press release.  Silver Standard seems to be in a strong financing position given that the company has around $671M in current assets (versus $333M in total liabilities), a producing mine, and a book value of $837M.  Instead of investing this capital in producing assets, the company is selling a mining asset (part of its stake in Pretium) for cash.  In my opinion, Silver Standard is not making a mistake.

*Disclosure:  I am short Pretium common shares and will be holding onto my position.  I don’t follow Silver Standard and have no interest in it.

CTGO: Closed my position

Contango Ore is a company that should be releasing news but isn’t.  The reason to own it is if you think that it has a promising deposit that has very good chances of turning into a mine.  In that scenario, the logical next steps for CORE are:

  1. Complete a resource estimate and then a pre-feasibility study.
  2. Start hiring people with mine engineering experience.
  3. Start working on financing.  The company could bring in a partner that brings mining experience and some financing, e.g. seniors like Goldcorp, Agnico Eagle, Teck, etc.
  4. Perform additional drilling and/or announce plans for the next exploration season.

The lack of news makes me very antsy.  Something may not be right, e.g. the company has had difficulty selling the deposit or raising capital because the deposit is a dud.

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CACC Part 3: Why Credit Acceptance is brilliant

In my opinion, Credit Acceptance has excellent execution across all areas of its operations:

  1. Creating value for dealerships.
  2. Servicing loans efficiently and keeping costs low.
  3. Learning how to underwrite well across a wide range of situations.
  4. Being disciplined in underwriting.

Very few companies do all four of these things well.

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CACC Part 2: The fundamentals of subprime auto financing

Originally, there was a segment of subprime auto financing that was a fairly low-risk for dealers extending credit to their customers.  If the downpayment is equal to what the dealer paid for a car, then risk management is much simpler and underwriting skill doesn’t matter much.  The dealer could lend money to even the riskiest customers.  Dealers could break even on the initial sale and hope to profit from the financing of the car.

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