The equity markets can cure themselves. They make themselves better and it's something that's often unseen and totally inexplicable to all until much later when the improvement becomes self-evident.
That's how I feel right now toward a market that suddenly embraces everything it hated not that long ago, especially the speculative stocks of companies that live in the commodity world.
Let me start by pointing out two concepts: The first is that there is a tremendous short-covering rally going on. For months on end, stocks in the commodity, mineral and resources groups have been on the decline. Consider, for example, the case of Marathon Oil (MRO). In the heyday of the oil blow-off, the real run to the top, in the $100s, Marathon traded at $41. Three years before the peak, Marathon had split up from Marathon Petroleum (MPC), its refining and marketing company, to give investors pure plays on either end of the oil business.
Marathon seemed at the time to be both a logical takeover target and a fantastic fount of oil. It had borrowed a huge amount of money to become one of the largest independent major oil companies. It put up spectacular numbers in 2012 and 2013, earning $2.24 and $2.49 a share, respectively, and then as oil peaked in 2014 it reported an astounding $4.48 a share.
But in 2015, it lost an equally astounding $3.26 a share and all of that debt turned the stock from a darling to a pariah. At the end of last October, with the stock down more than 50% from its highs, the company slashed its dividend from 21 cents to 5 cents a share to save $425 million. At the same time, it indicated that its quarter would come in better than expected and the stock jumped 5% on the news.
It was a phony rally. Seven months later, with oil plummeting to $26, the stock dropped to $7 and then fell to $6 and change even as oil bounced off the $26 level. Oil then jaunted to $33 at the end of February, taking Marathon to $8.23. At the end of that day, Marathon announced an equity offering of 135 million shares "in the hole," meaning at a substantial discount to the last sale, although the discount was not known at the time. The company, seemingly desperate for the cash to keep drilling and to keep its bankers happy, priced the merchandise at $7.65, a discount so big that institutions flocked to it, and instead of selling 135 million shares, the company had demand for 145 million shares.
Ever since then, with oil continuing to rally, the stock never looked back, and with the stock at $11, the bottom-fishers were rewarded with a more than 40% gain in a little more than a week.
That's phenomenal.
But perhaps more phenomenal is that whatever worries there were about Marathon and its bankers seems to have disappeared with that billion-dollar-plus offering. Sure, it was dilutive, meaning that when earnings come back, each share will make less.
But the beautiful thing here is that the company will live to play again, even in a lower-price, longer-lasting downturn.
We have seen these deals before. Devon (DVN) sold 69 million shares at $18.75 each, 25% more than the company thought it could sell, and that came right after Devon stated it didn't even need the money. Its stock is at $24. Newfield (NFX) offered 30 million shares at $23.25, again at a nice discount to the last sale. Its stock is at $29.
All of these stock deals do two things: One, they give the company ample cash to keep drilling to cover interest expenses, and two, they give the banks breathing room not to have to write down debts. The former is why the stocks can pop so much -- consider it an instant steroid that makes them better. The latter is why the banks can rally as they have. They had been crushed by talk that they would have gigantic losses, but if these companies can all issue equity in the hole and so many buyers can make money, then why not expect that it can happen to pretty much any of these companies?
For example, we know Chesapeake (CHK) owes billions of dollars in debt. Its stock was at $1.50 one month ago. But as these deals have played out and oil has rallied -- even as natural gas, its real strength, is at 17-year lows -- it is possible Chesapeake could pull a Marathon and raise enough money to pay debts that it might owe for several years to come.
Given that we don't know when or if these equity offerings will occur, but we do know the stocks have run further than where they were the day before the deals, you can see why the higher Chesapeake goes the more it is worth. So why not buy as long as oil is running? Everyone's made money on every deal, so why should this one be different -- if, that is, they do one.
It's something that the bears out there, who have been coining money, suddenly have to fear. They didn't fear takeovers because the marginal oil companies all looked like they were about to go under. Now they have to fear the equity deals, which are proving to be quite formidable.
Now all bets are off if oil comes down, but it is safe to say that what you are seeing is the capitalist system at work. While there have been virtually no initial public offerings being done, these deals raise money as surely as an IPO does, and these companies live to play again.
There's something else at work here, too, that's worth noting. Simultaneously with these oil stocks and the commodity bottoming, we are getting extraordinary moves in other commodities. No commodity has been more decimated than iron ore. It's been falling from excess supply for many years now. Last weekend, however, the Chinese government announced aggressive goals for better growth and those who had been betting seemingly forever against iron ore frantically scrambled and this metal, basic for the making of steel, rallied 19% in one session! The impact?
Once again, it allows the iron ore companies to do the same thing as the oil companies if they want to as the iron ore stocks soar: Vale (VALE), the colossal Brazilian iron ore company, has seen its stock more than double in the last few weeks. Again, its viability can be extended in life.
Freeport McMoRan (FCX) makes copper, gold and oil. This stock has almost tripled from its January bottom when its very survival seemed at stake. I bet this company could easily sell 100 million shares and eliminate any near-term liquidity concerns, which would, again, allow the stock to climb ever higher. The virtuous circle at work.
Of course, these moves boost the shares of those companies that make equipment for the producers, hence the monster run in Caterpillar (CAT) from $58 in mid-January to $75 today.
What could be next? How about aluminum? The price of this totally non-precious metal has gone from 66.5 cents when the year began to 72 cents and change. One of the best shorts out there had been Alcoa (AA), which traded down with its namesake metal. But if aluminum keeps rallying, how can anyone justify staying short it, especially given that the company will soon be splitting into a highly value-added engineering company with about $6 billion in aerospace sales, very similar to that of Precision Castparts (PCP), recently bought by Warren Buffett and a pure play on rising aluminum prices.
I have mixed emotions about this whole rally. It is based on commodity prices continually rising, and that's not going to happen. However, with the companies that have issued equity able to stave off the grim reaper, you can presume that the worst may be over for any commodity stock that has advanced out of the $2-$3 range where investors tend to be scared that bankruptcy could be on the horizon.
Some have dismissed this whole commodity move as one gigantic short-covering rally. I have bad news for these bears: Every substantial rally I have ever seen in my career started as a short-covering rally. This one is no different. What's very true, though, is that, like when the banks did massive equity offering after equity offering back in the bad old days of the Great Recession, they, too got saved. This is the same thing. It's overly bullish and while it can't last forever, it is self-fulfilling and it's just plain bullish for a whole new beaten-down sector.
Random Musings: You should take a look at a very provocative piece about Trump and free trade and so many other issues by my writing colleague Matt Horween. Be prepared to have your eyes opened.
