Masters Seek Material "Subplots"

12/24/2004 12:00 am EST


Ken Kam

CEO, Marketocracy, Inc.

"Energy and materials are the  top sector weightings in our portfolio," says Ken Kam, manager of the Marketocracy Master 100 Fund. Here, he looks beyond the "obvious candidates" to find several lesser-known subplots within in these sectors.

"Not all energy investments are created equal. While the main story has focused on the general price of oil over the last several months, we’ve got another less-followed insight on where some of the most compelling stocks may lie within the sector. The subplot we are referring to the difference between sweet and sour crude, and what kind of opportunities may be available in this sector based on this factor. The price of oil that is most frequently mentioned in the press is the price for what is called light-sweet crude. Light-sweet crude is easier to refine into finished products than other grades of oil that are called heavy sour crude. For this reason, light-sweet crude typically sells for a premium over the heavy-sour grades.

"Because most of the incremental production this year has been the heavy-sour variety, an unprecedented spread in the price between light-sweet and heavy sour crude has opened up. Recently, the price for some grades of heavy-sour crude has been as much as $10 - $15/bbl less than light-sweet crude. The increased heavy-light spread is not ephemeral. It should continue as long as most incremental production, especially from OPEC, is likely to be in the heavy-sour grades.

"One notable beneficiary of this widening spread are the US pure-play refiners that have capacity to handle heavy-sour crude. Refineries that can process heavy-sour crude cost only a few dollars per barrel more to operate than those that can only process light-sweet crude, so the refiner pockets most of the $10 - $15/bbl spread. Standouts among refiners are Valero (VLO NYSE), Tesoro (TSO NYSE), and Premcor (PCO NYSE). Meanwhile, among oil producers, those that produce light-sweet crude benefit the most from a widening spread. Canadians Nexen (NXY NYSE) and Talisman Energy (TLM NYSE), and the Norweigans, Norsk Hydro (NHY NYSE) and Statoil (STO NYSE), look best.

"Meanwhile, within the energy sector, we have several top picks. Hyperdynamics (HYPD OTC) is an oil and gas exploration company we added to the portfolio in mid November. It’s share price traded sideways during the month, just above the $3.00 level, and it’s at a market cap of just over $130M. As a small company, shares of Hyperdynamics are likely to react more sensitively to oil prices - and based on our analysis, we expect for there to be upward price pressure in this sector going forward. We’ve watched Magnum Hunter Resources (MHR NYSE) consensus earnings estimates rise over the last month, and subsequently stepped in to add 60% more shares to our existing position during the last 2 weeks alone. As another oil and gas exploration company, we expect Magnum to add to the strong gains so far in the fourth quarter of 2004. Excel Maritime (EXM AMEX) began November with the announcement that revenues rose 86% for the first 9 months of 2004, compared to the same period last year. Since then, shares have traded strongly higher, from just under $25 per share to nearly $40 by the end of the month. We’ve been buying all throughout last month, as we expect continued performance from Excel going forward."

"Meanwhile, materials investments such as gold and precious metals serve as an excellent hedge against the continued devaluation of the dollar, while also protecting against the threat of inflation. We’re expecting foreign investment in the US dollar to continue to fall, which will automatically raise the dollar denominated price of gold. Additionally, much of the reinvested foreign proceeds will find their way into tangible stores of value such as gold bullion - another boon for the industry. But that’s not the entire story for the materials sector. Beyond the headline of the falling US dollar, there are several subplots around the globe that continue to benefit other companies operating in the materials sector.

"Among the metals and mining sub-industry lie companies dealing in copper, nickel, steel and coal. The demand for copper is driven by 300 million people in China and India achieving a middle class lifestyle with accompanying demand for plumbing & wiring. Nickel’s demand is being driven by developing Asia as well, this time for stainless steel. And the rise of coal is due to Asian demand as natural gas in North America has become too expensive an alternative. Between the natural relationship of a falling US Dollar to a rise in the price of many commodities-based companies in this sector, and the global demand story, the catalyst for our Materials investment is in place. Here are our top sector picks:

"Novagold Resources (NG AMEX) is a natural resource company engaged in the exploration and development of gold properties in North America. During the last two weeks, we’ve increased our position in NovaGold by over 70%, as we expect this gold producer to be one of the stronger performers in the Gold industry. Meanwhile, During November, we more than doubled our position in Cambior (CBJ AMEX), whose revenues for the third quarter of 2004 grew more than 74% over the same period one year ago. With Gold prices near recent highs, and gold production targets being hit already for the year by Cambior, we have high expectations for this pick. Finally, Methanex (MEOH NASDAQ), the world’s largest maker of methanol, announced during November a stock repurchase plan and quarterly dividend. These plans to enhance shareholder value were positive signs that gave us comfort in establishing a position during mid-November, and then increasing that position by roughly 600% in the last two weeks of the month."

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