How We Bet, Part IV: Is the Odds Engine a Cure for Common Estimation Errors?

In our experience, yes: It protects us from asymmetric skewing.

It is of a union between projections of future value and bias that asymmetric skewing is born.

What is an estimation error?

An estimation error is the difference between an estimated value and the actual probabilistic value.

Most estimation errors that we run into are products of handicapping. Let’s use Denison Mines as an example.

We use a period of 23 Years in order to calculate Benchmark Odds against which to measure Denison’s Implied Odds. Without the Benchmarks, we would not be able to determine the presence of value.

PRICEBENCHMARK ODDSODDSVALUEImplied Probability
0.6117/65/1No16.67%
0.5212/112/1No33.33%
0.464/191/2No66.67%

As you can see, we don’t have any long value bets staring us in the face, but even so, the odds of rising to 0.46 in 2020 are quite good — 66.67%.

Interestingly, that’s not far off the mark of Denison’s intrinsic value at $24.70/lb. U308, which we’ve estimated at 0.41. So it looks like, from a fundamental standpoint, shares can be picked up today at a 11% discount.

That’s great, but where are the estimation errors?

The big estimation errors occur when an estimate of future value is calculated. For instance, take Denison’s valuation at $30/lb. U308. At $30, we think Denison is worth 0.49/share. And if somehow, by some miracle, spot uranium popped to that level, Denison would have a 33.33% chance of rising to its calculated valuation.

But the market is stubborn. It simply will not revalue a stock in concordance with your projections. And it is of a union between projections of future value and bias that asymmetric skewing is born. In other words, your own estimation errors have convinced you that your betting odds are considerably better than they actually are.

The odds matter…

PRICEBENCHMARK ODDSODDSVALUEIMPLIED PROBABILITY
0.377/161/2No66.67%
0.3114/93/1No25.00%

Here’s another consequence of estimation errors: You miss out on the value bets* that intersect with good odds.

*The 0.37 price point was so tantalizingly close to representing a short value bet at great odds, that it would have been a shame for a value bettor to pass up (Note: It wasn’t passed up, obviously.)

URANIUM: Now the Real Carnage Can Begin!

Now that the majority of our initial Odds Engine downside targets have been reached (see here and here and here and here), the real carnage can begin:

And from our post of 12 December 2019 — Cycle Death and the Uranium Junior — were you curious about our estimated time-frame for a bottom:

P.S. It’s important to remember that the 900% return you expected on the stock you bought at $0.50/sh. and which has declined by 90% to $0.05/sh., now is represented by a rise to a mere $0.50/sh. There are still good trades to be had down the pike, but this requires that position size scales proportionately as shares cheapen.

Uranium: The Downside, Probabilistically Speaking

PREAMBLE


First and foremost, we are traders. We play the odds. Sometimes the odds aren’t good, but even poor odds at a fair price can be profitable. And at the end of the day, that’s what matters to us: making money. But in order to do that, one must preserve one’s independence. That means being willing to hold an unpopular opinion and to not be beholden. Being beholden to peers or to the management of the companies in which one invests, unduly colors judgement to the extent that the odds are no longer perceived in the cold, calculating light in which they must be regarded.

Someday, the odds for long trades in uranium stocks will improve. We look forward to that day. In the meantime, we are happy to hold the unpopular opinion that the bear lives and breathes, even if it costs us ‘friendships.’

ADDENDUM


Probabilities are a sport for me and for my business partner, my beautiful wife Tina. We have developed rigorous buy and sell standards that leverage probabilities, but there is one sector on which we broke every rule and subverted every standard, buying against all odds, when all indicators pointed to trades with an exceptionally low probability of success: uranium.

Every last one of our uranium holdings represents a bad bet. We were suckers. Bad bets at good prices are forgivable, but we can’t even claim to have bought any uranium names, save for Forsys, at a good price.

My mantra has always been ‘lower for longer,’ but I never imagined that I’d still be saying lower for longer 3 years after taking our initial stake in Goviex. I’m still, gulp, saying it.

We have never participated in a sector with bleaker prospects — prospects that grow dimmer daily. Yet we plan to hold our uranium book in spite of the odds against it, as we are allocated in a way that guarantees that we can not be annihilated in the worst of downturns.

However, this may not be the case for all of you. Are you allocated in a way that will enable you to weather a fierce acceleration of the uranium bear market? Will you live to fight another day if your portfolio’s uranium constituents drop by 50%? 75%? Are you hedged?

So here it is: I can’t think of a single thing about the sector to which one may look forward and consequently, I am officially a bear, albeit a long/hedged bear. I see uranium oozing out of every sewer drain and sidewalk crack. Every dish is served with a side of it. I find it behind my son’s ears when he’s taking a bath. There’s just too goddamn much of it. And until there isn’t, the high probability setups belong to the shorts.

$DYLLF : Deep Yellow to Fast Track Tumas PFS

The impressive results from the [Scoping] Study clearly demonstrate advancing this project to the pre-feasibility study stage is justified, appreciating that uranium prices are expected to improve strongly over the next two to three years. With this approach, the Company has a significant opportunity to continue prudently advancing the Tumas palaeochannel deposits in a cost effective and timely manner and assist in achieving our aim of establishing Deep Yellow as a tier-one uranium producer.

John Borshoff, “Positive Scoping Study Delivers Pre-Feasibility Study Go-Ahead”

Cycle Death and the Uranium Junior

We observe cycle death on a regular basis. It often presages a rebirth. But precious few traders have the stomach for it.

Presently, cycle death has occurred in Fission, Denison, Deep Yellow, NexGen and GoviEx. The cycle, interestingly, remains intact for Forsys Metals. We have an idea why Forsys hasn’t uncoupled from its long-standing cycle, but that’s for another day.

What is cycle death?

It is the point at which price becomes unhinged absolutely from previously established long-term cycle patterns. All of the above-mentioned names shared an almost identical cycle length of XX Weeks (The Basis of Our Approach: An Edge on the Margins).

Cycle death struck Fission at its peak in January ’18 but did not become evident until approximately 12 months later. GoviEx uncoupled from its cycle in April of this year. Denison and Deep Yellow decayed out of the cycle following their respective September ’18 peaks and NexGen has decayed out since November ’18.

Why does cycle death happen?

Cycle death is a process — sometimes a long one — caused by capitulation. Structurally, cycle death and price decay are important for the health of any subsequent recovery. Complacent shorts also are known to add during low-volatility cycle death, which leads to ferocious short covering during the early stages of a recovery.

When does cycle re-birth occur?

We like to see pivot compression, low volatility, flattening price curves, and extrapolated price indicators turn upward before we feel confident calling a recovery.

Conclusion

We like cycle death. It’s one of the more reliable indications of true bottoming, which hasn’t been evident until recently in uranium stocks. It is also the point at which we like to add most aggressively.

I’ve been vocal about the dim prospects for uranium stocks and have on several occasions been adamant about lower prices for longer. But, I’m happy to report that I don’t think prices will remain lower for too much longer, as we’re getting the structural prerequisites ticked off for a rally.

Finally.

NuChem International Catalyst Fund Annual Rebalance

SYMBOLWEIGHTING
PIRGF1.15%
VNNHF1.25%
TGB1.26%
LRTNF1.29%
AUNFF1.32%
TMRC1.47%
TSRMF1.47%
DYLLF1.69%
BCEKF1.78%
MGDPF2.20%
GUYFF2.23%
FSM2.45%
ARNGF2.50%
SBGL2.58%
VITFF2.60%
AG2.89%
VGZ2.91%
SSPXD3.23%
AAU3.31%
POTRF3.49%
FOSYF3.53%
EXK3.69%
PZG3.73%
DNN3.75%
ASM4.04%
IAG4.36%
HL4.48%
ALO5.44%
NXE5.59%
EQXFF5.81%
FCUUF5.88%
GVXXF6.61%

Oh, Look, a Shiny New Uranium ETF, but Why Aren’t My Stocks Moving?

There are two reasons. Well, actually one, which works two ways: Operational Shorting and Operational Buying, common activities associated with the creation/redemption process. For our purposes, we are chiefly concerned with the former: Operational Shorting.

Huh?

Take URNM, for example. It’s a new uranium ETF issued by Exchange Traded Concepts on the behalf of North Shore Indices. Folks will certainly line up to buy units under the innocent assumption that the securities the fund ostensibly represents will in turn be purchased, thus boosting prices, and these folks aren’t to be blamed because the basic, albeit misguided, expectation of the average ETF investor is this: I buy ETF shares and the authorized participant (AP) will in turn buy shares of the companies of which the fund is composed. But this doesn’t always happen. In fact, for some ETFs, it almost never happens as advertised (e.g., Global X Uranium ETF).

So what does really happen?

Well, instead of buying the represented securities, APs have found that they can make oodles of moolah by selling you nonexistent ETF shares that may be generated at some date in the future. This is Operational Shorting. You can even gauge when Operational Shorting is taking place or is about to take place by measuring the growth of creation units, which typically are made up of up to 50,000 ETF shares each, relative to price-action of underlying securities.

Operational Shorting is what underlies much of the puzzling behavior of boutique ETFs: Investors buy the ETF, the ETF may even rise a bit in price, but the stocks the ETF is supposed to represent don’t budge — because no AP is really buying a single share of those companies! It’s a swindle that is a built-in function of ETFs and it is legal under present market making rules.

APs for URNM, for example, can sell you new ETF shares to fulfill your order, but the APs will very often opt to delay physical share creation.

What is ‘physical share creation?’

Physical share creation is the actual practice of purchasing the shares of the securities (e.g., GoviEx, Uranium Participation, Cameco, etc.), then swapping the actual shares for the ETF shares that were initially issued to you to fulfill your order. In an honest world, physical share creation always happens, but this is not an honest world. In this world, you often hold AP-issued placeholder paper (naked) for ETF shares that have not yet been created and that may never be exchanged for real shares of the companies you think you are investing in.

What to watch out for:

For starters, watch volume. A creation unit is composed of 50,000 ETF shares (In the case of URNM, it may be 25K). Once order balance rises or exceeds this level, ETF shares, if they aren’t naked, are supposed to be swapped for the aforementioned securities (physical share creation). If volume is pumping in your ETF beyond the level at which creation units may be exchanged for actual securities but the underlying securities aren’t moving, you’re probably witnessing Operational Shorting by greedy APs that crossed the Rubicon.

This is rarely the fault of the ETF’s sponsor. They want to build the ETF of their dreams, full-to-overflowing with the unsung companies that they believe deserve your attention and capital, but are otherwise ignored by Mr. Market. But there’s a problem. A lot of these companies were ignored by Mr. Market because they are illiquid. And many ETF managers don’t realize that this will pose a problem for their ETF until the ETF has debuted and order imbalances start building — a situation of which APs soon take advantage.

Tom, as usual, you’re confusing me. Help me understand this problem.

Okay, so the ETF owns these deserving, illiquid stocks, like Global Atomic or Bannerman Resources and investors are lining up to buy them, utilizing URNM as a proxy. So far so good. But APs soon discover that the ETF is substantially more liquid than the underlying securities with which the ETF has been padded out. They’ve got half a dozen creation units built up but there’s no way to exchange them for the underlying securities without upsetting price or incurring liquidity costs, which can be high. At first, the APs typically do nothing unless or until order flow reverses.

Tom, what are you saying?

When order flow reverses while APs are sitting on unswapped creation units, APs may elect instead to earn the ETF’s own bid-ask spread rather than incur the trading costs associated with buying the fund’s underlying securities, effectively initiating an Operational Short.

Hey, maybe this new ETF is different and its APs will subordinate self-interest to the interests of the fund’s investors. Time will certainly tell. It always does. If the rumored 25K is indeed URNM’s creation unit threshold, then it has had time to build its first creation unit. Will it be exchanged for underlying securities or will URNM’s APs pull a pig in a poke?


At 0.85%, URNM also carries an expense ratio that is more than double the average ETF. Needless to say, management is going to do exceptionally well, even if you don’t. As an investor, I’d want to know why the OER is so high and the name of the yachts it’s paying for.

$DYLLF : John Borshoff’s Shopping List

We think a bid of up to U.S. $55M (cash and shares) for turnkey Kayelekera is possible in an effort to begin padding out Deep Yellow’s 2023-2030 development pipeline.

In other words, Borshoff certainly could strike a better deal than has already been made with Lotus — a deal with which the Malawi government would be comfortable, as the preexisting one that Paladin struck with Lotus is raw. It is our hope that Bintony Kutsaira continues to stonewall the June A$5M arrangement.

Were I Borshoff, I would aggressively undercut Lotus and negotiate with Kutsaira a mine stake boost of up to 30%, from 15-20%, in exchange for generous tax breaks through 2030.

This is just our opinion. As always, anything can happen.

We also think Forsys Metals is an attractive acquisition target, with each outstanding share of Forsys presently representing a whopping $15.11 worth of U308, or ~0.6 lbs./share (you WANT to command a lot of resources per share), a result of the company’s long-term commitment to effective dormancy and ultra-low cash burn.

Another metric that probably hasn’t gone unnoticed is Forsys’ Market Cap Valuation per Resource Lb., which is a mere $0.14, which in our eyes, makes the company one of the most undervalued development-stage uranium names.

Additionally, Forsys Metals’ $12.8M market cap is currently valued at half a percent of the value of proven reserves at Norasa ($2,371,805,000), which is outrageous.

$CCJ : Cameco — Levels We’re Watching

Cameco is in a tricky position, technically speaking. Sellers are in control, albeit marginally. Without a move above 10.30 next month, the stock will end the year with a bearish bias, with a price-neutral start in 2020.

Come January, we will be looking for buyers to enter at 8.16. If they get traction, we anticipate renewed selling interest at 10.53. If buyers usurp bears at 10.53, we will be looking for a fight through congestion to 11.85, a clear break through which clears a path to 14, 15.18 and higher.

On the flip-side, if buyers prove too weak at the 8.16 level, a dip to 6.85 is possible with a subsequent decline to 4.70 and lower, at which price we would be ferocious buyers.

To sum it up, we are buyers above 11.85 and short-sellers under ~6.80, covering and repurchasing just under 5.