Barron's makes the case for Valero in its recent issue. The stock is down 30% this year after an 8 fold stretch as oil made its march toward $100 a barrel. Valero recently projected lower earnings, but analyst are expecting a bump coming into the summer driving season. At issue for Valero are the crack spreads. Recent short-lived negative spreads have became positive again at $7.43 a barrel. The recent spreads are well below the $40 a barrel from last summer, but above the $3.50 a barrel average of the 1990s. Analysts are expecting at least $10 spreads in the near future. Valero is also expected to generate cash by selling some of its 17 refineries, which should command a nice price given that not only is it near impossible to build a new refinery (at least in the U.S., and certainly not in a short amount of time), but the Valero refineries are also able to refine the heavier, sour crudes. Given demand, earnings forecasts, and stock buybacks, analysts see profitability, even without selling refineries. Deutsche Bank has a price target of $72, 64% above the recent price (as of 4/12/08). No doubt that Valero has been beaten down, but a number of things need to occur to reverse the recent slide, some of which may be outside their control. Recent chart activity also looks poor, and the trend is in the wrong direction. Picking a bottom at this point and trying to be a hero may not be the best strategy. Giving up a little upside to see if the story has changed is probably worth the wait.


Ticker: VLO

Implied volatility has recently decreased on the S&P 500 Index options. As mentioned in Barron's: "This follows the Federal Reserve's decision to finance investment banks, seen by many investors as the equivalent of a massive put option that reduces the future possibility of extremely low stock prices." Many options investors are going cash. The low volatility reduces the premium for selling options, while the recent actions in the market (poor news and little upside, Fed propping up various industries) currently makes both long call and long put options suspect, even with lower prices.

What could cause a change? Many believe either continued poor earnings season, or a drop in consumer spending. In a recent post we discussed the lower returns generated during earning season over the last 5-6 years. Credit Suisse recommends that to hedge against poor corporate earnings, investors should take out a bear spread, buying S&P 500 SPY May 135 puts, while selling May 125 puts. Goldman Sachs gives a similar position bias, but recommends hedging with SPY puts that are 5% out of the money. As mentioned in Barron's, "Those are both good ideas, as GE's earnings shortfall may signal more bad news and rising options volatility."

Tickers: SPY

The recent issue of Barron's has an article with Jim Rogers. While Rogers can get downright depressing at times, the truth sometimes hurts, and is certainly good to hear every now and then (imagine that). Beyond commodities, Rogers mentions that "perhaps the safest investment is the renminbi, the Chinese currency." Rogers has a built in bias toward China (he even moved there so his daughters could learn Chinese), but the strength of the Chinese economy does bode well for the renminbi. A spread between the renminbi and dollar, even with a potential dollar rally, might not be too bad an investment, especially given the amount of U.S. debt in China and throughout Asia. Rogers is also buying airlines, mainly international airlines, partly due to the increased fares and full planes he is observing. As for commodities, Rogers believes we are not in the initial stages of the commodity bull market, which probably began around the turn of the century, but somewhere in the middle with maybe 10 more years to go before we see a long-term reversal. Even so, he expects to see some corrections over the next 10 years, but does not expect to see overall commodity demand fall off. Given that no major mines or fields have been found recently, and the fact that it takes a long-time to even bring a new mine or field on-line, the bull market in commodities looks fairly safe for the foreseeable future.

It looks like structured products are not for everyone, even those that advise investors on structured products. As reported by Investment News, a recent survey at the Structured Products Association convention in New York (who knew they had a convention?) showed that 40% of over 200 industry representatives at the convention do not invest in derivatives-based products. Maybe they know something we don't. Or possibly, just the opposite. Like others, maybe they have no idea how some derivative-based structured operate, or what the risk are. Of course, they do know one thing - they generate huge fees.

Forbes is speculating how the "euro experiment" may come to a soon end. The problem is that each of the euro-based countries has its own unique monetary problems. Apparently there is growing tension in countries with inflationary pressures (such as Germany, Austria, and the Netherlands), and countries with growth pressures (such as France, Italy, and Spain). If countries start to break from the euro, the spiral unwinding could be hard to stop. To take advantage of a break from the euro, the author suggest shorting the euro and buying the dollar, or possibly selling investments in Italy and Spain, while buying fixed-income assets in Germany.

Some of the same financial engineering that contributed to the recent credit problems is being used to provide liquidity during the recent credit crunch - with the help of the new Fed Primary Dealer Credit Facility. Apparently, Lehman Brothers has moved about $2.8 billion in loans and risky LBO debt to an off-balance sheet structured investment vehicle, which then issued debt securities that were backed by the loans and debt. The vehicle used was a CLO (collateralized loan obligation), which was split into two parts (tranches). The first part, around $565 million, was not rated, but was structured to incur the first 20% of losses. The second part contained the remaining $2.26 billion in securities. Since the pool would need to lose at least 20% before the second part would suffer losses, credit rating agencies assigned it an "A" rating - yes, those same agencies that many don't really trust anymore.

This is the point where the Fed comes in. Since the $2.26 billion has an investment grade rating, Lehman can pledge it as collateral, utilizing the Primary Dealer Credit Facility to obtain low interest, short-term loans. Why all the trouble? The Fed only takes securities that have market prices and investment grade ratings. The risky LBO junk rated debt does not qualify. This is where the CLO comes in, allowing Lehman to create an entirely new vehicle with investment grade ratings.

Of interest is how some on Wall Street are calling the move "brilliant," allowing "investment banks to get liquidity from assets that they don't want to sell at fire-sale prices," while others are disgusted that the credit rating agencies are being used again in this way. Finally, some just think the move was more of a test to see what the Fed would accept. I guess now we know.

Bloomberg is reporting how a commodity hedge fund advised by Brain Hunter is up 49% in the first quarter. The fund mainly trades energy contracts, such as crude oil and natural gas, using options to profit from price differences. Of interest is that Hunter is the trader who lost $6.6 billion for Amaranth Advisors back in 2006, after making $1 billion going long natural gas futures after hurricanes Katrina and Rita. Apparently things are different this time around since the fund, called the Peak Ridge Commodity Volatility Fund, from Peak Ridge Capital Group, apparently maintains control over trading and risk management. Hunter is acting only as a consultant, developing trading models and strategies for the fund.

As the MSFT-YHOO saga continues, it appears that more of the "strategy" is beginning to unfold. As we have discussed in other posts, the various players being talked about (News Corp, Google, Time Warner - AOL) could end up being components of any deal, but that may be secondary to the discussion. What each provides is leverage. In essence, Yahoo! wants a higher bid, but Microsoft does not want to bid against itself. Enter the new players. Without even making a real bid for Yahoo!, they give this appearance, or at least the illusion, of more value, allowing Microsoft to raise the stakes. Given recent developments, I would not be surprised to see Microsoft offer $33-35 a share, allowing everyone to be happy, go home, and avoid any more confusing partnerships - some of which may actually destroy value. The fact still remains that Microsoft needs Yahoo!, and Ballmer needs a win - all toes are too deep in the water already. The additional discussions have also given Jerry Yang the time to realize that his baby has grown up and is probably going off to college in Seattle. Always painful, but part of the process.

As was pointed out by a Bull Bear Trader reader, Google will probably be the winner in all of this. Notice that they really did not offer much, just enough to keep things interesting and honest, and more importantly, messy. I am sure they prefer two weaker search engines as competition, instead of one stronger one, but it may not matter in the end. As mention in the WSJ: "Google handily won the last phase of online competition focused on the small text ads tied to Web searches. Those ads account for roughly 40% of the U.S. online ad market." So successful is the search advertising, that even Yahoo! is farming out tasks to Google's AdSense.

Of interest in the WSJ article is how Google and its competitors are moving to display advertising, such as banner and video ads. Currently, these types of ads only account for about 30% of U.S. advertising dollars on the Internet. As viewers move from TV to the Internet, more advertising is also being placed on video sites, and sites for women's issues. Google dominates search advertising, but display advertising is still being fought over. Google's YouTube purchase, and Yahoo! recently introduced site Shine (see other posts, or http://shine.yahoo.com/), are well positioned. This is where a combined Microsoft, Yahoo!, and potential News Corp. agreement is critical. It could also allow News Corp. the opportunity to further leverage advertising at MySpace, beyond previous agreements with Google. Better opportunities (i.e. better profits) may be available, but integration will be challenging. Previous talks with partners have failed, and as mention, News Corp. may just be a secondary player in the current discussions.

Tickers: MSFT, YHOO, GOOG, TWX, NWS

Fast Money is once again mentioning the agriculture plays. Of notable interest is Dupont, which recently raised guidance once again after just raising it one month earlier. Option activity is also strong in the stock. Two other less popular stocks mention include Syngenta (which is like Monsanto in Germany) and Eastman Chemical Company. Eastman also recently raised guidance, stressing that higher sales volume is more than offsetting higher raw material cost. Technically, the stock is also displaying a bullish pattern after breaking out on guidance.

DD, SYT, EMN

Analysts at RBC Capital Markets are suggesting that investors should take profits in gold as the traditional summer slowdown approaches - with the slowdown this year coming in concert with the potential for the Fed to quit lowering rates, thereby easing inflationary pressures. RBC then suggests buying back gold (hopefully at lower levels) in July, waiting for the rebound in gold prices that should occur in September or October.

The RBC analysts uses some data to support his/her case. Apparently the one year average return for gold equities following the beginning of an interest rate cut cycle is 17%. The current cycle began over 6 months ago, with gold and gold equities returning over 20%. The average cycle last about 8 months. Once the rate cuts begin to take effect (usually delayed 6 months), gold will generally under-perform the broader market.

Certainly worth considering, and interesting, but more research is probably in order. Keep in mind as well that gold plays often end in tears, as reversals are at times steep, swift, and unexpected.

RBC Recommended Tickers: KGC, HMY, JAG, and WGW
Other Gold Tickers: GLD, GG, NEM, ABX, AEM, KGC

BHP Billiton shares were up after a report stated that China is planning to build a 9% stake in the company, in part to have a say regarding BHP's proposed takeover of Rio Tinto. It is believed that China fears the takeover will give BHP additional pricing power over key commodities that the country needs. Not sure what "have a say" implies as far as controlling commodity prices, other than an attempt to block any deal. Is this rumor, and does it have legs? Hard to see the impact on commodity prices.

Tickers, BHP, RTP

Not much of a surprise, but inflation is reaching high levels all across the globe. We are well aware of increases in commodity prices, as a result of higher agriculture products to make alternative energy, and higher energy and raw material costs due to increase global growth. What often gets overlooked is how the weakening dollar is also having an impact on inflation, and not just in the U.S. Since many countries link their currencies to the U.S. dollar, these countries and their economies are forced to feel the impact of U.S. Federal Reserve rate cuts, even if their economies are not slowing. Of course, lower rates and a cheaper currency are just the opposite of what these counties may need when faced with inflationary pressures.

It is amazing how fast things develop when it gets personal. The latest news from the WSJ reports that Yahoo! and Time Warner's AOL (which they may like to give away cheap, just to get it off the books and out of their memories) are close to a deal to combine Internet operations. Of course, Microsoft is developing its own battle plan, hooking up with News Corporation in an effort to possibly mount a joint bid for Yahoo! and its new partners - Google, AOL, .... and everyone else who hates MSFT. An interesting statement in the article is that "Microsoft and News Corp. have yet to reach an agreement on joining forces but one person apprised of the plan described the discussions as serious." Now why would the WSJ have the inside track on a possible MSFT / News Corp deal? Hmmmm.

Of interest is how AOL (aka Time Warner) would purchase shares of Yahoo! at a price above the Microsoft offering price. Essentially, AOL and some cash would come Yahoo!'s way. The deal would not include AOL's dial-up access business , and would value AOL at $10 billion (do they still have a viable dial-up business, and does anyone except the AOL dial-up or broadband folks go to the site?). Yahoo! would use the cash to buy back stock in the $30 to $40 range.

The question that gets lost in all this is whether all these partnerships are actually good for Yahoo! shareholders, or even Microsoft for that matter? Will the combined partnerships be worth more than $31 a share? Some analysts are already skeptical. Looking at the new proposed partnerships, Yahoo! seems to be getting the short end of the stick. AOL brings less to the table, other than a declining business, albeit a still significant number of eyeballs (still 4th overall with 109 million visits in February - although every time someone logs on the Internet - with either their AOL dial-up or broadband - they hit the site, even if they don't intend to, or plan to stay around). News Corp, on the other hand, brings an increasing social network to the plate with MySpace and their growing media presence.

At first blush it looks like Yahoo! is strategically placing itself in a position to command a higher bid, while Microsoft is setting up an alliance that will allow it to offer a higher bid. With a new partnership with AOL, Microsoft can rationalize a higher bid, and still save face (at least a little). In the end, everyone may realize that the $31 per share was a good price, and certainly less complicated for valuing the deal.

Tickers: MSFT, YHOO, GOOG, TWX, NWS

Citigroup is close to selling $12 billion in loans to a group of private equity firms that include Apollo Group, the Blackstone Group, and TPG. The average price is just below 90 cents on the dollar. The loan sale is an attempt to help sure up their books after incurring exposure to $43 billion in leveraged loans last year. Another good call my Meredith Whitney a few weeks back.

Tickers: C, BX

One of Yahoo!'s largest shareholders, Legg Mason (almost 7%, 2nd largest holding) said it is prepared to support Yahoo! in its effort to remain independent ........ should Microsoft lower its offer. Legg Mason portfolio manager Bill Miller goes on to say Microsoft blundered by threatening to offer a lower price, but that if Microsoft were to offer even $1 dollar more per share over the original $31, it would go a long way to appeasing shareholders. Translation: Please offer more, we have no other options. In fact, he does goes on to say that Yahoo! does not really have any other good options, but also that Microsoft needs the deal to happen. I still expect a slightly higher bid, and agreement. Of course, with Ballmer, you never really know.

In related news, analysts from Piper Jaffray Piper mentioned that their survey of 20 institutional Yahoo investors showed that a majority favor the current deal to no deal.

Tickers: MSFT, YHOO

Some firms on Wall Street are actively trying to reassure investors that they are reduced their exposure to borrowed money, given the recent problems at Bear Stearns. Of course, to reduce leverage, firms must either raise money or sell assets. In the current market, both are proving to be costly. Furthermore, reduced leverage means reduced profits, at least in those areas where firms were able to increase profits by using leverage to their advantage. Before the recent credit problems, such firms had ratios of assets to shareholder equity of 30 or more. Goldman Sachs may be one holdout, with a ratio of assets to shareholder equity of 28.2 in their fiscal first quarter, up from 26.2 as of last November. A Goldman Sachs spokesman is reported to have stated that they are comfortable with current leverage levels, and that current measures of financial strength are misplaced. They believe that risk-adjusted capital and the quality of assets are more important measure for performance. They stress that they are focused more on opportunities and observed stresses, and less on leverage compared to liquidity. Of course, shorting sub-prime paper at the right time also helps (the spokesman did not make the last statement, but probably wanted to).

Ticker: GS

Yahoo! executives reiterated today that the Microsoft takeover bid "substantially undervalues" the company. They did leave the door open by stating that they remain open to a deal if it "is superior to our other alternatives." Other alternatives? Such as the price dropping back into the teens with a bid withdraw? Such as Microsoft lowering their bid and taking an even more aggressive approach, such as nominating a new board? My guess is they are looking for a higher price, and Microsoft is likely to pay up, regardless of what each side is saying in public, but who really knows. With comments like "Moreover, Steve, you personally attended two of these meetings and could have advanced discussions in any way you saw fit," it is certainly getting more personal - which always complicates things.

Tickers: MSFT, YHOO

Barron's discusses Wyeth's new Alzheimer's drug. The company's initial Alzheimer's vaccine caused some patients to develop encephalitis, but later studies showed that the vaccine reduced the deposits that also caused the disease. When the part that attacked the plaque deposits directly was tested alone, positive results developed. The drug has been fast-tracked by the FDA, with phase II results expected in June. If successful, some are expecting this drug to be one of the largest selling drugs in the future. Given that 1 of 8 over the age of 65, and 1 of 2 over the age of 85 are expected to form some level of Alzheimer's, along with the increased numbers of baby boomers entering this demographic, the potential could be tremendous. With phase II and III results still forthcoming, caution is in order. Nonetheless, the company is certainly worth keeping on the radar. Wyeth's partner in the research is Elan.

Tickers: WYE, ELN

Barron's this week has a nice story about DryShips, the chartered cargo ship company. The company has 39 vessels that haul iron ore, coal, and grains by sea. The stock is down over 50%, but the fundamentals are starting to look nice. At $64 a share, the stock is trading with an estimated P/E ratio of 3.5 if earnings come in at over $18 per share, as expected. The stock is trading down compared to its peers, who typically have longer, and less volatile contracts. Barron's estimates that even if profits fall 50%, the P/E will still only be around 7. Charter rates have dropped significantly over the last 6 months, but have recently been moving back up. Given higher rates, some worry about new ships coming on line, but barriers to entry are high, given the initial cost and current credit issues in the market. It is expected that delays and retirements will also prevent new ships from outstripping demand. Other actively traded stock in the industry include Diana Shipping (DSX) and Kirby Corporation (KEX), both mainly in the petroleum transportation business. Kirby recently gave a bullish earnings forecast, and Dryships reported in February higher profit, with revenue tripling.

Ticker: DRYS, DSX, KEX