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Why The Stock Market Casino Is Dangerous: The Case Of Looney Tunes In the Sand Dunes

Tyler Durden's picture




 

Submitted by David Stockman via Contra Corner blog,

On August 4th the Wall Street Journal carried a breathless tale of how a handful of obscure oilfield suppliers were striking immense riches in the sand dunes of Wisconsin. Owing to the “shale revolution”, the stock price of an outfit that had originated in the  stagnating business of supplying sand traps to golf courses, and which had been at death’s door as recently as 2011, had gone parabolic.

Emerge Energy Services (EMES) presently traded at $145 per share, reflecting a red hot gain of 8.5X over its $17 IPO price fifteen months earlier. In a literal sense, silicon valley had come to the silicon dunes of Lake Michigan, as reflected in EMES’ valuation at 43X its LTM earnings.

EMES Chart

EMES data by YCharts

Given the fact that EMES’ share price had most recently risen by $100 or $2.5 billion of market just since January 2014, the “momo” story was self-evidently all about upside growth, not current profits or cash flow. In fact, during its 14 quarters as a public filer, EMES had generated negative $50 million of operating cash flow after CapEx. So at a total enterprise value of $3.7 billion, the punters chasing the stock straight up the parabolic curve would seemingly have anticipated some stupendous growth indeed.

Except……except they had no idea about EMES’ sustainable growth potential and didn’t care because the buyers were robots, day traders and flavor-of-the-month hedge funds. They were piling into the stock of a company selling a form (white sand) of the second most abundant low-value commodity on planet earth for no other reason than Emerge Energy Services was another momo play on steroids. The “price action” was the investment thesis.

Yet this typical momo “rip” had occurred not out of the natural elements of human greed and capitalist enterprise, but because the stock market has been destroyed by the Fed. That is, the combination of ZIRP and wealth effects “puts” have eviscerated all of the checks and balances that contain and modulate speculation in honest free markets.

On the one hand, Fed policy has massively subsidized momo speculators in two powerful ways.  First, most of them operate through the options markets or employ other forms of heavy, short-term position leverage.

Accordingly, their “carry” cost is close to zero, and their position leverage can be continuously rolled-over without risk. That’s because the Fed’s foolish commitment to “transparency” in pegging its policy rate means that speculators are in the catbird seat.

In effect, the Fed is committed to sending its interest rate change messages by pony express to speculators who operate in the nano-second based cybersphere of modern trading technology. It’s not even a contest; its a bad joke which showers the 1% with stupendous windfalls.

Secondly, even the friskiest day traders who intend to survive need to take out market insurance against their momo bets. That is, they buy puts on the S&P 500 to protect against a market wide downdraft.

Yet owing to the Fed’s drastic financial repression and market manipulation, this downside insurance is dirt cheap—meaning that the net returns on momo-chasing are inordinately high due to the Fed’s implicit subsidy of their cost of doing business (i.e. hedging).  Supernormal returns, in turn, attract ever greater sums of speculative capital, thereby providing even greater buying power to the momo trades.

There is no secret as to why downside insurance is so heavily subsidized by the central banking branch of the state and is therefore so cheaply available to speculators. The absurd doctrine of “wealth effects” and the implicit Greenspan/Bernanke/Yellen “put” has generated a toxic deformation in the risk asset markets.  Namely, the “buy-the-dips” reflex which has purged volatility from the broad market index almost entirely.

The pattern below would never occur in a honest free market. Nearly six straight years of continuous vertical lift just wouldn’t happen in a setting where the GDP of the underlying economy—US and Europe—-has grown virtually not at all since 2007 pre-crisis level, and where earnings are facing massive headwinds from global cooling, deflation and the heavy anchor of “peak debt”.

But the worst of the market wrecking deformations attributable to Keynesian central banking is not simply the massive implicit subsidies to financial gamblers. Of even greater significance is the fact that no financial market can be healthy and balanced without an abundance of well-capitalized short-sellers. Yet the impact of financial repression has been the utter destruction of whatever short-sellers remained at the time of the financial crisis or their subsequent conversion to “blue pill” longs during the period since.

That proposition was evident in spades in the case of EMES’ meteoric rise. At its late August peak market capitalization of $3.5 billion, it had sported LTM earnings of just $80 million. Yet it would not take more than 15 minutes of reflection to recognize that even those meager profits represented the whip-of-the-whip-of-the whip.

That is, frenzied credit pumping and construction mania had driven the petroleum use rates of China and its supplier satellites to unsustainable peaks, causing crude oil prices to rebound from their post-crisis low of $35 per bbl. to $110. These credit bubble prices, in turn, had attracted an enormous flow of cheap debt and capital into high cost energy production—–most dramatically the US shale patch where production rose from less than 1.0 million bbls/day prior to the crisis to more than 4.5 million per day by last fall.

In turn, the gusher of oil coming out of the shale wells depended upon a massive prior injection of sand—3 to 6 million pounds per well. This is designed to prop open (hence “proppants”) the pores in the shale rock and keep the oil flowing after fracking.

So “fracking sand” production rose from about 14 billion pounds per year in 2007 to 50 billon pounds by 2011; and then to 73 billion by 2013, with bullish estimates rising to 100 billion pounds by 2015 or shortly thereafter.

Needless to say, in another example of the credit driven commodity price aberration where supply temporarily lags an unnatural explosion of demand, the price for fracking sand soared. From about $30 per ton in 2008, it rose to $45 per ton by 2012 and upwards of $80 per ton by mid-2014, with some trades already above the $100 per ton level.

As a result, by mid-2014 sand dunes had become the equivalent of gold mines. Marginal extraction costs of around $25 per ton had rising only modestly, meaning that variable profits from the fracking sand business had risen from under $5 per ton prior to the shale boom to more than $50 per ton.

Stated differently, the reported $80 million of EMES’ profits was perched way out on the end of a long whip of windfalls. Most of Emerge Energy Services’ modest reported earnings, in fact, were not economic profits at all; they representing transient rents generated by the global credit bubble.

Accordingly, the proposition that EMES was worth 43X earnings had nothing to do with rational calculation or honest price discovery. It was a pure artifact of the gambling casino created by the Fed and the other money printing central banks.

Reviewing the facts above, even a modestly adept short seller could have discovered via the government’s latest Minerals Yearbook (2012) that the bottled air being reported as “profit” by  Emerge Energy Services did not have much of a future—even had crude prices not collapsed by 50% since mid-year. In the above publication, the USGS describes the Ordovician St. Peter Sandstone in the Midwest as being “a primary source of silica sand for many end uses, including frac sand”. It is mined in the vast area shown below, and is the opposite of rare.

St Peter Sandstone Formation

StPeterSandstoneFormation

And it did not take long to unleash the diggers. In 2010, Wisconsin had only five sand mines and five processing plants. By the end of 2013, according to the Wall Street Journal, it was estimated that 100 sand mines, loading and processing facilities had received permits in that state alone.

Moreover, in another demonstration that high prices are their own best cure, the quest for fracking quality sand spread far and wide. In the rich black earth “corn and soybean” lands of Illinois, for instance, ordinary $10,000  per acre land prices soared to upwards of $20,000 where white sand was buried by mother nature under the black top soil.

Indeed, the same geologic process that had deposited the shale, had also produced its modern day extraction “proppant”. So the same WSJ story also noted that one entrepreneur was heading for the black hills to mine white sand:

As the good sand becomes increasingly difficult to find, one company is turning next door to South Dakota. Pat Galvin is chief executive of South Dakota Proppants LLC, which aims to resurrect a 1950s-era mine on federal lands about 40 miles from Mount Rushmore. Located in the Black Hills National Forest, the abandoned mine is filled with the same type of high-quality sand frackers have come to count on, and it could generate up to one million tons annually, he said.

In short, even by mid-2014 the worm was turning. There is white sand virtually everywhere, and the number of new mining operations was proliferating dramatically. It was only a matter of time before supply would have caught-up, causing prices to weaken and the windfall element in a plentiful commodity to be ground out of profit margins.

But with the global collapse of oil prices, the whip is now recoiling violently. At $50 per barrel, the 1700 rigs in the shale patch will drop to under 1,000 as contracts run off, and tumble lower from there. Since fracking demand is driven by new drilling rather than current production, the fall-off in demand will be equally severe.

It goes without saying that in the face of today’s great oil deflation, EMES’ volumes and margins will collapse and its windfall rent bloated earnings will wither as current contracts run-out. But never mind, the fast money is already out of the stock. At $54/share, its down to less than half of its value on Labor Day because the crude collapse has now triggered an equal and opposite mode of “price action”.

Undoubtedly, the home gamers and slow-witted mutual funds managers who bought at the top are once again being taken to the cleaners.  But that’s the least of the ills.

The larger point is the Emerge Energy Services is a poster boy for the “irrational exuberance” that has become institutionalized throughout the length and breadth of the Wall Street casino.

Today’s Wall Street Journal story coming just five months after last summers potboiler is therefore not simply an update on a speculation gone horribly wrong. It’s actually a template for the deluge to come.

 

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Fri, 01/02/2015 - 22:08 | 5617236 Your guess is a...
Your guess is as good as mine's picture

Shock! Horror! Commodities are useful and worth money!

Sat, 01/03/2015 - 13:31 | 5618465 KnuckleDragger-X
KnuckleDragger-X's picture

Put your money on the table and get in the game, don't worry about the risks because the road goes on forever and the party never ends....

Mon, 01/05/2015 - 10:08 | 5623268 Remington IV
Remington IV's picture

Jimmy Rogers =  . . .  wrong .... again

Fri, 01/02/2015 - 22:11 | 5617240 bania
bania's picture

Stock market theme song...

https://www.youtube.com/watch?v=YHv5jgXz9I8

Fri, 01/02/2015 - 22:12 | 5617246 Your guess is a...
Your guess is as good as mine's picture

Didn't this story come out about 2 years ago? Yeah, sharp sand is useful, states in the Middle East import it to make concrete. Some vegetables on your table are imported, the clothes you wear are made of imported cotton, the laptop you're using - right now - has ingredients from many countries. Welcome to the 21st century, you stupid cunt.

Fri, 01/02/2015 - 22:15 | 5617254 buzzsaw99
buzzsaw99's picture

...no financial market can be healthy and balanced without an abundance of well-capitalized short-sellers.

BULLSHIT

Fri, 01/02/2015 - 22:27 | 5617281 Philo Beddoe
Philo Beddoe's picture

No shit, we are in asexual reproduction mode.  

Fri, 01/02/2015 - 22:31 | 5617286 Choose Sanity
Choose Sanity's picture

What ever you say Buzz.

Fri, 01/02/2015 - 22:33 | 5617292 buzzsaw99
buzzsaw99's picture

a system that allows gamblers to "sell" stock that they don't own is one sick puppy

Fri, 01/02/2015 - 22:50 | 5617334 Uber Vandal
Uber Vandal's picture

But I REALLY need to sell the Brooklyn Bridge, I need to get the collateral to help this Nigerian Prince fellow who contacted me via e mail, he seems legit enough.......

Sat, 01/03/2015 - 02:14 | 5617765 Bopper09
Bopper09's picture

Likely more legit than the Fed

Sat, 01/03/2015 - 09:39 | 5618097 Winston Churchill
Winston Churchill's picture

Prolly is the Fed.

Sat, 01/03/2015 - 10:05 | 5618131 Chief Kessler
Chief Kessler's picture

Ii haven't seen a good Obama hatin post in a good long time and I think it's time. Dammit Tyler's ! What in the hell are ya doin? We need more hate festerin, looney bringin out, commentin round here dang it! I thought he was satans spawn comin to reap the prophesies fer chrissakes, and I just bowt a ton of ammo cause my willie is too small, now what do I do? Suggestions?

Sat, 01/03/2015 - 12:18 | 5618340 swmnguy
swmnguy's picture

That function is now fulfilled by posts containing videos of fights between impoverished black people in a ghetto environment, be it a McDonald's, a gas station, a discount store, or just on the sidewalk.  Put a post of that up on ZH on a legal holiday not dominated by televised football, and the page hits and comments from regular denizens of FreeRepublic and Chimpout will pile up all weekend, until markets reopen.  Never fails.

Sat, 01/03/2015 - 05:18 | 5617901 Canoe Driver
Canoe Driver's picture

If you're at all serious,buzz,then you've made possibly the most absurd post on ZH since '09. Short selling is in everyway equivalent to long trading except that it's done in reverse. The fiction of borrowing the stock is more pablum for the public. Your broker, so long as the trade is legal, merely puts a "minus" sign on it if it's a short. You have made a bet to the downside. So what? How is that any less scrupulous than buying stock on some dimwit hunch?

Sat, 01/03/2015 - 09:54 | 5618118 disabledvet
disabledvet's picture

Have to pay the dividend as a short seller.

 

"Free money for the longs."

Sat, 01/03/2015 - 11:01 | 5618213 TheGreatRecovery
TheGreatRecovery's picture

IMHO, short selling is for people who really know a LOT about whatever it is they are selling short.  Anyone who sells short based on what he reads in the MSM is trying to be a pig, and PIGS GET SLAUGHTERED.

Sat, 01/03/2015 - 13:18 | 5618472 KnuckleDragger-X
KnuckleDragger-X's picture

Day trading at its finest, don't worry about the rules, just play the game cause Jim Cramer et al has your back.

Sat, 01/03/2015 - 11:47 | 5618287 techstrategy
techstrategy's picture

You inadvertently make a more important point.   There's WAY TOO MUCH TRADING and WAY TOO LITTLE INVESTING.   HFT painting the tape for daytraders to amplify has destroyed the capital markets.   There's no investment signal left.   Trading is ZERO sum.  Investing creates value.  By overwhelming the role of investment in the market,  traders have made it a glorified theft operation certain to fail.   The parasites have killed the host.   

 

I'm certain I'll get tons of down arrows because people don't want to confront the uncomfortable truth.   But,  until we do,  we cannot get about fixing what's broken.   Tax ORDERS at $.05 apiece.  HFT would be done in one swoop.  Investors would be completely unaffected.   Day traders would be fine.   Humans would again have control over our markets and markets would again serve people,  not institutional abuse. 

Sat, 01/03/2015 - 17:38 | 5619050 VAD
VAD's picture
Invest locally, do business in cash and don't report it, support local business, get your money away from Wall Street, starve the motherfucking beast.
Sat, 01/03/2015 - 17:57 | 5619098 jaxville
jaxville's picture

 There is a big difference between a fully hedged short position relying on borrowed shares and a naked short position.  Hedged shorts provide a floor for stock values whereas naked shorts send a share to the floor.

Fri, 01/02/2015 - 22:19 | 5617261 Peter Pan
Peter Pan's picture

Just more vomit in a sick world.

Fri, 01/02/2015 - 23:13 | 5617389 Temerity Trader
Temerity Trader's picture

Just supply and demand. The writer implies there is now some evil force at work. I beg to differ, speculation and gambling has been Wall Street’s business model for 100 years.  Yes, the Fed has unleashed loose money and low interest rates to foster the ‘wealth effect’. Millions have benefited from this ‘New Normal’. Fund managers look like geniuses, millions of 401K’s have soared in value. Fools and their money are not the Fed’s problem. They serve the rich and if the lemmings believe there will always be a bigger fool to buy their shares, so be it. “Growth” is now 5% and the masses are betting it will go even higher. They cannot lose buying stocks with full Fed support and that’s the way the Fed bankers want it. This has nothing to do with data points, earnings, P/E’s, P/S’s, etc. It is all about behavioral economics, nothing more. They read Bernays and know the masses are easily lead. To decide if the ‘New Normal’ is unsustainable, you have to answer the question, ‘is limitless debt now really possible with no downside?’ Nobody yet knows.  If it is, then the sky truly is the only limit, and Dow can go to infinity.

It is too soon to write off fracking. One big Middle-East war and oil goes to over $100/bbl. The oligarchs know that too.  

Fri, 01/02/2015 - 23:47 | 5617489 disabledvet
disabledvet's picture

And bailots too. TBTF is alive and well.

Sat, 01/03/2015 - 09:01 | 5618065 silverer
silverer's picture

Yes, but the speculation was not really gambling, it was calculated risk. Do you think you are seeing thoughtful calculated risk here, or just mostly manipulation using market mechanisms?

Fri, 01/02/2015 - 23:45 | 5617479 disabledvet
disabledvet's picture

"Give me control of a nation's media and I care not about prices period."

 

I would laugh if a thousand years from now a million shares of this crap was sitting on the Fed's TRILLION dollar balance sheet.  Wouldn't surprise me.

 

What we KNOW is that the Fed is/was monetizing the Federal deficit to the tune of TRILLIONS first.

 

Lest folks forget interest rates used to be far lower than they are now in the USA.

 

So does this mean all these "sand mines" (sic) are about to be shuttered?  Well, its not like coal "mining" is any different out there...so I doubt it.

 

Coal prices have totally collapsed globally.  These oil folks clearly did not study geology very well...let alone chemistry.

 

And of course GE has the best diesel engine in the world on the market today.  Throw in a battery and a generator (they already have an all electric drive system...and I ain't talking a puny sports car here) and who knows, maybe those Class 8's will be getting 600 miles a gallon instead of the current 6...BY NEXT YEAR.

GM roles out the new Volt this month.  I would hold your breath on that one.  Folks keep claiming they can get a thousand miles a gallon on that so we'll see.

Sat, 01/03/2015 - 09:58 | 5618122 disabledvet
disabledvet's picture

Debbie downer day...

Sat, 01/03/2015 - 00:44 | 5617617 OldPhart
OldPhart's picture

"MoMo"?

Momentum Moment?

Sat, 01/03/2015 - 09:00 | 5618062 silverer
silverer's picture

Yes, I saw "momentum investing".

Sat, 01/03/2015 - 00:56 | 5617642 Fuku Ben
Fuku Ben's picture

I'm sure the Keystone XL pipeline and the St Peter Sandstone Formation crossing and any reference to Keys, Tone, X (Saturn), L (or El -> god), St Peter (Who Holds the Keys to the kingdom of Heaven), Sands (of time aka Father Time aka Saturn), Tone, Format (ie computer disk drive - Shape of Saturns rings), Ion (Power) are not symbolic and mean nothing. All just coincidence

https://1.bp.blogspot.com/-r9oIFPFagok/Tk3ix0VpHEI/AAAAAAAAAT4/OSsEKRobS...

http://www.fssp.org/objet/clesfsspC.jpg

Thanks for stopping by

All monsters and zombies may now return to sleep

Sat, 01/03/2015 - 08:56 | 5618061 silverer
silverer's picture

So the share price is totally distorted due to the super robo pump of the market? But aren't almost all stocks? But this makes a good example, for sure. When are the robo traders going to be told the fracking business is about to deep six? Somebody will be caught holding the bag on these trades, maybe even real people.

Sat, 01/03/2015 - 09:00 | 5618064 Downtoolong
Downtoolong's picture

EMES would have been fine if it had declared itself a social network, or better yet, a bank holding company. I'm sure Goldman could have helped them with the latter for a fee.

 

 

Sat, 01/03/2015 - 12:24 | 5618361 swmnguy
swmnguy's picture

Exactly.  What a bunch of idiots, trying to get rich doing actual things with actual stuff.  That can only work for a very short time anymore.  The real money is in doing nothing with nothing.  Everybody knows that.  

I was a little slow  to figure it out, myself.  I remember my "A-Ha!" moment.  I was working on a corporate event for Target Corporation, when I heard their then-CFO mention that their most profitable line of business--by a long shot--was issuing branded VISA cards.  That way, Target made money even if you used it at Wal-Mart.  They opened their own bank, "Target National Bank," in Sioux Falls, SD, where they don't have banking laws or corporate taxes.  They were laughing their asses off.  JPMorgan Chase offered them something like $15 Billion for parts of their credit card portfolio in about 2006, and Target laughed in their faces.  Then in 2009, they sold the whole business to JPM for about $6 Billion.  So there is an expiration date, even on bullshit, but only if you're not in the in-crowd that can get bailouts written for themselves by their employees in DC.  Target thought they had that kind of clout, but they were very much mistaken in that regard.

EMES is on the right path, though.  Take a business mining sand that's everywhere for anyone to dig up, and turn it into a financial speculation operation.  That's the kind of mining that actually pays off these days.  And who knows.  Maybe you can "Like" sand.

Sat, 01/03/2015 - 12:32 | 5618375 falak pema
falak pema's picture

They say USA future Saudi, but looks like that will not occur before 2017.

In the meantime its tuff shit for the Oil lobby. 

What is not clear is if the Financials will influence US shale's rise like the Phoenix, from its coming (but temporary?) ashes.

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