Thursday, March 11, 2010
What is a Black Swan Event? Does General Moly Qualify?
It is 6:00 AM sharp. Have a hot cup of Thor's java and let's talk about unusual events. Wild horses are abundant in Northern Nevada but if I told you I saw a zebra grazing in Antelope Valley, you may offer to drive me to Reno for a brain scan. Horses don't come in black and white stripes, at least in these parts. Up to the 17th Century, Europeans thought all swans were white. After the discovery of black swans in Western Australia in 1697, by a Dutch explorer Willem de Vlamingh, the term "black swan" came to mean that a perceived impossibility may later be found to exist.
Fast forward to this century and a book called The Black Swan (2007) by Nassim Nicholas Taleb. Mr. Taleb regards almost all major scientific discoveries, historical events, and artistic accomplishments as "black swans" — undirected and unpredicted. He gives the rise of the Internet, the personal computer, World War I, and the September 11, 2001 attacks as examples of Black Swan Events (see note 1).
This concept has been extended to markets and the statistical models that attempt to predict their behavior. My experience is that markets behave statistically as physical processes...until they don't. Extreme deviations from normal expectations are when things get exciting and sometimes are also referred to as Black Swan Events. One year ago when the S&P 500 dropped below 670 is an example, one most of us would like to forget.
Mr. Taleb lays out a simple criteria to judge the occurrence of a Black Swan Event:
1.The event is a surprise (to the observer).
2.The event has a major impact.
3.After the fact, the event is rationalized by hindsight, as if it had been expected
Last Friday, General Moly (GMO) announced that they expected full funding of the Mt. Hope project from the Hanlong Group and their share price skyrocketed to $3.99 at the market close (A Game Changer for General Moly & Eureka County). GMO traded a record 12,227,852 shares, sixteen times their average volume. To put this in perspective, major molybdenum producer Thompson Creek Metals (TC) trades an average of 1,773,148 shares per day. Impressive but was Friday a Black Swan Event for General Moly and Eureka County?
Before we answer this question, let's review some statistics. Now don't run out of the break room pardner, this won't hurt and Shaquille O'Neil will give us a hand. The average American male stands 5'10" tall. The heights of males statistically follow a Gaussian or bell-shaped curve. The average height falls in the middle of the curve; short folks are on the left, tall'uns on the right. Two thirds of the population fall within a Standard Deviation of the average which for America is about 3 inches. Standard deviation is also called "sigma" and here's how it works for tall folks:
Average heigth 5'10" +/- 3"
1-sigma group is 6'1" to 6'4"
2-sigma group is 6'4" to 6'7"
3-sigma group is 6'7" to 6'10"
5-sigma group is 7'1" to 7'4"
Since most men are within several standard deviations of the average, the "bell-curve" has a peak in the center and then "tails" off dramatically. OK Shaq, help us out. Shaquille O'Neil is 7'1" falling just inside the 5-sigma group and you don't see too many guys his height walking around...get the picture?
The Colonel created a model of General Moly relative to Thompson Creek. The chart below compares the stock price of GMO to Thompson Creek Metals (TC) for the last 3-months (a larger, more readable version, is near the bottom of this blog page). The magenta line is the "fair value" of GMO relative to TC; the aqua lines represent the expected range (+/- 2-standard deviations) for GMO given this 3-month record.
Given last Thursday's (3/04) closing price for TC of $13.94, the fair value of GMO was $2.68 in a range of $2.41 to $2.96. On Thursday GMO's actual price was $2.56, undervalued with respect to TC by 0.9-sigma (standard deviation).
On last Friday (3/5), GMO knocked the cover off the ball with an 8.7-sigma price event. You'll notice that for 3-months, GMO price action has faithfully stayed within the expected range with a tight correlation of 0.877 (one-year correlation is 0.873). The jump Friday definitely qualifies for a "fat tail" in the bell-curve, something that happens very rarely. But is this a Black Swan Event?
Let's answer Taleb's three qualifying questions. First, was the announcement a surprise? Yes, the Hanlong transaction passed under the Wall Street radar; generally someone finds out about such things and the stock price shoots up prior to the press release. This is often called "buy the rumor, sell the news." In our case GMO was undervalued prior to the announcement; no rumors, no bounce. Statistically anything greater tha a 2-sigma move is a "surprise"; 8.7-sigma is a much, much taller Shaq walking down Main Street!
Only time will tell whether this deal will have a "major impact" on Eureka. With a projected mine life of forty years, Mt. Hope should be a significant part of our economy for the kids and grand kids. Unless something upsets the ore cart, I'd give the major-impact-question a resounding "yes." The last question will probably also earn an affirmative once folks see brand new haul trucks rolling down HWY 50 on low-boy trailers destined for Mt. Hope. "Who didn't expect them to get funding?" some will say forgetting the Great Recession, tight credit markets and an uncertain global recovery. Yes, this will all look like a sure bet when little Eureka school kids learn how to spell m-o-l-y-b-d-e-n-u-m right after mastering m-i-s-s-i-s-s-i-p-p-i. I think we have a black swan in our pond buckaroos!
Now what about that herd of zebras in Antelope Valley?
Enough talk, let's walk the walk:
4-WD is OFF - the VIX or "fear index" is below 25, improving broader markets are expected; metals & miners are headed for smoother roads with FCX above $74 (what is this?)
The YELLOW light is switched on our fuel gauge with oil above $80
An ORANGE light is ON for possible adverse regulation/legislation: Miner's claim fee, Miner taxation, Cortez Hills & mercury emissions
Otherwise, all lights are green on the Eureka Outlook Dashboard (upper right, what's this?)
NYMEX/COMEX: Oil is down $0.09 in early trading to $82.00 (April contract, most active); Gold is down $2.6 to $1105.5 (April contract, most active); Silver is down $0.023 to $16.995 (May contract); Copper is down $0.0070 to $3.3610 (May contract); Western Molybdenum Oxide is steady at $18.25, LME 3-month futures (seller) bumped up to $18.14; 15-month, $17.91
The DOW is down 7.78 points to 10559.55; the S&P 500 is down 1.39 to 1144.22. The miners are mixed today:
Barrick (ABX) $38.85 up 0.26%
Newmont (NEM) $50.12 down 0.30%
US Gold UXG) $2.92 up 2.10%
General Moly (Eureka Moly, LLC) (GMO) $3.50 up 0.29%
Thompson Creek (TC) $13.55 down 0.15%
Freeport-McMoRan (FCX) $79.96 down 0.15% (a bellwether mining stock spanning gold, copper & molybdenum)
The Steels are down, (a "tell" for General Moly & Thompson Creek):
ArcelorMittal (MT) $41.87 down 1.34% - global steel producer
POSCO (PKX) $122.99 down 1.58% - South Korean integrated steel producer
The Eureka Miner's Grubstake Portfolio is is down 0.20% to $1,354,654.59 (what is this?).
Note 1: More about Black Swan Events