Smallcap Discoveries: Weekly Update: July 4

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Subject: Smallcap Discoveries: Weekly Update: July 4 - 8

July 4 - 8

Market Commentary

North American markets started the week with a strong tone as energy prices plunged on growing recession fears. Higher energy prices has been a major contributor to inflationary pressures so any weakening in energy prices, especially gasoline, is expected to allow the Fed to take its foot off the interest rate gas pedal. However strong US employment data looked to change all that, but the markets seemed to it off and ended the week higher. Nonfarm payrolls increased by 372,000 in June beating economist’s estimates of 250,000. Strong job growth is expected to give the US Fed the ammunition it needs to continue its interest rate tightening plans especially if inflation continues to stay stubbornly high. Everyone will be watching next week’s consumer price index data very closely.

The Dow finished the US holiday shortened week up by 0.8%, and Nasdaq powered higher by 4.6%. The TSX ended the week 0.9% higher.

Energy

As was noted above energy had one of its worst weeks in quite a while. WTI oil plunged almost 15% to just below US$96 from over $111. It managed to recover somewhat and ended the week at $104.90. Nymex natural gas also suffered early in the week reaching multi month lows but managed to close higher by the week’s end closing at US$6.045.

Most energy stocks were even weaker than the underlying commodity and the sector 4-month lows before bouncing from severely oversold conditions.

A number of well followed Canadian energy stocks hit lows last seen in January well before the Ukraine/Russia conflict.

North American drill rig counts continue to climb. Canadian rig count was up by another 9 rigs to 175 while the US added 2 onshore rigs to number 752 by the end of the week. Demand for energy services continues to be very robust. I do not see this changing unless we get significantly weaker energy prices which I don’t expect. I think an oil price in the $90 - $100 range would be a level that would keep the Fed somewhat happy and still allow for tremendously strong cash flow for most of the producers.

It’s important to understand that the US Fed needs to see weakening prices for many economic inputs. Energy is a major input. It effects so many other products and services and has a large effect on overall inflation. The Fed is trying to break energy demand with higher rates. Demand destruction or a big ramp up in energy production is needed to tame energy inflation. While production is increasing it isn’t moving fast enough to effect prices. The Fed wants lower energy prices and I think they’ll get it. I’m watching gasoline closely. Gasoline prices alone, in Canada, were responsible for 1.4% of the 7.7% CPI number. In other words if gasoline prices had stayed flat May’s inflation rate would have been 6.3%. Gasoline is likely the best proxy for energy inflation right now and gas prices seem to be going in the right direction for now.

Energy is a major inflation basket input. The other major input is labour. The Fed will never publicly state that they want to see a weakening labour market they clearly need to see the labour market weaken if there is any chance of a lower inflationary data print. I think the Fed wants to see at least a small “r” recession. Tame energy and labour and you’ll tame inflation.

Commodities

Most commodities had decent bounces off very oversold conditions.

Last week we mentioned the rapidly changing commodity markets and how we’ve seen a dramatic change in economic narrative from an inflationary trade to a recession trade. The trend in many commodities appears to be to the downside for now. This would be very welcomed by the Fed and investors need to continue to watch commodities to get a sense of what the Fed’s next moves may be.

Not only are commodity prices trending lower but so are shipping rates. Supply chain disruptions seem to be waning, raw material and finished products seem to be moving again which is also helping on the inflation front. Container shipment pricing has dropped by roughly 40% since the start of the year but has a long way to go to get to pre pandemic levels.

Even used car prices, which spiked dramatically during the pandemic, continue to trend lower. Except for electric vehicles. While used car prices are higher than they were this time last year. May marked the fourth month in a row where average car prices were lower than the previous month. If it weren’t for EV’s and hybrids, which have been trending higher, the average car price would be dropping even faster.

And my last comment on this inflation subject…. Construction and housing have also been seeing input prices reverse. Consider products like lumber, steel, aluminum, copper etc. All used to build homes and buildings. Lumber has dropped by over 50% from it’s recent highs. The American Steel index is down 35% since April. Copper is down 26% and dropping fast. Even aluminum is down 35% since March. The cost to build is dropping faster than home prices are in many areas. Could we get to a situation where new homes are cheaper than some resale homes that were purchased at recent highs?

What we are doing – The “Easy Trade”

For the last year or so the “easy trade” has been energy. Going long energy stocks while shorting almost everything else would have produced big returns. The energy ETFs (XLE) broke above a long-term downtrend and started hitting new 52-week highs in early 2021.

The energy service ETF (XES) did the same a few months later.

Those were signals that it was a good idea to start looking for new leaders within the sector.

The energy sector up until a few weeks ago was far and away one of the best performing areas in the market. Buying a handful of the leaders of that sector would have produced fantastic results.

Many of these stocks were themselves hitting new 52-week highs around that time for the first time in years.

Some turned in to “10 baggers”.

Had you been watching for those signals and had the nerve to buy these hated stocks you would have done very well. Energy was the “easy trade” if you knew what to look for. We think we have the next “easy trade”, life sciences.

I’ve been going on for weeks that we think we’ve seen the turn in the sector. The life science ETF (XBI), while not having hit a new 52-week high, has broken a long down trend.

The XBI had dropped 64.7% from it’s 2021 peak to May 2022 low. It tested that low again in June and what is interesting (and bullish) is that it bounced of those lows and looks to have put in a “double bottom”. It’s technical speak but you can easily see it on the chart above. XBI has now moved up 37% from that recent low and traded a “higher high” from the mini peak $77 it reached in late June. Bullish signals.

And the XBI has really begun to outperform the overall market. It was up 10.3% this week alone.

Add the fact that we see strong new capital flows into the sector. Sophisticated investors are either covering their short positions, establishing long positions or both. Early (brave) investors are doing what we saw in the energy sector in the first part of 2021.

And we are seeing more bullish evidence when we look at the daily Nasdaq new 52-week high list. A growing number of new 52-week highs are life science companies. 38 of the 53 (72%) new daily 52-week highs were life science companies. This just doesn’t happen without solid capital inflow and investor confidence.

Here’s just one example of what these stocks are starting to look like.

The new 52-week high list is a great place to look to spot the new leaders of any new bull market that may begin and can certainly tell you where capital is flowing.

So, with that tailwind in place, we are starting to allocate more capital in the sector as well. I’m beginning to trade some of the bigger and more liquid names. I successfully swing traded TWST this past week having bought a small position at $35.70 and sold several days later at $42.50 for a quick 19.0% gain. These types of moves will attract some of the momentum traders as the sector continues to gain strength. While these trades may be fun the big wins should come from accumulating bigger positions in solid companies with strong fundamentals. The smaller ones that aren’t on the radar screens of the early mover sophisticated investor.

My current favorite in the smaller space, and that fits most of the buying criteria we look for, is a name I’ve been nibbling on for several weeks now, Ceapro, CZO.V. We got quite a bit more aggressive this week and added a sizable amount at $0.56 and $0.57. We are adding Ceapro to our SCD portfolio and will start full coverage as soon as we can get all the details together.

Ceapro is a Canadian biotechnology company involved in the development of proprietary extraction technology and the application of this technology to the production of extracts and active ingredients from oats and other renewable plant resources. Ceapro adds further value to its extracts by supporting their use in cosmeceutical, nutraceutical and therapeutics products for humans and animals. The company has a broad range of expertise in natural product chemistry, microbiology, biochemistry, immunology and process engineering. These skills merge in the fields of active ingredients, biopharmaceuticals and drug-delivery solutions.

The highlights are:

Closing price: $0.56
Shares outstanding: 77.7 million
Market cap: $43.5 million
Record Q1 revenues - grew revenues 31% in Q1
5 consecutive quarters of profitability
Grew profit by 288% in Q1
Trades at approximately 10.0 times trailing 12-month earnings
Healthy balance sheet – Over $8.7 million in cash, $13.6 million in working capital
Total liabilities: $3.3 million
Q1 gross margins 64%
Insider ownership; 8%

As I said we will get a report out with much more detail as soon as possible. In the meantime I will be looking to add to my position below $0.60

What we are keeping an eye on…..

Farmer protests are breaking out in many places around Europe. While for the time being these likely effects local economies this could turn into something bigger and it’s hard to predict what dominoes can be set off.

China/Taiwan – I’m trouble by how often I’m hearing from credible reports that tension is increasing between these 2 countries.

China steps up use of combat aircraft in Taiwan sorties as military tries to extend its reach

China Seeks to Pre-Empt Sanctions in Case of Taiwan Clash, F.B.I. Chief Says

We’ve seen the global economic and humanitarian impact from Russia’s invasion of Ukraine. An invasion of Taiwan by China would have a much greater impact. This could be a major “black swan” if a conflict erupts.

To your wealth,

Paul and Trevor

Buys and Sells This Week

Bought Ceapro Inc, CZO.V @ $0.56/$0.57

Bought ImmunoPrecise Antibodies IPA.V @ $5.27

Bought Athabasca Oil, ATH.T @ $1.97

Sold Athabasca Oil, ATH.T @ 2.10

Sold Bri-Chem, BRY.T @ $0.81

Smallcap Discoveries

Select Portfolio

iFabric (TSX: IFA) Price - $1.51 Market Cap - $45M

iFabric Corp Signs New Agreement with The North Face
Press Release https://tinyurl.com/4zyphtaa

Spectra Inc (TSX.V: SSA) Price - $0.035 Market Cap - $2.7M

Spectra Products Inc. Reports Resignation of two Directors and
Appointment of two New Directors
Press Release https://tinyurl.com/yc2cbekh

Smallcap Discoveries

Select Watchlist

Aequus Pharmaceuticals (TSX.V: AQS) Price - $0.07 Market Cap - $9M

Aequus Signs Exclusive Distribution Agreement with SCOPE Ophthalmics for Canadian Distribution Rights of Dry Eye Products
Press Release https://tinyurl.com/32kwem3u

Firan Technology Group (TSX: FTG) Price - $1.90 Market Cap - $46.5M