As we approach the 103th anniversary of the sinking of the Titanic, one can see ancillary similarities with the plight of uranium stock Cameco Corporation (USA) (NYSE:CCJ).
Back in 1912, the largest floating ship at the time of its service was considered unsinkable. Comparable sentiments have recently raised eyebrows in the financial markets regarding Cameco shares, which saw a substantial increase in bullish options activity in early March.
The rationale has a tempting logic. As one of the world’s principal uranium producers, it is difficult to imagine equity valuations falling further than they already have. On a year-to-date basis alone, shares are down 14% at time of writing. Yet, as we will soon see, not only are such assumptions arbitrary — as they were for the Titanic — they are also highly improbable.
The Bear Case for Cameco (CCJ)
When Cameco released its fourth-quarter earnings results on Feb. 6, it reported a 14% boost in quarterly profits thanks in part to higher prices for the underlying uranium market. Three days later, CCJ shot up more than 8% under aggressive volume, hitting an intraday high of $16.24.
Unfortunately, the enthusiasm was short-lived, with a closing price of $15.26 netting only a 1.9% gain. A month later on March 4, Mike Yamamoto of OptionMonster noted an unusual influx of demand for the September 20 call options. He further added that total options volume for Cameco shares exceeded 200% the daily average for the month of February.
Taken as a whole, investors may be tempted to believe that a breakout is imminent. However, CCJ is at greater risk for a breakdown for the following reasons:
- Cameco’s touted earnings boost relies on a favorably selected time frame. Annual net income trends, on the other hand, are worrying. At $158 million for 2014, this is almost a 50% haircut from the prior year’s result, and is down more than 37% against fiscal year 2012.
- While the recent positive trajectory of the uranium spot price has benefited Cameco and its competitors, the reality is that on a long-term basis, uranium is struggling to capitalize on its momentum. Between January 2010 until June 2013, the $40 price level has acted as technical support for yellowcake. Since then, that same level has acted as resistance and was only briefly penetrated in November of last year.
- Volume is simply the total number of shares trading hands for a stock, and interpreting such a broad concept can be fickle. Volume of options contracts is especially fickle. The greater issue is how a company stock performs after a major announcement. For Cameco, the statistics aren’t pretty. Since its Feb. 6 earnings release, there have been 17 advancing days, 18 declining days and one “doji day” (Japanese candlestick for flat). Of the advancing days, the net average return is less than 2% — hardly a ringing endorsement.
Perhaps the most convincing argument against buying CCJ is in the probabilities.
Currently, the average performance of Cameco shares over the past half-year period is -3.16%. Using a median statistical framework where we sequentially list 20 half-year performances above and below -3.16%, and plot the results against average market returns six months later, we get the following chart:
Out of the 40 total moves from the above criteria, bullish returns after a six-month period occurred only nine times. Statistically speaking, from CCJ’s current technical posture, there is a 77.5% likelihood that valuations will decline by the time its September options contracts expire.
With an average market loss of 15.1%, this suggests that at expiry, CCJ will — at the highest — be trading hands at roughly $13.50 (it currently trades at $14.16).
Essentially, quantitative models urge a contrarian approach by ignoring common volume interpretations and instead either buying puts on CCJ or shorting the stock outright.
Similar to the iceberg-laden route that tragically succumbed the Titanic, the uranium sector is notoriously volatile and unpredictable. However, unlike the popular hubris at the time, Cameco and other uranium producers are not immune to further downside despite having suffered immense equity losses in recent years.
Following fundamental logic and the numbers themselves can save investors from a painful knife-catching exercise.
As of this writing, Josh Enomoto did not hold a position in any of the aforementioned securities.