Profiting From the Commodity Collapse - The Case Against U.S. Global Investors

As just about anyone following stocks knows, energy stocks have been absolutely wrecked as oil has aggressively declined off its July 11 high of $147.30. As a way to benefit from this collapse, I just went long some out of the money puts on U.S. Global Investors (GROW), an investment management firm whose mutual funds are highly levered to commodity and materials stocks like Occidental Petroleum (OXY), Transocean (RIG), and Freeport McMoRan (FCX).

Let's look this press release the company issued on July 10, ironically, the day before oil peaked. According to the release, USGI "U.S. Global managed $5.39 billion in mutual fund assets as of June 30, 2008, and 95 percent of these assets were in funds ranked in the top quartile of their respective peer groups in at least one of the time periods going back 10 years, according to Lipper."

Asset management companies typically sell for 1% to 2% of assets under management. This would imply a valuation of roughly $54 to $108 million for USGI versus the company's $184 million market cap. On top of that, AUM actually fell from March to June, despite a big rally in energy stocks. And since June, the energy and emerging markets complexes have been destroyed, which will erode revenues and earnings from existing AUM.

Plus, I can't imagine investors will be throwing money into commodity funds following a 30% decline in the XLE. And of course, we can't ignore the implosion of major hedge fund Ospraie, which likely won't be the last closure of a commodity-driven hedge fund. At the very least, we're going to see continued delevering among hedge funds, which could bring more energy stocks onto the market.

Looking at it from another angle - USGI is a financial stock and is owned by mutual funds specializing in the sector, like the Fidelity Select Brokerage & Investmnt (FSLBX). So technically, USGI is a stock in a bad sector that is levered to another bad sector.

Just an FYI to anyone who is interested in taking a long or short position in GROW, the company reports on Thursday which could drive significant volatility in the stock. However, my personal opinion is that USGI will continue to crater as its earnings power continues to evaporate.

Wow, oil is down another dollar since I started writing this! Gotta hop!