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Knowing How to Play the Avian Flu


Please don't be the last one standing when the music stops


On Wednesday's Buzz, I opined:

"For those considering doing the "Avian Flu Hits " trade, please see also the pattern of trading in stem cell stocks around the 2004 election. Realize this is already a mature trade (stem cell stocks circa Q4-2004) so quick trigger fingers are necessary if you're going to play. Be smart here and realize this is already a greater-fool trade -- i.e. you can still make money as long as you are not the last one to the party."

I'm on a mission to make sure anyone reading Minyanville who wants to play in the avian flu space knows what they are getting into.

Aside from drugs already on the market to treat influenza like Gilead (GILD) and Roche's Tamiflu or GlaxoSmithKline's (GSK) Relenza, every other investment in the space is speculative. That includes companies with so-called "contracts" to develop H5N1 vaccines.

The current H5N1 virus is infectious only to those people in very close contact with infected birds. You have to be so close, in fact, that you have to inhale live virus from the birds into your lungs and/or get infected blood splattered into your nose, eyes, and mouth. From what we know thus far, the exposure has to be repetitive and constant over a period of many days in order for H5N1 to take hold in humans. Unless you work with (slaughter) infected birds on a daily basis without even a minimum of protection, you are exceptionally unlikely to catch H5N1. There are theoretical cases of human-to-human transmission, but nobody seems to know exactly how it works.

Bottom line, the H5N1 virus is hard to get and it currently does not transmit easily (if at all) between humans.

The poultry industry is mostly unique in the world in that it nearly exclusively takes place indoors under highly controlled conditions. Foodstock poultry in the US is not ever co-mingled with migratory birds that are the carriers for H5N1. They are quarantined from the outside world for a reason. Remember, versions of avian flu have been around for decades and the poultry industry in the US is well aware of how to prevent transmission.

The exception to this is so-called organic "free range" poultry. This recent food craze is part of the "green" organic movement. The marketing gimmick here is free-range/organic birds are supposed to be healthier because they hunt and peck for food around some open farm instead of inside a building. The presumed benefits are not proven via scientific method, but that's a column for another time. The point for today is this portion of the poultry food chain is not segregated carefully and is exposed to migratory birds – or at least has a much higher chance of exposure.

Bottom line, except for niche "free range" products, the H5N1 virus is unlikely to penetrate the American poultry food chain.

With those two items as a foundation, let's discuss a few things pertinent to the investment landscape under the assumption a headline will blare in the not too-distant future, "Bird Flu Hits America."

Let's first identify what that headline will and won't mean.

  • It won't mean the start of a human-transmissible pandemic.
  • It will mean some wild bird has been discovered dead with H5N1 viral copies.
  • It won't likely mean the H5N1 has penetrated the poultry food supply.
  • It will move the markets in specific and, I think, predictable ways – most of which have nothing to do with actual science or fact.

If you've been reading Minyanville for any length of time, I'm fairly certain you are familiar with the concept that stocks go up and down based largely on perception and not reality. Perception-based moves can last for quite some time before reality takes hold – so long, in fact, that stubbornly sticking to the "right" position can make a very large dent in your portfolio's value. Given that, I'm not going to be focusing on how the markets should move according to fact, I'll be discussion how I expect markets will move based upon perceptions.

Let's focus generally on the poultry business first:

Anyone producing poultry for human consumption is likely to see immediate declines in their stock prices when the headline appears. This decline will be across the board. For nearly all producers, there is no connection between the perception of risk and the reality of risk, but as I noted above this will not matter. Those companies who have previously been given a premium for their "free range" or organic business should be hurt the worst since they are most at risk, but I would not expect that trend to be noticeable early in the reactionary trades – if ever.

Now let's focus on the human side of things:

Any H5N1 investments not directly related to drugs already on the market to treat influenza (
Gilead 's Tamiflu and GlaxoSmithKline's Relenza) are very speculative. Please focus on the word "speculative" because I think that should place most people in the proper frame of mind for what's going on here.

You must understand some basic science to be able to correctly interpret the next part.

To create a preventative vaccine against a virus, you must first identify the exact virus. If you are unable to identify the exact virus, you cannot make an effective vaccine.

The current H5N1 virus is not the one that will cause a pandemic. The current H5N1 virus will not be used for any vaccine given to humans to prevent the spread of H5N1 influenza.

Logically, therefore, any press release you see from a company claiming to have made a vaccine against H5N1 is hype. By scientific definition, the virus we need to vaccinate against does not yet exist. It is impossible to create an influenza vaccine against a virus that does not exist.

That does not mean the stock of a company who issues such a press release won't go up. It also doesn't mean that company is a good short candidate, even though there is a factual disconnect with scientific reality. You could run out of money supporting a short position long before the market perceptions catch up to the facts.

If you are going to invest in one of these vaccine companies, you need to understand you are dealing with a mania. The goal of investing in a mania, if you must, is the same goal as playing musical chairs. Also sometimes called a "greater fool" trade, the goal is to not be the last person standing when the mania stops. Profitable long trades in this mania depend 100% on your ability to sell to someone else who arrives later to the mania trade than you do.

You'll make money as long as you are not the last person.

I have no problem with this sort of trade – the money spends the same way as a "sane, fundamental investment" after all. I just want you to be darn sure you know what you are getting into.

One more bit of science to help in picking, if you must, an H5N1 vaccine stock:

When I analyze biotech companies, I am most comfortable when there is a "fall back" position. This is why companies with multiple products in the pipeline are valued higher than companies with a single drug. If (when) the drug fails, multi-product companies have residual value equal to their pipelines. Single product companies don't.

Along these lines, my interest in H5N1 vaccine companies would be skewed towards those companies (if any) who have a technology allowing for the production of a vaccine in a couple of weeks as opposed to the 3-5 months typical of current approaches. That way, when this bird flu thing finally becomes boring to Wall Street, the company still has a saleable product. Any company who can produce an effective influenza vaccine in a few weeks compared to the decades-old, cumbersome and expensive current process, has a saleable product.

Even in terms of bird flu, such technology is important. Without it, the prospective vaccine producer will be competing directly with the giants in the vaccine industry – Sanofi and Glaxo. If H5N1 reaches pandemic status, health organizations will publish in the public domain the vaccine strain. They will make it available to anyone and everyone with a vaccine manufacturing facility. Any small company using the traditional manufacturing process will be run over by the larger companies.

If, however, they have a new process that takes only a couple of weeks to produce vaccine lots, they will beat the bigger producers to market by months.

My goal here is not necessarily to discourage you from trying to make money off the inevitable "Bird Flu in US" headline. The market moves should be large enough to create profit for someone. My goal here is to help everyone reading this article go into that kind of a trade with their eyes wide open.

This is a speculative headline trade, not a long-term investment. Set your profit/loss goals accordingly before you enter the trade.

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No positions in stocks mentioned.

The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.

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