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MAY
15 2008 2:25PM - Gold moved higher
today on the inflation theme and left its buddy silver
trailing behind. Yet it is silver that seems to have
the better fundamentals at present, what with another
2 million ounces added to the big Barclays iShares ETF
yesterday. Perhaps silver's lackluster performance today
can be traced to the CFTC's erstwhile attempt
to disprove Ted Butler's theories about silver manipulation
on the COMEX.
The
CFTC takes apart most of Mr. Butler's claims about the
silver market rather convincingly using logic that appears
pretty solid. For example, the CFTC claims to have interviewed
5 of the largest 10 commercial traders in COMEX silver,
finding that the commercials have numerous customers
on whose behalf they trade that sometimes leaves them
net long on the COMEX but typically close to neutral
when combined futures contracts, physical positions
and OTC derivative positions are taken into account.
Of course, the rub is the OTC derivative positions and
if there is any truth to Mr. Butler's claims, it lies
here. Yet that truth is most likely much smaller than
Mr. Butler alleges. In particular, it is the OTC derivatives
and not necessarily the COMEX that creates the main
risk of default in silver deliveries. Be that as it
may, only a few will probably notice that the CFTC
actually makes a critical admission that is in
total agreement with Mr. Butler and also exceedingly
bullish for silver prices: that low silver prices in
the past were due to the existence of stockpiles and
the recent rise may have been due in part to the exhaustion
of such stockpiles. The CFTC does not proceed to reach
the natural conclusion that silver prices will continue
to rise unless more stockpiles become available or new
ones can be built up, but this is understandable considering
its job does not include providing investment advice.
So, this CFTC study ends up being a very bullish development
for silver even though it pretty much puts one of the
biggest silver bulls in his place.
Speaking
of studies, over the next several days I will complete
my review of the recent silver surveys released
by the various metal consultancies and will post a critique.
For now, I will just say that a disagreement about the
future prospects of the white wonder metal seems to
be emerging.
Now
for a quick update on silver stocks. I bought another
5,000 shares of U.S. Silver, under 50 cents, in the
past 2 weeks. The company recently announced a share
buyback of up to 7 million shares, which is not huge
compared to the 211 million shares outstanding but it
does indicate that the ballooning share count is probably
not a big worry going forward. I still view my strategy
of U.S. Silver doubling by early December as viable.
Then
there is Hecla, which released its first quarter
results recently and the shares got knocked because
earnings did not meet expectations and costs are rising.
On the earnings front, the miss was basically due to
a delay in shipping a month's worth of concentrates
from Greens Creek, so this was really a nonissue. With
respect to costs, Hecla made a point that should be
of interest to all shareholders who own companies that
produce silver in lead and zinc concentrates: apparently
lead/zinc smelting costs are about to go much higher
like many other aspects of the mining industry and there
also appears to be increasing competition for smelting
contracts with the possibility that some producers could
be left out in the cold (the last part is my speculation,
not Hecla's). So, I would suggest that you add another
arrow to your "due diligence quiver"--namely,
it is now more important than ever to understand the
wherewithalls of your silver producers' smelter contracts
especially where production is growing from a small
profile to a large one.
Finally,
it looks like Silver Wheaton will keep announcing silver
stream deal after deal, the latest
with Farallon Resources. This actually has an interesting
tie-in with the CFTC study. Some of you may recall that
I wrote a piece a few years back about how Silver Wheaton
was about to change the silver market because by-product
miners typically sold their silver production forward
and this was the basis for a significant portion of
shorting including the commercial shorting on the COMEX.
In fact, the CFTC refers to this being one of the major
reasons for commercial shorting on the COMEX. So along
comes Silver Wheaton and others like Capstone Silver
and Coeur d'Alene Mines and they start to buy up this
by-product source of silver. The result is that, little
by little, the source of forward selling is diminished
and the silver price is no longer pressured by an artificial
(paper) supply of silver coming on the market prior
to the appearance of real supply in the form physical
production from the mines. I thought (and I still do)
that such a development would chip away at one of the
major constraints to higher silver prices--the propensity
to short forward production. And so, Silver Wheaton's
ability to still do these types of deals is a very bullish
fundamental factor in the silver market, even though
I'm the only one who seems to talk about it.
MAY
14 2008 2:22PM - The dollar is
still deciding what to do next and Wall Street continues
to fantasize about the "worst being over".
The au/ag moving averages, however, continue to
rise with the 200DMA currently residing at $15.50 for
silver and $830 for gold. If another bottom still
needs to be put in before au/ag advance higher, I don't
expect it to be much lower or too far in the future.
MAY
7 2008 2:44PM - While the dollar
threatens to move higher we cannot be too confident
that au/ag have put in bottoms. In addition, oil
has risen to a level it may not be able to maintain
for long yet that rise has translated to very little
assistance to au/ag. The flipside may be that any decline
by oil would not hurt au/ag that much, but then again
such an outcome won't help either.
The speculative
shorts in COMEX silver futures according to the latest
COT report are down to an incredibly slim 11% whereas
commercials hold 73% of short positions and the remainder
are "spreads". Unlike Ted Butler, I don't
believe spreads are uneconomic: their tiny margins allow
them to be used as effective tools to speculate on changes
in the basis (contango/backwardation). In fact, this
is an area of I've been looking at very carefully lately,
although I haven't made any moves yet. In any case,
the current COT structure in silver is very unusual
and it portends some potential fireworks ahead. Mr.
Butler claims one possibility is that commercial shorts
are unable to liquidate their positions further
and therefore this could mark the beginning of a "big
move up shortly".
MAY
2 2008 12:36PM - The latest big
news
ignored by the "don't worry, be happy" crowd
on Wall Street is the Fed's increase in the Term Auction
Facility from $100 billion to $150 billion along with
the easing of collateral restrictions under the Term
Securities Lending Facility. Now, AAA-rated asset-backed
securities of all types can be pledged, not just mortgage-backed
securities. What this means is that credit deterioration
and liquidity problems continue to spread outside the
mortgage sector.
The
other big news today was the addition of 4 million ounces
to the Barclays' iShares silver ETF, which is now closing
in on 200 million ounces. This should make it clear
to everyone paying attention that: (1) investors will
buy physical silver when the price is rising; (2) investors
will buy physical silver when the price is falling;
and (3) investors will not sell physical silver during
price spikes. Perhaps this is why silver had a nice
rise today.
MAY
1 2008 3:05PM - It took about 5
hours for my latest silly technical analysis to be invalidated,
which is a good thing because there really wasn't any
time to act on it. Unfortunately, the present au/ag
dip indicates further declines are likely. In particular,
a breach of the $16 level in silver (it has not happened
yet) portends a quick drop to $15. But cheer up,
there is some good news here. First, silver is now within
$1 of its 200 day moving average and is thus presumably
getting close to a bottom. Second, the recent new bloom
may wear of the U.S. dollar and economy rather quickly.
Today, stocks soared on the news that consumer spending
rose last month despite the fact the rise was due almost
entirely to price inflation. Delusional is an understatement.
Third, investment holdings by silver ETFs and funds
continue to be steady in the face of steep unrealized
losses. Fourth, the FED's balance sheet still looks
bad with $283.8 billion of reserves at risk (although
down somewhat from last week). Fifth, au/ag's vulnerability
to a substantial decline in oil and commodities has
been decreasing. Sixth, COMEX open interest in silver
has plummeted to normal levels and gold is also down
substantially from the highs. All in all, I believe
the above factors point to a solid au/ag buying
opportunity ahead, if not here and now.
Here
is an interesting point. A friend suggests the recent
stellar performance by bullion did not translate to
PM shares, especially the juniors, because the buyers
in 2007-2008 were not the same as those who drove the
market in 2005-2006. Namely, the 2005-2006 buyers consisted in
large part of individual investors in the U.S.,
Canada, Germany, etc. who split their funds somewhat
democratically between physical metal and shares. These
individual investors were attracted to the junior market
and threw substantial amounts of money at it, causing
it to soar. By contrast, the 2007-2008 buyers were
mostly institutional investors looking for diversification
or direct exposure to commodities. They piled into index
funds and au/ag futures, causing open interest to explode.
They also bought some of the large resource stocks,
which is why the HUI and XAU have done relatively well,
but they largely ignored the junior market.
He
had another pretty good point, which is that some mining
share booms such as the one in 1995-97 were predicated
on new discoveries and not necessarily higher metal
prices. Indeed, relatively low metal prices have the
effect of keeping most marginally-economic projects
in check and thus the number of companies vying for
investors' attention is reduced. That allows the true
gems to really shine and creates the opportunity for
substantial price appreciation across a swath of quality
companies. This is only natural since there is
a finite number of quality projects. Compare that to
today when the majority of "new" projects
are really just old projects that were not economic
at lower metal prices. This means that, ironically,
higher metal prices can actually obscure the true value
of worthy projects. Another takeaway is that investors
should be weary of projects whose value is predicated
on high metal prices. This doesn't mean such projects should
be shunned, but instead investors might do well to understand
the risk and balance it with companies whose projects
would be profitable even at marginal metal prices. In
effect, low cost producers are safer as investments
while high cost producers have better prospects as speculations.
At
the start of this bull market, the marginal price for
silver was roughly $5 and for gold it was $300. Today,
those numbers could arguably be increased to $8
and $500. Among companies that produce silver, three
juniors jump out as easily profitable even at marginal
prices: Silvercorp, Excellon and Fortuna Silver. There
are others as well but these are the three I've had
a chance to analyze recently and would have few qualms
buying (although I don't presently own any shares).
Among the seniors, Hecla, Pan American and Silver Wheaton
would also be profitable at marginal metal prices. I've
been buying Hecla for unrelated reasons but perhaps
I'll buy more of it based on this investment thesis.
APRIL
30 2008 11:00PM - The Fed did nothing
surprising today but it appears that au/ag were prepared
for the worst judging by their relief rallies after
hours. The monetary metals have not, however, escaped
the gravitational pull of weak sentiment nor
have they repaired the recent technical damage. Silver
will need to trade above $19 and gold above $950 for
that to happen. Fortunately, we don't need to wait until
then to establish long positions from a speculative
perspective. You see, the July 2008 COMEX silver contract
never quite got down today to the $16.42 level that
it hit on April 1. There is some significance to this
because the $16.40 level marks the bottom of the uptrend
line starting on August 17 at $11.55 and touching
$13.975 on December 17. Moreover, a similar pattern
in 2006 was resolved in a rather bullish manner. Click following
chart for a better view.
I admit
this is pretty silly even for technical analysis, but
it does give us a pretty good place to put a stop. Namely,
just below $16.42 basis July 2008 COMEX. At the moment,
the price is right around $17.00 so there is a bit of
downside exposure, but not too bad. Should we get another
pullback, the setup would get even better because the
stop would be tighter. Now here is the real interesting
thing though. Note the trend line was kissed about 6
weeks after the 2006 high was put in, and that was the
absolute low of the move. That low has not been threatened
since, not even by the August 2007 washout. Today, it
is also about 6 weeks past the 2007 top (so far) and
the trend line has just been kissed as well.
Okay,
enough chart voodoo, it's time to move on to mining
voodoo. On April 22, I had this to say about Crystallex:
"It can't get
much worse for the company unless the project is simply
taken away." Well, that's pretty much what appears
to have happened today as a Chavez bureaucrat denied
the final environmental permit for Las Cristinas. The
denial was based on a subjective, simple decision--one
that could have been made years ago, sparing Crystallex
shareholders the endless agony and pain and saving the
company hundreds of millions in expenditures.
Meanwhile,
Aurelian has announced a layoff of 300 local employees at
its Fruta del Norte project in Ecuador as a result of
that country's amateur experiment with revising mining
laws. At least in this case no additional money
will get spent on a project that could be destined for
nowhere.
No
wonder the PM stocks are in such a state of malaise:
the wet blankets just keep coming and coming and coming.
Novagold at Galore Creek, Northern Dynasty at Pebble,
Gabriel Resources at Rosia Montana, plus the aforementioned
Aurelian and Crystallex are all 10+ million ounce world-class
gold deposits that may never produce a single ounce
of gold. Perhaps this is what Barrick management was
thinking when they announced Peak Gold last year.
Okay,
enough griping. I'd like to briefly update the U.S.
Silver situation. The company put out some pretty bad
fourth quarter 2007 numbers yesterday which tend
to show the tough and long road that still lies ahead
before the turnaround can be called a success. The first
quarter of 2008 is not looking significantly better
and so shareholders will now have to wait 4 months for
some possible good news (when second quarter results
will be released). This represents yet another reigning
in of already low expectations and some frustrated shareholders
took the opportunity to throw in the towel today. As
a result, the shares traded as low as 41 cents
Canadian on big volume of almost 8 million shares. Buying
at these prices were those investors who've peeked between
the lines and found some reasons for hope. Some of these
reasons could include: (1) operations appear to have
bottomed out during the third and fourth quarter of
2007; (2) if possible to achieve historical head grades
again, operations would be very profitable even at current
low production levels; and (3) management may have finally
lowered the bar enough to jump over it with ease. With
respect to my previously-outlined strategy, nothing
has really changed given that the success (or lack thereof)
of any turnaround should still become apparent
during the third quarter of this year. The only
thing different now is the financial results were
bad enough that the share price could see pressure
for some time. For me, this means an opportunity
to acquire shares cheaper and for longer, and that's
exactly what I intend to do -- carefully. I will mention
each time I add to my position in order to help develop
this important concept of "carefully" when
it comes to speculation. So far, I have 5,000 shares
at 61 cents and 5,000 shares at 55 cents.
I'm
going to wrap up today on a more positive note. My favorite
gold porphyry hunter, Exeter, just announced
a phenomenal drill intercept at Caspiche in Chile consisting
of 719 meters of 1 gram per tonne gold and 0.38% copper.
This hole confirms the world-class potential of this
project and the main question now is whether it is
merely large (10 million ounces) or humongous (20 million
ounces). I'm not exaggerating much when I say this is
a billion dollar hole. It puts to shame everything
that competitors Serengeti and Southern Arc have done
and easily bests Canplats' impressive Camino Rojo
work. Yet apparently the market didn't seem to notice
(or agree) given that Exeter was up less than 10% on
tepid volume. Regardless, it's only a matter of time
before PM investors start to realize this is a must-own
gold explorer. I have removed all stop losses from my
positions and will instead aggressively accumulate for
my long-term speculative portfolio on any weakness.
It will probably take some time for Exeter to fully
blossom but I'm fairly certain that it will trade
at $10 in the next couple of years and maybe sooner.
I base this on the observation that MAG Silver, a joint
venture partner with Penoles in certain concessions
at Fresnillo, Mexico, has a similar share capitalization
as Exeter yet it is trading at $12. This based on
drill results not much better than what Exeter has been
doing at its Cerro Moro project in Argentina. On this
basis, Exeter's $4 share price is more than justified
by Cerro Moro alone, which means that you are getting
the 719 meters of 1 gram per tonne gold and 0.38% copper
for free. If you like giveaways, here is one for a billion
dollars.
APRIL
29 2008 2:00PM - It doesn't look
good here as both gold and silver failed to maintain
support today with the Fed meeting underway. Oil
appears ready to take a rest, the dollar continues to
threaten a rally above 73 basis the index and investor
mentality is getting more and more mental. By "mental"
I mean oblivious to the nasty economic conditions that
appear to lie ahead.
How
quickly the fortunes of monetary metals can change!
Just a couple of weeks ago the problems seemed so severe
that only a fool could say that the end was in sight. Yet
tomorrow there is a reasonable chance the Fed could
signal--and stoke the misconception--that the worst
is over by not cutting rates or by cutting 25 basis
points while signaling that rate cuts are coming to
an end. In the short term, a shift in investor
sentiment toward complacency could very easily clobber
the vulnerable resource sector along with au/ag. The
vulnerability is on account of potential hot money outflows
as speculators flee for the hills. The failure of support
at $890 gold and $16.70 silver is very worrisome in
this regard as it portends a sharp move lower at least
to the 200 day moving average currently around $825
for gold and $15.25 for silver. A severe drop could even
breach these levels and result in a decline to perhaps
$750 and $14.00.
On
the other hand, I'm not convinced the Fed actually cares
a whiff about inflation given the persistent and very
real threat of an economic disaster. After all,
home prices are still falling, loan defaults are still
rising, consumer confidence is still sinking and spending
is still shrinking. The liquidity crisis at the banks
may have been temporarily forestalled, but the liquidity
crises facing consumers and businesses appear ready
to spin out of control. Unfortunately, there are no
easy, practical solutions for such crises but there
are plenty of impractical approaches, such as
the tax rebate checks going out in the mail this week.
Too bad this type of economic stimulus will be
about as effective as peeing into an inferno.
There
should be little doubt that other, more meaningful
yet no less impractical approaches will be tried in
the future. They too will fail. Meanwhile, the
practical solutions don't seem very practical and
that makes them very difficult and unpopular: (1)
encourage a substantial rise in labor costs
and general price levels in order to eat away at
relative debt levels; (2) return to the gold standard;
(3) endure monetary collapse and start over with yet
another fiat standard; etc. These scenarios are all
bullish for au/ag prices. In fact, I can't really think
of a practical solution that would be bearish.
While
the above are longer term considerations, even the gloomy
short-term picture has some rays of hope for au/ag. For
example, the growing au/ag pessimism may be a sign
that the worst is actually over and any further declines,
even if sharp and painful, could be over very quickly.
It is also possible that the imminent Fed action/inaction
could be interpreted as bearish for the dollar, at least
by its foreign holders. Furthermore, any Fed validation
or legitimization of concerns about inflation
would be bullish for au/ag regardless of the dollar's reaction.
It's a long shot but one potential outcome is a
disconnect in which the dollar rallies moderately while
au/ag prices explode. Even if, however, none of
these things come to pass, it is entirely possible that
the Fed action has already been discounted by the markets.
That could mute any dollar or au/ag reaction and
might even reinforce the dominant trend (dollar down,
au/ag up). In summary, the risks are significantly less
acute than they would be if gold was still trading above
$1000 and silver above $20.
Be
that as it may, the rays of hope for PM stocks
seem to have completely faded away as the share prices keep getting clobbered
day after day amid steady selling and pessimism.
It's hard to imagine how some of these prices can possibly
go lower but yet they keep going lower regardless. We
are already at levels in many stocks that are below
their lows of last August and yet the final washout
may still lie ahead.
Hopefully
many of you who have been buying in the past few weeks
and months are doing so carefully and therefore
still have some funds left to scoop up the current
and future bargains out there. Right now, you can find
good values by asking a blindfolded monkey to throw
darts. Some of the recent companies I've discussed,
such as Hecla, U.S. Silver and First Majestic, are approaching
valuations that are more appropriate for banks and utilities.
Personally, I will be making some careful additions
to my position in these and other companies in the days,
weeks and months ahead. If the au/ag bull market is
not over (a 99% chance), then the current situation
represents one of the best buying opportunities
in PM stocks ever.
APRIL
25 2008 2:30PM - One foot went over
the edge of the cliff this morning but the other foot
wouldn't follow, so we'll have to wait until next week
to see the au/ag drama play out. One negative in
gold is the recent reduction of gold holdings by the
GLD ETF to the tune of 1.6 million ounces. On the other
hand, the silver ETFs are holding steady even if they
are not adding.
Speaking
of adding, I bought another 5,000 shares of U.S. Silver
today at 55 cents. The shares have now reached an all-time
low and this is a bit disconcerting given the imminent
release of presumably positive 4th quarter financial
results. Until I see those, I'm not going to buy anymore
as 10,000 shares is more than enough of a risk
on what could turn out to be a punt. I also bought a
small position in Hecla today as I expect it to double
from current levels (more on that later). I will be
adding to this starter position on weakness. Finally,
my "stink bid" in Oremex has not been filled
yet but I am still looking to augment my First Majestic
position with this small gamble on a share-for-share
basis.
A
quick roundup of some other stocks. After exiting Southern
Arc and Serengeti positions a few weeks ago I don't
see much price impetus in the immediate future. Southern
Arc may have some good drill results in a few weeks
and I'll watch for those, but for now my focus has actually
shifted to another stock, Canplats, that I've recently
mentioned. The price of this one has finally started
to come back down yet its Camino Rojo project near
Penasquito in Mexico remains fairly exciting. I have
not bought shares but I'm looking into it. I'm also
mulling over Exeter near $4 as it seems to have found
its legs and a slew of drill holes from its Caspiche
discovery in Chile should be announced soon. Finally,
I'm an observer of Silver Quest, a stock that has done
particularly well in the past few days. The company
has recently had to raise money at a lower price than
it would like which has caused some dilution, but the
financing was supposedly oversubscribed and the stock
has been on a minor tear since then. The latest news out
of this junior microcap silver explorer is the appointment
of Exeter man Michael McPhie to its Board of Directors.
The one thing I'll point out is that today's impressive
price move was made on very little volume so there is
probably going to be some retracement, but this might
be one to keep an eye on especially if it falls back
toward the 20 cent level.
APRIL
24 2008 11:00PM - I've noticed that
many of the au/ag bulls are expecting the correction
to continue, which could be a pretty good indication
that it might be just about over. Prices still
hover at the edge of a cliff but until that last
step is taken, there is always the chance for salvation.
One interesting development I've been watching over
the past couple of days is the divergence of prices
in different spot markets as if traders are marching
to the beat of their own drums. This could mean there
is aggressive buying in some markets and aggressive
selling in others. If so, it could be good news in that
the current downtrend may not have much coherence behind
it.
I'd
be tempted to make a moderate physical purchase here
(if I didn't already have my fill) considering the current
silver price and the growing availability of bullion.
Some dealers like Tulving
are now sitting on a bit of inventory as purchases have
slowed down in the past few weeks. I note that Tulving
has recently reduced its minimum silver order to 300
ounces so you no longer have to be a millionaire to
buy in bulk. I'd certainly keep some dough in case
the correction does continue, but tactically this represents
a pretty good point to average in a purchase. We are,
after all, $5 off the recent highs. The equivalent in
oil would be under $90 per barrel, which seems
worlds away.
Despite
all the negativity, there are several short-term reasons
to remain bullish on au/ag. One of the biggest is this
business about rice shortages, which is putting our
mass psychology on display. Riots, panic, hoarding,
withholding. All the qualities that we should expect
to see in monetary metals at some point down the line!
To a minor extent, we've actually already seen a bit
of this in the retail silver market. And let's not forget the
near-failures of Northern Rock and Bear Stearns,
which have brought the fear of financial panic forward
from the back reaches of our minds. Food shortages certainly
feed into this mentality. And according to the Economist,
this is one trend that may be here to stay.
Not to mention that the new status of commodities as
an investment class are bound to make the situation
even more extreme. What I'm saying is we could be in
for one torrid hot summer where "sell in May and
go away" could turn out to be a disastrous investment
decision.
As
I was reading that Economist article, something occurred
to me that I wanted to throw out as fodder. It was during
1972-74 that we had the industrialized world's first
major "food shock" along with the better-known
"oil shock". The mess in oil was the
result of the 1973-74 Arab Oil Embargo, which was punishment
for U.S. aid to Israel during the Yom Kippur
War. My guess is that today there is a "silent
embargo" to punish the U.S. for its invasion of
Iraq. Moreover, the rise in early 1970's food
prices also appears to have been caused by similar
factors that are in play today. The first one is the
relationship between food and energy (back
then it was because both were key components of
production and consumption, today because ethanol made
from foodstuff is used as a substitute for oil). A second
similarity is new demand driven by the rise in the incomes
of large segments of the world's population (back then
it was the U.S, Europe, Japan, etc., and today it is
China, India, Brazil, Russia, etc.) In 1973, there too
was much talk about reaching global production peaks
and not having enough food to feed, clothe and power the
world, just as there is today. Finally, of course, there
is the similar rise in mistrust of governments
and their fiat monetary systems during both periods.
There
are some interesting implications here.
First,
food and commodities quickly topped out by 1974-75 on
an inflation-adjusted basis and after more than 30 years
they are only now approaching their real 1974 levels.
By contrast, au/ag rose multiple-fold after a serious
correction in 1975-76 to peaks in 1980 that we are nowhere
near today in real terms, especially in the case of
silver. Could it be that we are merely in the first
innings of this au/ag bull market instead of the second
or even third stage as some pundits claim? Possibly,
given that we are just now having our first food
and oil shocks of this bull market.
Second,
I note a similar performance of PM stocks today compared
to what took place in 1974-76. This chart
provides a good reference point. Note the choppy action
for almost 2 years, which is comparable to the price
action we've had since June 2006. Note also that gold
stocks were making highs as the Dow crashed and that
they remained strong for almost a year after gold put
in a top. This lagging out-performance of bullion by
stocks was even more pronounced at the end of the bull
market in 1980. So perhaps we shouldn't be so confused by
the tepid performance of gold stocks these days;
it could very well mean the best still lies ahead.
Third,
widespread price inflation (as measured by core and
non-core CPI and PPI) did not become entrenched
during the 1970's until after the initial oil and food
shocks of 1972-74 had actually started to subside. Similarly, price
inflation (should it be on its way) this time around could
also have a lag effect with the entrenchment coming
perhaps in 2009 or 2010.
Fourth,
this time we may not get a severe spike in commodities
with a subsequent bust as occurred in the mid-1970's
but perhaps rather a spike followed by stable, elevated
prices. Eventually, labor costs would have to be adjusted
to match this new reality (for one, so workers don't
starve) in spite of globalization and this would increase
the price of manufactured goods, creating a feedback
mechanism that in turn pushes commodity prices higher.
This is precisely what happened in the late 1970's
on the national scale. This time around, it
would be global.
Fifth,
the large amount of fund flows into the commodity
sector may have an unpredictable and dramatic effect
on prices in both directions, but for reasons I've tried
to explain before, the direct impact on supply
and demand may actually weaken over time. By comparison,
investment considerations were largely non-existent
during the 1970's. One possible reason for a declining
impact going forward include the growing popularity
of short or reverse Exchange Traded Notes which would
allow the Commodity Index Traders to offset long index
positions on paper without the need for futures. In
addition, government policies at some point will probably
discourage or restrict organized commodity speculation.
Yet eventually, high and stable prices may encourage
commercials to hedge an increasing percentage of
future production, which would allow the free market
to alleviate investment pressure.
So
to wrap things up, here is one possible scenario using
the 1970's experience and the Economist playbook. Commodity
prices rise during 2008 and reach a peak at some point,
then fall back moderately but remain at elevated levels
as a result of factors such as ethanol and continued
prosperity in emerging economies. Au/ag peak possibly
around the same time and then also proceed to correct
until the first whiff of price entrenchment, which may come
hard and fast on the heels of the commodity peak. In
the meantime, gold stocks remain resilient and start
to outperform bullion. As price inflation heats up,
it feeds directly back into commodity prices. Commodities
become proxies for price inflation but au/ag, for a
myriad of reasons, outperform oil, food, base metals,
etc. as was the case at the beginning of the bull
market. At some point the monetary system collapses
or fantastic solutions are found for all the big
financial problems, and then it will no longer be worthwhile
to own au/ag for speculative or investment purposes.
Don't get too excited, it's only a theory.
One
last thing. The Economist article makes a point that
countries with large agrarian sectors such as India
are net beneficiaries in a world where food is "cheap
no more". This could be an important point because
Indian farmers have historically been big buyers
of au/ag and may continue to be big buyers as prices rise
much higher. Like I said, rice shortages could turn
out to be very bullish for gold.
APRIL
24 2008 2:35PM - Still clinging to the
bottom of their support zones as I type this, au/ag
struggled all day to keep it together as the dollar
threatened a rally. It will be interesting to see how
the Asian markets respond to these prices later tonight,
although investors there might be too busy buying rice
to care much about the monetary metals. The rice shortage
is now making worldwide headlines and it looks to get
worse before it gets better: Brazil, for no apparent/good
reason, has just suspended
exports.
The
dollar rose the last couple of days partly because
a chink in the armor of the European economy is becoming
apparent while investors in the U.S. are starting to
think the worst is over. For example, the German economy
is showing early signs of trouble as German business
confidence dropped more than expected last month. Second,
Credit Suisse has just reported a first quarter
loss on account of a $5 billion write-down. Meanwhile,
U.S. investors celebrated a tiny profit out of struggling Ford,
a small decline in unemployment claims and murky data
on durable goods. Little shrift was given to another
horrible report on new home sales. All in all, the market
remains "cuckoo for Cocoa Puffs".
In
my opinion, the most important--and relevant for au/ag--news
continues to be the Fed's balance sheet, which has deteriorated
once more. As of yesterday, a total of $304 billion
of monetary base was at risk which represents 39% of
the $777 billion of Federal Reserve Notes outstanding.
How long will this continue? Well, the amount at
risk has increased progressively each week to the point
that it may have resulted in sufficient (for now) liquidity
injections into the credit system. $304 billion is a
lot of moolah and it is still probably sloshing around.
As a result, we could see some stabilization at this
point. This in turn might even allow the Fed to repurchase
some of its Treasury security holdings just in
time to bring Treasury yields back down. Yet I expect
things will get worse down the road as long as
the housing mess continues to fester, which it will
until inventory is reduced and banks start to lend again.
APRIL
23 2008 1:00PM - Au/ag back down
to the bottom of their ranges even with oil at record
highs and the dollar within spitting distance of
a record low. This is very troubling because au/ag should
be shining at this moment. If oil and the dollar are
nearing the end of their moves in the short term, it's
pretty much guaranteed the current levels in au/ag won't
hold and they are headed back to their 200 day
moving averages. PM stocks are getting hammered today
in recognition of this possibility. It seems they just
can't catch a break. Meanwhile, bullion buyers are holding
their collective breaths as evidenced by the major ETFs
being stuck at the same level of holdings.
The
positive side to all of this if you like to speculative
with options is that the July puts are still pretty
cheap--for example the July '08 $15 for under $1,500--while
the calls are starting to approach bargain territory
(possibly for good reasons). If the current levels hold,
there is still the chance to make another run at the
March highs but it will need to happen before the end
of June. That makes the July call options an appropriate
bet, although it is very risky to buy them before we
know the $16.70-17.00 support will hold or not. If I
were to buy, I'd probably buy the $20 calls in pairs,
selling one on a rise back toward $18 to pay for
the other. Of course, the safest bet right now is
to have some money available for future bargains in
bullion and stocks instead of blowing it on restless
speculation.
Here
is one reason why we might be seeing this pathetic weakness
in au/ag. It's quite self-explanatory:
Strong euro prompts manufacturers'
threat
GENEVA, Switzerland, Apr 22, 2008 (UPI via COMTEX) --
The weakening
dollar has forced major European manufacturers to consider moving production to
dollar-based economies, an industry coalition said. On Monday, the AeroSpace
and Defense Industry Association warned of "massive relocation of aerospace
production capabilities to U.S. dollar priced locations, where labor costs
are approximately 30 to 40 percent lower than in the euro zone," The New York
Times reported. As a sign of the shifting currency values, European
Aeronautic, Defense and Space company Airbus is raising prices of the super
jumbo A380 plane by $4 million, the Times reported. EADS also announced
Tuesday it would purchase a California security systems company, PlantCMI for
$350 million, in part to strengthen its presence in a dollar-based economy.
The
above, though anecdotal, is good ammunition to use next
time you hear some pundit saying the dollar is toast
and will imminently collapse.
APRIL
22 2008 9:00AM - Silver showed its ugly
side yesterday by sliding another 3% as gold
struggled to stay even despite weakness from the dollar
and record oil prices. We have at least a partial explanation
for the strange happenings late last week in "lease"
rates, basis and spreads with the revelation
that banks have been under pressure to underreport
LIBOR in order to lower their own short-term borrowing
costs. My quick examination of the facts and circumstances
indicates that there might in fact have been a
certain amount of underreporting. In particular, LIBOR
in the past few weeks and months appears to have been,
at times, anywhere between 5 and 25 basis
points (0.05% to 0.25%) below where it might otherwise
have been expected. On average, it appears to have
been about 10 basis points lower. This is much less
than the 30 basis points some experts have alleged,
but there is another issue that could even be more important.
It seems that LIBOR tends to get "sticky"
when it should be rising, as if the banks are trying
to influence market rates by trying to put a break on
them via the self-reported LIBOR. Each time it becomes
clear to the banks that the ploy won't work or the rate
differentials simply get too big, the banks appear to snap
LIBOR back in a swift move that closes the gap within
a day or two. This is precisely what seems to have happened
late last week. The "catchup" appears
to have been even more fervent than usual due to the
widespread publicity about the underreporting, which
may have resulted in an additional 10 basis point rise
in LIBOR above and beyond what was required to restore
parity with the market. Apparently, all the banks have
been told to stop whatever they may or may not be doing.
The net result of all this is last week's increase in
the futures spread and basis may have been anomalies
that should be ignored like all the other noise.
Where
does yesterday's drop in silver leave us? Well, still
above the important $16.70-17.00 level but basically
back within a trading range. Silver will now probably
need to fight its way all the way to $19 before we can
confirm another breakout. The good news is that all
this time the 200 day moving average has been climbing
and recently crossed $15, which is a mere $2 and change below
current levels. That means it might be getting close
again to when it is safe to accumulate au/ag. Lo and
behold, the bullion dealers seem to have found some
inventory just in time! Be that as it may, I'd continue
to be slow and careful for now.
On
the other hand, it might only be a matter of time before
the dealers run out of silver again. First, however,
the grocery stores might run out of rice! There are
people apparently stockpiling
rice here in Silicon Valley if the story is to be
believed. I haven't seen it personally and curiously
it hasn't made the local media, but I'm sure it will
if the phenomenon spreads. There is a major risk
to au/ag here in that government attempts to cool down
food and commodity prices could be targeted at the monetary
metals, or else they might be collateral damage. Already
there are threats out of the European Central Bank that
there could be coordinated intervention to stop the
dollar's slide as well as give the commodity markets
a cold shower. Presumably such cold shower would come from
the policy side, such as higher taxes on commodity gains,
position limits or restrictions on the size of investment
vehicles.
Speaking
of cold showers, the resource market got another big
one late last week as the silly government of Ecuador
has passed a "mandate" that freezes all exploration
and development work for up to 6 months while a new
mining law is drafted. The mandate also strips most
companies of the majority of their land holdings, potentially
bans open pit mining, and significantly increases the
odds that a project can be denied on arbitrary
environmental
grounds. In effect, this mandate has killed mineral
exploration in Ecuador for the foreseeable future. The
share price of Aurelian, which hopes to develop the
Fruta Del Norte deposit hosting at least 13 million
ounces of high grade gold, has cratered along with other
companies that have projects in the equatorial country.
I believe this latest setback to the mining industry
will also have a negative impact on companies
that don't have projects in Ecuador as it again reminds
investors of the significant political risks borne by international
mining outfits. I expect
companies with projects in other politically risky regions
will be hit the hardest although there is one company
that might be somewhat immune. That company is
Crystallex, the operator of the Las Cristinas project
in Venezuela. It is a single permit issuance away from
starting construction on its 17 million ounce gold
mine (and has been for almost a year). Unfortunately,
the economics of this world-class gold mine depend very
heavily on Hugo Chavez's mood from day to day as well
as the foreign exchange regime of Venezuela, which
has been subject to artificial controls for 5 years
now. Without fully understanding the implications of
exchange rates, it would be foolish to consider Crystallex
as an investment although it might be a worthwhile speculation
on the basis of imminent permit issuance. It can't get
much worse for the company unless the project is simply
taken away. Along with Apex Silver's San Cristobal,
at least 3 top world-class projects have now essentially
been ruined by South American madmen.
APRIL
18 2008 4:30PM - In typically frustrating
fashion, silver gave back all of its hard-fought gains
of the week by the time the COMEX opened this morning.
It seems that finicky traders in London sold the monetary
metals with abandon as the dollar index rose above
72 and the Euro cooled off a bit.
Oil
remained strong, however, as did several other commodities.
Stocks in general are also rallying today based
on Google earnings that assign a forward P/E of 45 to
the Internet darling's shares as well as the news
that losses at Citibank were bad, but not as bad as
expected. This of course is demented logic and
so it comes as little surprise to me that gold and silver
(shorthand from now on: au/ag) should suffer on
a day when talk of a rise in bond prices on account
of inflation fears is starting to dominate the
financial media.
In
any case, this market nonsense is ignoring the latest
deterioration of the Fed's balance sheet, wherein $286
billion of backing for the Federal Reserve Note has
now been placed at risk. This represents 37% of the
U.S. monetary base and essentially means the dollar
is facing the most precarious situation of
its almost-centennial existence. Yet it is probably
still too early to question the survival of the
world's reserve currency given that rising bond yields increase
the Fed's ability to print and drop money from helicopters.
Many commentators claim that the Fed has already been
doing this, but the truth is that the Fed has done zilch
to directly increase the money supply since the beginning
of the crisis. You see, the only means for the Fed to
increase the money supply is to issue Federal Reserve
Notes (FRNs). The rest is the responsibility of banks
and financial institutions through the process of fractional
reserve lending. To wit, FRNs in circulation stood at
$775.789 billion on August 15, 2007 and today they stand
at $777.511 billion. Moreover, this number has been
roughly the same since late 2006.
So,
basically here is what might happen. If bond rates keep
rising while credit conditions resume their drop into
a bottomless pit, the Fed will be able to take
advantage of "good helicopter-flying weather".
Aggressive Fed buying of bonds will then lower the long
end of the yield curve while flooding the system with
fiat money. Under these conditions, the dollar could
be expected to make another steep decline, perhaps all
the way down to the 52 level discussed in my March 18
commentary. Look, I'm not saying the Fed is willing
to do this, but at some point the danger of waiting
longer may start to exceed the danger of flying the
helicopter. Despite all the huff, Bernanke likely understands
that printing money has got to be the last resort, and
he probably looks forward to taking the credit for doing
so at exactly the right time. That means when it finally
happens, it will be quick and out of nowhere. You want
to own some au/ag in advance because it will be difficult
and very expensive to obtain afterwards. In fact, you
should be planning to sell (some) in the aftermath
of a true helicopter drop.
The
above essentially means that rising bond yields are
very positive for the au/ag price assuming that the
credit markets will continue to depend on massive
central bank intervention to avoid collapse. Conversely,
newfound stability in the credit markets and improvements
in the Fed's balance sheet will signal a reduction in
the urgency to own au/ag. We are talking about intermediate
trends here that can influence prices over the course
of months and years, not day to day fluctuations.
Okay,
enough monetary B/S, I'd like to move on to some nuts
and bolts. Or is it soup to nuts? Specifically,
I would like to talk about a couple of silver producers
that reported very good financial results yesterday.
The first is First Majestic, one of my subjective favorite
silver stocks, which has recently started to publicly
emphasize its goal to become a senior silver producer.
The latest operating results represent a solid step
in that direction. Highlights include 3.1 million ounces
of silver produced in 2007 (3.5 million ounces of silver
equivalents, expected to grow to 5.5 million in 2008)
and C$15.9 million in mine operating income excluding
non-cash charges. With C$50 million in the bank and
a fully-diluted market cap of C$375 million, this is
pretty good but the valuation clearly relies on expansion
of production in the future.
So
far so good, but listen to this. The company raised
over C$45 million in an offering last month, something
that was not necessary if the plan were to simply
continue developing its 3 existing mines. Its Chalchihuites
or other projects certainly aren't ready for that kind
of exploration money, either, which brings up the possibility that
First Majestic is once again on the hunt for major property
(or small company) acquisitions. Unfortunately, there
aren't many properties remaining in Mexico so First
Majestic will probably have to bite the bullet and by
some company kit and kaboodle. Fortunately, this
is something First Majestic's president Keith Neumeyer
seems competent and comfortable doing, given his diverse
investment, finance and operations background.
So,
why don't we look around to see if there are any
tasty targets that First Majestic could gobble up with
its modest C$50 million war chest? Alas, the only one
I could find is an unloved, downtrodden little
company by the name of Oremex. Provocatively, Oremex has
already sold a property to First Majestic during 2006 (in
the La Parilla district) and still holds a small
concession in the Chalchihuites camp where First
Majestic has been poking around in an attempt to
consolidate the district. Thus, the two sets of
management likely have become well acquainted with each
other already. Considering the paltry C$10 million
fully-diluted market cap--despite the 50 million
ounce inferred silver resource at the Tejamen open pit
project--it's no wonder that Oremex recently adopted
a shareholder rights plan. You see, if the surface rights
negotiation at Tejamen can be concluded soon,
the project might produce perhaps 3-4 million
ounces of silver starting as early as 2011 or 2012.
That production would be almost pure silver with
minor gold credits, one of the few in the world this
size (similar to Coeur's soon-to-be-shuttered Rochester
Mine in Nevada). Given First Majestic's goal of
becoming a senior silver producer and its largely unrecognized
status as already having among the highest percentage
of production from silver (which goes a long way to
explain why the company is a subjective favorite of
yours truly), Tejamen would fit in pretty well.
Now,
please don't get me wrong, this is all pure speculation
based solely on publicly available information and a
bit of brain juice. Also, realize that Oremex is a risky
stock as illustrated by the more than 50% decline in
share price since I put it on my potential "Ten
Bagger" list in late 2006 (does that make it a
"Twenty Bagger" now?) But here is something
to consider. Why not buy a share of Oremex for each
share of First Majestic you buy or already own? That
limits the risk in that you won't go crazy buying too
much Oremex, and if it goes kaput you can mentally deduct
the cost from your hopefully big profits in First Majestic.
On the other hand, if Oremex gets bought out for a mere
$25 million (not a remote prospect), you've made some
respectable dough in a tough market regardless of what
happens with the price of First Majestic. And if First
Majestic does end up being the acquirer, it might not
be a bad idea to roll the Oremex proceeds right back
into First Majestic in order to leverage the presumably
accretive results.
Alright,
let me move on to the second "silver" producer
(no, Oremex wasn't it). It is Fortuna Silver, and I
put the silver in quotes because the silver component
of its current operation, Caylloma in Peru, is actually
25% or less as a percentage of revenue. Still, the 2007
results were impressive for the first full year of operations,
producing 0.5 million ounces of silver and approx. 10,000
tonnes combined of lead and zinc (roughly 2.5 million
ounces total production on a silver equivalent basis).
Of course, when silver is such a small component of
the product mix, it doesn't make sense to report silver
equivalents, and Fortuna management to its credit has
refrained from the practice. I note this hasn't
stopped some gurus like Jim Dines from picking Fortuna
Silver as their top pick for "silver" producers
expected to benefit from a near-term rise in the silver
price. I'll get back to this in a second, but first
I will note that Fortuna generated C$19.0 million in
mine operating income excluding non-cash charges during
2007 as falling zinc prices were partially offset
by rising lead prices. Fortuna also had around $50 million
in cash at year-end (probably higher now) and a fully-diluted
market cap of C$225 million as of today. The market
cap compares favorably with First Majestic on the basis
of mine operating income, and arguably if First
Majestic is undervalued then Fortuna is even more so.
On
the other hand, one possible reason why the market
has assigned a fair and square lower value to Fortuna's
2007 operating metrics might be the mix of silver
to base metal production: less than 25% silver
for Fortuna whereas it's the reverse for First
Majestic at more than 75%. Yet the base metal argument
becomes less convincing when one realizes that Fortuna's current
silver-poor ore mix is the result of a deliberate decision
to mine the veins at widths that capture most of
the lead-zinc (which is somewhat diffused) but
substantially dilute the silver (which tends to occur
in discrete bands). Caylloma has veins that are
in fact very rich in silver: recent assays include 6,231g/t
(around 200 ounces) of silver plus 10% combined
lead, zinc and copper over an estimated true width of
1.5 meters. Such bonanza grade material is easily
80% or more silver by value and could be added
to the production mix using selective mining methods
without huge difficulty, though an increase in cost.
If and when there is an improvement in the
proportion of silver produced, this should transfer
directly to the share price.
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