The idea is that supply chains are only as strong as their weakest link. The fact is that many thousands of technologies — electronics, aerospace, military, automotive, clean-tech and renewable energy, to name just a handful — rely on a small number of specialty metals, or what some call “technology metals.” These metals have obscure names, but in many cases, there are simply no substitutes.

United States of Windmills

Some so-called “technologies of the future” are destined to fail due to lack of critical metals with which to effect buildout. Take the rare earth, neodymium, for example. It’s a component of strong permanent magnets — which are made out of a mixture of neodymium, iron and boron.

Strong permanent magnets are critical to gaining efficiency in rotating power-generation units like, say, windmills. Y’know… we’re going to replace burning fossil fuels with windmills, right? Isn’t that the idea? We’re going to live in the United States of Windmills, right?

Except one fact of physics is that without strong permanent magnets, you can’t generate nearly as much power with each turn of the large blades. So neodymium — in the magnets — is critical to our windmill future. There’s NO substitute for neodymium, and believe me, people have tried to figure a way around it.

But with neodymium, as with a host of other relatively obscure substances from the periodic table, the global supply is precarious. In some cases, the supply chain is at great risk because there are but a few sources. For some of those sources, we see things like a major mine playing out due to depletion (Baotou, China, for rare earths) or shut down due to environmental issues (Mountain Pass, Calif., again for rare earths). With other metals, many mines are effectively off-limits due to political problems (in the Congo, for instance).

Looking Ahead with Critical Metals

Most of the strategic and critical metals are just plain “different” than other major industrial metals, like copper, aluminum, lead and even gold and silver.

From the standpoint of nuclear physics, for example, rare earths are not like the other elements. They are brilliant, stubborn and complex, and at the same chemically similar and uniquely individual. You take each rare earth atom the way it was formed in a nuclear reaction within some long-gone, exploded sun, billions of years past.

Another more mundane aspect of the critical metals is that few are exchange traded. For the most part, there’s no futures market, other public market or well-defined transparent price discovery mechanism. There has never been sufficient volume to build up a worldwide market for futures in these obscure elements. So most of the critical metals that get used in world commerce are sold under one-on-one, long-term contracts.

Lacking a forward market, industrial users can’t lock in future prices or deliveries through traditional hedging. They have to sign a contract and agree to pay for future product. It sounds straightforward, but the reality is different. The firms that use many specialty metals live in the worst of both worlds. There’s no futures market, but they are still vulnerable to supply interruptions, spot shortages and price squeezes in the market.

Dealing with Risk, and Virtual Hedging

One technique for users — as well as strategic-minded governments — is simply to pay upfront and stockpile material. This leads to issues with the costs of storage, ensuring physical security, the cost of money and the usual problems with inventory accounting and taxes. Also, with some metals, there are insurmountable storage problems with the rapid deterioration of product due to oxidation or other chemical deterioration.

In other words, in a world where supplies of critical metals are spotty, the traditional tools of costing and forecasting are unreliable. There’s just more risk in the critical metals biz, in some cases rising to “bet the company” levels.

The newest trend in the industry is what’s called “virtual hedging.” This is a term to describe a menu of techniques for developing forward prices and assured deliveries of critical raw materials. Firms use virtual hedging where a futures market does not traditionally exist.

One tool of virtual hedging is to make a direct investment in a mine and get payback via guaranteed metal deliveries (also called off-take agreements). Other kinds of virtual hedging are wide ranging, from stockpiling (for oneself or others), synthetic and/or over-the-counter hedges, material leasing, strategic reserves (i.e., get the government to do it for you) and closed-loop recycling.

Meanwhile, users are hard at work trying to work around issues of physical supply. There are aggressive efforts going on with traditional programs like critical material “thrifting” (use less and see what happens), material substitution, pricing index selection (gear the amount of input to the cost), flexible transfer pricing (charge the customer a surcharge for the extra costs of critical inputs) and in-house waste stream recoveries. The idea is to develop an overall strategy and methodology to mitigate price and supply risk of critical raw materials.

Similarly, producers and industrial processors may also employ these tools as a way to assure adequate income streams for debt retirement, more assured profitability and funding for future expansion and production. Virtual hedging truly has the ability to be the elusive win-win formula that most Western businessmen publicly promote, but are rarely able to employ.

Living Off Past Stockpiles

With one particular element — which I’ll decline to name just now — there’s already a severe supply crunch. This is an element that’s used in a wide variety of electronic products. The supply chain could run dry soon.

Thus, the industry that uses this item is “living off past stockpiles,” according to one inside player. Last year, the general estimate was that there’s enough product in the supply chain to last for two years. So the pipeline will be dry by 2012.

What happened? The problems originated with an unprecedented spike in the spot market price in 2000. In this thinly traded resource, supply fears caused many nervous dealers to sign long-term contracts and lock themselves into high market prices. Then when prices crashed for product off contract, across the user community, there were significant inventory write-downs, both current and future.

By 2006 and 2007, the industry returned to some semblance of normality. But with the crash of 2008, everything fell off a cliff as the economic meltdown jammed the brakes on consumer demand.

Meanwhile, the few companies that mine the substance suspended production. So now there’s a situation in which primary production of ore is all but shut down. There are stockpiles, and just a very limited amount of material coming out of a very small number of mines in faraway jurisdictions.

Thus, with this product, as with most other of the critical technology metals, the question to ask is what does is the downstream industry fear more? High prices for an essential, irreplaceable input? Or lack of physical supply from the mine and mill and widespread unavailability of any product at any price?

It’s a problem within the industry. And it’s just this kind of situation that gives us an entree into an opportunity for profit.

Until we meet again,
Byron King

October 30, 2009

Rare Earths and Other Critical Technology Metals was originally featured on Whiskey and Gunpowder

“I don’t know if I will live to see it,” said Brazil’s president Luiz (Lula) da Silva a couple weeks ago. “But Brazil has to transform itself into a big power in the 21st century. We have everything to make it happen. We are not talking about a little country here.”

No, indeed. Brazil is not “a little country” anymore. Any prudent investor has to consider how to hitch a ride on the Brazil growth story. Brazil is transforming into one of the world’s great powers in this century. It’s important to follow the news from Brazil. At the same time, you have to know where to look, and how to read between the lines.

By official count — what the Brazilian government will confirm — the rocks of Brazil hold nearly 20 billion barrels of proven reserves. That number is on par with the total for U.S. oil reserves, including Alaska and the Gulf of Mexico.

It’s an impressive number, but then there’s also the unofficial Brazilian reserve count. How much oil is “really” down there under Brazilian jurisdiction? It depends with whom you talk. Some Brazilian officials will smile and say the country has 50 billion barrels of resources. If the Brazilians can tap into this treasure, it adds up to more than twice the total reserves of the U.S., including Alaska.

Other knowledgeable — VERY knowledgeable — Brazilians give much larger estimates. I’ve seen estimates that place the resource number at “over 100 billion barrels.” This puts Brazil in with the largest of the large oil nations, such as Iraq, Iran and Saudi Arabia.

These massive oil resources offshore Brazil lie beneath deep water and thick layers of salt. And since it’s all within Brazilian waters, the government of Brazil is increasing its control over offshore development. This way, Brazil will have its own oilmen keeping an eye out for the overall national interest — and making big money for the Brazilian treasury.

The new level of Brazil’s state control over oil development is a strategic decision. Brazil is counting on the hydrocarbon resources to help propel it forward as one of the world’s major powers. And the development in Brazil will control the destiny of a good number of players in the OI portfolio.

Many companies whose fate is tied to the wheel of the Brazilian ship of state are in that portfolio. All of them have operations that span the globe. They’re not a pure play on Brazilian energy development. Just the same, it’s nice to know that they’ll be pulling down a big chunk of business in one booming region over the next couple of decades. As I see it, these firms are long-term core holdings for any diversified energy portfolio.

Gold on the Move

This week, the price of gold touched $1,040 per ounce. Silver also took the elevator to higher floors, to now over $17 per ounce. It’s been good news for all of the gold and silver miners in the OI portfolio.

We’re way up on many of the miners I’ve added this year to the OI portfolio. Some of the beaten-down guys are also showing us their inner Lazarus as precious metals prices soar.

What’s with the Rising Tide?

I just love it when the stocks in the OI portfolio are going up. It beats the heck out of what we experienced last October with the meltdown, that’s for sure. And it makes it easier to be the editor of a financial newsletter that focuses on precious metals, energy and other natural resources.

What’s going on? What’s with the rising tide? I believe we’re seeing some short covering in the precious metals arena. It has always amazed me in the past couple of years that there were people out there shorting gold. Huh? It’s like that scene from the movie The Deer Hunter in which Robert De Niro is playing Russian roulette with a pistol holding bullets in the chambers. You don’t have to be crazy to short gold, but it helps.

I may not have the same eyesight today as back when I flew Navy jets. But how close do you have to look to see that the U.S. dollar is in trouble? Yet people still want to bet on the dollar and against gold? Hey, it’s a free country. And I’ve spent the past few years feeling pretty lonely at times as I described my vision of monetary gloom and doom.

So now the dollar is dropping due to bad news on many fronts. The U.S. economy is NOT “recovering,” contrary to the propaganda from Washington. Unemployment is up, and it’ll stay up for a long time. There’s a structural readjustment going on within the U.S. economy, and it’ll take years (maybe decades) to play out. Meanwhile, U.S. tax policy, energy policy and the overall political process are a train wreck in living color. Can anyone explain to me how this has a happy ending?

The world, of course, is noticing. Now we read about a group of nations (the usual suspects, but add in modern allies Japan and France) trying to figure out how to ditch the dollar and use some other medium of exchange to trade oil. It’s not exactly a new rumor, but now it’s getting traction. And like people smelling smoke in a crowded theater, dollar holders are looking for the exit signs.

Is anyone surprised at this? How much fiscal and monetary abuse can the greenback stand? Hence, the precious metals prices are levitating.

We’ll probably see a pullback in precious metals prices, but that’s just going to be profit taking and the market working its magic. Long term, the metals are still going up.

It’s part of the long-term thesis of Outstanding Investments. Go with precious metals. Go with energy plays. Go with solid resource plays.

Until we meet again,
Byron King

October 8, 2009

Energy, Brazil, Gold: What More Could You Want? was originally featured on Whiskey and Gunpowder

Before we delve into the reasons behind all the publicity, here’s the basic skinny on REEs: One, they are rare, at least sort of. Two, they are indispensable to modern technology. Three, the number of active, dedicated producers is tiny, with more than 90% of the world’s supply coming from China.

If you took high school chemistry, you probably remember the periodic table of the elements. But if you’re like most of us, even if you pulled a 95 on the chem final, you may not recall many of the details today. And there’s a better than even chance you never bothered to memorize the names of the REEs. It’s time to get reacquainted.

They’re generally clustered in a separate grouping at the bottom of the table, are known collectively as the lanthanoids, and these are their names, in order of atomic number (57-70): lanthanum, cerium, praseodymium, neodymium, promethium, samarium, europium, gadolinium, terbium, dysprosium, holmium, erbium, thulium, and ytterbium. Yttrium (39) and lutetium (71) are also sometimes included.

Need to Know, Point 1: Rarity

Fact is, we begin with something of a misnomer. These elements are not, strictly speaking, rare. Earth’s crust is full of them. True, they’re not as common as iron, carbon, or silicon, but are about on a par with nickel, copper, and zinc. Even the scarcest is way more abundant than gold, platinum, or palladium.

What is rare about them is that they’re widely dispersed. Very seldom are they found in economically exploitable deposits. Complicating matters further is that there are so many of them, and they clump together. They have to be separated first from the ore and then from each other.

Thus REE production comes primarily from other mines’ byproducts. The miner strips off the metal he’s really after, then sends the REE clusters to a specialty refiner.

Need to Know, Point 2: Applications

It’s safe to say that life as we know it would be very different without the REEs. The more our technological accomplishments pile atop one another, the more crucial these metals become. Because of their unique properties, there are generally no substitutes for them.

Of all the REEs, the one people may have heard of is neodymium. Alloys containing it have revolutionized permanent magnet technology, allowing miniaturization of all sorts of electronic components in appliances, A/V equipment, computers, communication systems, and military gear. Your hard drive probably has neodymium in it. So does your DVD player.

Liquid crystal displays depend on europium. Fiber-optic cables can’t function without erbium. Virtually all specialty glass products, from mirrors to precision lenses, are polished with cerium oxide. Several REEs are essential constituents of both petroleum fluid cracking catalysts and auto emissions-control catalytic converters. Half a dozen REEs go into the manufacture of the energy-efficient fluorescent bulbs that will soon be mandatory. Lanthanum-nickel-hydride rechargeable batteries are replacing older ones based on lead or cadmium. And no REEs, no electric cars. Nor next-generation wind turbines.

That’s only a partial list. But what makes REEs an increasingly sensitive topic is their role in national defense. Here are a few small items that have become dependent on them: jet fighter engines, missile guidance systems, underwater mine detectors, range finders, space-based satellite power plants, and military communications systems.

Think the Pentagon is very, very interested in maintaining a steady REE supply?

Need to Know, Point 3: Supply

95% of the world’s REE production originates in China. If you’re looking for reasons why we’re so nice to the premier Communist power left standing, this is a biggie.

We weren’t always so dependent. Not long ago, mines such as Mountain Pass in California made us nearly self-sufficient in REEs. But in the early ‘90s, China flooded the market with cheaper product, until it had driven all of its competitors out of business.

Today, Mountain Pass is being revived, but the start-up of an old mine is a lengthy and costly process. There are also some from-scratch REE development projects under way in the U.S., as well as Canada and Australia. But for the moment, China holds the hand with all of the high cards in it.

Forget your hard drive. Forget 11th-grade chemistry experiments. This is a national security issue. The American government cannot afford to lose that supply source, period. Maybe someday, but not now.

And that’s what’s behind the recent furor over these obscure elements. Because China threatened just that, a cutoff. The one thing that really gets Washington’s knickers in a twist.

In August, the story broke in the mainstream press. Sources in China leaked news of a draft copy of a report from the Ministry of Industry and Information Technology. It allegedly calls for a total export ban on five of the rare earths, with the rest restricted to a combined export quota of 35,000 metric tons a year, far below annual global consumption of 125,000 tons, and rising fast.

This doesn’t look like a move they’d follow through on, if only because of the lost trade revenues. And it’s only a recommendation; final approval rests with China’s State Council. But consider it an opening shot across our bow, if you wish. Or perhaps they’re telling us they need their REEs for the domestic economy, and we’d best go find our own supplies. Either way, the scramble is on to find alternatives.

That could backfire. REE prices and demand were already dropping last fall as the recession deepened, and China maintains a decided competitive advantage beyond control of supply: lax environmental standards (many REEs are highly toxic). Thus the new companies could spend the fortunes required to come on line, only to find themselves victims of yet another market glut engineered by the Chinese. Still, these metals are so important, it wouldn’t surprise us if the U.S. government subsidized domestic production, rather than risk a squeeze.

The Market

The market took due notice of the China story, driving the stocks of Western REE producers, and would-be producers, nearly straight up. Since late August, Avalon Rare Metals has gained 120%, Arafura Resources is up 75%, Rare Element Resources has added 72%, and Lynas Corp. is 50% higher (China, ever the master strategist, exploited the credit crisis to grab 25% of Arafura and more than 50% of Lynas). Lurking in the background is Molycorp, the private company redeveloping Mountain Pass. It’s planning an IPO that may well come out of the gate red hot.

With market action this frantic, the sector is on the frothy side at the moment. The heady market caps being awarded to these companies are obviously not based on fundamentals, and a savvy investor takes care not to get caught on the wrong side of a bubble.

Even though the Chinese export ban may never materialize, the ever-growing need for REEs is dead serious. And while the current bubble may pop any day, the long-term prospects for successful miners are outstanding.

Regards,
Doug Hornig

October 5, 2009

Why All the Fuss Over Rare Earths? was originally featured on Whiskey and Gunpowder

But with all the artificial stimulus money floating around, you can never be sure of what you see. Is this a real recovery or is it an artificially ripened tomato, and hence an imposter? When the stimulus money stops flowing will the recession get worse?

It’s hard to say, but let me give you a couple examples of distortions…

CNN’s bailout tracker reports that US government stimulus has totaled $2.8 trillion so far this year, with another $8.2 trillion in commitments. Most of this money has gone to the financial sector. Some of it has gone to infrastructure projects and to consumers (cash for clunkers, for example).

That is a lot of money. It is hard to say how all of this spending has artificially boosted economic activity in some sectors of the economy. It is obvious that such spending cannot continue indefinitely.

This has also been a worldwide phenomenon. There isn’t an economy of size that does not have some stimulus-spending program in place. Governments are spending money they don’t have. The result is widening budget deficits and higher debt levels.

First up, take a look this graph, from the Economist, which shows the industrial production of emerging Asia compared to the United States.

Looks like Asia is recovering pretty well. That chart shows the “decoupling” that became such a hot topic of discussion last year. The idea was that the emerging markets would not necessarily follow lockstep with the Western countries.

But this graph only tells a part of the story. China is one of the countries in “Emerging Asia.” China supposedly grew in the first quarter at an annualized rate of 15%. Yet, the government also spent a lot of stimulus money. As Eric Sprott writes in his latest letter to shareholders:

“The Chinese have injected a stimulus equivalent to 64% of their first half 2008 GDP in the first half of 2009… The Chinese government has effectively spent and lent enough in six months to buy 122 Ford Class aircraft carriers at US$8.1 billion a piece. It is akin to the US government injecting (and US banks lending) almost $4.5 trillion USD to its citizens and businesses before July 2009…an ungodly sum that would impact every asset class under the sun. Is it any wonder then that the Shanghai stock exchange has more than doubled from trough to peak since its November lows?”

Let me remind you that GDP is a clumsy way to get at an economy’s size. It is a figure that includes government spending. So, put another way, stimulus money this year is about 64% of the recorded economic activity in the first half of last year for China.

Where the Money is Going — Commodities

In some ways, the Chinese government spent well — investing in the commodities it craves. It’s locked down oil and gas assets, iron ore contracts, interests in rare earths and more. It’s put up power plants and laid down roads and pipelines. It’s made long-term investments in Africa and Brazil. Some of that will pay dividends down the road, if not already.

For instance, in the first six months of this year China became Brazil’s single largest export market. That’s the first time that’s ever happened. The Chinese and Brazilians are doing deals. For instance, China will lend $10 billion to Petrobras in return for 200,000 barrels of oil per day. China, in fact, has been active throughout South America, investing billions in mines, refineries, ports, and railroads.

These shifting patterns of trade always fascinate me. And we are living in an era of great change on that front, as new patterns emerge on a scale we have never seen.

It’s clear that China will have enormous needs for commodities over time. In the short-term, we are surely seeing distortions from the stimulus money. But the long-term demand is there nonetheless and the Chinese have a lot of money to spend.

Global Infrastructure is Still Getting Older Everywhere

In fact, infrastructure needs — especially in the areas of water and energy — are becoming more of a headline issue than ever. Not a week goes by where I don’t pick up a handful of stories of infrastructure falling apart somewhere. This, too, is a global story.

This week, for instance, there was a terrible accident in a Russian hydropower plant. Eleven people were killed and 65 were missing after water burst into a turbine room. It also destroyed the turbine. Besides the irremediable loss of life, it will take hundreds of millions of dollars and years to repair the demand.

As the FT reported, the accident “was a powerful reminder of Russia’s dire need for hundreds of billions of roubles in investment in its crumbling Soviet-era infrastructure.”

Putin’s government put aside $200 billion for infrastructure in two oil windfall funds, but that money is already being tapped for social spending programs and to help make up budget deficits. As in many places, including in the U.S., money set aside for infrastructure has been essentially hijacked by the political process and diverted to other uses.

Another story this week comes from Britain. Britain faces huge deficits in energy and the risk of widespread blackouts. Its energy complex is old and strained. The Economist reports: “The nuclear stations are simply too old to carry on: most are over a quarter of a century old. Around half have already been shutdown and are being decommissioned.”

About half of its electricity comes from natural gas, a legacy of its North Sea riches. But the North Sea peaked in 1999 and has been in steep decline ever since. Britain’s coal plants struggle under new pollution control rules and the effects of age. It’s an ugly situation that will cost a lot of money to fix.

The positive for investors is that there are several firms that are right in the sweet spot of this global infrastructure crisis. We own a few.

Regards,
Chris Mayer

August 25, 2009

The Effects of Epic Stimulus was originally featured on Whiskey and Gunpowder

If we were using numbers instead of metaphors, we’d say the CRB Reuters/Jeffries Index had its biggest monthly rally in 34 years. It was up 14% on the month. That was the best performance since July of 1974.

A monthly performance like that can only mean one thing. We’re just not sure what one thing it is. It could mean commodities have rebounded from being oversold, as they were in late 2008. It could mean that markets are less pessimistic about the global economy than your editor at the Old Hat Factory (though we doubt that).

It could also mean that investors increasingly prefer tangible assets as a long-term growth strategy over financial assets. Even after $1.465 trillion in realized losses by global banks and financial institutions, there are trillions more to come. Commercial real estate…the option-ARM recast period in the U.S. housing market…European banks…any or all of these things could conspire to lead to more losses and more capital raisings in the financial sector.

Perhaps that is what explains crude oil’s biggest monthly gain in a decade. July crude futures traded at $66.52 in Friday’s New York action. The U.S. dollar price of gold powered to $981.20, before sliding back a bit $975.

The Aussie gold price is fighting its way up despite the fact that the Aussie dollar keeps gaining on the greenback. While the Aussie gold price is up just $1.71 in the last 30 days (0.14%), the U.S. gold price is up nearly nine percent. We reckon the Aussie gold price will begin moving up closer to $1,500 again on a combination of events (weakness against the greenback for one.)

There are also two data releases this week that will affect the Aussie dollar. The RBA meets today to decide the price of money in Australia (set interest rates). And then Wednesday, the March quarter GDP figures come out. This will tell us how bad the recession is, although not how bad it may become.

It’s no use predicting these things, but for what it’s worth, our view is that we’re in a bit of a plateau between down moves. The “down moves” will come again in financial stocks, although they may not be as “down” as before, and employment. Mostly, the indices are going to have to price in very slow GDP growth for the remainder of the year and more job losses.

The wildcard for Australia is trade. Its proximity to Asia means that a rebound in that part of the world provides some cushion to resource companies. But then, we thought the resource stocks would be pretty well insulated from the first round of deleveraging too, and we were wrong about that. And the second time around?

Well, even if the long-term underlying demand for Aussie resources is real and growing, it still takes real money to make new projects happen. The financing of resource projects will continue to be a key issue in your stock selection. The other issue, obviously, is the direction of commodity prices.

Take LNG, for example. Last year the Australian Petroleum Production and Exploration Association said it wanted to triple Australia’s LNG output to sixty million tons per year. Meeting this weekend in Darwin, the group says 50 million is a more realistic target, given both the slump in energy prices and tight credit markets.

If LNG prices track oil prices-as they did in the big run up to $150 per barrel for crude-the economics of big Aussie projects get a lot better. Our view is that energy prices are going structurally higher anyway. Global recession aside, the big plunge in energy capital spending virtually guarantees a supply shortage in the coming years anyway.

Besides, you have to wonder why big international energy firms would be investing in conventional and unconventional Australian LNG projects if they weren’t convinced that a) oil prices were going higher, or b) more carbon-friendly fuels like gas would gain as coal gets politically demonized and punished with cap-and-trade or emissions-trading-schemes.

Obviously, if global trade continues to contract and a second round of losses in the global banking industry triggers another financial crisis, demand for energy is going to fall. And while we’re at it, stocks would probably test the 2003 lows too. We enter a new stage of grimness.

In the meantime, energy and precious metals stocks are riding higher commodity prices. And there’s a distinctly 2007 mind-set in the air. It’s vogue to be long-commodities and indifferent to risks in the financial system. It’s enough to make an investor with a short memory nervous.

Regards,
Dan Denning
Daily Reckoning Australia

June 2, 2009

What Are Commodities Saying About the Financial Crisis? was originally featured on Whiskey and Gunpowder

I just want to sing my little song,” plot my stock charts, love my great sailor, play in my greenhouses, buy gold no matter what the economy is doing, and be the happiest sweet little old lady in the whole USA.

Unfortunately, (1) in order to stay as wealthy as I want to be (a leisurely, joyous life seeking knowledge is true wealth, not the Sultan of Bahrain’s vault) by reading runes, I have to live in a free country with a free market that is able to function without hindrance from the government, a reasonable desire Mr. Obama is frustrating, and (2) Executive Order 10-998, dating back to JFK, concerns all of us.

The exact language is of EO 10-998, which allows federal control of “all food resources” is:

“‘Food resources’ means all commodities and products, simple, mixed or compound, or complements to such commodities or products, that are capable of being eaten or drunk, by either human beings or animals’ (sic) irrespective of other uses to which such commodities or products may be put, at all stages of processing from the raw commodity to the products thereof in vendible form for human or animal consumption. For the purposes of this order the term ‘food resources’ shall also include all starches, sugars, vegetable and animal fats and oils, cotton, tobacco, wool, mohair, hemp, flax fiber, and naval stores, but shall not include any such material after it loses its identity as an agricultural commodity or agricultural product.” (Naval stores traditionally include lumber, timber, tar, turpentine, paint, and rope.  In modern naval provisions that could cover almost anything.)

10-998 authorizes the confiscation of everything edible and much that is not, including our stores of flour and un-ground wheat, the beef in your freezer and that I have on the hoof…what is in your pantry and your garden…my chickens and Mr. Sanderson’s, and perhaps our little dogs to feed visiting Chinese.  That EO lays claim to a friend’s vast wheat and corn harvests, cattle feed, and your small daughter’s night-night snack.  Alcohol is a form of grain, so you can’t even count on having a little tot of whiskey if locusts in full battle gear clean you out.

In a world of rising demand and costs Liberals are doing everything possible to lower food production.  Very severe restrictions on small farms are popping up; 100 pages strangling small milk producers is in the Texas legislature and a similar measure is going before Congress.  It will be practically impossible for anyone without megabucks to stay in business, because without a Grade A Diary license the proposed regulations expressly forbid even giving milk away, as well as transporting it privately, on pain of fines and even jail time!  Milk:  the new contraband.

Farmers’ markets are under attack, and if they deny us those there are no markets left.  Small farms cannot begin to meet the needs of large grocery stores, certainly not year around.

Produce can only be labeled “home grown,” not “organic,” a term that has been redefined from what most of us think it means to restrictions that only agribusiness can meet.  Add that to the whack the big boys are getting from losing subsidies they have long regarded as “income,” and a flier in commodities could be a pretty good bet for those who can’t stand being out of the market, and emulating the Mormons in accumulating a year’s supply of food seems like an excellent idea.  If you can hide it.

We have to survive in the world that is and the one we can forecast, and then we can concentrate again on excelling at picking stocks and buy and sell points.  Survival first is why we keep talking about a very deep depression and “peak food.”

It wouldn’t matter how much your portfolio were worth if the grocer’s shelves were bare and armed men had taken your last cans of asparagus and foie gras.  Maybe the colonists didn’t know when they were well off; troops quartered in my house would have a vested interest in preserving the larder.

Sincerely,
Linda Brady Traynham

March 20, 2009

Executive Order 10-988 was originally featured on Whiskey and Gunpowder

The first half of the year saw ALL-TIME HIGHS in gold, crude, wheat, unleaded gas, copper, corn and soybeans. But as they say, what goes up must come down, and the force with which commodities fell from the sky was rather amazing.

At any rate, I believe there are great things in store again for 2009 — the entire world concentrating on global economic problems and messing with natural market forces could create a lot of unintended consequences. And commodity traders should be able to take advantage.

The dollar has recently strengthened with negative numbers out of Europe, but the economic stimulus package details dwarf any short-term data. Remember, money will be spent like never before in American history.

The strategy is to rebuild infrastructure and create 25,000-50,000 jobs for every billion dollars spent by the government. The connection couldn’t be more obvious. Construction of bridges, dams and roads and improvement of decaying schools and other government buildings get back to the basics of supply and demand.

It all comes back to commodities, with depressed steel and copper leading the way.

Hidden Inflation

Sometimes, we get inflation that you don’t see. It just sneaks up on you when you aren’t looking and just trying to start you day with the usual bowl of oat wheat sugar flakes cereal and, “Hey, either my hands have grown larger or this box is thinner than just a few weeks ago!”

This downsizing of packages is one way for food manufacturers to avoid raising prices. At first, it was to offset higher fuel and commodity prices, but now it has turned into profit growth — with 10 less potato/potatoe chips in my bag.

The indented bottom of a Skippy peanut butter jar got more indented, turning an 18-ounce jar into a 16.3-ounce one. Ice cream containers shrank by one-quarter of a quart. And for breakfast, a jug of Tropicana orange juice got 7 ounces lighter, while that box of Froot Loops lost more than 2 ounces.

According to recent analysis by Nielsen Co., about 30% of all packaged goods have lost content over the past year. This at a time when U.S. grocery bills are rising — up 7.5% in October versus a year ago — at the fastest rate in 18 years.

More indirectly, with more stimulus, consumers will eventually have more money to fiesta, in this case, and spend as the year goes on — all the time feeding inflation.

Commodities Past and Present

Consumer spending has been impacted by the extremes of the stock market and commodities, as well. The wealth effect created by escalating home prices from 2000-2007 drove demand, and consequently all costs and goods, higher. That trend reversed in 2008 and the 40% stock sell-off has constricted almost all buying for most of us. The challenge is to not let the overriding psychology affect your market sentiment – or your trading mentality.

You can’t see the beautiful stars if your head is down.

The tie between a stock recovery and commodities demonstrates a rebuilding of economic confidence. By the time most investors get comfortable enough to get back at it, a large move will have already been made.

As stocks hold and build stability, commodities will continue to find more equilibrium, possibly much higher, with people having little choice but to eat, heat and drive every single day.

How will we know that the government stimulus is working to stabilize the markets?

I was on Chicago radio a couple days ago and answered that very same question.  I’m normally at no loss for words, as anyone who has seen or heard me speak will testify to, but the answer didn’t hit me until the caller was gone.

Very simply, It ALL comes back to commodities; we will know that the financial markets will stabilize when… oil prices rise again.

The economic data that the media tend to focus on are often lagging indicators. Unemployment, GDP, corporate earnings and retail sales tell us what has already happened… not what is going to happen.

The stock and credit markets most times have discounted and factored in the dire information that we are getting every day. Markets are forward looking, and higher crude oil prices are a sign that the worst is over and a recovery is under way.

Let’s not get too positive or too negative — both ways cloud sound judgment. Investors seem paralyzed by the events of the last six months, but they need to roll with the punches, instead of getting knocked out. Don’t call it a comeback; call it an opportunity for those with the proper fight training.

There will be plenty of opportunities this year with commodities.  After all, it all comes back to commodities.

Regards,
Alan Knuckman

February 2, 2009

A Commodities Outlook for 2009 was originally featured on Whiskey and Gunpowder

Dozens of stocks come to mind that were sold down to insanely cheap levels as hedge funds scrambled for cash. That scramble is probably not over, so we may be in for more turbulence. Plenty of stocks come to mind that are still trading too high relative to their earnings potential. We’ll be looking to bet against those in 2009. Plus, many companies will not make it out of 2009 without going through bankruptcy. I expect to find a few more “short to zero” stocks — like Fleetwood Enterprises (NYSE: FLTW) — in 2009. We sold Fleetwood short in March at $4.43 and covered in October at 27 cents, for a 94% gain.

When asked by family and friends over the holidays what I think about the 2008 stock market and economy, my response has been, “I expected a nasty bear market in 2008, but the carnage since September took me by surprise. The economy will remain weak, but I think the worst of the widespread market carnage is behind us. Future damage should be concentrated in sectors with horrible fundamentals. Thankfully, 2009 should be a year when fundamental analysis should start to matter once more.”

This will be a welcome development, because 2008 was a year when the following strategy worked best:

1) Sell short any stock or ETF, without bothering to do any fundamental research
2) Invest the proceeds in Treasury bonds, preferably with as much margin as possible
3) Repeat Steps 1 and 2, over and over.

Clearly, this “deflation trade” strategy is not sustainable over longer time frames — not in an era of worldwide paper money standards. In fact, I’d expect that such a shotgun-based investment strategy of short S&P 500/long Treasuries could lead to big losses in 2009.

I think the key to approaching 2009 markets will be to view everything form the perspective of the Treasury and the Fed. Everyone knows that the real economy stinks and that America is overly indebted. But I doubt everyone realizes just how extreme Treasury/Fed will be in using the deficit and the paper money system to stop the Great Depression II scenario. Theses tactics will be inflationary at some point.

The U.S. banking system became destabilized because its core collateral – houses and mortgage-backed securities – collapsed in 2008. While the authorities may not be able to re-inflate old bubbles in these assets, I’m betting they can employ cheap Treasury financing to cushion the decline. This involves refinancing homeowners out of toxic mortgages into conventional mortgages. They’ll also find some way to deal with the problem of negative home equity, even if it involves highly inflationary tactics like Treasury assuming losses from principal reductions via Fannie and Freddie. And even if foreigners balk at absorbing new Treasuries, the Fed will monetize them – i.e., buy them itself. Again, these tactics would be highly inflationary.

So let me enumerate a few predictions for the New Year:

1) It’s far too easy and popular to be bearish on everything but Treasury bonds, so odds favor a sharp rally in early 2009 — a rally in the S&P 500, led by stocks with the most sustainable fundamentals, including energy, commodities, and infrastructure. Stocks with weak fundamentals may participate, but quickly roll over as economic reality sets in. Many will go to $0 in bankruptcy.

2) The SEC will suspend mark-to-market accounting, or at least modify it to allow more management discretion in marking values of securities. The era of wholesale shorting of financial stocks is likely over. A massive wave of refinancing is also a backdoor way to recapitalize the banking system; perhaps the most efficient way to increase the value of exotic mortgage-backed securities, (and bank capital) is for many of the mortgages backing these securities to “prepay” upon refinancing. Bankers will re-emerge from their bunkers and look to make new loans to creditworthy borrowers, since a sub-1% cost of funds courtesy of the Fed is too low to ignore.

3) Oil will rebound to $80 per barrel on lower than expected production, despite weak demand. If demand rebounds, oil could go to $120.

4) Gold will rally beyond $1,200 on weakness in the U.S. dollar, unprecedented Treasury bond issuance, and tepid foreign demand for U.S. dollar assets. Weaker foreign demand for Treasury bonds will prompt the Fed to step in as buyer of last resort and monetize debt. In its December policy statement, the Fed signaled that if foreign lenders look to sell Treasuries, it would step in as a buyer to keep rates low. If this happens, more savers and bond fund managers will look to invest in inflation hedges like gold and energy.

5) Many more hedge funds will fold in 2009, but this is good for the long-term health of the market. Most of the new funds should not have been started because they just went “long” everything on margin. Their closure will result in a more efficient – and less volatile – market.

6) 2009 will be a “stock picker’s” market. Nothing worked consistently in 2008 other than indiscriminate shorting of stocks and buying of Treasuries. The worst of the wholesale liquidation of stocks is likely over, so 2009 will offer lots of opportunities to buy and sell short individual stocks using fundamental analysis.

That’s the good news…So let’s end on that note.

Regards,
Dan Amoss

January 12, 2009

Stock Strategies: Random Predictions for 2009 was originally featured on Whiskey and Gunpowder

How do you measure these things? In yields. This, by the way, is how you’ll know the bubble is popping. When that happens (bond yields rise like a rocket ship) it’s going to unleash financial chaos. But for now, the bubble just keeps on getting bigger and yields on short-term U.S. bonds keep approaching–and even reaching–zero.

“The Treasury sold $27 billion of three-month bills yesterday at a discount rate of 0.005 percent,” reports Bloomberg. It’s, “the lowest since it starting auctioning the securities in 1929. The U.S. also sold $30 billion of four-week bills today at zero percent for the first time since it began selling the debt in 2001.”

How do you think that conversation goes?

“Thirty billion you say? For four weeks? And you’ll pay me how much interest?”

“Nothing.”

“I’ll take it!”

“If you invested $1 million in three-month bills at today’s negative discount rate of 0.01 percent, for a price of 100.002556, at maturity you would receive the par value for a loss of $25.56,” reports Daniel Kruger.

Yes. That’s how much investors currently prefer government-backed bonds to equities at the moment. It implies there will be hardly any inflation at all over the next ten years. But that notion should make you spew milk through your nose as you laugh, unless you’re unfamiliar with the growth in the global monetary base. If so, let us remedy that.

You can see that in the U.S. alone the adjusted monetary base is…growing. So why isn’t the increase in the monetary base showing up in the kind of inflation that would terrify bond investors and lead to a rebound in commodity prices and equities? That’s another question we got last night.

The answer is that so far, the huge liquidity injections have been quarantined in the financial sector, mostly on bank balance sheets, or on deposits by banks at the Federal Reserve and other central banks. In other words, all the new money is going into bonds and central bank accounts, not into new business or consumer lending.

Put another way, the quantity of money is increasing, but its velocity is not. That’s because the new money isn’t getting into the hands of people who are just itching to spend it. But it will soon enough. And when it does, look for bond yields to rise and the great inflation to begin. Also, televisions and hookers.

“I think this will be the greatest time in my life to buy stocks at these prices. I just wish I had more capital,” said one of the attendees at the Doomer’s Ball last night on Southbank. We heard this sentiment time and again over the course of the evening. And there is no doubt that the valuations are good.

There is doubt, however, about what the Australian resource sector will look like in a world where capital is scarcer. Will it lead to a contraction in the number of viable firms? Is the credit crunch like a meteor strike that kills all the giant reptiles that fail to adapt to the new conditions? If it does, there will be a huge survivor bias favouring the stocks that remain.

But there was also some anxiety about further falls in stocks, especially the longer the bar was open at the Ball. One reader is forecasting another 20% fall on the ASX before the lows are in. In fact, if the All Ords reaches the 2003 lows (2,673) it’s a decline of 24% from today’s levels. If it overshoots that low–as markets tend to do when they correct–you’re looking at a thirty percent fall from current levels.

If you treat it as a thought experiment and ask yourself what would have to happen for the ASX to fall that much, you get some alarming possibilities. The liquidation of Oz Minerals? The dismemberment of Rio Tinto? The fall of a major investment bank or leveraged institution?

Or perhaps it’s something simpler: more falling prices for commodities. That’s what the World Bank seems to think anyway. As reported in the FT, the World Bank’s Global Economic Prospects report says the commodities boom has, “come to an end.” It adds that, “Over the longer run, the price of extracted commodities should fall.” It reckons slower population and income growth will contribute to slower resource demand growth.

Naturally, this is diametrically opposed to the logic of the boom that began in 1999. Then, you had 200 years of falling real prices for tangible goods seemingly reverse itself, mostly because of growth in global population and per capita income. So which thesis is right?

Well you know what we think. We think the Money Migration is the long-term transfer of the world’s wealth from the debt-based consumption economies of the West to the world’s savers and producers, roughly in the “East.” This certainly favours Aussie resources for at least a generation.

But the migration has been massively disrupted by the credit crisis, which is really just an epic attempt by the U.S. and other English-speaking economies to avoid their Day of Reckoning. But don’t you worry. That day is coming. It’s just taking longer than we originally thought. Ben Bernanke is a creative man. And he’s desperate too.

But why don’t we ask China what it thinks? After all, it’s a pretty important party to this discussion. China? What do you think? Hello China. Are you there?

Hmm. China is not taking our calls. Maybe that’s because some Chinese firms are too busy looking for ways to take advantage of the current situation by securing long-term supplies to resources at lower market prices. And maybe actions speak a lot louder than words about Chinese desire for Aussie resources.

“Shenzhen Zhongjin Lingnan Nonfemet Co., China’s fourth-biggest zinc producer by output, said it agreed to acquire a 50.1 percent stake in Australian miner Perilya Ltd. through a private placement,” reports Bloomberg. And Forbes reports that Chinese steel-makers are set to push for a major reduction in iron ore prices to reflect the fall in global steel prices.

The average price in October for a metric ton of iron ore fines, according to Forbes, was $US90.60. But Chinese steel makers reckon that with steel prices back at 1994 levels, iron ore prices should roll back to. In 1994, a metric ton of fines was US$20.40.

A lot has changed since 1994. Supply of ore is up. Demand is up too. But costs for resource producers are way up too. It’s unlikely the steel-makers are going to get a price cut that large. And if they do, it will put some smaller ore producers under enormous pressure (even harder to with stand if you don’t have access to credit).

Where are we then? A year ago BHP held the whip hand and chased Rio in a dream of grand ambition. Now BHP is reconsidering its strategy. Rio is reeling. And pricing power has switched back to resource consumers in China, who are eager to use the whip as well, it appears. There’s been a lot of whipping going on, hasn’t there? More on what it means tomorrow.

Finally, yes. We too saw the reports circulating that the International Monetary Fund is getting ready to dump a bunch of gold on the market. So far, we haven’t found anything to substantiate them. We’re looking around, and will report back on what Diggers and Drillers editor Al Robinson digs up as well. Until then…

Regards,
Dan Denning

December 15, 2008

The World Bank Goes Nuclear on Commodities was originally featured on Whiskey and Gunpowder

Eddie Cantor (1892-1964) was a comedian, singer, songwriter and actor. “Banjo Eyes,” as he was sometimes called, was also the author of two little books on the Great Depression. “People used to rob banks,” he writes in Yoo-Hoo Prosperity. “Now we’re lucky when it isn’t vice versa.” Cantor jokes about many troubles in the Great Depression, but one recurring theme is the relative lack of food.

A millionaire is “one who eats three square meals a day.” Things were so bad that “the pigeons are now feeding the people.” They were funny lines…sort of. For many of the people living during those times, Cantor’s jokes were not so far from the truth.

We have it comparatively easy in this, the crisis of 2008. We may have to make do with fewer Swatch watches and Coach handbags. We may have to pass on the latest iPod and make do with last year’s winter coat. These hardships are not important, except for people selling those goods. But the credit crisis is also affecting the world’s ability to produce one thing important to everyone: food.

It’s harder for farmers to get credit for next season’s crop, especially farmers overseas. They need fertilizer, seed, fuel and more. And most farmers need to borrow money to obtain these essential items. No credit; no crops.

Therefore, the global credit squeeze might reduce plantings of key grains, even as world inventories of these grains hover near historic lows. In Russia, for example, cash-starved banks have cut off funding for the industry. The head of the Russian Grain Union says, “Many farmers probably won’t be able to borrow money for the spring sowing.” This is important because Russia is no lightweight in the grain division. It produces 9% of the world’s wheat, for instance. No surprise that the United Nations considers Russia a critical component of the global food supply.

Ironically, Russia just had its best harvest ever. And still, global grain inventories remain low. Bloomberg reports that global inventories of corn, wheat and soybeans are the second lowest they’ve ever been since 1974.

A number of countries already fear what might happen next year. The Washington Post Foreign Service in Shanghai reports that China adopted a number of measures to protect itself from the worsening food crisis: “Among the most extreme measures [China] took was to impose new export taxes to keep critical supplies such as grains and fertilizers from leaving the country.”

These taxes are extremely high, on the order of 150%-185%. China worries that richer countries may outbid its own farmers for supplies and weaken China’s own food supply. One Chinese fertilizer company, which produces 150,000 tons per year, already said that the new taxes mean exporting is no longer profitable. China was the biggest exporter of certain types of fertilizer. No longer. That’s a lot of supply off the market.

Fertilizers are absolutely critical in maintaining (and improving) crop yields. Without them, we’d produce far less per acre. As a result, in parts of Africa where people depend on Chinese fertilizers, the food supply problem is now more acute. China’s export taxes and bans follow those of other grain producers, including the Ukraine, India, Pakistan and Argentina.

Amazingly, despite these various maneuvers around the world to prevent grain exports, the prices for wheat, corn and soybeans are all half of their mid-summer highs. It seems the market believes a global recession will dampen demand. Maybe so, or maybe the market doesn’t know anything. The severe commodity selloff during the last few weeks might be saying a lot more about the desperation of hedge fund managers to raise cash than about the prospect that grain demand will fall – in which case, we could see another surge in prices next year.

Demand for grains is still very strong. In China, each wage-earner devotes about 40 cents of every dollar earned to buying food. In India, that number is a staggering 70 cents out of every dollar earned. In other words, the food budget in these countries is hardly a discretionary item. It will remain constant, or even rise, no matter what the global economy does.

Meanwhile, the people in these countries who have a couple of extra rupees to toss around are upping their consumption of meats, which increases the per capita demand for grains. As PotashCorp chief William Doyle recently pointed out: “The average daily protein intake in China has increased by 40% over a 20-year period, with the greatest percentage of that increase coming from meat consumption.” You can see it in the size of the people themselves: The average 6-year-old Chinese boy is 12 pounds heavier and 2 inches taller than 30 years ago. These people aren’t going back to the ways thing were. This is a long-term story, and these trends should continue.

Yet even if demand growth for grains slows, it’s not likely that those low global grain inventories will improve. Even if grain demand fell to 2% per year, we’d still need record production to keep grain inventories from falling further.

For all these reasons, I think the future is still bright for agriculture and all that it entails. I think the fertilizer companies look cheap again. In my monthly newsletter, Capital & Crisis, my subscribers owned Agrium (NYSE: AGU) for nearly three years, and it more than tripled our money. The stock is now a good one-third below what we bought it for initially.

PotashCorp (NYSE: POT) and Mosaic (NYSE: MOS) are other names I’m looking at hard right now – both have been crushed in this troubled market.

Beyond that, irrigation companies have come way down, even after posting outstanding results. Lindsay (NYSE: LNN) and Valmont (NYSE: VMI) are two irrigation equipment makers, for example, both coming off great quarterly results.

In 1931, Eddie Cantor wrote that the biggest thing in years was bread. “Why, they’re giving it away free! Whenever four men get together at a street corner, it used to be a merger,” he writes. “Now it’s a bread line!” It’s funny now. Next year, it might not be, at least to some.

Regards,
Chris Mayer

December 03, 2008

Crash in Food Supply was originally featured on Whiskey and Gunpowder