By The Energy Report, on March 23rd, 2011
 The earthquake, tsunami and resulting problems at the Fukushima nuclear power plant in Japan could impact some coal plays as global demand shifts to fossil fuel. In this exclusive interview with The Energy Report, UBS Securities Analyst Shneur Gershuni argues a bullish case for coal demand and shares some select coal stocks poised to benefit significantly.
The Energy Report: How has the tragedy in Japan at the Fukushima nuclear power plant impacted the outlook for coal globally?
Shneur Gershuni: There are actually two different types of coal. One we refer to as “thermal,” or steam coal, which is used in a boiler to generate heat. It creates steam to hit the turbine space, and that’s how you create your power. The other type of coal is called “metallurgical,” or met coal. Some people incorrectly refer to it as coking coal. This coal is mixed with iron ore, and you put it into a blast furnace to create the pig iron for the steel-making process. So, when you think about where and how you want to be positioned, it’s the steel fundamentals that will drive metallurgical coal demand, and energy needs will drive thermal coal demand.
Given the challenges with the Japanese nuclear facilities, we expect fossil-fuel generation will be used to partially offset the near-term generation losses related to the nuclear fleet to the tune of 5–10 million tons (Mt.). We wouldn’t be surprised to see unscheduled shutdowns of nuclear facilities around the globe as regulatory bodies seek to review nuclear safety procedures in the wake of the Japanese crisis. The incremental demand will add more pressure to the global supply/demand balance for thermal coal, which has been tightening of late (as evidenced by the recent move in API 2—delivered price into Europe, which has surged in the last six months and will likely move higher on increased Japanese demand.
TER: Is that on top of the 10 billion short tons of global consumption by 2030 forecast by U.S. Energy Information Administration (EIA)? Even that would be a 48% increase over 2006’s reported 6.7 billion short tons of coal.
SG: Yes. Incremental demand will add pressure to the global supply/demand balance that has been tightening of late anyway based on the international delivered price into Europe API. API surged in the last couple of months and will likely increase more in the next few months due to events in Japan.
TER: Tell me a bit about the growth drivers in both the thermal and metallurgical markets.
SG: Sure. Thermal coal is used primarily for power generation. In the United States right now, things are changing due to the way commodity prices are moving with the fuel switch to natural gas and so forth, but roughly 48% of power in the U.S. is generated using coal currently. That number could increase at least in the short term if there are cutbacks in nuclear power generation. Internationally, as economies grow, the demand for power increases and that tends to put pressure on power-generation sources to deliver. Obviously, coal has been a big part of that, especially in Asia, over the last couple of years and could be an even bigger part going forward.
TER: Does the use of thermal coal far exceed that of metallurgical?
SG: Yes, on an absolute basis, it’s a much larger market. But what’s interesting is that demand for steel, particularly with respect to the infrastructure build going on in Asia, has really put pressure on the metallurgical coal market. In fact, the price of met coal touched $125/ton a couple of years ago. That was a phenomenal price at the time; but then, in 2008, the settlement reached roughly $300/ton. Even during the depth of the financial crisis the annual settlement was $129/ton, which tells you demand was effectively outstripping supply, which is kind of where we sit now with a tenuous supply/demand balance.
So, while on an absolute basis, the thermal coal market is a much larger market in scale, the fact is that we have seen some tremendous pricing pressure and margin improvement on the metallurgical coal side driven by steel demand. Go back to 2005, for example, when we were consuming 1.1 billion tons (Bt.) of steel on a global basis. In 2007, over 1.326 Bt. steel was used. We forecast that will continue to increase in 2011, 2012 and 2013 and are looking at 1.4 Bt. steel in 2011. So, steel has been a big driver, and the pricing environment on the metallurgical coal side has actually been quite strong over the past couple of years even in the face of the global financial crisis.
TER: Is metallurgical coal still an opportunity for growth?
SG: Yes. Margins in the thermal coal business could be $6, $7, $8 or $9 a ton. But then, if you look at a met coal environment wherein you’re getting potentially +$300/ton, your margins could be north of $100/ton. So, the margin expansion has become very different between the two markets due to the tight demand/supply balance in the met coal market.
TER: Tell me how fast the met coal market is growing.
SG: Well, here’s where it gets kind of interesting. Growth of late is driven largely by China where steel production has been tremendous. If you look back to the earlier part of the last decade, China was using 300 million tons of steel. We don’t yet have final numbers for 2010, but we’re looking at potentially 590 Mt. of steel for China. What’s interesting is that China’s been somewhat self sufficient in producing its own metallurgical coal and really hasn’t been a major participant in the seaborne market until recently. In fact, in 2009, due to safety issues and also to increase capacity utilization of some of the mines, the country actually shut down some mines, but its infrastructure build continued.
Suddenly, China, which had not been much of a market participant, became a major importer of met coal. In 2009, for example, the country took roughly 34 Mt. met coal, and we estimate that it likely took 45 Mt. in 2010. That’s a significant percentage of the total marketplace given that the seaborne-traded market for met coal was 268 Mt. in 2010. That would be about 16% of the seaborne-traded market. Because the U.S., Europe and Western nations haven’t necessarily recovered on the demand side for steel, China has come in and taken the demand the West would’ve put on this marketplace.
So, we’re struggling now and looking to grow supply from a lot of nontraditional sources. Mongolia has become a source of supply, and Australia is looking to expand as much as it can. The U.S. is also looking to bring new met coal supply online and put it into this marketplace. And some of the lower qualities of coal are crossing over from the steam market into the met market to satisfy all this demand.
Consequently, as Western-civilization demand starts to come back online over the next couple of years, we’re hoping this new supply kind of offsets that. Because China is in the marketplace now and taking that kind of tonnage when previously it wasn’t even a major participant, it adds a lot of pressure. That’s kind of why we’re in an environment now in which we have an elevated pricing environment above what we believe should be a traditionalized, more long-term, normalized price because of this pressure on supply/demand right now.
TER: Is it becoming more difficult to get coal out of the ground because we’ve taken so much already?
SG: The answer is definitely yes—and this goes for both met and thermal. What it comes down to is you always want to mine the easiest coal that you can deliver first. About 100 years ago, they were mining easier seams than those we are mining today. In fact, in Appalachia, the seams continue to get thinner and thinner and that continues to hinder productivity. If you think about it from a fixed-cost-absorption perspective, it increases your costs over time. Because met coal is relatively scarce right now, people are going to areas they might not have chosen to mine 20 years ago. But at current prices, it suddenly makes sense to mine those reserves.
TER: It sounds like the price increase far offsets any margin pressure caused by greater difficulty.
SG: Right. To put a couple of things in perspective, when we set our long-term, normalized pricing assumption, we think that everything tends to normalize over the longer term. Obviously, if you’ve got great prices it’s going to incentivize people to bring on more supply, which will then force your margin back down to something more normalized, right? So, you do have this elevated margin opportunity over time; but over the next three years, we are expecting it to move down gradually.
TER: Shneur, I’ve created an unweighted portfolio of a group of coal stocks and I’m looking at 51% price appreciation over the last six months. Was that seasonal? Was it due to the floods in Queensland, Australia? What has caused this?
SG: A lot of it has to do with the economic recovery, frankly. Certainly, the most recent move had much more to do with Queensland and, clearly, that affected some of the more metallurgical coal-sensitive names like Walter Energy, Inc. (NYSE:WLT). There also has been some M&A in the sector, but it’s largely met coal pricing that has improved margins. Companies that were able to move production out of the thermal coal market into the met coal market and achieve that margin expansion have really enjoyed the benefit.
At the same time, in the U.S. thermal coal market, we hit peak inventories of 203.4 Mt. in November 2009—that was a record inventory build. Going back as early as April 2009, companies attempted to cut production in an effort to get it in line with demand. We don’t have the final 2010 data yet, but what happened is that in one year the U.S. went from 203 Mt. down into the 170s in what we like to refer to as an “inventory cleanse” between 2009 and 2010. It also had these production cuts, which limited the supply side a little and did have a good hot summer, which also helps power generation burn. So, all of these together have resulted in an improving inventory outlook.
TER: How might Japan’s nuclear problems impact the price of thermal coal going forward?
SG: Thermal coal will be a beneficiary of the nuclear challenges. CONSOL Energy Inc. (NYSE:CNX), Peabody Energy Corp. (NYSE:BTU) and International Coal Group, Inc. (NYSE:ICO) are fairly well positioned to be thermal coal exporters. Peabody exports both met and thermal coal out of its Australian operations, so it’s right in the heart of Asian demand.
TER: Are there any other companies that you’d like to mention?
SG: I think it’s worth mentioning that Peabody is not as volatile, but earnings growth has been a bit more stable. It’s very well respected and, on a longer-term basis, is well positioned globally. On the value side, we prefer CONSOL and believe its natural gas assets aren’t fairly valued due, in part, to the weak gas environment. When we put the coal and gas businesses together, we see the stock at a deep discount. But the catalyst for CONSOL will be continuing strength in both the global thermal and gas markets.
TER: Ok, so any other companies you’d like to mention?
SG: You know, another company that we think is interesting is Arch Coal Inc. (NYSE:ACI). It has a lot of exposure to the Powder River Basin on a production basis, so the company is well positioned. But its eastern coal business has metallurgical coal exposure, and that’s a material part of its earnings play. So, you can almost say that a stealthy piece of its earnings does come from the met coal side. The company completed the Jacobs Ranch acquisition successfully and things seem to be going well. Cash flow is all right, and we believe its earning-guidance range will likely continue to move up through 2011. We think there’s an opportunity for positive earnings revisions.
TER: Can met stocks appreciate from these levels dramatically?
SG: Yes, we think they can appreciate further from current levels.
TER: What are the plays? What should growth investors be looking for?
SG: On the metallurgical coal side, the Asian market is definitely important. Two names are Walter Energy, which I mentioned briefly, and Patriot Coal Corporation (NYSE:PCX). Walter is just about the closest thing to a pure met play. Patriot has exposure to both.
TER: You’ve mentioned Walter a few times and I know you like it, but it’s up 73% over the past six months. Should an investor be long on Walter now?
SG: It’s actually seen an even bigger move than that over the last two years. The stock is at $116 right now but, based on our discounted cash-flow analysis, we believe it should trade closer to $150—clearly, that’s material upside from where we are right now. The company is in the process of closing a transaction—a USD$3.3 billion merger with Canadian met coal producer Western Coal Corp. (TSX:WTN), and that will help to diversify its operations. Walter produces the highest-quality coal in the U.S.
TER: Is Walter your favorite play?
SG: For met coal, it depends on your risk tolerance. Patriot has lower-grade metallurgical coal but ends up with wider earnings expansion as a result; however, it tends to be a lot more volatile than does Walter. So, if our thesis plays itself out and things do well or even better than what we’re anticipating, then Patriot is likely to outperform Walter. Walter is a little lower down on the risk profile, so it’s really about your risk tolerance. The beta for Patriot is just higher, but part of that has to do with the fact that the earnings expansion, in theory, is greater.
TER: Patriot’s market cap is almost exactly one-third that of Walter’s. That has to contribute to its volatility, does it not?
SG: I think that might be a fair conclusion. Obviously, larger versus smaller cap is part of it. Walter hopes to close the Western transaction. If it does, the company’s market cap and enterprise value also will increase, so it will widen that, too. Patriot is definitely a smaller market-cap company relative to Walter.
TER: It’s been so nice talking with you, and I hope to speak with you again sometime in the future. Best wishes.
SG: Ok, that sounds great. Thank you.
Shneur Gershuni is an executive director in the Energy Group at UBS. An analyst since 2004, Shneur covers the coal sector and, until recently, also was second lead for the natural gas sector with Ronald Barone. Before UBS, Shneur was a U.S. equity analyst for Bissett Funds at Franklin Templeton Investments in Toronto. Prior to that, he was a credit analyst in the Canadian Private Placement Group and a portfolio management assistant in the U.S. Bond Portfolio Group at Canada Life Assurance Company. He began his career at Primerica Financial Services, a member of Citigroup, as a mutual fund and high-liability specialist. Shneur holds an MBA in finance from Degroote School of Business, McMaster University and a BA in economics from York University in Ontario. He is also a CFA charter holder.
By B.P.T., on March 23rd, 2011
The Mortgage Bankers’ Association purchase index was released at 7:00 AM EDT, and there was a week to week increase of 2.7% in the Purchase Index and a week to week increase of 2.7% in the Refinance Index.
At 10:00 AM EDT, the New Home Sales report for February will be released. The consensus is that 290,000 new homes were sold last month, which would be an increase of 6,000 from last month.
At 10:30 AM EDT, the weekly Energy Information Administration Petroleum Status Report will be released, giving investors an update on oil inventories in the United States.
At 12:00 PM EDT, Federal Reserve Chairman Ben Bernanke will give a speech on Community Banking in a Period of Recovery and Change to the Independent Community Bankers of America in San Diego.
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By The Gold Report, on March 22nd, 2011
 Good rocks and good people are the core building blocks of successful junior miners. Casey Research Senior Editor and Mining Strategist Louis James wants to see the mineralization close up and talk to geologists to verify the powerful upside potential that may be in these stocks, which are also vulnerable to staggering corrections. In this exclusive interview with The Gold Report, Louis reveals how to benefit from the combination of geopolitical and domestic uncertainty and growth potential in the ground.
The Gold Report: You are a fundamental investor and as such you don’t look at macroeconomic trends quite so closely. As you say in one of your reports, you “kick the rocks.” But, are you still bullish on gold?
Louis James: I don’t think those two are necessarily antipodes, nor is there any tension at all between keeping an eye on the big picture while looking for value in a specific opportunity. The one is the context for the other. I look at the overall picture, and the basic idea is to find a trend that’s going to be your friend and place your bets accordingly. But, of course, you want your bets to be the best possible ones. A rising tide may lift all ships, but you don’t want to bet on a leaky one. So, yes, I go out and kick the rocks to try to pick the best ones.
To answer the question—yes, I am very bullish on gold. Gold is in the midst of a $25/oz. retreat as we speak, and I love days like that. That actually helps us to buy gold or gold stocks from weaker hands that are shaken by such moments.
The reasons for the bull market in gold haven’t gone away; in fact, they’ve only gotten worse—or better, depending on your perspective. We were amongst the few contrarians that were calling for a financial crisis leading to a currency crisis, before the crash of 2008. Anybody can look back at our publications to verify that, and the reasons for those predictions are still in full force. If anything, they’ve been made worse by quantitative easing (QE), Bernanke’s non-printing printing of money (he has claimed both that the Fed is and is not printing money) and all the other things governments are doing that are, as our founder Doug Casey likes to say, not only the wrong things but the exact opposite of the right things to do. And what’s bad for fiat currencies is good for gold, so, yes, we’re very, very bullish on gold. That said, one we should never forget that we’ll be taking one step back for every two steps forward.
TGR: You believe there are fundamentals in global economies that are acting as catalysts for inflation?
LJ: That is correct. And, not just inflation but, political. . .
TGR: Catastrophe?
LJ: Trouble. Look at the protest in Wisconsin from the government trying to balance the budget there. Unlike the federal government, state governments can’t print money. So, at some point, they have to cut somewhere or they won’t have anything to pay the bills. The huge response in Wisconsin is quite interesting—part of a bigger trend that is much, much deeper than trouble in the Middle East. There’s a lot of trouble on many different fronts. We don’t think it’s a coincidence that you see political unrest at times of economic difficulties. Look at the price of food and cotton and other commodities. These are things that have immediate and direct impact on the lives of the masses—the transmission belt between economic trouble and political trouble—and eventually social upheaval.
TGR: Were you implying that the Wisconsin protests are similar to the anti-austerity protests and rallies that we saw in Europe, particularly in Greece and Spain?
LJ: I’m saying just that. Belt tightening is never popular, and it’s just getting started. Americans are still relatively comfortable compared to people in other places. You framed your question about Europe in the past tense. That’s just the warm up. The musicians tuned their instruments, and we heard the overture. All the ingredients for significant social turmoil are there, as the concert goes into full swing. The implications are quite significant and they’re global.
TGR: You have written about black swans.
LJ: Yes. A black swan is any unexpected event that upsets your projections. Many people were expecting Arab-Israeli tensions to increase, but weren’t expecting the collapse of Arab despotisms. I can’t say that we saw that specific thing coming either, but I can say that we have stated in print that such despotisms eventually have to go the way of the dodo bird. Actually, it wasn’t so long ago that Doug Casey did a report on Egypt wherein he said it was basically a caldron that was waiting to bubble over. But those are just examples of certain kinds of black swan—anything can come and upset the apple cart. If, for example, some U.S. state is suddenly unable to pay its bills and the lights go off, a lot of people will call that a black swan—though it should be no great surprise. Or it could be China, India or Japan. It could be the Koreas shooting at each other. I just think the climate is right; it’s a black swan-friendly environment.
TGR: Given that you’re a bit cautious currently, you were recommending a dollar-cost-averaging strategy to enter new long positions that your readers didn’t already own.
LJ: Yes.
TGR: If we are in a rising market, a dollar-cost-averaging strategy is a negative. It hurts investors.
LJ: I disagree completely. This is not investing. This is speculation.
TGR: Ok. Go ahead.
LJ: To be able to sleep at night has enormous value. Of course, that’s just a rubric for a larger financial concept here. We are dealing with serious risk, and I think it is very dangerous to imagine that you’re investing when what you’re really doing is speculating. These two are not the same thing.
The junior resource sector, our focus at Casey Research, is without question the most volatile market on earth. These stocks all correct. They all fluctuate. Even market darlings and great success stories frequently will retreat 50% or more, even without a 2008-style crash, before they go on to new heights. So, there’s always reason to be careful, to deploy wisely, to wait for days when the markets pull back to buy, to take cash off the table when you accumulate gains.
Going all-in is a gambler’s game. I can’t stress this enough to people. Gains are not gains until you realize them. At Casey Research, when we report a track record it includes realized gains—not just high-watermarks stocks reach after we recommend them. We include the profits we’ve taken off the table, which we do routinely.
TGR: Back in the fall, you visited some mining operations in Colombia. It was a due diligence trip. What do you do on these trips? You’re fluent, or at least conversant, in multiple languages and I’m sure that’s a big help to you. What are you looking for?
LJ: I use what we call the “8 Ps,” Doug Casey’s formula for resource stock evaluation. As the words “due diligence” imply, my function is to verify all of the Ps, as much as I can. But it does tend to boil down to a few things. One is to go and physically look at the rocks and see if they match what management is saying. They don’t always. You can go down the ladder of the mine and look at the vein on one level, see that the vein continues on levels below and reasonably conclude that there’s mineralization between. That’s the kind of physical verification I do.
Particularly crucial is the first “P”—people. I meet with management and the technical people who will actually do the work that adds shareholder value. Do they seem to know what they’re doing? What kind of experience do they have? Is it relevant to the task at hand? Will they look me in the eye when I ask them questions? Sometimes that’s the most important thing. You could call it the smell test. And yes, the languages help.
TGR: So, you want to get away from the guided tour. What happens when you feel like there’s a discrepancy between what you’re seeing with your eyes and what management has said?
LJ: It’s rare to get a flat out lie. It’s more common for something to be not quite as rosy as described. Typically, when there’s some kind of discrepancy, I discuss it with management and give them a chance to explain. I’m not interested in conflict, and we don’t generally report negatively on companies. If something doesn’t make the grade, we just move on to the next opportunity.
TGR: What about takeover targets? Antares Minerals is gone. Newmont Mining Corp. (NYSE:NEM) is picking up Fronteer Gold Inc. (TSX:FRG; NYSE.A:FRG). Ventana Gold Corp. (TSX:VEN) is in the process of being taken over. What are some of the good opportunities left for investors, particularly in Colombia?
LJ: In Colombia, one obvious candidate would be Sunward Resources Ltd. (TSX.V:SWD). It’s developing a new project that has big multimillion-ounce potential, but the company hasn’t finished drilling it off yet. There’s still a lot of work to do. It’s a new story, gathering a lot of interest.
The other obvious one in Colombia would be Galway Resources Ltd. (TSX.V:GWY), which is immediately on strike from Ventana. It’s got more going for it than just the proximity—good drill results show that Ventana’s mineralization does indeed continue onto Galway’s property. On the other hand, Galway did not get taken out with Ventana; so you have to ask yourself: If Brazilian billionaire Eike Batista is not in a hurry to take Galway over, is there any reason for us to hurry to own the stock?
Colombia is perhaps my favorite jurisdiction in Latin America. The country is now headed in the right direction with new free-trade agreements and a population that wants to work and is very focused on rebuilding the economy. There are environmental issues, particularly the high-altitude Páramo ecosystem protection legislation with which Greystar Resources Ltd. (TSX:GSL) has run into trouble recently. It’s important for people to understand that this was not a new regulation slapped onto Greystar. It was an existing regulation that the government never had the power to enforce before because they were in a war for 40 years or more. The government did not start changing the rules on the company—that was always a risk there.
In line with that and your question about disciplined buying, we like to recommend that people buy in tranches. Buy a first tranche, maybe just 20% of your ideal position to make sure you don’t miss the boat. Then, when it corrects—and they always do—buy another 20%. That gives you 40%. Then, if you get a big reversal without any bad news from the company—things go on sale periodically in our sector—back up the truck and buy a big block at low prices. That would be the sort of approach I would recommend with something like Sunward, which already has seen a great deal of share price appreciation in advance of the anticipated results. I also like Colombian Mines Corporation (TSX.V:CMJ).
TGR: Colombian Mines is down 20% over the past 12 weeks, while Sunward is up 24% over the same period.
LJ: Yes. Sunward has had some good drill results. It drilled into thicker and higher-grade mineralization than previously at its Titiribi Project, which is known for being big but low grade. The new results are not high grade—but higher-grade, which is important for a big bulk-tonnage project like this. It makes sense for SWD shares to appreciate.
Colombian Mines hasn’t had a game-changer like that yet. The company has identified a gold porphyry at its Yarumalito project. It’s big and potentially could be a company-maker; but so far, the drill results haven’t really sewn that up. There are assays pending that may bear on that. We’ll have to see. Colombian also has the higher-grade El Dovio project, which is earlier stage but potentially very rich for the company. CMJ also has joint ventures (JVs) on some of its projects. I like using OPM (other people’s money) on high-risk exploration, so I like Colombian Mines. We already own the stock and are happy with our position. We’d like to see the company gain some traction on these projects before we buy anymore.
Miranda Gold Corp. (TSX.V:MAD) is a newcomer in the region, but I know the management and I like them a lot. In spite of the good people and prospective properties, Miranda hasn’t had a lot of luck with its projects yet. That does happen sometimes; even with the best geologists, Mother Nature isn’t always cooperative. So, I like the company but I’m waiting for it to have the tiger by the tail, or at least some indications of a company-maker on hand.
TGR: What about others?
LJ: Pulling back to the global picture looking for takeover targets, one of my favorites is Premier Gold Mines Ltd. (TSX:PG). That’s Ewan Downie’s spin out of Wolfden Resources Inc. with projects that are all potentially big, high grade and in top mining jurisdictions. Most are within spitting distance of Goldcorp Inc.’s (TSX:G; NYSE:GG) producing assets. Premier is working to proving up significant high-grade, multimillion-ounce potential targets—it has takeover written all over it. I don’t know when it will happen, but I think it will. Goldcorp might be happy to see Premier spend its money and do a lot of work for it, but if Goldcorp starts thinking that somebody else may come in and scoop them up, I would expect it to move aggressively.
An earlier-stage one we’ve mentioned in our publications would be Bayfield Ventures Corp. (TSX.V:BYV). It has a continuation of the Rainy River deposit called the Burns block. This has graduated from being just “the property next door” to having a high-grade gold shoot immediately on the Bayfield side of the property line. And you know that high-grade pocket is not going to be left hanging in the wall of an open pit. Somebody’s going to want to produce that gold—it’s just crying out for a takeover.
Trade Winds Ventures Inc. (TSX.V:TWD) is a similar situation but not quite as extreme. It’s got a multimillion-ounce gold resource growing on trend from Detour Gold Corporation’s (TSX:DGC) Detour Lake deposit. The project is a 50/50 JV with Detour already, so there’s a natural synergy there and potential for takeover, but it could get big enough to justify a stand-alone operation.
TGR: Any other companies you might be able to discuss?
LJ: Because you’re interested in Colombia, I could mention Mercer Gold Corp. (OTCBB:MRGP). I like the company, I like the people and I like this particular model, which is to try to explore on the other side of the mountain from the famous Medoro Resources Ltd. (TSX.V:MRS) project in the Marmato district. Marmato is an infamous environmental disaster zone in Colombia with hoards of illegal miners dumping cyanide down the mountainside, and Medoro is the company that’s working to clean that up. There aren’t any swarms of illegal miners on the other side of the mountain; in fact, there are only five miners and they’re all in an association with which Mercer has formed an alliance. There’s no established gold resource on Mercer’s side, however, and so far, Mercer’s drill results have not produced any company-making discovery holes. It has the right kinds of rocks, so it’s got potential but it’s early stage. Medoro’s riskier at this point but certainly has a great deal of upside if the company hits what it’s looking for.
TGR: Louis, are there any closing comments you’d like to leave with our readers?
LJ: Yes. We see a great deal of possibility for correction ahead. If the trouble in the Middle East settles down, and if the economy seems to be continuing to recover and the fear factor recedes, we could see gold retreat significantly. The retreat we had in January was only about 5%, which is really quite small as far as gold corrections have gone during this cycle. Gold has retreated as much as 25% in this cycle before going on to new highs. We really haven’t seen a major retreat in gold since the big ramp-up last year; so, we are urging people to be cautious. If you do buy anything now, make it a first tranche and keep some powder dry for lower prices ahead. If that doesn’t happen, and if the market doesn’t correct, the market may go really manic, inflating a major gold bubble. If that starts happening, you’ll be able to see it and there will be time to redeploy into that bubble. So, we do urge caution right now.
TGR: Many thanks, Louis.
LJ: You’re very welcome.
Always on the lookout for the next double-your-money winner, Louis James is the master of metals at Casey Research where he’s the widely read and well-respected senior editor of the International Speculator, Casey Investment Alert and Conversations with Casey. Fluent in English, Spanish and French—and conversant in German and Russian, to boot—Louis regularly takes his skills on the road, evaluating highly prospective geological targets, visiting explorers and producers at the far corners of the globe and getting to know their management teams. In addition to subject matter expertise, he’s built a following on the basis of a dynamic combination of investment savvy, practical advice, experience in physics and economics and a gift for comprehensible technical writing.
By B.P.T., on March 22nd, 2011
At 7:45 AM EDT, the weekly ICSC-Goldman Store Sales report will be released, giving an update on the health of the consumer through this analysis of retail sales.
At 8:55 AM EDT, the weekly Redbook report will be released, giving us more information about consumer spending.
At 10:00 AM EDT, the FHFA House Price Index for January will be released, providing more information about the direction of the housing market.
By Claus Vistesen, on March 21st, 2011
The past week has showed the dark side of media coverage and analysis of current events and a test on just how much information you stuff down the public’s throat. In the narrowness of my own world the financial industry has a tendency to produce an extra amount of hyperbole in situations of geo-political tensions and/or natural disasters with unknown consequences. In some sense this is a reflection of one of the oldest theories of finance and economics in the form of the efficient market hypothesis and how it tends to break down in the context of extreme uncertainty. Still, I swear that if I open one more report whose authors are turning self-made nuclear scientists overnight I will bin it!
Yet, the long term consequences of the ongoing upheaval in North Africa and the Middle East as well as how Japan manages to rebound from the worst crisis for the country since the Second World War are important for investors. In the following and with a promise of no mention whatsoever of nuclear fuel, rods, or Chernobyl I will evaluate some of the potential effects on Japan’s economy (and indeed, Edward has beat me to it over at JEW, so do have a look there too).
Saving for a Crisis?
In some sense it is too early start putting a numerical figure for the costs of reconstructing in Japan, but it also almost certain that the economy retains the capability to rebuild itself and thus to stage a strong “technical” growth rebound.
Yet, the crisis may also lead to a number of structural changes.
As a first point I would note that the earthquake is likely to speed up the path towards the inflection point at which the BOJ starts monetizing the marginal flow of Japanese government bonds (JGBs) or Japan starts to borrow externally. In principle, I would hold these two scenarios to be one or the other, but in reality we could see a combination.
Two points are important.
1) Japan owes much of its growth rate and indeed its ”survival” to a very strong net international investment position. This is crucial to understand. Japan owns much more assets abroad than foreigners own in Japan and this adds a positive income flow which adds to gross national income (GNI).
2) A strong net investment position essentially translates into positive external savings and leads to a positive income balance which, alongside the trade surplus (or deficit), makes up the current account . This means that when we speak about Japan as export dependent it is a misnomer. Japan is much more dependent on positive net foreign asset income (the income balance) than the exports of excess widgets. If the CA/GDP is about 3% in Japan 2% is the income balance and 1% is the trade surplus (as a rule of thumb). Obviously, on the margin export flows matter a lot but added together over time the ”national wealth effect” from the income balance is higher.
In relation to the reconstructuring efforts, the standard story goes that Japan would have to repatriate these foreign assets effectively selling foreign assets and getting USD, EUR, AUD etc and converting them back into JPY. This would then lead to JPY appreciation which would further crimp the Japanese economy.
Now evidently, this week’s snappy moves in the JPY has nothing to do with this as this is likely to be a slow process but structurally this may become important and a real challenge for Japan. According the initial judgement of the situation by Fitch, the Japanese insurance industry (and indeed the global re-insurance) existing capital buffers should be plentiful.This suggests that this is a non-issue, but given the evolution of savings in Japan relative to the demand for JGB financing there is alreadt a very large future claim on these foreign assets. More specifically, Fitch is arguing in the context of potentially downgrading Japanese insurers on the capital loss of paying for the rebuilding efforts and thus the analysis can not be directly related to Japan’s foreign assets.
Megan McArdle is less sanguine;
(…) while the global reinsurance industry will bear some substantial losses, in many cases, the losses will be borne by the government–or by people and companies whose insurance does not cover the damage that was done. The nuclear industry was required to buy insurance through a special industry insurer with liability limits that now seem laughably small–about $2 billion. And many of the damages simply aren’t insured at all.
In a cynical way, this squares off well with Fitch’ concrete assessment of the insurance industry in that they are likely to dodge the main costs. On the other hand, as Megan also points out, this is certain to put an even stronger strain on Japan’s already overstrained government finances.
Indeed, even if the reconstructing would not drain anywhere close to all of Japan’s foreign assets it would constitute a de-facto claim on these assets either directly or because it would lead to a higher flow of JGBs in the primary market in need for buyers.
There is an alternative of course. As I have argued before, it would be infinitely more attractive for Japan that the BOJ printed money to fund the reconstructing so that the export machine did not falter, but this again would bring the point closer at which the BOJ would effectively be the only bid for the marginal flow of JGBs. You might call this the obviously irresponsive reply, but remember that Japan is still stuck in deflation and thus the cost of such policies is effectively zero at this point.
The big macro picture here is then that Japan may now be forced to run down its only source of savings and essentially its main source of economic growth.
The metaphor here is very simple. Let us say I am unemployed and only earn very little income from the bits and bobs of small jobs I can find (i.e I have a low ”trend growth in income” as Japan does). However, my uncle left me a pool of money and these are all parked in tasty dividend stocks which gives me some income each year so that I can live well.
Now, my house burns down and I have no insurance. What do I do?
Well, I do the only thing I can. I would need to sell those stocks in order to build a new house with the proceeds, but then once my house is rebuilt, my portfolio of dividend stocks will be much smaller and I will earn less dividend income (and I will still unemployed!). This, in a nutshell is the issue for Japan. When I have no more dividend stocks, I go to the bank and they either charge me an interest rate I can’t pay or tell me to bugger off altogether.
And I would re-emphasize that Japan is in a really tight spot since domestic growth and savings are in a structural downtrend and deflation is now a reality in Japan. So it will become very difficult to rebuilt those external savings.
Now for the good news. On even the worst estimates, it is very unlikely that the rebuilding efforts will eat away all Japan’s external savings and let us remember that Japan won’t sink into the Pacific. But with the power grid in need of major structural overhaul, the ensuing and looming disaster with the nuclear reactors at Fukushima, the general knock to economic growth, the already already public debt overhang etc one would be complacent if one did not think a little about straws and camel backs. Indeed, this is also the conclusion made by Edward;
Serious as the short term impacts may well be, in the longer run the shadow which will be cast by what is currently happening in Japan could well be very long indeed, in a way which few today can even contemplate (although see this for a good first pass). The justification for this assertion is not only our increased awareness of our collective vulnerability to the impact of natural disasters, there is also Japan’s pioneer status in one very new and very global phenomenon – population ageing – to think about. As we will see below, the optimistic (I would say denial) prognosis is that Japan will soon valiantly overcome this latest bout of adversity in a similar way to which they overcame the post WWII devastation. The Japanese will surely be valiant in their efforts (one only has to think of the spirit of sacrifice of those poor workers who have been asked to handle directly the reactor problem), but their ability to overcome adversity will not be comparable to that registered in an earlier epoch when they had the wind behind them rather than gusting straight into their faces.
Shock and Awe by the BOJ?
Even before the earthquake roiled Japan, comments were beginning to emerge that the BOJ was going to be forced into a shock and awe jolt of QE that would trump even that of the Fed. The reasons here though would be the same as they would be now. Essentially, the BOJ is fighting a war on three fronts.
- General freeze in money markets and general cash/liquidity levels in the economy
- Backstopping the JGB market which could take a severe knock here. I think Ben is very right to point to the risk that the CDS on Japan is very sticky, once it goes up it does not go down. I mean, why should it really?
- The JPY.
On the first, I think time is working for the BOJ and after last week’s extreme bout of uncertainty due to the unravelling of the nuclear reactors, pressures should already be easing. I would then hold this to be ”managable”.
On the second, it could get very serious, very quickly and I would be looking closely at the BOJ balance sheet. In this week’s G&F Chris Wood points towards how the earthquake has given the BOJ room for movement;
From a valuation perspective, the Topix is now trading below book value again at 0.96x price-to-book . Global investors should use this opportunity to overweight Japan if they have not already done so. GREED & fear’s bull case rests on two foundations, as discussed here recently (see GREED & fear – An ode to the BoJ, 3 March 2011). The first point is the extent to which Japanese corporates have proven they can live with a stronger yen. This is why it is not necessary any more to believe in a weakening yen to assume an outperforming Japanese market. Second, there are clear indications that Japan has commenced a new property upturn which increases the collateral value of the banking system. On this point the earthquake has “helped” in the sense that it has prompted the Bank of Japan to increase its assets purchase programme of private sector assets, and not just JGBs. Thus, the BoJ doubled its asset purchase programme to Y10tn on Monday, with the maximum amount of purchases in index-linked ETFs and J-REITs both doubled to Y900bn and Y100bn respectively.
Two effects need to be noticed here. One is the effect from the BOJ expanding its balance sheet on equity markets and secondly, there is the need to support the structural deficit spending. On the latter, it is noteworthy that CDS on Japanese long term government debt has been creeping up especially as it may prove quite sticky. This means that the BOJ may need to massage the curve on the long end it stands to reason that mounting concern over long term debt sutainability in Japan could lead to a strong steepening of the curve. This is to say that the long term default risk of Japan could rise very quickly since in the end, they will default at some point so in theory it could simply go parabolic. I am not saying that this will happen, but think about the Eurozone. The ECB is effectively the only buyer of peripheral bonds … it could be the same for Japan and long dated bonds.
Naturally, they could move the financing down the yield curve which could mask some of the default risk as duration changes, but in the end it would be the same. But here I am shooting blanks since I don’t know the maturity schedule of Japan’s government debt portfolio.
Structurally, the BOJ faces two main challenges with the JGBs. One is to soak up the annual excess issuance of JGBs relative to domestic demand and secondly there is the flow in the secondary market as pension funds run down their balance sheets to fund pension payouts.
On the third, nilly willy intervention in the spot market will work for about five minutes and then it will get bid down again. In this context, it was interesting to see that the violent move in the JPY prompted the G7 to intervene. Whether they have the clout to lean against the market here is debatable, but ironically they may soon have to back off if the BOJ starts monetizing debt as the rest of the world tightens.
Japan will Move On
In the end, we should all already be vindicated by the strong resilience shown by the Japanese people in the face of their current tragedy. I am certain that Japan will move on as a people and as a society. However, as a macroeconomy things are looking increasingly grim. We don’t yet know what will really come of the attempts the by G7 to keep a lid on JPY appreciation and failing that, we don’t really know what the world will look like with a BOJ engaged in QE far and beyond what the Fed is currently administering.
The point here is not to kick a country which is already down but simply to face up to the realities that the costs of this truly exogenous shock will weigh down on an already unsustainable economic system. So although Japan may now see the opportunity to push the reset button in a number of corners of society, there is no economic equivalent.
By B.P.T., on March 21st, 2011
At 10:00 AM EDT, the Existing Home Sales report for February will be released. The consensus is that existing homes were sold at an annual rate of 5.15 million last month, which would be an decrease of 21,000 from last month.
By Winton Bates, on March 18th, 2011
There can be no doubt that western democratic governments have been attempting to promote the happiness of citizens for a long time. They may not talk much about attempting to achieve the greatest happiness for the greatest number, or any similar high-sounding principle, but they have a wide range of policies intended to promote the well-being of citizens in general or of various groups. When it comes to discussion of government policy most citizens could be broadly described as utilitarians. We may feel strongly about rights, but we have come to expect policy debates to focus on the effects of proposed policy changes on particular groups of gainers and losers and on the wider community.
As I see it there is nothing inherently wrong with governments seeking to enable us to live happier lives, particularly since this is what many citizens want. It is certainly better to have people in government trying to enable us to live happier lives than for them to be trying to make themselves happier at our expense. The main problem as I see it is that the approaches that we – the people in western democracies – have been encouraging governments to adopt to help us to live happier lives have often been counter-productive.
The first problem has to do with our perceptions of the nature of happiness. I think we have been too ready to assume that the best way to enable people to live happier lives is to attempt to control their lives for them. Thus, for example, people are taxed during their working lives to provide health care or retirement incomes that they could afford to provide for themselves. Added to this we have proposals to prevent people from saving too little, working too hard, gambling too much, eating too much and so forth. We need to consider whether the humans are able to flourish if they do not have control of their own lives.
The second problem has to do with the idea that governments could promote the happiness of society if only it could be measured correctly. There has been an ongoing debate about the shortcomings of GDP as a well-being measure and various alternatives are being proposed, including some involving direct measurement of happiness. We need to consider whether it makes sense to discuss the relative merits of different indicators as though all the different factors that are important to the flourishing of any group of individuals can be captured by a single statistic.
The third problem has to do with the effects of government pursuit of happiness on individual flourishing. The more governments take over responsibility for our happiness, the more restrictions they impose on the opportunities that are available to us. For example, if governments regulate to reduce working hours in order to enable people to enjoy more leisure, this restricts the opportunities available to people who have strong personal reasons for working longer hours. We need to consider more carefully the likely effects of such government interventions.
The fourth problem has to do with the effects of government pursuit of happiness objectives on the social fabric. The opportunities available to individuals depend to a large extent on the kind of society they live in. If they live in a corrupt society in which rule of law is breaking down, their opportunities for mutually beneficial interactions with other citizens are likely to be diminished. Incentives for corruption are obviously stronger when governments intervene extensively to regulate the behaviour of citizens. We need to consider how successful different societies have been in containing corruption in the face of such incentives.
These issues are to be discussed in a book I am currently writing, with the provisional title:
We need to be
Free to Flourish
The introductory chapter of the book is available here. Comments would be appreciated. (Please do not be offended if I do not respond immediately because it may take a few days to re-surface, or come down to earth from other activities.)
By Richard Daughty, on March 18th, 2011
Thorsten Polleit, of the Frankfurt School of Finance & Management, penned an article in The Free Market newsletter of the Ludwig von Mises Institute titled “The Many Names for Money Creation.”
It starts off almost humorous, reading more like an interesting, mood-lightening sidebar to a banner article titled “We’re Freaking Doomed (WFD)!” as he notes that the dire economic conditions are such that “euphemisms have risen to great prominence. This holds true in particular for monetary policy experts, who are at great pains to advertise a variety of policy measures as being in the interest of the greater good, because they are supposed to ‘fight’ the credit crisis.”
He then illustrates how the term “unconventional monetary policy” is meant to convey the happy virtues of “courageous and innovative”, as opposed to the bad old “conventional” monetary policy, which is now “outdated.”
In a similar vein, he notes that “Aggressive monetary policy” is meant to signify “bold and daring action for the greater good,” and “quantitative easing” is just a confusing term used to make it difficult for people to see “what such a monetary policy really is – namely, a policy of increasing the money supply (out of thin air), which, in turn, is equal to a monetary policy of inflation.”
A policy of inflation! Yikes! What was in that article “We’re Freaking Doomed (WFD)!”?
From the perspective of the Austrian school of economics (the only true economic theory!), this is not going to be the ordinary kind of inflation, either, but the really nasty, evil kind, where “monetary policy pushes the market rate of interest below the natural rate of interest (the societal time-preference rate), thereby necessarily causing malinvestment rather than ushering in an economic recovery.”
In other words, the Fed and the government are making it worse.
And if you want to know about malinvestment, then ask my boss, who never tires of telling me that I am the only employee, alone, apparently in the whole freaking history of employees, that has a consistent negative value to the company, meaning that the bottom-line of the company would be immediately improved if I was, to coin a rhyme, removed.
So I asked her, “What’s with that ‘improved if I was removed’ stuff?” to which she asked, “What are you talking about? You are the one that said that in the previous paragraph, you moron!” to which I asked, “What?” and then she asked, “What?” and then we just looked at each other, confused as hell.
There was an awkward silence, as I struggled as if I was in some weird parallel universe, since her point was that she is, only now, realizing that I am, as an employee, a huge mal-investment, but I can’t be fired since I am too old and too savvy not to sue the hell out of all of them for my termination, even though their case is air-tight and I should have been fired long ago.
And, as I never cease saying, some other, much worse mal-investments, such as the stock market bubbles, and the bond market bubbles, and the derivatives bubbles, and the debt bubbles, and the housing bubbles, and the bubbles in the sheer, staggering size of governments, were NOT my fault, but are all the fault of the Federal Reserve creating the money that made it all possible
Now, as if playing right into my hands, Mr. Polleit writes, “Sooner or later the dependence of the people on government handouts reaches, and then surpasses, a critical level,” which I assume we have reached.
The worse news is that he figures that “People will then view a monetary policy of ever-greater increases in the money supply as being more favorable than government defaulting on its debt, which would wipe out any hope of receiving benefits from government in the future.”
The terrifying point of all of this is when he writes, ominously, “In other words, a policy of inflation, even hyperinflation, will be seen as the policy of lesser evil.” Hyperinflation! Gaaahhh!
Hyperinflation! Immediately, I go into We’re Freaking Doomed (WFD) mode, which usually involves a lot of hyperventilating and a feeling of panic until I realize that all I have to do is buy gold and silver to keep what is going to happen to everyone else from happening to me, and make a lot of dollars in the process, which always makes me feel better, leading to euphoria, as in, “Whee! This investing stuff is easy!”
A Monetary Policy that Encourages Malinvestment originally appeared in the Daily Reckoning.
By The Energy Report, on March 18th, 2011
 Even in the face of problems at Japan’s Fukushima Dai-Ichi nuclear reactor following a massive earthquake and tsunami, Jennings Capital Mining Analyst Alka Singh takes a positive long-term view on uranium prices. In this exclusive interview with The Energy Report, Alka explains why uranium demand will increase globally in the next two years and offers a few companies poised to capitalize on that need.
The Energy Report: In the wake of the 9.0 magnitude earthquake and tsunami in Japan, how will both the reality of the problems at the Fukushima Dai-Ichi nuclear reactor and the media reports surrounding the events impact demand for uranium and uranium stock prices?
Alka Singh: Well, I don’t see a lot of changes to my model because I’m still using a long-term uranium price of $75 per pound. But, there is so much market uncertainty that I put off initiating coverage on uranium names because of negative sentiments people have surrounding this sector. I think that all of this is more emotionally than fundamentally driven. Actually, this is a great buying opportunity to pick some of the better uranium companies with the solid assets and management teams. But, I’m just waiting for the market volatility to slow down.
TER: Are some companies going to do better than others based on their size, their stage of development or their geography?
AS: That’s an excellent question. The companies that are already in production with all their permits and most of their long-term contracts in place are the best companies to own right now. The long-term contracts have already been signed, so the utilities are actually paying the set price for the next five to eight years. Typically, companies that are already in production tend to sell about 70% to 80% of their production on these long-term contracts. Only 10% to 15% of their production is sold on spot prices. So, companies already in production with low cash costs and long-term sales contracts in place are the types of companies that you would want to own.
TER: What are some specific companies you’ve been following that you think are going to do well?
AS: Some of the producers who will be doing well would be companies like Cameco Corp. (TSX:CCO; NYSE:CCJ) and Paladin Energy Ltd. (TSX:PDN; ASX:PDN) because they have long-term sales contracts and are in production. As they are already in production, they don’t have the permitting risk in the equation. You may see regulators in some countries, including the U.S., take the news negatively. They will probably tighten the criteria that they look at before approving licenses for new nuclear reactors, which will impact demand for uranium.
The uranium equities are responding negatively as the market expects lower uranium demand in the coming years. It’s just that markets will get scared, as they did when the oil spill happened last year. People will call for a moratorium and there will be a lot of uncertainty in the near future, which will be negative for the uranium companies. But, don’t forget, when the oil spill happened BP Plc. (NYSE:BP; LSE:BP) share price dropped approximately 60%, and then recovered in six months.
TER: Why has the reaction in Germany, which is shutting down reactors, varied so much from countries like China and India, which are still moving forward with nuclear plans?
AS: Germany is taking preventive action. The country’s suspending life extensions of 17 nuclear reactors that were supposed to shut down in 2021 originally but were extended by an average of 12 years based on the nuclear crisis in Japan.
In China, the China Environmental Minister came out and said that while the country had learned lessons from Japan, it would not change its plans for a nuclear renaissance. India also has talked about caution—not dramatic change—and is in the process of trying to acquire uranium from Australia. Together, China, India and Russia have 42 reactors currently under construction, another 82 planned and 210 proposed.
TER: Does the design make a big difference in the viability of the project?
AS: The three hydrogen pressure explosions that happened at the nuclear plants in Japan were in the exterior of the nuclear reactors. This disaster is actually much different from the Chernobyl disaster that happened in the Ukraine where no containment vessel was in place. The Japanese government has done a very good job of managing the situation. It could end up as a positive, proving that designs of nuclear reactors being built today are much better than the ones that failed during the Chernobyl crisis.
It’s not as if the Japanese reactor exploded because of an operational failure. We are talking about a huge earthquake, followed directly by a tsunami. Even a nearby oil refinery burst into flames and collapsed. More countries may do stress tests and expanded permitting, which is time consuming and more costly. But, as of right now, I don’t think you can say this event is an end to the nuclear renaissance.
TER: So, are you saying the impacts are going to be different in the short term versus the long term?
AS: That is true. The short-term reaction is obviously one of panic. Over time, people will realize that nuclear power is the only viable way to fulfill the world’s energy requirement. Either you burn more fossil fuel and pollute your environment or you go for very expensive wind power and solar power. Hydropower is built out, basically. Nuclear power is still the cheapest. You can actually produce power at US$0.02 per kilowatt hour compared to coal at US$0.03, natural gas at about US$0.05 and oil at US$0.12 per kilowatt hour. So, what do you do? Do you pollute the environment or do you look for ways to build containment vessels that can handle this level of natural disaster? I still see the supply/demand fundamentals as very positive for uranium.
TER: In your last interview with The Energy Report, you were really positive about the prospects for uranium prices. At the time, they were in the $60–$70/lb. range. Obviously, that price has fallen in the last four days. Is this a short-term price impact or will we see long-term adjustments?
AS: Term markets are responsible for 80% of the total uranium sold annually, while spot markets purchase from 8%–12% every year. That’s it—that’s how small the spot market is. However, equities tend to react more to the spot market than the long-term market. The long-term prices have not changed; they are still at $73/lb. It is the short-term price that has fallen to $60.
The producers or companies actually signing long-term contracts right now will not be impacted by the spot price. Only hedge funds and traders—the guys who are afraid of what’s going on in Japan and trying to make a short-term trading call—are shorting uranium equities on the assumption of a nuclear meltdown as 11 of the nuclear reactors (11 of the 54 operating nuclear reactors) in Japan are in the earthquake/tsunami impact zone. Long term, I think that these guys will start closing the short positions in the near future. It’ll be similar to the oil spill situation with BP.
TER: If this is a short-term selloff of uranium shares, where do you see opportunities?
AS: This is a great opportunity to buy good uranium stocks for the long term. Short term, hedge funds could still short all of these uranium names without knowing which one is better just because they have the word “uranium” in the name. There could be still some tears in the market in the short term. However, if you find good companies that you like with good assets and management teams, this could be a great opportunity. I am talking about companies with good assets, low-cost production and maybe in-situ recovery (ISR) production, including Uranium Energy Corp (NYSE.A:UEC) and Uranium Resources Inc. (NASDAQ:URRE) in the U.S. Their cash costs would be under $25/lb. compared to conventional operations.
At Denison Mines Corp. (TSX:DML; NYSE.A:DNN), where the cost of production is about $45, you don’t want to be long. Cameco would be my other go-to company. As one of the largest uranium producers, the company could gain a lot when the Highly Enriched Uranium (HEU) Agreement between the U.S. and the Russian Federation expires in 2013, leading to higher uranium prices.
In the U.S., 104 operating nuclear reactors need about 60 million pounds (60 Mlb.) of uranium per year. But the country produces only 4 Mlb., which leaves a gap of 56 Mlb. to be met by secondary sources, including the HEU Agreement. So, this is a good time to be long uranium producers/developers. Uranium prices had been recovering in the latter part of 2010 and early 2011 before the crisis happened in Japan. This gives investors the best opportunity to buy since the 2008 financial meltdown. I can understand why people are concerned; but for a risk taker, this is good high-reward opportunity.
TER: Thank you so much for taking the time to talk with us.
AS: No problem. Thank you.
Prior to taking a position as mining analyst at Jennings Capital, Alka Singh was the managing director and senior metals and mining analyst at Rodman & Renshaw in New York City for two years. Previously, Ms. Singh was a vice president covering the metals and mining sector in Canada at Merrill Lynch, and prior to that she was an associate analyst covering the gold and base metal companies at Orion Securities Inc. Ms. Singh holds an MBA from Schulich School of Business, York University in Toronto, Canada and a Bachelor of Science in geology from the University of Delhi in India.
By The Gold Report, on March 17th, 2011
 After working in the gold mining industry for many years, consultant Ken Reser has turned his attention to special opportunities in minerals of strategic importance to North America and Europe. In 2004, he developed an early interest in molybdenum as a vital resource, and then in 2007 became intensely interested in manganese as an element that would gain prominence due to the unique properties that make it irreplaceable in the manufacture of steel. Also, its growing importance in nascent battery technology will revolutionize development of electric and hybrid automobiles. In this exclusive interview with The Gold Report, Ken shares some thoughts on the significance of manganese and how investors might play growing demand for the metal.
The Gold Report: What makes manganese desirable in a commercial sense?
Ken Reser: It’s been a U.S. Defense Department-designated strategic metal since World War II. It’s a critical supply chain mineral for the steel and aluminum industries, as well as many other key industries. And there’s a lot of new technology relating to manganese-rich (electrolytic manganese) lithium-ion batteries for electric and hybrid cars, as well as many other battery uses. It’s a metal that’s rapidly transitioning through new discoveries and new uses.
TGR: So, advances in technology continue to create new opportunities for use of this element?
KR: Exactly. Manganese raw ore is basically $0.18/lb., but electrolytic manganese metal (EMM)—pure manganese metal—is roughly $1.65/lb. It was $2/lb. and higher back in 2007–2008. The thing that people are missing in the manganese story has to do with North American domestic supply—there is none. . .period. Just as China is safeguarding its own domestic supply of rare earth elements (REEs), electrolytic manganese and various other minerals, North America should be doing the same.
North American end users are paying China because it controls over 97% of the world’s supply of EMM. All the end users in North America, for example, are paying the transoceanic shipping costs of raw ore from places like Africa, Brazil, Australia and Russia. They’re paying for finished products to be shipped across the oceans, and then China charges a 20% export tax and the U.S. charges a 14% import tax. So, it’s not a very level playing field for North American end users. I might also mention that about 40 years ago, the United States produced more steel than the rest of the world’s countries combined, but now it’s in number five position. The world is growing rapidly, and you can’t make steel without manganese and without steel production the world stops.
TGR: And, clearly steel is the primary current manganese growth driver?
KR: Yes, I believe the steel industry consumes roughly 47% of the electrolytic manganese supply, aluminum another 32% and electronics 14% and the rest in fertilizer and chemicals. A steel company metallurgist explained to me once that if you didn’t put 10–20 lb. of manganese into each ton of steel (depending on the type of steel that you were forging), a 4 ft. x 8 ft. sheet of steel an inch thick dropped onto a cement floor would shatter like a piece of glass.
TGR: With development of new manganese-rich cathode technology for batteries, is it possible that those uses for manganese could outstrip its use for steel?
KR: Well, that’s kind of forward-looking. I don’t know if it would outstrip it, but it’s definitely going to add a large component. Both the U.S. and Japan have the technology for these batteries, and EMM is a key component. I think actually 65% of the battery component is electrolytic manganese.
TGR: How far along is manganese battery technology now?
KR: The Chevrolet Volt is already utilizing this lithium-ion manganese rich battery at present. MIT is developing another battery technology for wind farms, and these are container-size batteries that are liquid. There is liquid antimony in the lower portion of this battery, and a proprietary catalyst in the middle. There is molten magnesium on top. They state that a farm of these batteries can supply the power for a small city. Of course, the power is generated by wind farms. I’m assuming that the same can be done with solar farms. Magnesium is another key critical metal that I have recently started writing about and of which the U.S. has only one small domestic supplier.
TGR: This is an issue of greater power capacity. Is that correct?
KR: Yes, lithium-ion manganese rich batteries can store power about five times longer. Because of the electrolytic manganese-rich cathode, they can use about 50% less batteries in EVs and thus gain a weight, as well as a capacity, advantage.
TGR: If you can store five times the amount of electricity, you can come closer to supplying a sustained baseload of power.
KR: Yes, exactly. This other magnesium battery by MIT is for wind farms. It is in early stages but it’s something that I’m following quite closely.
TGR: Ken, the spot price of electrolytic manganese has doubled over the past five years. Still, even at $1.65/lb., it sounds plentiful and inexpensive to get out of the ground and process into the EMM.
KR: Well, manganese is a very common element so there’s lots of it. There are various types of ores—carbonate and oxide ore. The carbonate ores are more expensive for extraction to pure metal. A mix of toxic chemicals is used, as well as multiple grinding and crushing processes that aren’t used or needed in a clean (of impurities) oxide ore.
The key thing I focus on is the fact that the U.S. has no domestic supply and only three companies currently have manganese projects in North America; one is in Canada and two are in Arizona. In North America, this EMM can be produced much more cheaply by one of these companies than it can in China where electrolytic manganese costs roughly $1/lb. to produce. If it’s sold at $1.65/lb. and taxed at 20%, and then the U.S. adds a 14% import tax, this leaves American end users at a disadvantage.
TGR: Well, there’s clearly an arbitrage opportunity here and that would be to build production.
KR: Exactly.
TGR: So, how finite is the commodity?
KR: Manganese itself isn’t that finite at all but oxide manganese ore deposits are much less common. Manganese is the fourth-most traded metal in the world. The overall manganese ore industry is growing at about 8% per year and electrolytic manganese demand has been growing at 26% each year for the last five—that shows the huge growing demand for it.
TGR: You said manganese is a strategic metal, which implies there are no substitutes for its uses.
KR: Yes, that’s correct. There is no substitute for manganese in its many applications.
TGR: And you believe there will continue to be new uses for the metal?
KR: I do.
TGR: How do you quantify manganese dependence in the U.S. and the rest of North America?
KR: 100%, unequivocally 100%. The U.S. does some recycling, but that’s marginal.
TGR: Is this dependence situation the same in the EU and other parts of Asia outside of China?
KR: Yes. Russia has its own ore deposits, and it’s closer to China than North America. Shipping of ore and finished product would be less expensive from China to Russia than it would be from China to North America.
TGR: Is the manganese industry nationalized in China, or is it just nationalized by virtue of the export tax?
KR: It’s both. The country has both nationalized as well as private operations. But the country’s actually closing down a lot of the electrolytic manganese plants simply because of its pollution factors. I think we’re going to see an amalgamation of some of these state-owned and private companies as we move forward.
TGR: This is a China story in so many ways. The country creates demand with its infrastructure buildout and is the great producer of manganese with a tremendously unfair advantage.
KR: Yes, we see China putting export limits on rare earths and many other minerals. It’s just simple mathematics. The country wants that product for its own domestic use; so, it’s not going to sell it to the rest of the world, and then find itself with a shortfall. The developing world is growing rapidly, and it isn’t just China—it’s also India, Brazil and Russia. The rest of the world wants to move into the 21st century and will move ahead regardless. Whether North America grows with it or not, that move ahead is going to place huge demands on a developing world for all kinds of different minerals.
TGR: Do you expect to see an exponential rise in the price of manganese over, say, the next decade?
KR: Oh, I believe the price of electrolytic manganese is definitely going to climb because there will be new discoveries and new uses, and China is running out of ore. There are just so many changes. I follow the area of patent applications quite closely and maybe once a month, or once every couple of months, there’s a patent application for some new use of EMM.
TGR: What are the cash costs for manganese in North America?
KR: Well, the only company that has revealed a cash cost is American Manganese Inc. (TSX.V:AMY, OTCPK:AMYZF), and it’s expecting an EMM cash cost of $0.44–$0.45/lb. In China, electrolytic manganese costs $1/lb. plus shipping costs, and then you have the 20% export tax and a 14% U.S. import tax.
TGR: Well, at a $1.65/lb. spot price, that would be a very generous margin for American Manganese.
KR: Yes, the company has a tremendous benefit there. According to the USGS, American Manganese’s Arizona deposit at Artillery Peak is an oxide ore. It’s a friable ore, which, in geological or mineralogical terms, means it’s very soft and doesn’t require multiple milling and grinding processes, roasting process or toxic chemicals. It also has a low water use with benign tailings. The key component to the low cost is a process perfected by Kemetco Research Inc., which is under patent application by American Manganese. The complete Kemetco Process can be viewed here.
TGR: There were two other North American companies.
KR: I’ve spoken with the management of Wildcat Silver Corp. (TSX.V:WS) and Buchans Minerals Corporation (TSX.V:BMC), and I think they both have very robust projects. Wildcat Silver, for example, has about 120 million ounces (Moz.) of silver and its deposit contains zinc, as well as a manganese grade of 7%–8%.
In the case of Buchans Minerals, I believe it has a 7% or 8% average grade of manganese, as well as 12% iron. Both companies’ deposits appear very large. I suspect its costs will be quite a bit higher than American Manganese’s Artillery Peak project, as it has multiple grinding and milling and separation processes that will require roasting and use of chemicals because they are not oxide ores and do contain byproduct minerals.
TGR: American Manganese is up 196% over the past three months. Wildcat Silver is up 130% and Buchans is up 31% over the same period. Is there still upside on these?
KR: Oh, I believe so. These companies have a long way to go, but American Manganese has already identified approximately 15 billion pounds (Blb.) of EMM with a lot more drill work yet to be done. Buchans Minerals is in the early stages of its discovery work. Wildcat Silver is primarily a silver deposit, and it just closed a $13 million private placement with Silver Wheaton Corp. (TSX:SLW; NYSE:SLW) that gives SLW first refusal on any rights Wildcat might want to sell from its Hermosa property in Arizona [formerly known as the Hardshell property]. Wildcat is primarily a silver play with a potential carbonate manganese byproduct.
TGR: Among these three companies, does one have any greater advantage over the others?
KR: Well, I would say yes. I’ve been consulting for American Manganese for some time now and I know what its project entails. It’s much more advanced and it’s open pit. The ore is amenable to sulfurous acid leaching and doesn’t require the multiple grinding and crushing circuits, the roasting of ore or hazardous chemicals, therefore, it has benign tailings. So, you could say that it’s a very environmentally friendly process. AMY’s putting up a pilot mill this spring to bulk test the process. Also, it has a lot more drilling to do because it appears the company’s 15 Blb. EMM resource can be greatly expanded. The company has recently contracted with Wardrop to complete an NI 43-101 prefeasibility study.
TGR: I have really enjoyed meeting with you. Thank you for taking the time with us today.
KR: Thank you for having me.
Ken Reser, an independent mining consultant, has over 20 years of direct involvement in the gold mining market industry, as well as having been a placer gold miner for a number of years in Yukon and British Columbia. Since 1990, he has had significant investor and public relations experience with junior base metal miners, gold, diamond and oil explorationists. Ken has consulted on gold exploration and prospecting projects in Ghana and Bolivia, as well as having staked his own extensive mineral claims in Lac De Gras, NWT, British Columbia and Yukon. He is a founding member of the Gold Anti-Trust Action Committee (GATA) and he is presently involved in an R&D consulting capacity for various Canadian junior mining companies. Since 2005, he has been actively writing mining editorials on various topics, including molybdenum, manganese, magnesium and gold. Ken can be contacted at 403-844-2914.
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