Adam Michael: Base Stock Evaluation on $90 Oil

Adam Michael Platform Advisors Founder Adam Michael searches the globe for oil and gas discovery stories with established cash flows that support share value in reasonably secure political environments. In this exclusive interview with The Energy Report, Adam reveals some names from his own portfolio holdings that he believes could generate considerable upside production growth to return significant multiples for investors, even if oil prices hover at $90/bbl for the next year.

The Energy Report: We’ve had a 10% correction in Brent crude since the end of April, and oil has been a bit weak as we’re starting to see some real signs of improvement in the U.S. economy where it really counts—employment. What factors are putting downward pressure on oil?

Adam Michael: I think the biggest factor over the last year has been quantitative easing (QE), which has led to speculators entering into the crude futures market in proportions that I haven’t seen before. For instance, the net long in crude oil futures by speculators is more than twice as high as it was back in 2008. This has gotten the attention of Congress, and recently we’ve seen the Chicago Mercantile Exchange, CME Group (NASDAQ:CME), begin to raise margin requirements for crude futures. I think the goal is to get some of the speculative money out of crude futures, and that’s one of the reasons we’ve seen a decline over the last month.

TER: Sounds like a healthy thing that could dampen the potential for a bubble.

AM: I think so. Crude oil dropped $20 in a matter of a couple of weeks. That’s a pretty sharp correction, but I think it was healthy because it helped wipe out some of the excess speculation. There could be some more downside to go but, historically, crude kind of tops out sometimes during the summer and maybe late June and early July. I don’t see any reason why that wouldn’t play out this year. We’re still in a kind of historically strong period for crude oil. I’m not sure how much down side there is from here.

TER: In terms of oil price per barrel, is there a sweet spot where the macroeconomy can remain vigorous? What is the upside price-per-barrel limit on commodity oil?

AM: Well, I have read various opinions on this and I have to think that a good price for oil right now would be somewhere in that $90–$100/bbl range. That would allow the economy to keep taking steps and provide for improvement in global industrial production and gross domestic product (GDP) without choking off too much demand. So, I think $90–$100 is a great price for crude oil, and that is kind of a sweet spot. The kind of volatility we could see is $80–$120/bbl. I don’t know how long it will remain there at those swing points. So, I think $90–100 is the right price.

TER: Do you have a forecast for oil?

AM: I don’t really have a forecast, but for the longer term I use $90/bbl crude in my models and for my sensitivity analysis. I look at what kind of cash flow a company can generate with $100 or $80 oil. I think $90 is a good, safe number to use.

TER: Do you feel that $90 oil is a conservative enough estimate to build your models for the next 12 months? The next 24 months?

AM: Well, I think it is a good number through the end of 2011. As global demand continues to creep higher, eventually, we’re going to soak up that spare capacity that OPEC has, and that’s when things will get a little more interesting. That’s probably a 2012 event, but then we’re talking $110–$120/bbl oil. At some point, the price will get high enough that it will support some demand destruction—but we’re not there yet.

TER: The U.S. just ran up against the federal debt ceiling of $14.3 trillion back on May 16, and the credit and equity markets really want that ceiling to be exceeded (at least temporarily). But it seems pretty obvious that something must be done to reduce debt to a lower percentage of GDP. What impact would this kind of austerity have on the economy? Will it strengthen the U.S. dollar? Will it hurt oil? Will it hurt energy companies?

AM: Obviously, the debt ceiling is a hot topic right now. I am guessing that Congress will probably negotiate with the president, and the negotiations might go all the way up to the deadline on August 2. I’m not sure how big of an effect it’s going to have, and one of the reasons is that there seems to be a shortage of bonds because investors are having a tough time finding yield. So, there’s a really healthy credit market out there right now.

Clearly, a default by the U.S. Treasury on government bonds would be a very bad thing, but I think there’s about a 0% chance of that happening. There will be much talk over the summer as it’s negotiating. Cooler heads will prevail, and I’m sure we will do what needs to be done on the debt ceiling with a combination of austerity measures; but the bottom line is that there’s a healthy economy out there. If it weren’t, credit spreads would not be this tight. So, I’m actually pretty positive on the economy right now. This summer could be a little tricky as we hear more about the debt ceiling and as, you know, investors can be short-term minded sometimes. Ultimately, I think this plays out well for the economy. The dollar is probably due for a rally, but it doesn’t necessarily mean that commodity prices will go down. Sometimes they go up with a stronger dollar; it doesn’t happen often, but it can. So, the bottom line is I am positive on the global economy. I think we will get our debt ceiling figured out and we will just keep humming along.

TER: Aside from buying small caps for your portfolios, what is your general investment thesis?

AM: I like to look at companies that have a proven reserve, cash flow or something else that I can get my hands around for a base-case evaluation. In addition to that, I like to see some kind of embedded call option in the form of a large land package—that is at the top of the learning curve where there’s a lot of leverage for upside.

TER: Is it hard to find stable cash flows and rising production, especially in politically stable jurisdictions?

AM: I don’t think so. Domestically, in this latest cycle, we’ve seen the emergence of unconventional oil through the development of the Bakken Shale, which is probably the most widely known unconventional oil play. But other plays are developing now that have a lot of upside running room. And it’s very much analogous to what we saw in the last cycle with the emergence of unconventional shale gas. Now, I think we’re just seeing the same thing as history repeats—or let me say, ‘as history rhymes’—this time it’s the emergence of unconventional oil, where I think there’s a lot of running room. And there are other sources out there besides the Bakken that are starting to emerge, which also have good running room.

TER: Where are you finding these characteristics right now?

AM: Not to be confused with the Bakken Shale in North Dakota, there’s an emerging play called the Alberta Bakken that stretches through Montana and into Southern Alberta. I think it’s going to see a lot of drilling and appraisal work done over the summer. You can’t do much over the winter. In Alberta, a lot of the roads are closed for spring break up, and now we’re just getting on the other side of that.

Rosetta Resources Inc. (NASDAQ:ROSE) and Newfield Exploration Co. (NYSE:NFX) are the two big players south of the border in Montana, and they’ve been doing science and vertical wells to test the Alberta Bakken. From what we’ve heard on recent conference calls, both companies are pretty excited about it and are going to start horizontal wells.

On the northern side in Southern Alberta, you’ve got a handful of micro-cap players with good land positions. Just in the last couple of weeks, we’ve seen the first results come out that were made public by DeeThree Exploration Ltd. (TSX.V:DTX). I think we’re at the top of the learning curve, and the initial results look really good. So, there’s a lot of running room here for these guys.

TER: Is DeeThree a company that you own?

AM: It is.

TER: DeeThree is mostly natural gas, which is expected to be stable over the next 12 months at best. Where does the upside come from here?

AM: Well, it is currently doing a couple thousand barrels oil equivalent per day (boe/d), and most of that is gas—probably 70% gas and the rest a mixture of light oil and liquids—so you have a little bit of cash flow there, which I like to see. It also has a couple hundred thousand acres in the Southern Alberta Bakken play, and I think, at least 70,000 acres in what I call the “sweet spot.” So, there’s a lot of running room there. DeeThree just drilled its first well and completed a frack. The average one-day test rate was 250 boe/d. The company is now removing the frack string and putting in production pipe. That’s a very positive first result for its first horizontal well. And there are other excited players also in the play—big players, at that.

Murphy Oil Corp. (NYSE:MUR) signed a joint venture (JV) with DeeThree and has drilled a couple of wells that are rumored to be pretty good. Murphy has committed to drilling four wells on DeeThree’s acreage by year-end to earn a 60% working interest in about 15,000 acres. DeeThree is being carried on the wells and will receive revenue from first production.

TER: Is that JV with Murphy on the Lethbridge property?

AM: It sure is.

TER: You sound optimistic about this play.

AM: Well, I’ve seen the cycle repeat over and over wherein you have an unconventional play that’s in its drilling stages, and it takes a few months for industry to crack the right science to produce the most assets in the most optimal way. The wells should become more prolific with time, and drilling cost should trend lower.

TER: Where else are you looking?

AM: Well, there’s a company I mentioned in my interview a year ago with The Energy Report that I really like over in Egypt called TransGlobe Energy Corp. (TSX:TGL; NASDAQ:TGA). Since then, the company has identified a new play called the Nukhul Fairway, and it extends across several of TransGlobe’s acreage blocks in Egypt. The wells cost $1M–$1.5M, and some of them are coming on at 1,000 barrels per day (bpd) and holding up fairly well. It’s become more of a developmental play where the company just keeps punching holes, and production is going to increase pretty rapidly this year.

Last year, about 30% of TransGlobe’s production came from Yemen—most of which has been shut down due to the political turmoil there, but the Egyptian production has ramped-up so strongly that it’s already eclipsed the Yemen production. This has allowed the company to keep its guidance that originally included Yemen. I expect that to continue this year, and I like the strong cash flow that’s associated with the wells TransGlobe is drilling right now. There’s just a lot of upside there and a lot of strong cash flow backing up the stock. So, TransGlobe is a company I am still very excited about.

TER: Amazing that the stock could be up 76% over the past 52 weeks with the shutdown in Yemen, which was producing 2,300 bpd.

AM: The Egyptian play has a lot of running room, and it has more than made up for the Yemen shortfall. Eventually, Yemen will become straightened out. I don’t know if it will be three months from now or six months from now, but that production will come back. I am not counting on it, and I can get a good valuation without it at the current stock price level. So, I think there’s a lot of upside for TransGlobe based on the rapid production increase in Egypt and possibly bringing Yemen back online later this year.

TER: Ok, you’re in Egypt and the Alberta Bakken in Canada. Where else in the world are you currently looking?

AM: Well, the Colombian oil companies have been hit hard over the last six months, after having been a little frothy last year. We’re now starting to figure out which ones are the real players and which ones are not. The premier oil company in Colombia is Pacific Rubiales Energy Corp. (TSX:PRE; BVC:PREC). I still think it has the best land package with more than 10 million acres for exploration upside. But what I really like about Pacific Rubiales is that the stock has been beaten down a bit and there are some very strong cash flows. It will increase production by about 20% to more than 110,000 boe/d by year-end, and I have it generating over $2B in EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) this year. It has a very strong, healthy balance sheet and it’s proven the premier operator in Colombia. So, for Colombia, I’m going to stick with the “best of breed” and that’s Pacific Rubiales.

TER: The company has a $7B market cap and is buying back up to 4.3% of its outstanding equity. That shows some confidence, I would think.

AM: Yes, Pacific Rubiales has a strong balance sheet, which gives it the ability to buy back stock when its value is not reflected in the market. I agree with management, and I think the stock has tremendous value here. It’s going to generate $2B in EBITDA this year, and it’s trading at about one-half the multiples that we see here in the States. I like the stable production profile, strong cash flow, management team and, like I said, I think this is the blue chip of Colombia and a great way to play Colombia.

TER: Is there any place in the U.S. that you’re looking?

AM: Well, I like to go back to the old Permian Basin. It’s been a long-standing producing region for Texas. We still keep finding new ways to get more oil out of the ground, as technology gets better and we do horizontal drilling and multistage fracking. One company I like, in particular, is Approach Resources Inc. (NASDAQ:AREX), which has some good reserves on the books.

What’s gotten me excited is its new 130,000-acre Wolffork oil shale play. The first wells have just recently been announced and the horizontal wells are producing 200–300 bpd. I think the ultimate recoveries on these wells could be as high as 200,000–300,000 bpd. I should also mention that EOG Resources (NYSE:EOG) is just north of that play and is seeing a little better rates in the 400- to 500-bpd range on its first producers, and it’s also rumored that Apache Corporation (NYSE:APA) is acquiring acreage in the area. So, there’s a lot of running room with 130,000 acres in Approach’s portfolio, and the company believes it has derisked about 70,000 acres of it—more than 1,000 locations. The returns on these wells are going to be good, and they’re only going to get better as Approach works down the learning curve. It fits my preferred profile, as you have some base reserves to kind of get a conservative valuation of maybe $20/share. You have a lot of upside and running room as this new play is being developed.

TER: Is there anything else interesting you’d like to hit on?

AM: Well, I would like to mention one speculative name in Colombia. I know we already talked about one with a larger market cap, Pacific Rubiales, but the other one that has gotten my attention is Canacol Energy Ltd. (TSX:CNE), which has about 10,000 bpd light oil production. That is good for both cash flow and funding for growth initiatives. But it also has one of the best heavy oil land packages that I’ve seen in the Putumayo Basin, and that’s something that’s going to take some time to derisk. Once the company derisks this, there’s a lot of upside to the heavy oil component of the company—and it makes it an extremely attractive acquisition target. I do like the fact that Canacol has some good cash flow to back up its valuation. I think it’s an excellent acquisition candidate.

TER: It’s been a pleasure speaking with you today, Adam.

AM: Thank you.

Adam R. Michael, 36, founded Platform Advisors, a California registered investment advisor that manages the Platform Energy Fund. Mr. Michael has over 10 years of experience in the energy industry in various capacities. With the majority of his career based in Houston, Texas, he is able to use his energy background and industry contacts alongside his investment experience to identify energy investment opportunities in geopolitically stable countries with attractive geological prospects and fiscal regimes. Mr. Michael has a bachelor’s degree in industrial distribution from Texas A&M University (1997) and an MBA from Rice University (2004).

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Worst of Both Worlds

Tom Clougherty, on the Independent Commission on Banking’s recent proposals:

I hope this isn’t the case, but if it is, it probably suggests a far more radical regulatory approach than the Independent Commission on Banking has considered. It might even point in the direction of ‘narrow’ or ‘limited purpose’ banking, which would involve imposing strict structural divisions in the finance industry, and require banks to hold dramatically higher levels of liquid reserves. Bank of England governor Mervyn King has nodded in this direction.

Of course, I’d much prefer the free market option, but the trouble with the Independent Commission on Banking’s proposals is – arguably – that they do neither one thing nor the other. They don’t eliminate moral hazard and risk subsidies or restore real market discipline to the financial sector. But they don’t offer a particularly strong regulatory response either. As such, the banking sector is liable to cause more problems in future.

Regulation is the natural and proper response to subsidies. If the government is going to subsidize something, it is only natural that the government also regulates it in order to ensure that the new incentives don’t lead to financial (or behavioral) malarkey. In fact, the general purpose of incentives is not to upend the market, but rather to tweak it slightly. Of course, not all consequences can be appreciated in advance, which is generally why regulation is an inevitable response to subsidies.
As such, there are two proper responses to subsidies: either abolish them, or regulate the recipients. The banking commission appears to have taken the worst approach, which combines the free-market approach to regulation coupled with an interventionist approach to subsidies. One need not be a genius to see that this plan is doomed. If the banking commission desires to be successful, it needs to have a consistent philosophical approach: either free markets or proper intervention. It does not need some half-way measure combining the two. Compromise is counterproductive and damaging in the long-run, and so the commission simply needs to get off the fence.

Economic Events on May 26, 2011

At 8:30 AM EDT, the preliminary GDP report for the first quarter of 2011 will be announced.  The consensus is an increase of 2.1% in real GDP and an increase of 1.9% in the GDP price index.  The real GDP estimate is 0.3% higher than the advance value for the first  quarter of 2011, and the GDP price index is the same.

Also at 8:30 AM EDT, the U.S. government will release its weekly Jobless Claims report.  The consensus is that there were 404 ,000 new jobless claims last week, which would would be 5,000 less than the previous week.

Also at 8:30 AM EDT, the Corporate Profits report from the Bureau of Economic Analysis will be released.

At 9:45 AM EDT, the weekly Bloomberg Consumer Comfort Index will be released, providing an update on Americans’ views of the U.S. economy, their personal finances and the buying climate.

At 10:30 AM EDT, the weekly Energy Information Administration Natural Gas Report will be released, giving an update on natural gas inventories in the United States.

At 4:30 PM EDT, the Federal Reserve will release its Money Supply report, showing the amount of liquidity available in the U.S. economy.

Also at 4:30 PM EDT, the Federal Reserve will release its Balance Sheet report, showing the amount of liquidity the Fed has injected into the economy by adding or removing reserves.

Ian Gordon: Gold Stocks Offer Protection from Financial Storm

Ian Gordon Economic cycles, like weather, run in seasons. Longwave Group Founder Ian Gordon explains why he believes the world economy is in the “winter” portion of an approximate 80-year cycle and how the financial excesses of the past 60 years are now being wrung out of the system. Ian also explains how investors can prepare to profit from the coming financial storm by positioning themselves in gold and junior gold stocks in this exclusive interview with The Gold Report.

The Gold Report: Good morning Ian. Thanks for taking the time to bring us up to date with your current thoughts about the economic situation and on specific companies you think our readers might be interested in learning about today. When you spoke with The Gold Report in January, you expressed your thoughts on where things were headed. Can you give us an idea of what you think people should do with their financial investments now in order to protect their assets? What changes do you see, and what do you think now in light of what’s happened since January?

Ian Gordon: I think things are actually getting worse. Basically, the currencies of the world are under fire right now. I’m not sure that the euro will even survive this year. All it will take will be one country, like Greece, to leave it, and then the whole thing will probably collapse like a house of cards. Of course, the U.S. dollar, as the reserve currency, has been under fire, as well. So, I think things are coming to a head here, which is something we anticipated in our own work because it’s based on the Long (Kondratiev) Wave Theory.

In 2011, we see parallels to 1931 because we’re 80 years beyond that time. We believe 20-year cycles are important anniversaries, and this is just four twenties. In 1931, the whole world monetary system effectively collapsed. We’ve been long anticipating a collapse in the current world monetary system based on the collapse of 1931. However, we see that the current collapse is going to have far more significant and devastating implications than the collapse between 1931 and 1933 simply because it’s the collapse of the paper-money system now. Essentially, paper money is credit money. When paper money fails, credit fails. Effectively, the economy will fail on credit.

TGR: So, given what could be a major upheaval in the way the global economic cycle works, if this all comes to pass, what sort of system will we end up with? Are we going back to the gold standard or something similar to it? How is this going to happen, how long is it going to take and what are the implications for investors?

IG: I’m pretty sure that we will go back to a gold standard system. Paper-money systems have never survived throughout history. Generally, they’ve been set around a one-country experiment. And when those have failed, as in France after John Law’s paper-money scheme failed in 1720 or the Assignat failed in about 1798, there was tremendous upheaval. And, following these failures, the country resumed gold as the backing for its currency. So, I think we have to go back to something like that because, in essence, gold enforces discipline on governments. We’ve seen a complete lack of discipline in the paper-money system that’s been ongoing since the 1931 collapse of the world monetary system. Paper-money printing has just gotten out of control; and now, parallel to the paper-money printing is the debt. They go hand in hand.

We’ve built massive debt worldwide, which, in total, is probably well in excess of $100 trillion. In the U.S. alone, the total debt is something like $57 trillion. So, that debt is starting to be wrung out of the world’s economies and everybody is facing a pretty frightening depression.

As investors, we have to protect ourselves as best we can. We’ve long been advocating positions in gold and gold stocks. In fact, we’ve been 100% positioned in both of those—physical and gold stocks—since 2000 because our cycle told us that that’s where we should put our assets. So, that’s what we’ve done. I think investors have to do that and they have to be out of the general stock market because, eventually, the stock market has to reflect the realities of the economy. The current U.S. stock market has been propped up by quantitative easing (QE) with massive amounts of money injected into the banking system. That banking system is not putting that money back into the economy because consumers are completely tapped out; they can’t borrow any more money. So, much of the money the Federal Reserve is putting into the banks is being used for speculation.

TGR: Can we pursue the mechanics of this a bit further before we get into more-specific investing ideas? Given the internationalization of the world economy and money being just electronic numbers on computer systems, how does the world get back on some sort of a hard-money standard without years of turmoil?

IG: When the global monetary system started to collapse in 1931, it began with the failure of the Austrian Creditanstalt Bank in Europe. Everyone was trying to bail out this large bank. The Fed was trying to bail it out, the Bank of England was trying to bail it out and JP Morgan also was in there trying to bail it out. They all knew the implications of the failure of this one bank would cause the bankruptcy of Austria and the failure of many other banks plagued with rotten paper money on their books. So, when this bank collapsed in May 1931, it was the beginning of the end of the world monetary system. A bankrupted Austria was forced out of the gold exchange standard system and was soon followed by Germany. Great Britain was forced out of the monetary system in September 1931, which effectively brought down the entire world monetary system. A new monetary system didn’t evolve until 1944 when the Bretton Woods system was signed into law. It was a long hiatus. The parallels with the current evolving monetary system collapse are pretty plain to see.

After 1931, America was pretty self-sufficient, had all the oil and food it needed and became very isolationist. Great Britain traded within its then-empire. World trade collapsed following 1931 and 2011 may well be a repeat of that tragic year, with the collapse of the euro and the unraveling of the entire global monetary system. It could be a long hiatus before a new system is developed. It goes back to that 20-year anniversary cycle I mentioned. The pure gold standard system that had evolved initially in Great Britain in 1821 collapsed in 1914 because the combatants in World War I couldn’t remain on a gold standard system and print the money they needed to fight the war. So, I would say that we will likely return to a gold standard in 2014—100 years after the gold standard collapsed in 1914.

TGR: So, you’re saying investors have a two- to three-year window to position themselves and their investments to profit from what’s going to happen when this is all turns around.

IG: Right.

TGR: We’ve had all this volatility in the metals prices over the past year and some substantial gains. How is this affecting companies in the mining business?

IG: For the main part, I’ve positioned myself in either new producing companies or companies that have gold assets in the ground. I’m principally more disposed to investing in gold than I am in silver. I think these assets are going to be extremely valuable. I met with one of my website subscribers just yesterday and said it’s quite possible that there won’t be enough physical gold available on the market to supply the demand. We produce only 80 million ounces (Moz.) of gold a year from existing mines. I think, eventually, the demand for gold will become so extreme that the producers won’t want to be paid in paper money because the paper system is collapsing. So, gold may well be taken out of the market, that’s why it is important to get the physical bullion now rather than later. Of course, gold company stocks that produce physical gold are going to be extremely valuable, as well.

TGR: Obviously, you’re quite selective about which companies you decide to invest your own money in and suggest that other people do the same with their money. What criteria do you use in selecting companies for your portfolios?

IG: First, I have to meet with management before I ever put my money into a company. I realize that a lot of investors can’t do that, but they can certainly talk to management. On the junior side, management is usually very disposed to talking with perspective shareholders. It’s just a matter of picking up the phone and asking the president of a company why it is a good investment, and then listening to the answers. I have to feel confident that a company’s management will be able to produce what they say they’re going to produce on behalf of the shareholders.

Another criterion that I use is geopolitical risk. I want to invest only in companies that I am confident are in politically secure jurisdictions. I have been bitten in the past by investing in companies in countries that I thought were politically secure, which became insecure. In Ecuador, the rules changed and mining almost ceased to function in that country. So, I particularly like companies that have assets in Canada, which I think is a very safe jurisdiction. Many of the companies that I’ve selected for my own portfolio have assets in Canada. I also like Mexico.

I think the U.S. is ok, but I’m a bit worried about what might happen when the whole system starts to collapse. After 9/11, I remember when an unnamed Federal Reserve spokesman said in an interview that it looked at many ways to avert a panic. One of the things he mentioned was buying gold mines. If the U.S. doesn’t have the gold it purports to have, it could well be that the country could nationalize gold companies. I do have investments in companies that are exploring for gold in the U.S., but not a lot. I particularly like companies in Canada.

TGR: There was a little fear recently about the possibility that the New Democratic Party (NDP) may be coming back into power in British Columbia. Its administration had a devastating effect a generation ago, when it caused the whole BC mining industry to retrench. I guess that’s probably not going to happen at this point; but if something like that was to happen, would that possibly have a negative effect at least on BC?

IG: Well, it might. If the NDP does win in British Columbia, I think it probably learned from past experience. Under recent governments, there’s been a tremendous amount of exploration and a lot of companies going into production in the Province. It’s going to be very hard to shut those down because they’re all permitted under present mining laws. So, if the NDP was to win in BC, it’s not something that I would be in favor of because I live in the Province and know what negative effect it had on the region’s mining not long ago. I think most of the companies in BC now are sufficiently advanced in terms of their exploration, and some have gone into production like Barkerville Gold Mines Ltd. (TSX.V:BGM). So, all the permitting is in place and it’s going to be very difficult to rescind it.

TGR: Can you bring us up to date on some of the companies you’ve talked about with us previously and give us some ideas on others you’re looking at?

IG: I own shares of Fire River Gold Corp. (TSX.V:FAU; OTCQX:FVGCF). I think the company’s put together an extremely strong management team in order to put the Nixon Fork gold mine back into production, and I’m confident that Fire River is going to succeed. Right now, on the basis of the reserves the company’s put together through exploration, it probably has only a three-year mine life. The company is going to continue drilling to expand that resource and will be able to produce 50,000 ounces (Koz.) gold per year.

Barkerville Gold Mines is probably my favorite gold-company investment at this time; I think it’s very undervalued. The company currently produces about 50 Koz./year and will probably more than double that when it brings the second mill onstream. It’s a very large property, which I’ve been on, and I think it has the potential to host a 5 Moz. gold resource. So, I’m very excited about Barkerville, and I think it’s going to do extremely well. I have about 15% of my portfolio invested in BGM.

TGR: Obviously, you’re voting with your money.

IG: What I tend to do, and also advise for my subscribers, is to take large positions in companies that I think are going to do very well and smaller positions in companies where I’m not as confident. But, if those companies really do well, they’ll boost the value of my portfolio. If they don’t, they won’t hurt it that badly either. So, by taking a large investment position in Barkerville, I am confident that the share price will perform very well.

Premier Gold Mines Ltd. (TSX:PG) is another great company building an expanding resource. I like the company very much. But I don’t own it because I think it’s expensive and that’s due to CEO Ewan Downey’s past record and reputation. He’s the CEO, president and director of the company and is a real mine finder. I think he’s repeating his past success with Premier.

I like Millrock Resources Inc. (TSX.V:MRO) because I have the utmost respect for Greg Beischer, its CEO and president. He’s put some great properties in Alaska and Arizona into the company, most of which he’s been able to joint venture (JVs) with major companies. Big companies just don’t do JVs on properties that don’t have big potential. So, I think Millrock is a company that, at these prices, is probably undervalued. But it’s a little more grassroots than my other investments.

Timmins Gold Corp. (TSX.V:TMM) is in production at its San Francisco Gold Mine in northern Mexico. I think it will meet the objectives the management team set out for the company, which was producing about 100 Koz. gold/year. Drilling results near the mine show an expanding resource. This company has always been an absolute standout in achieving the objectives its management sets. I still own TMM shares and have done very well.

Another little company I particularly like right now, and own almost 10% of, is called Colibri Resource Corp. (TSX.V:CBI), which has all of its properties in northern Mexico. The company just completed a JV deal with Agnico-Eagle Mines Ltd. (TSX:AEM; NYSE:AEM) on a big gold property where the geology is fairly complex and very similar to La Herradura, which is a Newmont Mining Corp. (NYSE:NEM)/Fresnillo PLC (LSE:FRES) JV property. The La Herradura property hosts roughly 12 Moz. gold and is only about 12 km. away. Colibri also has a silver property that looks extremely attractive. The company did some percussion drilling in 2006 and got great results, so it’s drilling it again. I’ve got just under 10% of the company. Sprott has just under 20% and Agnico-Eagle has just under 20%. With Sprott and Agnico, Colibri has some very important shareholders.

Another company I really like and own a lot of, and whose share price doesn’t reflect what I think it’s worth, is called Temex Resources Corp. (TSX.V:TME; FSE:TQ1). All of the company’s assets are in Ontario, Canada. It has about 1.2 Moz. gold at surface on its Shining Tree property averaging about 1.5 grams per ton (g/t), so it’s certainly mineable. You’re really only paying maybe $40 per ounce of gold in the ground for this company. So, I think Temex is extremely undervalued. I own a lot of the stock and think it will do very well for shareholders.

Another one I like and have been buying lately is a company called PC Gold Inc. (TSX:PKL). Between my wife and me, we’ve probably accumulated about 1 million shares. PC’s main asset is a past-producing, very high-grade mine on Pickle Lake in Northwestern Ontario. The company has been drilling and producing exceptionally good drill results and probably now has a resource of more than 1 Moz. I think it’s extremely undervalued. I’ve been buying it in the open market and believe it can do very well for investors. So, there are a few more ideas.

TGR: Thank you for those great ideas. Did you have any last thoughts about the future of the economy you’d like to share?

IG: Unfortunately, I’m very pessimistic about the economy. If paper money, which is credit money, collapses, then, essentially, credit collapses and the economy grinds to a halt. Quite a scary scenario could evolve from a collapse in the paper-money system. We almost had a major credit failure in 2008. What happens if credit does that again? Everything stops—trucking stops, the movement of goods stops and it becomes a very difficult time for everyone. I think people have to prepare for the worst.

TGR: We’ve certainly gotten used to a system that is automated and electronic. People press buttons and expect results. If things start falling apart as you predict, we could see some real turmoil—financial and possibly even physical.

IG: Investors need to keep those possibilities in mind and protect their assets as best as they can. I’m a little reluctant to admit it, but one of the things I keep on hand is a one-year supply of food. It’s a relatively inexpensive way of protecting your food source. If the system falls apart, as it could, you won’t be able to run down to the store and get what you want when you need it.

TGR: Thank you very much, Ian, for your valuable insights and recommendations.

IG: Thank you very much.

A globally renowned economic forecaster, author and speaker, Ian Gordon is founder and chairman of the Longwave Group, comprising two companies—Longwave Analytics and Longwave Strategies. The former specializes in Ian’s ongoing study and analysis of the Longwave Principle originally expounded by Nikolai Kondratiev. With Longwave Strategies, Ian assists select precious metal companies in financings. Educated in England, Ian graduated from the Royal Military Academy, Sandhurst. After a few years serving as a platoon commander in a Scottish regiment, Ian moved to Canada in 1967 and entered the University of Manitoba’s History Department. Taking that step has had a profound impact because, during this period, he began to study the historical trends that ultimately provided the foundation for his Long Wave theory. Ian has been publishing his Long Wave Analyst website since 1998. Eric Sprott, chairman, CEO and portfolio manager at Sprott Asset Management, describes Ian as “a rare breed in the investment-advisor arena.” He notes that Ian’s forecasts “have taken on a life force of their own and if you care to listen, Ian will tell you how it will all end.”

A Decent Half-Measure

What would evidence-driven copyright law look like? (I won’t discuss patents here, although this argument should roughly apply to patents as well as copyright.) The length should be determined by looking at earnings distributions for things like music and books, and cut the copyright protection period to only include, say, the first nine-tenths of the average distribution. Most copyrighted productions follow a power law – the bulk of their earnings from a novel or movie will usually be earned in the first couple of years (see diagram above). It’s the initial high earnings that IP should be aiming to protect, not the “long tail” that comes afterward. This would reduce the stifling effects that copyright has, without reducing much of the innovation incentive, since most profits would still be protected.

Let’s say, for sake of argument, that 90% of all revenue earned by copyrighted material is earned within ten years of creation. Let’s also say that, as a result, all copyright protections expire within ten years of creation date. And let’s also say that this system is currently in place.
How would this impact, say, J. K. Rowling’s income right now? Keep in mind that the first four books were released prior to 2001, so they would no longer be protected under copyright law. How much income would Ms. Rowling forego as a result?
It is, of course, impossible to say. Obviously, Ms. Rowling is still selling books. It is likely, then, that bootleggers could cannibalize some sails, depriving Ms. Rowling of income. However, Ms. Rowling’s publisher could compete with bootleggers on price by offering competing product and dropping the price of their books. And Ms. Rowling could voluntarily drop the amount of royalties she received in order to make her book more competitive with bootlegged copies.
Thus, Ms. Rowling would lose out on some money. However, the bulk of her sales have already occurred, at least in regards to books, so she wouldn’t lose that money. Furthermore, lower costs of her books in bootleg form would spur an increase in overall sales, which might spur sales of tie-in products (keep in mind that Ms. Rowling has written a decent number of tie-in books), which would improve her bottom line. As it stands, then, it appears that while Ms. Rowling would miss out on some income, it is not likely that she would miss out on a sizable amount of income, relatively speaking.
Therefore, the proposal to base copyright expirations on earnings distributions is quite reasonable. A shorter duration of copyright does not appear to place a significant cost on creators, whom it is presumably designed to protect. And a shorter copyright duration will better enable derivative works, which will only foster innovation. Frankly, the tradeoff appears worth it.
While this will not be utopia for the anti-IP crowd, it is still an improvement on the current system and is definitely a step in the direction. Significantly, this won’t impose major costs on creators, which should help to incentivize creation and innovation, which is the ostensible purpose of IP in the first place. Why not take a chance on it?

Economic Events on May 25, 2011

The Mortgage Bankers’ Association purchase index was released at 7:00 AM EDT, and there was a week to week increase of 1.5% in the Purchase Index and a week to week increase of 0.9% in the Refinance Index.

At 8:30 AM EDT, the Durable Goods Orders report for April will be released. The consensus is that there was a decrease of 3.0% from March.

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.

Why Not?

It’s time to liquidate some assets:

“The United States may have run up a huge debt, but it is not a poor country…,” the Washington Post announced on Monday as Our Rulers hit their credit-limit. “The federal government owns roughly 650 million acres of land, close to a third of the nation’s total land mass. Plus a million buildings. Plus electrical utilities like the Tennessee Valley Authority. And an interstate highway system.”

If there is one thing that does not make sense to me, it is the whole concept of the federal parks system.
First, why should the government be in charge of massive amounts of land in light of the fact that it has a long history of mismanaging resources and impoverishing citizens as a result? The government locks this land away, usually under the guise of preserving the natural beauty of the area being controlled. This approach usually means that the land the government owns is highly overvalued for its purpose, and that it is extremely undervalued for its alternative purposes.
ANWR provides a perfect example of these tendencies. Obviously, there is some value in preserving Alaskan wildlife. But there is also value in drilling and refining massive amounts of Alaskan oil. In a free market, there would be a proper balance between the two competing desires. Environmental groups could pool their resources and buy land for a wildlife reserve while oil companies could buy land that held oil. Unfortunately, the free market is not allowed to bring equitability to the problem. Instead, the government is involved, which has led to conflict for the past forty years, because the government basically says that the environmental value of ANWR completely overrides the energy value of the oil contained in ANWR.
And this is the overriding principle for every park owned by the government. It never occurs to bureaucrats that land can have multiple uses. And it never occurs to politicians that the market can easily solve the issue of resource distribution in a way that is voluntary, thus making the largest amount of people happy.
Second, why is the government still holding onto this land in light of the current federal fiscal situation? Selling off the parks and reserves would help to trim some of the federal budget and the money generated could be used to pay down the debt.
There’s no downside to this. Well, maybe a lot of environmental groups will be pissed off as a result of selling off the national parks. Like I said, there’s no downside.

Russian Demographics - Something Stirring in the East?

One of the reasons that I have always had a problem with Goldman Sachs’ infamous notion of the BRIC economies was not the fact that it excluded other important economies such as e.g Chile or Indonesia, but rather that Brazil, India, Russia and China never belonged in the same group. The reason for this is largely because of demographics. Both Russia and China are consequently set to age much more rapidly than India and Brazil due to very rapid fertility transition in the 1990s. The demographic situation is especially dire in Russia which not only saw a dramatic and lingering decline in fertility in the 1990s but also saw a corresponding increase in mortality (aids and alcohol as big culprits).

A recent piece by Carl Haub suggests however tha while doom and gloom used to be the prevailing tone on the state of Russian demographics recent trends suggest that this should change.

Back in 2000, Russia achieved what Russians consider a dubious milestone, deaths (2,225,300) outnumbered births (1,266,800) by an astounding 958,500. The crude birth rate had sunk to 8.7 births per 1,000 population. Along with a crude death rate of 15.3, natural increase hit an all-time low of –6.6 per 1,000, or –0.7 percent rounded off. The total fertility rate (TFR) bottomed out at 1.195 children per woman. The crisis, as it was seen to be, was definitely noticed, but nothing really effective was done until 2007 when Vladimir Putin announced a baby bonus of the equivalent of $9,000 for second and further births. Putin has been an outspoken advocate for raising the birth rate and improving health conditions in order to avoid the consequences of sustained very low fertility. The program must have worked since births in 2007 jumped to 1,610,100 from 1,479,600 the previous year and have rising ever since. This is one of the very few “success stories” in the industrialized countries’ efforts to raise the birth rate.

Together with the rest of Eastern Europe that was re-joined with the West after the fall of the Soviet Union, Russia experienced one of the most brutal fertility transitions ever seen. Indeed, history seems to have been extraordinarily cruel to many countries in Eastern Europe in handing them a second chance at the end of the 1980s just to take it away with the other hand as their demographic fundamentals collapsed. The birth dearth in the East even stretched into Eastern Germany where the total number of live births fell from 215700 to 88300 in the period 1988 to 1992.

I have previously mused that perhaps those multinationals eager to expand eastwards would have to go all the way to Kamchatka to find qualified labour and perhaps even fail entirely and back in 2006, the only silver lining that the Economist’s Berlin correspondent could find was how a residing population had led to a revival of wildlife with the lynx returning to Germany’s Eastern borders.

Perhaps though, it is time to put this discourse to rest?

Russia in Transition

From 1989 to 1999/2001 the total fertility rate in Russia fell from replacement levels to around 1.1/1.3 and notable effort [1] has been put into explaining why birth rates fell so much, so quickly.

Grogan (2006) uses a household survey tracking data from 1994 to 2001 and finds that a large part of the decline in fertility among married couples can be attributed to the decline in household income in the same period. Grogan (2006) however also sheds light on other aspects of Russia’s fertility during the Soviet era. In particular, the paper sets out to explain completed cohort fertility for women born between 1936 and 1961 and finds that women with higher education had considerably lower completed cohort fertility rates than their counterparts. This squares well with the notion of the quantity/quality tradeoff of fertility famously developed by Gary S Becker [2] and how parents substitute quantity for quality as their income levels rise (with education), but it comes with an important twist in the Russian case. Since female labour force participation was almost universal during the Soviet era and since women with less than higher education often earned the same (or more) than their better educated peers, Grogan (2006) seems to imply an inherent demand, by part of well educated women, for quality rather than quantity in their fertility decisions.

The other driver of fertility decline in the form of the tempo effect is also present in Russia, but Grogan (2006) is skeptical as to its merits in explaining the sharp fall in fertility in the 1990s. It does appear to coincide with a change in attitude towards marriage and, specifically, births outside marriage, but from 1988 to 2000, mariage rates declined for the broad category of women (aged 15-44) as well as the share of total live births taking place outside marriage rose from about 14% to 26%.

In essence, the tempo effect over the period in question is not linear and seems to neutralize itself over time.

From 1989 to 1994, the share of births to mothers under 20 actually rose and then declined to just above 1989 levels in 2000. Not surprisingly, the share of total non marital live births among mothers aged less than 20 years rose sharply from 1989 to 2000. This suggests that the extent to which non-marital live births increased, it resulted in children being borne to young mothers. From a theoretical perspective, this is important in relation to how a change in the life course towards postponing marriage also leads to a postponement of childrearing. A norm of non-marriage child births may then serve to weigh against the tempo effect of fertility.

This non-linearity of the tempo effect throughout what was essentially a sharp linear decline in fertility is interesting. The charts produced in Grogan (2006, p. 65 fig XI) clearly suggests that from 1989 to 1994 total live births for young mothers aged under 20 as well as those from 20-24 rose as share of overall birhts. This reverses somewhat in 1994 where live births for mothers aged 25-29 starts to increase as well as those aged 30-34. Yet Grogan (2006) notes that since there is no meaningful change in the fraction of total live births of “older” mothers in 2000 relative to 1989, the decline in fertility in Russia is not a postponement phenomenon.

Brainerd (2006) builds on the points above by similarly latching on to the idea that the economic hardship bestowed on Russian citizens in the 1990s contributed to the decline in fertility. This suggests again a more permanent negative quantum effect at work rather than merely a postponement phenomenon. But the underlying causes of the fertility decline is cut very finely by Brainerd (2006). Notably, the paper argues for a pure negative income effect on birth rates and thus a reversal of the standard quantity-quality tradeoff as developed by Becker. The interesting thing here is that little evidence is found that general macroeconomic uncertainty (of the future) affect fertility even if women with more negative expectations of the future had a higher propensity of abortion.

Quantitatively, Brainerd (2006) finds strong evidence for how marriage and a higher income per capita positively affects fertility using a fixed effect estimation with age specific fertility rates as dependent variable. Since marriage rates and income declined in the period 1989 to 1999, it leads to the conclusion that this caused the decline in fertility. I find this plausible, but would note that the estimation results suggests that underlying uncertainty of the future might still be affecting these results. For example, Brainerd (2006) shows how the effect of income on fertility is strongest for young mothers which indicates that permanent income may be a more useful proxy for linking fertility to income levels than the traditional method of using fluctuations in current income. It also sugggests that the income effect might be lower over time in the aggregate if we assume a general process of postponement, but this is dubious in Russia’s case following Grogan (2006).

And now lets go make some kids … ?

In general, the tendency of non-marital births is interesting to dwell on and Perelli-Harris (2008) [3] draws a sharp distinction between two reasons to explain it. The first relates to the notion of the second demographic transition [4] which postulates that the extent to which non-marital births occur in stabile cohabitations, as e.g. in the Scandinavian countries, it reflects a change in value towards marriage and thus a change in the life course. Contrary to this stands evidence, largely from the US, that non-marital births are associated with much less stable unions and, generally, poorer levels of society.

Not surprisingly, Perelli-Harris et al (2008) do not ascribe either of these explanations to the rise of non-marital fertility in Russia, but rather; a mixture of both. One important aspect here is the extent to which, after a non-marital contraception, women with higher education tend to enter into marriage with a much higher probability than women with lower education. But everyone will be able to find sources to support their argument with for example this article by Sergei V. Zakharov and Elena I. Ivanova arguing for a more traditional second demographic transition process in Russia.

One overarching conclusion which emerges on the fertility decline in Russia is that it was not driven primarily by birth postponement but seems to have been pushed by a more lingering quantum effect. The more specific driving forces of this quantum effect is much more difficult to get a hold on, but from the perspective of the macroeconomist it appears as if Russia entered a sinister spiral of increasing mortality and declining fertility just as the economy was meant to rebuild and then later take off on the much hailed wave of convergence. In particular, it appears as if the general adverse economic environment in Russia in the 1990s may have caused fertility rates to “undershoot”.

Pro-natalism in Russia, Action and Reaction?

While we may certainly look upon Russia’s demographic experience as a frightening example of the effect of negative population momentum, it would be unfair to say that the Russian leadership has been sitting idle. In 2006, Vladimir Putin announced a number of pro-natalist initiatives targeted at reversing the the decline of Russia’s population. The plan included longer maternity leave, increased child benefits and most notably a full USD 9000 payment to women opting to have a second child Brainerd (2006).

In May 2009, president Medvedev arranged for eigth families to be courted at the Kremlin where they were awarded the Order of Parental Glory; the Levyokin family chosen to represent the Moscow region had, at the time, given birth to no less than 6 children.

Getting his Priorities Straight

The question is whether it has worked?

According to Carl Haub it has (see above), and if this is indeed one of the few success stories of how  ageing economies can reverse their birth rate, it is worth paying more than scant attention to. The data here is subject to some uncertainty, but following Haub’s lead the total fertility rate in Russia stood at 1.54 in 2010 which is up from a low point of 1.2 in 2000. In addition, Haub notes an important distinction between rural and urban fertility rates with the former standing at 1.9 in 2010 and the latter at 1.42. This last point is difficult to underestimate since it shines a rather pessimistic initial light on the strides to increase fertility in Russia. In particular, it casts russia in a more classic emerging market context witha a very abrupt quantity/quality trade-off at work whereby especially urban fertililty undershoots significantly below the replacement level.

Still, the aggregate picture is improving.

(click on charts for better viewing)

In the jargon of the profession we must now be seriously asking whether Russia is about to join the very few nations that has managed to break free of the fertility trap defined here as how total fertility rates often don’t recover (or has not recovered yet!) once they fall below 1.5. The only two other countries which have seen their fertility levels rebound from below 1.5 are Denmark and France.

I would happily announce that this is the case, but the plot is just about to thicken.

On the positive side and given evidence from the academic literature that the tempo effect is not a relevant phenomenon in a Russian context, it stands to reason that this rebound can be interpreted as a real change in sentiment towards having children.

Score one for Russia’s pro-natalist policies then?

To some extent though Carl Haub pours water on this idea noting that the second derivative of the fertility increase is falling which leads him to ponder whether the rise of Russian births is losing steam. This argument is taken further by Kumo (2010) [5] who suggests that not only did Russia’s pro-natal policies not work in the first place, but also that the rise in the number of births can be attributed entirely to fluctuations in the number of women in their reproductive age. More importantly however, Kumo (2010) emphasizes the difficulties of micro managing fertility and specifically the issue of just how difficult it is to get a lasting impact on fertility from cash transfers. In short, empirical evidence shows that pro-natalist policies rarely have a permanent effect. This is even more likely to be significant in a Russian context as the fund set up to dole out money to fertile mothers expires in 2016.

Ageing in Russia, Adjusting for Mortality

To assume that the Russian government’s attempt to push up fertility rates will have a lasting permanent effect is probably as dubious as assuming that it will have no effect at all. In addition, if Russia is serious about securing a future balanced population pyramid, what is to say that there won’t be more initiatives?

Still, it appears that just as Russia seem to be making strides in the fertility department, the appalling situation for adult male mortality continues to taint the overall picture. Here, the optimists will call foul play and point out how the main story on Russian demographics has recently been a co-movement of improving mortality and fertility rates. This may be true, but overall conditions are still poor.

According to data from the World Bank only a mere 47.4% of a male cohort can expect to celebrate their 65th birthday which contrasts with 78.5% for women. On average (from 1998 to 2009) only 44.5% of a given male cohort could expect to reach 65 years.

Despite the visible improvement since the mid 2000s, the evidence from a birds eye view has not changed. Male life expectancy seems to be mean reverting around 61 to 62 (at birth) and mortality for adult males exhibits an increasing trend. An afinity to Vodka and other spirits as well as too many cigarettes appear to be lingering killers. Recent research (2009) from the medicinal sciences using mortality patterns from Tomsk, Barnaul and Biysk suggests alcohol was a cause of more than half of all Russian deaths at ages 15-54 years.

As a result, the natural increase is still negative as the up-tick in births has still not managed to pip the mortality rate here even if it seems a more lasting change may be underway here.

A Rare Sight

Regardless of the permanency of recent years’ improvement in fertility Russia cannot escape a rapid process of ageing. More than anything, this is why I so ardently argue against lumping Russia together with India and Brazil or more specifically; in Russia there is no positive demographic dividend in sight; rather what we have is a negative one.

Of course, we cannot simply assume that the Russian population will fall from here on as one would assume (and hope) that Russia manages to reverse the trend in mortality. What we can see however is that in terms of the prime age group (35-54), Russia is likely to have peaked already in 2004 even if the effect of the double hump is interesting to consider (a result of assuming a perpetually declining population).

In addition, the process of ageing means that there is almost no chance of Russia being able to contribute to global rebalancing by sustainably running an external deficit. This is one of the single most important macroeconomic characteristics which suggests why we should not label Russia as an “emerging” economy. Russia and the CEE will instead be fighting to escape the mantle that they may just have grown old before they made it to become rich.

Especially the younger part of the labour force will invariably be subject to a swift decline and the composition of the labour force is crucial to consumption smoothing on the aggregate level and thus capital flows.

However, the most important aspect in the context of ageing in Russia is to adjust for the continuing high mortality rate among men. In a recent piece in Sciencemag Warren C. Sanderson and Sergei Scherbov argue that we should rethink ageing given that as the world population ages so does the threshold at which we can consider a person (or population) to be “old”.

(…) as life expectancies increase and people remain healthy longer, measures based solely on fixed chronological ages can be misleading. Recently, we published aging forecasts for all countries based on new measures that account for changes in longevity (58). Here, we add new forecasts based on disability status. Both types of forecasts exhibit a slower pace of aging compared with the conventional ones.

This makes perfectly good sense and governments around the world are busy pushing up retirement ages to reflect this, but does this apply in a Russian context? What good would it do to push up the retirement age in Russia if less than half of a male cohort makes it to 65? The principle applied by messieurs Scherbov and Sanderson cuts both ways and in Russia’s case we must incorporate an additional accelerant in our analysis of ageing to account for the continuing high rate of mortality and indeed an effect which will take some decades to pass through the pyramid.

Something Stirring in the East?

The recent improvement in Russia’s demographic indicators begs the question of whether the glass is half full or half empty. On the former I would note two things. Firstly, Russia has indeed seen a noticeable improvement in both fertility and mortality and it seems to have coincided with the government’s strategic aim to actually do something about the country’s decaying demographics. Secondly, I will salute the effort in itself. We can all probably agree that Russia has veered a little too much towards the way of authoritarianism under Putin, but whatever the underlying ambitions to push forward a positive population agenda I think it is extraordinarily important.

On the latter however, I am still worried that the trend in mortality have not been reversed and that, if anything, the situation is improving all too slowly. I am open to a more positive spin, but the data and an, admittedly scant, look at the evidence gives little comfort. As a result, ageing in Russia will be much more acute and its effect will have a much larger and negative impact than if life expectancy was a steadily increasing function of time. Indeed, given the continuing poor state of especially male health in Russia it is questionable whether the measures above of “peak growth” apply at all.

The most important feature of Russia’s demographic rebound is its potential permanency and especially we should watch whether Russia manages to stay above a fertility rate of 1.5. If this turns out to be case, we could harbour a hope that not only lynxes but also a rejuvenated Russian population may be stirring in the East.

* All photos in this essay are taken from Creative Commons License accounts at Flickr. Data for the charts are from the World Bank Database and US Census Bureau (long term population forecasts).

[1] – In the following I will make extensive use of Louise Grogan (2006) – An Economic Examination of the Post-Transition Fertility Decline in Russia and Elizabeth Brainerd (2006) – Fertility in Transition: Understanding the Fertility Decline in Russia of the 1990s.

[2] – Becker, G. (1960) – An economic analysis of fertility, In Demographic and Economic Change in Developed Countries. NBER: New York

[3] – Perelli-Harris, Brienna and Gerber, Theodore P. (2008) Non-marital fertility in Russia: second demographic transition or low human capital? In, Population Association of America 2008 Annual Meeting, New Orleans, US 17 – 19 Apr 2008. , 33pp.

[4] – The second demographic transition has many sources but these ones by Dirk J. van de Kaa are a good starting place.

[5] – Kazuhiro Kumo (2010) – Explaining fertility trends in Russia, VOX EU

Rick Rule: Oil Will Be Major Economic Driver

Rick Rule Global Resource Investments Founder Rick Rule likes to look for unpopular investments because that usually means the prices are cheap. Today, that means oil, natural gas, uranium and geothermal. In this Energy Report exclusive excerpt from his talk at the Casey Research Conference in Baton Rouge, Rule explains the global forces that will lead to big payoffs in undervalued energy stocks.

The developed societies of the West are descending and destabilizing. People have come to believe that they are entitled to live beyond their means. I’m not an economist or a political scientist, but that perception leads to some very hard math. How can you add a column of negative numbers and come up with a positive? It’s not a uniquely American problem either. People in the old western societies, Canada and Australia suffer from the same delusion. We are old; we are fat; we are white and we are rich. Our collective problem was described by my grandfather in the following diddy: “When your outgo exceeds your income, your upkeep becomes your downfall.”

I’m not just talking about a problem of tax receipts or government spending or entitlements. It isn’t that we’re collectively stupid. It’s that we’re individually stupid. There seems to be a belief in the United States that a 55 or 56-year-old auto worker can make $55 an hour because he or she can employ technology better than a 22-year-old Indian auto worker. I don’t think so.

Another problem is that the root causes of the liquidity crisis of 2008 have still not been addressed. If you have a big problem that manifested itself in a fairly dramatic fashion and you haven’t addressed the causes, do you think it’s reasonable to be afraid of the fact that that probability may reassert itself? I do.

So, what’s the good news? The emerging and frontier markets—societies where people are un-free—are becoming a bit more free. As they become a bit freer, they become richer. Remember Chinese Communist Party Leader Deng Xiaoping, who famously said, “to become rich is glorious.” That phrase turned China loose. Make no mistake, we aren’t talking about an unending upward linear spiral. There is plenty of room for negative surprises. We have seen in places like Libya, Yemen and California that the road to freedom is uneven. But it is an undeniable force.

So we have descending destabilization of Western societies, which is not good for commodities. It’s not good for anything. But we also have ascending emerging markets. That is good for resources. When people get more money at the bottom of the economic pyramid, they buy things made of stuff. A poor person might trade a thatch roof for a metal roof. He might trade walking for a bicycle and eventually for a motor scooter. Old, fat rich people buy a nice dinner. Maybe we buy an iPod for a grandchild and load it with virtual songs. All good things, but they are not made of stuff. Selling stuff is what makes investors rich.

Think about it as two great weather systems coming together. Old, spoiled, rich and stupid meets this amazing demand for resources. What happens when two big weather systems collide? Stormy weather, turbulence, volatility. I think we’re going to see volatility on steroids. Volatility can cause strange things. Oil shoots up repeatedly above $100/barrel. Then there’s that other kind of volatility like in 2008 when things fell off a cliff. So, you have to manage expectations going forward. There will be more upward spikes and more down-spikes.

Now, volatility doesn’t need to be a risk. It’s up to you. Remember this. Perceptions of the future are set by immediate past experiences. That means in the near term, as Financial Author Jim Dines famously says, “a trend in motion stays in motion until it stops.” We often confuse a bull market with brains. Markets gain momentum and gain momentum and gain momentum and gain momentum. We buy a stock for $1.00. The stock goes to $2.00. What do we do? We double up. Think about this. Is this rational behavior? No, but it feels good. We’re smart. The stock went up. The sector’s good because the stock went up. The higher the prices go, the better we like it despite the fact that the value is eroding right in front of us. The contrarian thesis, of course, is to be brave when others are afraid and afraid when others are brave. It’s a wonderful slogan but it’s damn hard. When a company is selling for half it’s worth people complain that it never goes up. In other words, the fact that it’s cheap becomes a curse; a wonderful curse from my point of view. Unless, as occasionally happens, I’m wrong. What’s the biggest investment risk out there? Obama? Debt? Nuclear arms? No. The biggest investment risk you have is to the left of your right ear and to the right of your left ear. All of my worst financial experiences were self-inflicted.

The reality is that volatility is good because it represents a series of 40% off sales. It’s up to you whether you take advantage of volatility or whether volatility takes advantage of you. Common sense is the real determinant over whether you will do well. If something doesn’t make sense, very often it’s because it doesn’t make sense. Financier George Soros made almost all of his money finding widely-held premises that were wrong and betting against them. He famously decided in the year 2000 that the United States society was hubris infected. You remember the spectacular bull market of 2000. We had vanquished the Soviet Union and everyone thought nothing could go wrong with America. Soros bet against it. That’s the kind of common sense that will allow you to deal with volatility.

My approach is very simple. It comes down to this: “hit them where they ain’t.” Know this: A trade that’s popular, a perception that’s popular, an idea that’s popular is very likely overpriced. I’ve come to prefer underpriced. That’s why I concentrate on stuff that’s unpopular. Fortunately for me unpopular stocks are in fairly good supply. It’s an orientation that has served me well over the long term. Over the short term, however, this approach can be inconvenient from time to time. One thing that happens with lonely trades is that when you make a mistake, you usually make a fairly serious mistake. Your speculative portfolio isn’t trying hard enough if you don’t have a couple of positions lose 30% or 40%. I know this is hard to stomach, but it is true.

So, how do you create a portfolio that flourishes in the face of volatility when the resource market is no longer cheap? First case, create liquidity; have some cash. It’s ok if your cash is bullion, but have some cash. You have to have cash. When volatility occurs, cash will do two wonderful things for you. It will give you the ability and it will give you the ability to act in down markets. It doesn’t matter if stocks are cheap if you can’t do anything about it. Cash will also give you the courage to act. So, have some liquidity.

Then look for things other people aren’t looking at already. Ask yourself, “What’s unpopular?” I think energy is unpopular. Oil will be a major driver going forward. Globally, most oil is produced by national companies. It’s produced by the same people who can’t educate kids or deliver the mail. Governments are diverting oil revenue cash-flow to politically-expedient spending programs and not reinvesting in their oil business. I believe as much as 25% of the world’s supply of export crude will come off the market in five years. Specifically, I think that Mexico, Venezuela, Ecuador, Peru, Indonesia and, perhaps, Iran will cease to be oil exporters. So, think about some simple math. If worldwide export demand is growing at 3% compounded and worldwide supply falls by 25% remembering that prices are set on the margin, the outlook for the oil price has to be higher. And, oil drags all other forms of energy. Natural gas is already a third the price on an energy equivalent basis of oil. Natural gas prices are low and they are going to stay low for a couple of years. Natural gas is so unpopular in the Canadian brokerage community that gas might as well be a four letter word. No one wants to be near it. That means it is cheap. The same goes for uranium. What happened in Japan was a tremendous human tragedy. However, most of us, despite our fears about what happened in Japan, when we walk into a room and hit the switch prefer it if the lights go on. That is why global and Japanese use of nuclear power will continue to grow. I am also still positive about the prospects for geothermal. It is taking a long time, but that is why it is a good deal.

Good luck.

Rick Rule spoke at the recent Casey Summit “The Next Few Years” in Boca Raton, FL, along with 34 other renowned economists, investment pros and resource experts who shared their outlook for the future of the U.S. economy, the dollar, and the markets.

Economic Events on May 24, 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 New Home Sales report for April will be released. The consensus is that 300,000 new homes were sold last month, which would be the same as last month.