By Christopher Briem, on October 24th, 2011
In the 1980’s it was Homestead that staked out the emotional heart of the Rust Belt miasma. Outside of Detroit in recent years Braddock has cornered the PR market for as Jim R. would put it: “Rust Belt Porn”. Yet then and now the city of Duquesne has declined as much and suffered as much, just with much less notice.
So now the news comes with the outcome both inconceivable and inevitable that the state is likely to shut down the Duquesne school system completely. The city’s school district has already abdicated secondary education with its high school students shipped to nearby West Mifflin or East Allegheny. This is all more epilogue than news sadly. Still feels like a story from the worse off parts of the third world. In security studies if you anonymized the name it would in part be indisinguishable from case studies in failed states and feral cities.
But that news story highlights again how little we understand our own problems.. how myth overtakes reality. The section and quotes that caught my attention was the almost de rigueur logic on the impact of the steel industry. It goes by formula exactly like this:
Chepanoske points not to any person or government entity but to the loss of jobs and subsequent sharp population decline.
Census figures show Duquesne was home to 11,410 people in the 1970s when steel mills provided good-paying jobs. Today 5,565 people live there.
“When the mills were running full blast, things were really good,” Chepanoske said. “It started to deteriorate in the 1980s when people moved away.”
In other words.. it’s nobody’s fault. Steel left. Blame ’steel’. Whatever that means. That seminal year 1970 is the only horizon that matters it seems.
Did the decline of manufacturing cause Duquesne’s decline? Did it accelerate the population decline even? When was the last time things were really ‘good’ in Duquesne? Here is the city’s population over the century. Can you identify any meaningful break in trend in the 1980s? But if the problems are caused by the loss of steel jobs, and the decline in steel jobs are somehow beyond our control, then ergo.. this just isn’t anyone’s fault.
Is Duquesne’s plight unconnected to manufacturing? Of course not. But the heyday of Duquesne came long ago at this point. The workers in the mills along the rivers started abandoning those towns long before there was any conception steel was ever going away. The first hand memories people have of a growing or even stable Duquesne can only be among those receiving Social Security. If we misunderstand our problems we can’t ever fix them and attributing the plight of many of the barely existing.
I have not even gotten into the joke that Duquesne with barely 5K population in 2010 is still a ‘City’ according to the laws of Pennsylvania. Upper Darby Township in Delaware County, PA clocked in at over 82K residents in 2010. Makes sense somehow. Goes back to what the real problems are in Pennsylvania. Saddest part of the Duquesne story is that they just didn’t have any large bond payments to default upon. If only they had been so irresponsinle as to build a garbage incinerator, the Commonwealth apparachiki might have paid some real heed.
If you want to obsess on on the stylized Duquesne history, don’t recereate the wheel. Just jump over to DuquesneHunky. It would do the neighboring Tube City Almanac proud. I actually can’t believe it’s author is not Jason’s alter ego.
By Ajay Shah, on October 24th, 2011
Suppose a government tries to boost demand in the economy by boosting the deficit.
A fascinating feature of the situation is: Households are not wood, households are not stones, but men. And being men, they will look forward, they will optimise. Households know that all government expenditure requires taxation: all that is achieved by running a deficit today is postponing taxes to tomorrow.
India’s fiscal stance is now likely to lead to increased taxation in the future. We have a nice wide deficit today, but it’s increasingly likely that fresh taxation will come up in the future.
A core feature of human beings is that we do not like to deal with fluctuations in our consumption. So faced with the prospect of taxation tomorrow, we are prone to cut back on consumption today.
Through this, when a government raises the deficit today, some of this effect is counteracted by households that pull back on expenditure. Raising the fiscal deficit is less expansionary than some would think.
Economists have a fancy name for this: it’s called Ricardian Equivalence. This was originally thought up by David Ricardo, but made famous by Robert Barro. It is one of the many ways in which forward looking households are of essence in thinking about macroeconomics. “You are not wood, you are not stones, but men; and being men, you will optimise”.  
By Claus Vistesen, on October 24th, 2011
As I read the latest round-up of comments by Fed officials that they are certainly not ruling out another round of asset purchases I am wondering whether this signals another round of actual quantitative easing by the Fed or whether investors should change their mindset back to before the crisis where it wasn’t the USD that acted as the global carry trade funder but rather the JPY (or maybe the GBP here?).
Quote Bloomberg
Fed Vice Chairman Janet Yellen said yesterday that a third round of large-scale asset purchases “might become appropriate if evolving economic conditions called for significantly greater monetary accommodation.” A day before, Governor Daniel Tarullo said buying mortgage-backed securities “should move back up toward the top of the list of options.”
They join Charles Evans, president of the Chicago Fed, and Boston’s Eric Rosengren in calling for consideration of further stimulus to boost growth and bring down a jobless rate stuck around 9 percent or higher for 30 months. A stock-market rally and gains in manufacturing and retail sales may convince the Federal Open Market Committee, which meets Nov. 1-2, to decide that it’s too soon for a third round of bond purchases.
You see, the recent initiative of the Fed in the form of Operation Twist is not quantitative easing since it does not involve an expansion of the balance sheet. In stead, it is what we refer to as qualitative easing as the bonds the Fed intends to buy on the long end (to move long rates down to help the mortgage market) will be paid for by proceeds of selling bonds on the short end.
The biggest problem for the Fed here is not necessarily that Operation Twist is a bad idea. Indeed, to the extent that it fixes the effort squarely on halting the slide in the housing market and supporting volume and price in the primary and second market for mortgage securities I think it is an excellent idea.
But we are forgetting the auxiliary objective of QE by the Fed; to weaken the USD. Make no mistake that this is an important objective for the Fed even if they have never declared this formally. And herein lies the rub. Quite simply, with the recent announcement by the BOE of another round of QE worth £75 billion, with the ECB now willingly or unwillingly being forced into increased support of peripheral debt markets and with the BOJ also pledging more stimulus, the Fed is starting to look like the conservative central bank in the G4. [1].
In my opinion, this is very significant and also one of the reasons why Fed officials are busy ensuring markets that they have plenty of ammunition left should economic conditions merit it. But investors should not take anything at face value I think. Before the Fed actually starts to buy those MBS and/or moves to lower interest rates on excess reserves there is a real chance that especially the JPY will start to act more like the JPY of old, a.k.a global carry trade anchor of choice. Of course, this requires the BOJ to back up all the pledges with real action. For now though, the only thing we can say is that the Fed looks set to be outgunned by its peers in the G4.
EMU Outflanked
Is Europe now finally getting down to serious business or is it just another round of fudge from the fudge factory that investors have learned to respect for its ability to produce relief rallies out of nothing. Looking at the evidence I thoroughly inclined to go for the latter even if each failed attempt to shore up market confidence brings Europe closer to full fiscal union.
Even if Merkel and Sarkozy, and rightly so, appear most concerned with putting pressure on Italy, the most significant issue remains Greece which is now in default a fact that was un-sanctimoniously confirmed by the leaked bailout document which has the Troika admitting that the medicine they were mandated to administer would only make the patient worse and not better.
Quote FT
Greece’s economy has deteriorated so severely in the last three months that international lenders would have to find €252bn in bail-out loans through the end of the decade unless Greek bondholders are forced to accept severe cuts in their debt repayments.The dire analysis, contained in a “strictly confidential” report by international lenders and obtained by the Financial Times, is more than double the €109bn in European Union and International Monetary Fund aid agreed just three months ago.
The most recent estimate of haircut has now risen to 60% and this, mind you, would only reduce the debt to GDP to 110% and this without any consideration on how Greece is supposed to grow itself out of this level of debt while simultaneously dealing with the default. In addition and only adding to my disdain for the ECB, Reuters reports that the central bank opposed a 60% haircut on account that it the private sector would refuse likely refuse this leading to a “fullscale” Greek default.
I am continuingly amazed by the denial here. Ever since the first Private Sector Proposal (PSI) was put on the table, Greek has been in default and figuring out who would pay for recapitalising banks as a function of how large the final haircut ends up are merely steps in the actual default process.
The second issue on the table is what to do with the increasingly freakishly looking EFSF. There has been no shortage of suggestions on how to increase the scope of the fund using the same guarantee by the same countries for the same amount of money (currently €440 in effective capital). The suggestion that might actually work came from France which has aired the suggestion that the EFSF be turned into a bank which would then allow it to access liquidity from the ECB. Both Germany and the ECB however have vehemently denied this which indicates that there is still notable reluctance to allow the ECB to wield the full arsenal of quantitative easing.
The proposal which currently seems to have most traction is to turn the EFSF into a monoline insurer which would essentially use its capital to insure anything from 10% to 30% on any new issuance of sovereign debt by Italy and Spain. Crucially, the idea is that this “leverage” would bring calm to markets as this insurance could cover as much as 2 trillion worth of debt.
I really struggle to find adequate words here. I think this is madness and if any Eurozone politician were afraid that an equivalent of AIG would certainly enter the scene, they now seem content on creating one. The first and most widely flagged issue is this would obviously create a two tier bond market.
Quote Reuters
This would create a division between insured and non-insured debt, that could split a country’s investor base and suck liquidity out of the market unless new bonds were carefully constructed to allow them to trade on a par with existing debt.”The issuer would have to create a new curve of insured debt, limiting the liquidity in both curves with risks that investors would dump the old non-insured bonds,” said Commerzbank rate strategist Christoph Rieger.
Based on a 20 percent insurance model, JPMorgan estimates that insured bonds issued by Italy would trade at a yield around 100 basis points below existing debt with new, insured Spanish debt likely to be priced 80 bps lower than existing bonds.
I think this is significant, but we are missing the main point here. If this is set ut Spain and Italy will likely never be able to issue un-insured debt again and the contingent liability here is not only complex but will lock in future capital commitments to this aim of providing first loss insurance. For me, this is a horrible way to spend already scarce capital.
Another issue is obviously that it assumes that it will make the Spanish and Italian problem go away which it clearly won’t. However, much more fundamentally; while the idea is to ring fence Italy and Spain it almost guarantees painful haircuts in the case of Ireland, Portugal and Greece and once again, who will pay for those I might ask.
The only silver lining I have seen in the latest reports is that it seems to me that while the imminent objective is to fiddle with the EFSF, there has also been serious talk about bringing forward the ESM which would have a much stronger mandate and essentially constitute a first step towards socialising of sovereign risk in the euro zone. Until that happens, the EMU and her politicians will be continuously outflanked by economic realities.
—
[1] – I repeat that with the ECB not formally in ZIRP mode, the Fed still has the yield disadvantage here but do we really expect the ECB not to lower going forward?
By B.P.T., on October 24th, 2011
At 8:30 AM EDT, the Chicago Fed National Activity Index for September will be released, providing an update on economic activity and inflationary pressure in the United States.
By Dr. Jane Orient, on October 21st, 2011
When I went into solo practice of internal medicine in 1981, it was very easy to get a doctor to see a Medicare patient. All I had to do was make a phone call. A courteous receptionist answered. If the doctor couldn’t come to the phone right away, I could count on a prompt callback.
Consultants saw patients quickly, and generally called me to discuss their findings and advice. And very often there would also be a letter in the mail: “Thank you for referring this delightful patient to me.”
How things have changed! Now a doctor gets the phone menu, just as the patients do, and it often ends in voice mail. It might be a few days before a staff member calls back—usually with the news that “we are not accepting any new Medicare patients.” At best, my patient might be offered an appointment in several months.
One very fine gentleman, who had recently moved to a rural area, found it easier to fly to Tucson to see me than to get in to see a local internist. That was in 2009. Recently, he has become unable to travel, so I needed to find him a local doctor.
I tried to expedite matters by ordering him an immediate diagnostic test: an abdominal CT scan. I don’t think anyone could argue that it wasn’t indicated under the circumstances. One little problem: I am not enrolled in Medicare and don’t have the proper government-issued number to enter into the computer. A license to practice medicine is not enough. This National Provider Identifier (NPI) is supposed to protect the system against being defrauded. Without that number, the imaging facility could not get paid by Medicare.
“Why not use the radiologist’s number?” I asked. After all, he was the one who would get paid. Nope, a referral was required. How about a self-referral from the patient? Nope, we can’t allow patients to decide what tests they need. “The patient is willing to pay for his own test,” I said. Nope, if he’s on Medicare, they aren’t allowed to take his money.
They gave the patient 24 hours to find a properly enumerated doctor to countersign my order. Fortunately, he found a specialist willing to do so, and assume potential criminal liability for committing “waste, fraud, and abuse” by ordering a “medically unnecessary” study. (Fortunately for the patient, he turned out not to have cancer, but that could be bad news for the doctor.)
So this is the status of retired Americans. They can’t just walk into a facility and request a medical test, and pay for it with their very own money.
A man may be qualified to pilot a 747 across the Pacific, but once he’s on Medicare, he is unfit to make an unsupervised decision about his own medical care.
I did find my patient a doctor. None of the internists within a 150-mile radius who “take Medicare” are willing to take on a new Medicare patient. But through the website of the Association of American Physicians and Surgeons (www.aapsonline.org), I found a link to the Medicare carrier’s list of opted out physicians. They don’t “take Medicare,” but many are pleased to see older patients, for a reasonable fee. There was one internist on the list, 150 miles from my patient. She has a courteous and helpful assistant who actually answers the phone, and told me the charge for a new patient visit: $300.
Things could be worse—and already are much worse in Canada. The “soul-destroying search for a family doctor” is described in the Globe and Mail on Aug 21. The Ontario government’s program called Health Care Connect manages to link only 60 percent of patients with a doctor—although you might find a concierge doctor for $3,000 a year.
That’s the cost of medicine when it’s “free”—if you can find it at all. If ObamaCare is implemented, all Americans will be in the same boat. And guess who will get thrown overboard first.
By Christopher Briem, on October 21st, 2011
or if I had seen this, I would have just used it today…..
Just out from Stateline.org: Pittsburgh and Harrisburg: A tale of two deep-in-debt cities
I still have not had a chance to update much of it with the 2011 data, but on that we will gratuitously relink my iPension page with all the numbers you can ever really use on the city’s pension funding… or it would if I had time to update it. Also gratuitous, but don’t you long for the days when the pension fund was not a problem and fully on track to becoming fully funded.
and speaking of Downtown Pittsburgh.. just caught this in the news from New Mexico: Former Pittsburgh mayor urges innovation and risk. There is a quote near the end that is… well it is.
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By The Energy Report, on October 21st, 2011
 After nearly 30 years as an investment banker and another 20 years providing consulting to small companies, Newport Capital Consultants Founder and President Gary Bryant knows all the ins, outs, risks and rewards of small-cap investment. In this exclusive interview with The Energy Report, he shares his knowledge on what factors push small- and mid-cap growth, as well as some surprising new business models changing the dynamics of shale drilling.
The Energy Report: Gary, can you tell us about your background in small- and micro-cap stocks? You have a special interest in these.
Gary Bryant: I do. The microcaps and smallcaps have been my expertise for a number of years. I got in the business in the ’60s, and in December 1963 I got a securities license. In 1965 I was fortunate enough to start my own brokerage firm, Anderson, Bryant & Company with my partner Anderson, and we did a lot of small-cap deals through the years. I was lucky enough to be one of the founders of the Regional Investment Bankers Syndicate, which was the forerunner to the National Investment Bankers Association. That began in response to deregulation in securities markets in ‘78, which made it difficult for small-cap brokers to operate because the large-cap brokers could no longer do business with them on those syndications. It worked really well, and we were able to syndicate a lot of offerings that way.
TER: You have said that the small- and micro-caps are key to a vital economy. Can you elaborate on that?
GB: In the United States of America, it’s the real way to employ people in the absence of large-scale manufacturing. But small companies need funding, and it’s been a lot harder since September 11 to get anything done. Some of the small-cap companies that I have helped fund went from zero employees to 1,200 in a matter of three years.
TER: Aside from obvious liquidity issues, what are some dangers of investing in small- and micro-cap stocks?
GB: Let’s say you buy an SEC Rule 506 private placement, and you put $25,000 into it. These have to be accredited investors, meaning sophisticated, high net worth corporate or institutional investors. Thus, most of the time companies do get pretty good amounts of money. But what happens if they sell to only five or 10 investors and raise a quarter of a million dollars when the business plan calls for $1 million (M) or $2M? If you’re stuck in a company that didn’t get enough funding, you stand a good chance of losing your money.
Another problem is that even after they’ve raised capital, a lot of small companies don’t have sales to justify being public. It happens all the time. However, there are many counter-examples that do get enough funding to successfully go public.
TER: Gary, what do you do for companies today?
GB: I consult for these companies and introduce them to investment bankers and capital markets. I was an investment banker all my life, and I know that business very well. I have strong relationships with broker dealers around the country.
TER: When you take a micro-cap deal to an investment bank, what’s the first question they want to ask you?
GB: The first question is always, “What are their sales?” Most investment bankers qualify companies based on their sales. If your company has $1M or less in sales, then it’s definitely a startup. If you’re anywhere from $2M to $10M in sales, you’re barely getting started. They can work with you a lot better at $50M or $75M in sales.
TER: Does the investment banker want to know how much of this stock you are going to buy, and how long you will hold it?
GB: Not really. I often put my own capital into companies. And if I do, I’m sure to tell them about it. But they would rather I own stock than not.
TER: Aside from lack of sales, what conditions would prompt you to advise a company to wait six months or a year to go public?
GB: Sometimes companies want to go public, but they frankly just don’t need to be public. The management doesn’t have the experience to be in a public arena. Sometimes companies go public too soon. For example, a fast-growing company may only have $2M or $3M in sales, but its product is good and it is likely to increase sales to $10M the next year or $20M the next. It would behoove the company to hold off until bigger brokerage firms are considering underwriting the company, and when it could get a bigger offering and a much higher market cap.
TER: Does the investment bank want to see that management has mortgaged their houses and gone to their family and friends first?
GB: Sure. That’s usually the way it starts out. I’ll just give you an example: The founders of the company sometimes put their money in before going to friends and family. The friends and family are usually accredited investors, and will invest half a million or $1M. That will be enough to push the company to the next stage, where they can do another larger private placement and later go public.
TER: What’s the sweet spot in market cap size where a company is small enough to give investors huge gains but large enough so that mutual funds can own it?
GB: It’s different with almost every company. Generally, companies under a $75M market cap sometimes have mutual funds and hedge funds investing, but not often.
TER: I think you were the lead consultant on Petro Resources, which was later taken out by Magnum Hunter Resources Corp. (MHR:NYSE.A).
GB: That’s true. The other day I had the pleasure of talking with Brad Davis, senior vice president of capital markets at Magnum Hunter. The stock came down considerably from $8 to around $4. He said the company was three times better off than it was at $8, yet the general public is not paying the price for the stock. Sometimes stocks trade in a certain range.
Magnum Hunter bought three companies in the past two or three years that had sellers in them, and all of a sudden they get the benefits of a New York Stock Exchange company with a lot of liquidity. I think this is one factor that has caused the company to sell off. You never know.
TER: You’re interested in shale-fracking technology. Will this become the new conventional technology as low-hanging fruit dries up?
GB: Absolutely. Hydraulic fracking on shale plays is a tremendous invention. Ten years ago this technology was not developed. As a young man going to high school, I worked on some drilling rigs just to make enough money to buy a car. But when we hit shale, it was a really bad situation. Today they’ve learned how to go down to depth and then go two miles horizontally. I saw them fracking one of the Barnett Shale wells the other day. It is definitely the new-and-improved process with horizontal drilling.
TER: Do you have any favorite shale-fracking companies?
GB: Certainly. I like the major players, such as Continental Resources Inc. (CLR:NYSE), Devon Energy Corp. (DVN:NYSE) and Williams Companies (WMB:NYSE). They have been doing a lot with these particular formations. Now Magnum Hunter has interesting plays in the three big shale formations: the Eagle Ford, the Marcellus and the Bakken. Of course, there are a lot of other shale players too, like GMX Resources Inc. (GMXR:NYSE) on the border of Texas and Louisiana. It’s a gas play, and it’s doing pretty well.
TER: Are there any small- or micro-caps you have good feelings about right now?
GB: There’s one called Eagleford Oil & Gas Corp. (ECCE:OTCBB) and another called U.S. Energy Corp. (USEG:NYSE), which is run by the Larsen Family. U.S. Energy appears to be doing very well in the Bakken formation in addition to having success in its Wyoming production. I like Lucas Energy Inc. (LEI:NYSE.A). I like CAVU Resources Inc. (CAVR:OTCPK). Billy (William C.) Robinson is the CEO. He’s kind of changing his tune on how he’s doing business, as are others who are discovering opportunities in the sector beyond oil itself. For example, Xtreme Oil & Gas Inc. (XTOG:OTCBB) and CAVU are both drilling water disposal wells and making quite a bit of money by charging producers for water disposal services. Shale drilling involves getting rid of a tremendous amount of water, which has become a big problem over the last 10 years. For every barrel of oil recovered, some water is also extracted, and it’s not like drinking or ocean water. It’s more of a brine—twice as heavy and loaded with salt and chemicals.
TER: Do water disposal services de-risk these plays?
GB: They do, because the process alleviates an environmental problem by putting water back in the right sand. Companies build what are called saltwater disposal wells, and drill 4,000–5,000 feet, similar to an oil well. They reach a deeper, different type of sand in which they deposit the water, so it won’t touch drinking water sources.
TER: Gary, Xtreme Oil & Gas has been hurt pretty badly over the past 12 months. It’s down about 76% over that period, and it has a market cap of under $14M. Why have investors forgotten it?
GB: Knowing this company as well as I do, I know that it was a Gray Sheet company for years, and there was hardly any market in the stock. So when they registered on the Bulletin Board, it was trading around $1, but lightly. Market breaks have suddenly come in and driven the stock down. I’ve talked to CEO Will McAndrew about this, and the company has earned money two quarters in a row. Its disposal well business should help provide more sales and earnings. It’s one of those situations where the company has been improving but the stock has been going the wrong way.
TER: What do you think would get investors’ attention here?
GB: Making money three quarters in a row would probably do the trick. It needs to attract more institutional buyers and get the word out. I’m a believer in the value of attending conferences. The company has to do more PR and get some publicity from companies like The Energy Report.
TER: That micro-cap size is just a tough nut to overcome.
GB: It’s a very tough nut to overcome. No one has the solution to that. But Will McAndrew can get them out of the ditch. I see it every day. Before the Magnum deal, Petro Resources was a Pink Sheet-type of company, but it went out and raised a lot of money, so it was able to go from Pink Sheets to the American Stock Exchange. A large brokerage firm jumped on them and loaned them $75M to acquire properties up in North Dakota in the Williston Basin. Once companies get the ball rolling, doors open, but that first push is tough sometimes.
TER: Gary, it’s been a pleasure meeting you.
GB: My pleasure. Thank you.
Gary Bryant is the current president and founder of Newport Capital Consultants, Inc., an Orange County, California-based firm that has been providing consulting services to private and public companies since 1991. Since gaining his securities license in 1963, he has gained over 40 years of experience in the investment banking services industry, and was recently involved as a co-founder of the Southern California Investment Association (SCIA), which offers select small-cap companies a venue to present to investment professionals. In December of 2006, Gary received the prestigious “Founders Award” from the National Investment Banking Association, and in October of this year he was honored with a lifetime achievement award from the West Coast Wall Street Conference.
By The Energy Report, on October 20th, 2011
 Steve Palmer, chief executive of Toronto investment firm AlphaNorth Asset Management, scans the market for inefficiencies. And it pays off in the long term. While comparable market benchmarks are down as much as 46%, his small-cap fund has returned nearly 200% since its launch in 2007. In this exclusive interview with The Energy Report, Palmer explains why his long-term vision makes him a continued believer in oil and uranium.
The Energy Report: About 30% of the AlphaNorth Partners Fund, which consists mostly of Canadian securities, was invested in tech stocks, with similar percentages in metals and energy the last time we spoke in May. What’s the asset mix now?
Steve Palmer: Technology stocks comprise about 32%, metals 26% and energy 27%.
TER: Although the fund was down about 6.5% in August, it is up 23% for the year through August. It was down about 15% in September, but it’s still positive on the year. What edge does AlphaNorth have that allows you to make gains in an economic climate that’s as negative as this one?
SP: It’s very difficult to make money when markets drop more than 10% in a month. We don’t pretend to be able to make money in those kinds of months like we experienced recently and in the fall of 2008. However, since inception of the fund in December 2007, the fund has returned approximately 190% despite declines in the Canadian indices.
The Canadian indices that I use as benchmarks are both negative. The S&P/TSX Venture Index, which is the closest benchmark to what we do, is down 46% over that timeframe and the S&P/TSE Composite is down 5%. Despite the poor markets, we’re still able to generate substantial returns over a long-term timeframe.
TER: What is your primary strategy for generating profits?
SP: Good stock picking. We’ve had some good calls on specific stocks. We’ve been able to sell them at the right time. We use technical analysis to help do that. We do some hedging in the Partners Fund at certain times when we think the market is vulnerable to a correction. That has helped cushion the downside and contribute to positive returns when the short positions work out.
TER: In the coming quarters, do you see yourself leaning more towards one of those sectors that you mentioned earlier, perhaps at the expense of another?
SP: No, not particularly. Given the correction, all of those sectors have been beaten down pretty good. There are a lot of bargains across the board now.
TER: Let’s take a closer look at the energy portion of the AlphaNorth Partners Fund. What’s the mix in terms of oil and gas, uranium, renewable and coal?
SP: It’s mainly oil-focused. Coal would be the next most significant component and then iron ore and uranium.
TER: Uranium’s off the radar for many investors given the events resulting from the tsunami in Japan earlier this year. Are you still a believer in uranium?
SP: Yes, I’m still a believer. Long term, the supply/demand should result in higher prices. China’s still moving forward with building many new nuclear plants. There’s a huge demand for power in many parts of the world. Uranium is, in many cases, the most practical way to add power. It’s unfortunate what happened in Japan. It’s created a negative investor sentiment in the short term, but the fundamentals are expected to be strong over the long term.
TER: Many uranium projects being developed need $50 uranium just to break even. The spot price for uranium is just above that now. Do you believe Chinese demand alone can bring uranium prices up enough to make smaller development projects sustainable?
SP: Chinese demand will account for probably more than half of total new demand over the next 10 or 20 years. We’ve been working through stockpiles from nuclear weapons, but that’s pretty much depleted now. We do need new supply, but there are not many new uranium projects coming on.
TER: China’s Sichuan Hanlong Group is in takeover talks with Bannerman Resources Ltd. (BAN:TSX; BMN:ASX), which owns two uranium development projects in Namibia. Uranium titan Cameco Corp. (CCO:TSX; CCJ:NYSE) is in the midst of a hostile bid for Hathor Exploration Ltd. (HAT:TSX.V), which has a high-grade uranium project in the Athabasca Basin. These are clearly cases of larger companies preying on smaller uranium companies beset by low share prices. Could it be time to take positions in uranium companies with near-term development projects?
SP: It just demonstrates that larger companies need to increase production and economic uranium deposits are very difficult to find. They are more difficult to find than many other commodities. The good projects are going to be in high demand.
TER: What are some uranium stories in the fund?
SP: Athabasca Uranium Inc. (UAX:TSX.V; ATURF:OTCQX) is one.
TER: It’s not all that far from Hathor. It’s about to begin a drilling program in the next few weeks. What are you expecting from that?
SP: I’m not expecting anything, but I’m hoping for good results. It’s in the right neighborhood and there’s obviously a lot of high-grade uranium and some very profitable mines close by. The company has a very small valuation; they have reasonable odds of success. I’m just hoping that the drills are kind.
TER: Do you have any holdings in Australia?
SP: We have a stake in Mega Uranium Ltd. (MGA:TSX) in one of our other funds.
TER: What do you like about that story?
SP: It’s cheap. It has defined deposit in Australia, which is a good jurisdiction. It’s not just a one-project company.
TER: Some of those projects are in locations that need some political will in order to begin mining. Do you see that happening?
SP: Yes. I think there’s a decent chance that it will change. You need some political will in many areas for uranium. It’s not something that people typically welcome. The permitting process can be quite long regardless of where you are.
TER: What are some oil and gas stories that are undervalued right now?
SP: Canadian Overseas Petroleum Ltd. (XOP:TSX.V) has assets in the North Sea, which is a good jurisdiction. Management has drilled wells there before and been quite successful. They have multiple locations to drill. It has lots of cash to complete the job. If you risked their drill targets, you still get a net asset value (NAV) over $1 a share. It’s currently trading at $0.32.
I just saw some research yesterday from an analyst that has a risked NAV of $1.20. Assuming all of their drilling is successful, the potential NAV would be roughly $3.50. That’s unlikely to occur because they are not going to be 100% successful. The end result will be somewhere in between those two numbers.
TER: Is there another intriguing name?
SP: Primary Petroleum Corp. (PIE:TSX.V) is very cheap and it has a lot of potential. Primary is an emerging play in Montana for the Bakken. It’s a shale play that extends into Montana from Alberta. Several larger U.S. companies seem to be having some good success there. Rosetta Resources Inc. (ROSE:NASDAQ) and Newfield Exploration Corp. (NFX:NYSE) have been having a lot of success drilling in Montana. Primary has about 300,000 acres, which is quite large for a small company. It also recently signed a letter of intent with a U.S. major to farm in on the majority of their acreage where the partner will fund the exploration. Primary will have no requirement to spend any of its cash and it will benefit from the expertise and experience of its partner.
TER: What’s your outlook for the energy sector?
SP: Energy is one of the commodities I favor. It’s a resource that’s gone once you use it, so you constantly have to keep finding more. The demand continues to grow.
TER: Thanks.
Steven Palmer, CFA, serves as president, CEO and a director of AlphaNorth Asset Management since founding the firm in 2007. AlphaNorth currently manages a long-biased, small-cap hedge fund. As VP of Canadian equities at one of the world’s largest financial institutions, he managed assets of approximately $350M. He also previously managed a small-cap pooled fund, achieving returns ranked #1 by Morningstar Canada. He has a BA in economics from the University of Western Ontario.
By Christopher Briem, on October 20th, 2011
I have looked at this a lot, but never had a reason for posting about it. So now I note Bram passed on the image that highlights the conundrum going on Downtown and elsewhere as folks struggle to figure out where to focus their anger. It reminded me of what may be the ultimate financial infographic of all time. See below.
Not new, this has been floating around for quite some time at this point. I believe this is the original source, but it is hard to tell given how much the image has been passed around. This is the reverse engineering one couple did of what happened to a single mortgage as it went from the signing of their promissory note and down into the rabbit hole known as the financial markets. I keep trying, and failing, to find George Bailey in there somewhere. As much as the name and cartoons are far more accessible to the general public, this is a far more accurate representation of what is otherwise known as Toxie in other circumstances (I have no reason to think Dan and Teri are themselves anything other than good credit risks).
So let’s say you were angry over the foreclosure crisis.. where in this diagram is the center of gravity that you would vent your anger at?
By The Gold Report, on October 20th, 2011
 Marshall Auerback of Pinetree Capital believes investors get maximum valuation during periods of turbulence and fear. In this exclusive interview with The Gold Report, he explains why the economy is in better shape than it seems and shares the names of eight gold companies and two silver companies poised to take off.
The Gold Report: Many of the resource companies in Pinetree Capital’s investment portfolio are gold companies. Gold went from above $1,900/ounce (oz.) in early September to around $1,600/oz. currently. Now, European central banks have sold 1.1 million metric tons of gold into the market to drive the price lower. Pinetree’s share price has followed gold lower and your exposure to gold remains high. What’s Pinetree’s pitch to investors right now?
Marshall Auerback: We had a very significant run up in the gold price, so some correction is understandable. But the conditions that created the run-up to $1,900/oz. have not dissipated. If anything, they’ve become more pronounced, notably in the Eurozone, where investors must begin to seriously consider the possibility of a break-up of the European monetary union and the implications that has for gold. And if you look at the monetary overhangs in places like China and Japan, it’s hard to find stores of value there either. So we have had some significant spec liquidation, some central bank sales—a plus, as central bankers are usually a great contrary indicator—and yet the price appears to have stabilized around $1,600/oz. Gold stocks, in contrast, still reflect valuations that are substantially lower than the current gold price. It is also important to note that the capital markets, in contrast to late 2008, have not shut down. Good quality mining projects can still obtain funding, especially for projects with robust economics, which a number of our holdings possess.
Pinetree has a unique structure. We raise money from the markets, which means that our longer-term funding requirements are, to some degree, shaped by market perceptions and market enthusiasm for resource stocks. But it also means we are not subject to monthly, daily or quarterly redemption pressures, so we can hold on to some smaller names that now offer the most compelling value they have offered in years.
TGR: A few years ago, Pinetree went from being focused on technology and biotechnology stocks to resource-based equities. If you were making that decision today, would you still go in the same direction?
MA: Yes, the fundamental thesis has not changed. The developing world is likely to remain the dominant social, political and economic theme for at least the next few generations. Commodity prices have soared because the depletion of readily available resources is now finally outstripping the ingenuity of mankind to extract these resources. That is not just our view. Jeremy Grantham of GMO believes that this has changed the fundamental trend in real commodity prices, though the explosive nature of these prices in recent years has no doubt been amplified by speculation and historically unprecedented and ultimately unsustainable fixed investment in China. So you will get periodic corrections, especially during periods of global economic slowdown, but we don’t think this changes the long-term thesis. The portfolio composition has changed somewhat to reflect a changed economic environment of less base metals, more precious metals, but that is a tactical, as opposed to strategic, decision.
TGR: Did that one-month, $300-dollar drop in the gold price ruin gold’s reputation as a safe-haven investment?
MA: Not really. The price rise was, like other commodities, undoubtedly amplified by the actions of trend-following speculators. These are generally weak holders, and they tend to get shaken out when there are market gyrations of the sort that we have experienced over the past few months. But the fundamental reasons for holding gold have, if anything, grown stronger over the past few months.
TGR: Is the fear-trade gone? Is gold now trading strictly on supply and demand fundamentals?
MA: Given the way that markets have traded toward the end of the quarter, where you get maximum incentive to “paint the tape” in an upward direction, we think it is way too premature to suggest that the fear trade is over. Ultimately, though, gold is a supply/demand story. The market has been in fundamental deficit for decades and only the sales and leasing of gold by the central banks have prevented an even more acute price explosion.
TGR: The market is always about timing, but timing is even more important now given the rampant volatility in the markets. Fearing an economic collapse, many investors exited the junior sector once the volatility started in August. Many of those same investors remain on the sidelines today and some probably want to get back in. Is there something they should wait for—like a bottoming of the gold price—or is now the time to return?
MA: We think the time when you get maximum valuation is during these periods of turbulence and fear, when the baby gets thrown out with the bathwater. The good stuff is thrown out along with the bad as redemption pressures mount. Since we are in a comfortable position vis-à-vis our cash positions, we are in a good position to capitalize. Especially as Pinetree, for reasons explained before, doesn’t face comparable redemption pressures.
TGR: Our readers are primarily retail investors who like the high-risk, high-reward nature of the precious metals juniors. Pinetree is essentially a retail investor with lots of cash and a crack research team. How is Pinetree playing the current market? Have you been adding to your positions on the market dips? Have you sold off? Have you held tight? Give us the scoop.
MA: We try to “feed the ducks while they’re quacking,” in the sense that we recognize that many of these holdings are small and illiquid, and we tend to take large, strategic stakes. When our assessments are largely validated by market action, then we find that it is a good time to reduce, particularly because with these smaller, less liquid names, we are almost always going to be a bit early because we have to trim when there is good demand. This is especially the case when the company’s development has largely tracked what our analysts forecasted and with that comes the growing popularity of the shares with the broader market. Selling in those kinds of situations gives us the flexibility to take on new deals or, as is the case today, to buy from distressed sellers.
TGR: What are your favorite five gold plays in the Pinetree Capital portfolio?
MA: Gold Canyon Resources Inc. (GCU:TSX.V) is one. We are big believers in this deposit. The initial resource should be out by the end of this year and is promising to be several million ounces with grades exceeding most other bulk tonnage deposits in Canada. Looking at the dimensions of the deposit, specifically the new extension to the southeast, the potential here continues to grow far beyond what the company’s initial resource will give it credit for.
Queenston Mining Inc. (QMI:TSX) is the consolidation of key past producing mines in the prolific Kirkland Lake mining camp. There is an Agnico-Eagle Mines Ltd. (AEM:TSX; AEM:NYSE) take-out potential. Extensive drilling on the Upper Beaver and the South Mine complex joint venture with Kirkland Lake Gold Inc. (KGI:TSX) continues to add ounces.
RoxGold Inc. (ROG: TSX.V) is operating in Burkina Faso and has just raised the money needed to acquire 100% of its flagship asset. High-grade deposits are very hard to come by and the results it has consistently seen show potential for just that. With mid-major companies operating in the region, as RoxGold continues to add size, it becomes more and more likely to be an attractive candidate for a take-out.
Continental Gold Ltd. (CNL:TSX) recently reported a very large high-grade resource on its Buritica gold/silver/base metals deposit in Colombia. If you look around right now there aren’t too many deposits that hold size and grade like this one and, with 250 kilometers of assays to come since the resource was calculated, there is still a lot of upside from here.
Mawson Resources Ltd. (MAW:TSX; MWSNF:OTCPK; MRY:Fkft) is exploring at Rompas in Finland, a new discovery with bonanza gold where samples up to 22,723 grams per ton (g/t) gold and 43.6% uranium have been identified. The weighted average of all channel samples from the 2010 program is 0.59m at 203.66 g/t of gold and 0.73% uranium within a sampling footprint of 6.0 km. strike and 200–250m width. More than 300 discovery sites have now been identified within the mineralized footprint. At this very early stage of exploration, Rompas has to be considered as one of the most exciting global gold discoveries (with a uranium credit) to emerge into the marketplace, in terms of its high grades and hundreds of surface showing over a large area.
TGR: What are three gold plays Pinetree has positions in that few have ever heard of?
MA: Redstar Gold Corp. (RGC:TSX.V) is exploring in Alaska where properties have limited historical drilling. However, the company has seen very high grades. Currently, it is drilling up there and with the recent addition of the International Tower Hill Mines Ltd. CEO to their board, there is reason for interest. The company also has a joint venture with Confederation Minerals Ltd. (CFM:TSX.V) up in Red Lake. Thus far, Redstar has seen very high grades over 200 g/t over narrow widths stretching over a potentially several kilometer-long strike length. This kind of project requires lots of drilling; however, thus far, there has been some good continuity of success and with any sort of thicker intervals, this would be a project well worth the interest.
Prosperity Goldfields Corp.’s (PPG:TSX.V) exploration is headed up by Quinton Hennigh, who is also on the board of Gold Canyon and is heading up its exploration program. Stock had a large run-up prior to results, which the market clearly saw as disappointing. Despite this, we think these results show great promise given that Prosperity was the first in the area and the potential size of this deposit is very large. This project is in Nunavut; however, a winter camp has been set up and, relative to the region, the infrastructure is better than most.
Terreno Resources Corp. (TNO:TSX.V) is focused on a few different resources in South America. The company just raised $2.8 million and so it is cashed up to move forward on the initial exploration of both precious/base metal projects in Argentina as well as their phosphate/potash exploration in Brazil. It has had some solid trench results thus far down in Argentina, which is promising. The phosphate/potash market seems to be one of the few places where most analysts agree there will be a lift in pricing in the future so we are excited to see the exploration results.
TGR: Let’s switch gears to silver. Does Pinetree believe silver is a better near-term investment than gold?
MA: No, we think gold is likely to be the better performer if a global recession becomes the predominant concern, as opposed to systemic issues. That said, there have been some fairly violent moves to the downside over the last few weeks. The bear talk on China has really been overdone. Remember, China has over $2 trillion in foreign exchange reserves, so it has ample firepower to combat the forces of recession. In the very short term, we could get these massively oversold conditions worked off if it looked like the world was not coming to an end and silver could have a nice pop. Look at the U.S. data recently:
- Since late August, the U.S. economic data has surprised somewhat to the upside.
- Initial unemployment claims rose less than expected; September chain store sales look stronger than expected; Ford Motor Company’s sales for September were up 9%.
- It looks as though GDP growth may come in better than 2% annually in both the third and fourth quarters, surpassing recent pessimistic expectations.
As far as China itself goes, suddenly all the analysts, economists and portfolio managers that were all bulled up on China two years ago, a year ago and even six months ago have become all beared up on China. We are hearing about an imminent hard landing in China from everyone. So why the sudden bearishness about China?
It is claimed that China’s informal credit market is out of control. Property developers and businesses are starved for credit; business investment and real estate will fall. A hard landing is at hand. Let’s put this informal credit market into perspective.
This informal credit market is estimated at 3–4 trillion yuan RMB. The Chinese economy is now estimated at something north of 40 trillion yuan. According to Fitch, the formal credit market plus the shadow banking system totals about 70 trillion yuan.
When one looks at these numbers one can see that the growth of informal lending and the extremely high interest rates on informal lending represent a problem in China. But it does not impact a significant share of aggregate expenditures.
The real problem lies with the banking system and the shadow banking system.
TGR: Is this important credit market now poised to take Chinese aggregate demand down?
MA: We doubt it. Interest rates in the banking system are negative in real terms. The banking system is still expanding at a double-digit annual rate. Interest rates in the shadow banking system are much higher; they are no doubt positive in real terms, but it appears they are not usurious. In any case, this credit is still being allowed to expand at a very rapid rate. Will the authorities be able to deal with problems in the banking system or shadow banking systems, which are the credit markets that matter?
The answer is probably yes. The biggest credit excesses and the biggest white elephant fixed investments in this cycle lie with the local authorities. The Chinese government in one fell swoop removed half a trillion dollars of such loans off the backs of these local authorities. A half a trillion dollars! That is as large as the entire alleged informal credit market that everyone is getting so beared up about.
Longer term, the Chinese economy is an out-of-control Ponzi economy. Labor force growth will go negative. Surplus labor in agriculture is depleting. Fixed investment is impossibly high relative to a falling warranted rate of growth. Very bad things will eventually happen. However, the Chinese economy is also an extreme command economy. Extraordinary measures will be taken to avert these very negative outcomes.
The Chinese economy is highly indebted. The Chinese central government is not. Before the proverbial you-know-what hits the fan, the Chinese government will use its balance sheet to keep the white-elephant over-investment juggernaut going. Do not underestimate the fiscal capacity of the Chinese government and its willingness to use it. We do not think the excesses today in the Chinese informal credit market are a reason to get very beared up on China all of a sudden. The Chinese bear story will unfold progressively over a long time.
The real threat in China is inflation. China’s fixed investment has become increasingly credit dependent. To keep the fixed-investment juggernaut going and avert a hard landing, there must be sustained rapid money and credit expansion. There is already a large monetary overhang. The combination of these flow and stock dynamics threaten a very high inflation down the road. Which again makes the long-term case for gold very bullish.
TGR: Where is Pinetree getting its exposure to silver?
MA: Apogee Silver Ltd. (APE:TSX.V). The company’s primary focus is the Pulacayo-Paca Property located in southwestern Bolivia. The property includes the historic Pulacayo mine, which was the second largest silver mine in Bolivia’s history with historical production exceeding 600 million ounces of silver. Although there is obviously some risk with dealing in Bolivia, there are still many operating mines and we feel the deposit warrants the risk.
Southern Silver Exploration Corp. (SSV:TSX.V; SEG:Fkft) recently acquired the Cerro Las Minitas property in Durango, Mexico. There is a history of production right in the middle of the property and thus far, the company’s initial holes have been promising. This is a very early stage project and there is a lot more definition needed before a resource can be laid out; however, Southern Silver is in a good region and we feel the property certainly has potential.
TGR: What are some investment themes that you expect to play out in the coming months?
MA: We think that the markets could surprise again to the upside as we have apparently discounted a double dip recession, whereas a slowdown might be more accurate. This period might end up being closer to 1998 than 2008.
The trouble with the view that we are heading for another 2008 is that all crises are different. But they do share one common element: the inability of markets to perceive that when a market discontinuity is fresh in the minds of investors (e.g., 2008); it seldom repeats until that institutional memory is dissipated. Now, I believe that European banks are insolvent conditional upon the PIIGS collectively being insolvent. Clearly, this is the case for Greece (although the European Central Bank (ECB) could easily forestall this if it keeps buying Greek debt), but for the others, this is unclear—and, particularly in the case of Spain and Italy, a function of the rates at which they can borrow. So while the ECB provides a liquidity backstop, they have the room to adjust. Of course, the missing ingredient is growth. Europe already looks as though it has slid into recession. I would argue that recession, as opposed to systemic risk and bank runs, is already priced into European stock markets. But nothing is certain.
While the current crisis in Europe is worse than the 1998 crisis with LTCM and Russia, in 1998 it was thought that the entire system would collapse. Remember in 1998 Fed funds were 5%, not zero; 10-year notes, above 4%, not 2%+; 2-year notes were 5%; SPX was 30x earnings, not 15x. We had not gone through a 1974-style liquidation in reverse parabola terms except for the one day 1987 sell-off, as we did in 2008–2009. Real estate (houses) was not selling for prices yielding 10%–15% on lower-end real estate, but that is where the focus of foreclosures is felt. The story will be told in the next eight trading days.
TGR: Thank you for your insights.
As Pinetree Capital’s corporate spokesperson, Marshall Auerback is a member of Pinetree’s board of directors and has some 28 years of global experience in financial markets worldwide. He plays a key role in the formulation and articulation of Pinetree’s investment strategy. Auerback is a research associate for the Levy Institute and a fellow for the Economists for Peace and Security.
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