We are just coming up on the 30-year anniversary of what might have been Pittsburgh’s Etch a sketch moment. Three decades ago Pittsburgh was just about halfway through the 18 months that changed it forever. In August 1981 the region’s unemployment rate was 7.2%; a high, but not scary level. Total unemployed in the region measured 86,600. 18 months later in January 1983 over 212 thousand would be unemployed and the unemployment rate was at least officially reported as 18.2%.
At the very worst of the Great Recession (AP style guide requires the use capitals for that), regional economic conditions would barely hit half those numbers. If anything those numbers understate the differences between the two periods. The recent peaks in unemployment rate and total unemployed only reached those levels because there has been a turnaround in migration. There has been several years of net population migration into the Pittsburgh region, and that clearly has an impact on labor force data. Without the new residents coming into the region, neither the regional unemployment rate nor count of unemployed would have been as high. 30 years ago we all know the opposite was going on here with a steady stream of unemployed workers departing the Pittsburgh regon. The result was making those January 1983 peaks peak lower than they might otherwise have been.
Don’t get me wrong, 30 years ago there was still a lot of denial going on. Lots of folks believing manufacturing was going to rebound and there was no reason to shift course. Some of that denial persists to this day, but at some point 30 years ago a plurality of the collective consciousness accepted the inevitable and decided to move on if only because there was no other choice.
With ever-higher oil prices encouraging record investment interest, the cleantech energy sector looks poised for leaps and bounds. The most successful investors will be those who understand the challenges facing not only different industry segments, but individual companies within the same segment. In this exclusive interview with The Energy Report, Raymond James Energy Analyst Pavel Molchanov explains the four principal areas that comprise the cleantech arena—wind, solar, smart grid technology and biofuels—focusing on case-by-case investability. He also shares some names that just might be the next big winners in this rapidly developing space.
Companies Mentioned: KiOR, Inc. – Power One Inc. – Solazyme, Inc.
The Energy Report: Your research at Raymond James covers a number of alternative energy and biofuel companies. Can you give us a brief description of the various cleantech industry segments?
Pavel Molchanov: The cleantech arena comprises four key areas in terms of what’s investable in the public equity markets today. Solar carries the biggest market caps. Solar power companies in the public market tend to mainly be in the photovoltaic (PV) hardware manufacturing arena. These include producers of wafers, cells, modules and inverters, and to a much lesser extent, companies engaging in project development and system installation.
The biofuels subspace is quite a bit smaller in market cap than the solar arena, but it’s been growing more quickly because most of the recent initial public offering (IPO) activity in cleantech has been in biofuels. Many investors associate biofuels with ethanol, and there are still a few publicly traded corn ethanol producers. But most of the recent IPO activity involves more advanced, next-generation biofuels, such as cellulosic, algae and other emerging products.
There is also the wind arena. This one is more difficult to invest in because many of the companies with exposure to the wind industry are highly diversified. Some of the largest industrial conglomerates are in the wind turbine manufacturing business. There are many overseas companies in this space, as is also true of solar. But whereas many of the international solar companies, especially from China, trade in the U.S., when it comes to wind, many of the companies trade in overseas markets, such as Spain and Germany.
Lastly, there is the smart grid subspace, which is at the crossroads of cleantech and communications. Similar to wind, many of the companies with smart-grid exposure are larger businesses, both in the information technology sector as well as the industrial sector. But there are some smart grid pure plays that are publicly traded.
TER: As far as stages of development, how evolved are the various industries?
PM: Let’s take a look at solar and wind first. The global solar market last year was approximately 27 gigawatts (GW), whereas the global wind market was about 50% larger at 41 GW. Both markets are in the tens of billions of dollars, in terms of total industry revenue, and quite large as far as cleantech goes. Still, the market share of both solar and wind in total electric generation remains very low. In the U.S., solar is well below 0.5% of total electricity sales and wind is about 2%. In some European countries like Germany, the numbers are higher, but in general they are quite low.
We have to differentiate between first-generation and second-generation biofuels. Corn ethanol already encompasses about 10% of the gasoline market in the U.S., and sugarcane ethanol is even more prevalent in Brazil. Next-generation biofuels, on the other hand, tend to be very early-stage. Generally speaking, the cellulosic and algae companies are pre-revenue, pre-production businesses. It’s going to take two to three years before the industry scales up and enters the mainstream. Certainly, it’s going to be smaller in gallon terms than the corn ethanol market well into the second half of the decade, possibly even until 2020.
Next is the smart grid industry, which encompasses a lot of different products. Smart meters are perhaps the widest known product in this subsector, and they have been unquestionably ramping up in adoption both in North America and elsewhere. As of the end of last year, approximately 27 million (M) smart meters had been installed in the U.S. There are many more in Europe, China and Brazil as well. But there are other elements of smart grid technology that are a little bit more difficult to measure because they don’t lend themselves to counting units of hardware that are installed—things like demand response.
TER: The more established companies in ethanol, wind and solar have their basic technologies already in place. Are smaller companies largely focused on the research and development (R&D) stage, and therefore not generating much cash flow?
PM: Essentially, all of the publicly traded companies in the solar and wind arenas are currently generating commercial product sales. In the smart grid arena, that is also true. The one area where there is a significant number of public companies that are still in the pre-revenue commercialization stage is advanced biofuels. Over the past two years, there have been more IPOs of biofuel companies than all other cleantech companies put together. The vast majority of those have been pre-production, early-stage businesses.
TER: Government subsidies have been instrumental in giving alternative energy and fuels a kick-start to compete with conventional oil and gas. Will these new technologies be able to compete without subsidies?
PM: Yes, and again we have to look individually at the different subsectors within cleantech. In solar, the vast majority of demand for PV right now is in Europe. Last year, it was about 70%. A few years ago, it was even higher. Just about every major country in Europe has what’s called a solar feed-in tariff, which is a guaranteed purchase price for solar electricity that is set by the government. Utilities have to purchase the solar electricity that’s produced both by individual households that have a solar panel on the roof and solar developers with their own solar farms. Because it’s government-set and government-guaranteed, the economics are extremely visible and secure.
It’s not a subsidy in the sense of a direct cash payment by the government because the utilities pay the money and ultimately pass on the costs to the rate payers, but clearly it is an incentive. In the U.S., there are a few small programs in a couple of states, but certainly nothing comparable to Europe, which is why last year Germany installed more solar in the month of December than the U.S. did in the last two years combined. Keep in mind that Germany has one-quarter of the U.S. population and a lot less sunlight. So subsidies can be very important, and solar is a good example of that.
In the renewable fuel arena, the dynamics are a little bit different. With oil prices in the triple digits, it’s quite possible for renewable fuels to be cost competitive relative to gasoline or diesel without subsidies. The fuel tax credit for corn ethanol that had been in place for decades went away Dec. 31, 2011, and the U.S. continues to blend ethanol in billions of gallons annually. Government support is, however, important for the development of the next-generation biofuel industry. The greatest help comes from Department of Energy and Department of Agriculture loan guarantees to these early-stage companies.
Many early-stage businesses, even if they have a good technology platform and a well-defined business plan, have difficulty getting financing. Clearly, the IPO option is open, and many companies have been going public. Commercial lenders are certainly reluctant to lend to pre-revenue businesses in many cases, so the federal loan guarantees have been very valuable. The Department of Defense has also been quite active in supporting advanced renewable fuel through R&D partnerships, and in many cases, purchasing fuels from these early-stage businesses helps provide these companies with cash as well as the seal of approval from the Pentagon, which is the biggest energy consumer in the U.S.
TER: When oil prices were down at $40 or $50/barrel (bl), it made it pretty tough for alternative energy companies to compete. Have higher oil prices changed the economics for cleantech companies?
PM: Absolutely. At $40-50/bbl oil, it’s very difficult for most renewable fuels to compete strictly on economics. I will note in this context that many of the renewable fuel companies have been pursuing opportunities in the chemicals arena. You might ask, why would they sell into the chemicals market? The global chemicals industry is about a $3 trillion (T) market, certainly smaller than transportation fuels, but still enormous in absolute terms, and a huge addressable market. Most importantly, pricing and margins tend to be higher for chemicals, especially specialty chemicals, than for commodity transportation fuels. So many of the companies that are developing next-generation biofuels, both public and private, have been focusing their early stages of commercialization on selling into the chemicals industry, because it’s easier for them to make money without subsidies.
TER: But the volumes are much lower, correct?
PM: Three trillion dollars is the size of the overall global chemical industry, and within that, specialty chemicals are about $200 billion. For companies that in many cases have zero production today, that is more than enough running room. The name of the game here is market penetration. The addressable market is very large indeed.
TER: What technologies hold the greatest potential for longer-term economic success at this point?
PM: One of the difficulties in investing in cleantech has been commoditization. Five years ago, solar panel manufacturing was a relatively specialized business that tended to carry pretty high margins, 25–30% or even higher. Since then, the Chinese competitors in solar have been so aggressive in grabbing market share and expanding production that pricing has cratered amid this severe industrywide glut of solar panels. Margins have dramatically compressed to barely 10% on average for just about everyone. That’s the lesson of commoditization. Therefore, I would encourage investors to focus on technologies across cleantech that do not have the same degree of commoditization.
In the long run, perhaps just about everything can be commoditized, but certainly for the foreseeable future, there are a few areas that stand out. For example, the market for solar inverters tends to be significantly less commoditized than solar cell or solar panel manufacturing. Why? For one thing, there are a lot fewer companies making inverters. It’s a more sophisticated and fairly complex piece of electrical engineering compared to a solar panel. There is also not the same element of competition from China: There are just a few significant solar inverter producers in China compared to at least 100 on the solar panel side.
Within the biofuels sector, next-generation biofuels are all about intellectual property—not simply converting corn into corn ethanol at very slim margins. Each company has its own “secret sauce,” or production process and technology platform, and there is a myriad to choose from. While the different players in this arena are still in their early stages and have lots of execution risk, over time they should have the ability to generate pretty good margins because they benefit from their own internally developed intellectual property.
TER: What criteria do you use in deciding which high-potential companies to cover?
PM: My coverage encompasses 21 companies, both good and bad. So, by no means do I recommend every company that I cover. In fact, at this point, I have a fairly large number of sell-rated stocks simply because of some of the industrywide challenges I mentioned earlier, especially in solar. It’s certainly important to look at investability. Wind is a very interesting market with a large global footprint. But it’s very difficult for investors to play wind because, again, many of these companies are mega-conglomerates for whom wind is a tiny portion of their business.
Therefore, I tend to focus more on the cleantech pure plays. Within every industry, there are companies that are in a better competitive position than others. So we have to look at everything case-by-case. It’s very hard to make a universal, far-reaching call regarding whether a particular subsector is now the right or wrong place to invest. The solar industry is facing a lot of headwinds and yet there are still companies in that space that are quite profitable and successful.
TER: Can you tell us about some of these companies that you cover and why you like them?
PM: Within solar, Power One Inc. (PWER:NASDAQ) is the world’s second-largest manufacturer of solar inverters. This is a company that has been consistently profitable in recent years. Gross margins have been under some pressure, but nothing compared to the pressure that solar panel makers have faced. It has no debt on its balance sheet and about $200M in cash. It’s actually generating free cash flow just about every quarter. It has been repurchasing some stock, and I think there is lots of room for it to accelerate repurchases in 2012 and beyond.
In biofuels, I would mention two names. One is KiOR, Inc. (KIOR:NASDAQ), a true cellulosic biofuel company. It takes woodchips, uses a catalytic process very similar to a refining catalytic process and turns those woodchips into what we call biocrude, or renewable crude oil. It actually is crude oil but unlike petroleum, it is entirely renewable. That crude oil can be refined using normal refining infrastructure into just about any finished product—gasoline, diesel, jet fuel, you name it.
I would also highlight Solazyme Inc. (SZYM:NASDAQ), which is an algae-based company. Unlike KiOR, which uses a thermochemical process, Solazyme uses a fermentation or biological process utilizing its internally developed algae. It needs to use a relatively more expensive source of feedstock, sugar cane, rather than KiOR’s cellulosic biomass. The tradeoff is it can sell into very high-value markets such as cosmetics and specialty chemicals. In fuels, it would tend to focus on the most high-value products, such as jet fuel.
TER: What sort of revenues are these companies generating?
PM: KiOR is entirely pre-production. Its first plant is expected to come online late 2012. Solazyme has a bit of product revenue for the time being, but in 2013, its first large-scale fuels and chemicals plant is expected to start up in Brazil. Both companies are in their early stages of commercialization.
TER: Do you have any parting thoughts you’d like to leave with us?
PM: The key message to investors is twofold. Number one, focus on companies with a defensible technology platform and distinct intellectual property, rather than a pure commodity business. Number two, be very company-focused when looking at cleantech. Don’t make any far-reaching or sweeping conclusions about cleantech as a whole or even within individual subsectors, because there is so much differentiation from company to company. Companies that may look superficially similar can have very different fundamentals.
TER: Thanks for joining us today.
PM: Thank you for having me.
Pavel Molchanov joined Raymond James & Associates in June 2003 and has worked as part of the energy research team since that time. He initiated coverage on the alternative energy sector in fall 2006. Molchanov became an analyst in January 2006. He graduated cum laude from Duke University in 2003 with a Bachelor of Science degree in economics with high distinction.
Ryan is a supply-sider. He advocates one of the few economic innovations in years. He realizes that the budget cannot be balanced without faster economic growth. Sure, it would be nice to balance the budget in five years, but not with tax increases. Tax increases would only slow down growth. So his budget balances out in 2039, though possibly sooner. Some of the Republicans think that future Congresses cannot be trusted to carry out the cuts that Ryan proposes, certainly not through all the vagaries leading up to 2039. Well, for my part, I think they can. The country has changed dramatically. A new majority of Americans composed of conservatives and independents understands that we have been spending ourselves into the poor house.
I would generally agree that there is no practical way to sufficiently raise tax rates as a way of balancing the budget, and I would also agree that taxes cause economic damage in direct proportion to their nominal rate. I even agree that the fundamental assumption of the Laffer curve—that there is a revenue-optimal tax rate—is correct. I would thus theorize that a lower nominal rate, coupled with fewer loopholes as part of a simpler tax code, constitutes the best course of action. The fewer the taxes and (generally) the lower the rates, the better the results will be.
However, there is no tax rate low enough to achieve Ryan’s projected economic growth rate, and thus there is no way his economic plan is attainable, or even possible. It’s not even conservative, at least in the sense of being fiscally responsible. Quite simply, the way out of this mess won’t be a simplified tax system coupled with minor spending cuts; it will require a revenue-optimized ax plan with massive spending cuts. Since Ryan’s economic plan more closely resembles the former, it is doomed to fail, and is therefore unworthy of serious consideration.
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At 8:30 AM Eastern time, the monthly Personal Income and Outlays report for February will be released. The consensus for Personal Income is an increase of 0.4% over the previous month and the consensus Consumer Spending index change is an increase of 0.6%.
At 9:45 AM Eastern time, the Chicago PMI Index for March will be announced. The consensus index value is 63.0, which is 1 point lower than last month, but is still above the break-even level at 50.
At 9:55 AM Eastern time, Consumer Sentiment for the second half of March will be announced. The consensus is that the index will be at 75.0, which is 0.7 points higher than the value reported in the first half of the month.
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“The art of economics consists in looking not merely at the immediate, but at the longer effects of any act or policy; it consists in tracing consequences of that not merely for one group, but for all groups.” -Henry Hazlitt
Congressman Heck is trailing Mitt Romney in the valid solutions category. I felt compelled to offer a plan which he can weigh in on. Now I understand that people will disagree on ideas for a solution. That people disagree is axiomatic. We can disagree in a civil way, too.
That said, Aristotelian logic teaches us that A can’t be both A and non-A at the same time and in the same sense. In short, truth can’t contradict. If it’s true that artificially low interest rates are the problem, it can’t also be true that low interest rates are not the problem. It’s my sincere belief that Congressman Heck is wrong on housing. He would rather take an activist approach that directs resources towards undermining the price mechanism, rescuing some at the expense of the many.
Former Federal Reserve Chairman Paul Volcker, whom I have much respect for, pointed out that a 2% inflation rate means confiscating half of one generation’s wealth. In the end, he settled with price stability for the Fed’s mission. Far better than inflation targeting.
Federal Reserve Vice Chairman Donald Kohn promised that the Fed would turn off inflation if it happens (is the guy myopic, since it’s here already?). Ben Bernanke was talking about “green shoots” many months ago. Politicians were talking about a “glimmering of hope.” The Fed tells us it will stay loose until there’s an economic recovery, as though artificially low interest rates are therapeutic in nature. The parlance used engenders confusion, and it’s my purpose here to deconstruct a few fallacies.
Let’s start with this axiom: prevailing economic orthodoxy is wrong. If prevailing economic orthodoxy is so great, then how did the orthodox practitioners get us into this mess? Even I saw this one coming. See: http://www.webcommentary.com/php/ShowArticle.php?id=andersonm&date=060514
What is it that we are all pursuing and seeking? The betterment of our lives (i.e. economic growth). When government officials and politicians speak of economic growth, they should be able to define the phrase. If they can’t define it, then they have no business talking about economic growth. So what is economic growth?
Wealth is that which satisfies demands. Inasmuch as businesses satisfy consumer demands, they are being productive. Within the construct of the unhampered market, productivity can be measured by income, since income is earned by satisfying consumer demands. The government, on the other hand, does not sustain itself by satisfying consumer demands (i.e. earning its income). The government uses the threat of violence, or actual violence, to obtain its revenue (i.e. compulsory taxation). Thus the government can’t get away with saying that the more it taxes and spends the more productive it’s becoming.
The technocrats had to invent a different excuse for government: its spending is productive! So government spending – as well as private sector spending – has been placed into the GDP. The kleptocracy tries to camouflage itself with Keynesian formulas (e.g. the “multiplier effect”).
Nevermind the fact that if the “multiplier effect” held truth, so long as nobody saved anything – meaning zero-liquidity preference, in which case we would have hyperinflation – the “multiplier” would be infinity!
If you look at the textbook definitions of economic growth, objectively, it’s defined as a rising GDP. A rising GDP means we are having “economic growth,” because the GDP supposedly measures “economic growth,” and “economic growth” is defined as a rising GDP. Do you see any tautology here whatsoever? Even I noticed the tautology all on my own without anybody to point it out to me in any book. This is “Mark original” analysis.
Before economic growth can possibly be measured, it must be defined. Defining economic growth as a rise in the very indicator that supposedly measures economic growth is self-evidently flawed. Look at it another way. Measuring wealth in terms of a depreciating currency is akin to changing around the definitions of inches and feet in order to say that a person is changing in size. If the technocrats and politicians in Washington can’t figure this one out, then everything is hopeless.
The simplest definition of economic growth is a lessening of the unsatisfaction of wants or demands. We are diverse, and our wants, or demands, are subjective. Politicians and econometricians are not psychics. There is no way to quantitatively measure economic growth. Even Alan Greenspan wrote a piece – even while maintaining the fiction that the Fed is blameless – in which he claimed the Fed is blameless because it’s impossible to model malinvestment. See: http://us.ft.com/ftgateway/superpage.ft?news_id=fto031620081437534087 If it’s impossible to model malinvestment, then it’s impossible to model economic growth.
Prevailing economic orthodoxy tells us that there are two kinds of GDP growth: nominal and real. This is where thinking on the subject becomes dubious at best. Real GDP growth is defined as nominal GDP growth discounted for inflation, which is determined by the unreliable CPI (I won’t belabor the reasons why in this piece, but I have done so before and will do so again).
Let’s start with what should be a self-evident absolute: economic growth need not be discounted for inflation. Either we are having economic growth, or we aren’t. If the GDP must be discounted for an inflation component, then this means that some GDP growth is good, but other GDP growth is bad. But if the GDP is measuring the same thing(s) constantly, this makes little sense. Either the GDP measures economic growth and any rise in the GDP is good, or the GDP measures inflation and any rise in the GDP is bad. If the GDP can rise, but only in nominal terms, then this must mean that it can fall, but only in nominal terms.
When Fed officials and other D.C. technocrats speak of “economic growth,” they’re talking about rising prices in absolute terms, which is not inflation but the result of inflation (i.e. monetary expansion). If a person conflates rising prices with economic growth, they’re boxed into an awfully awkward position. The only way to have a fast economic recovery would be to have prices rise fast (i.e. hyperinflation).
Real economic growth engenders falling prices. Falling prices increases the ROR (rate of return) in real terms. I remember when I was growing up during the 1980s, and if I wanted to make a photocopy, I had to walk down to the drug store to use the big, bulky copy machine. If I had to send a fax, I went to Kinko’s, or another commercial location. At that time, nobody would have thought that the average household might have its very own fax/copy machine. Today, you can get an all-in-one for under $100. Who would have thought a century ago we would go from horses and buggies to automobiles?
Undoubtedly, this is a positive development. Albeit demand for the copy machine at Kinko’s and horses and buggies has dropped. But those things have been replaced by at-home copy machines and automobiles. This drop-off in demand for Kinko’s and horses and buggies would be detected by the GDP as economic decline. The political response would be to bailout Kinko’s and the horses and buggies industry, as though market share is supposed to remain static. One man’s loss of market share is another man’s gain of market share.
Conversely, if the western part of the United States went to war against the eastern part of the United States, the GDP could rise exponentially. But would that be a positive development for the economy? Hardly.
For the Fed to keep the price level the same in nominal terms requires inflation (i.e. an expansion of the money supply). Thus, even if prices were to remain stagnant, we can still be suffering from the effects of lost deflation. The question is: what would prices otherwise be absent central bank manipulation? We don’t know, but it’s safe to say prices would be a lot lower.
It’s the effort to prop up prices through stimulus that’s preventing the economic recovery. People are losing their homes because homes are unaffordable (not because they are too cheap). Thus deflation is the cure (not the problem). What sense does it make to provide somebody with a cheaper mortgage – by interest rate manipulation through loose monetary policy at the FOMC – on a more expensive house that costs more to maintain? But that is what present policy is aimed at pursuing. What sense does it make to stimulate more home building when housing isn’t clearing the market as is?
No matter which way the government inserts itself into the housing market, this diminishes the need for sellers to set prices pursuant to supply vs. demand (i.e. market-clearing prices). Whether the government buys up bad mortgages, bails out the homeowner or the bank, this interferes with the price mechanism. What Joe Heck advocates is subsidizing the purchase of homes for non military service members in order to assist the airmen. If we continue down the current policy path, one will have to be politically connected to get an “education,” get a job, get healthcare, and…get a house!
Suppose there’s a shop owner whose inventories are piling up because nobody can afford to pay for his prices. What does the shop owner have to do? Lower prices. But suppose the government inserts itself into the picture and subsidizes the shop owner. No longer is the shop owner’s sustenance dependent upon having to satisfy consumer demands, thus diminishing the need to set market-clearing prices. Within the construct of the unhampered free market there can’t be price gouging any more than there can be wage gouging, since vendors can’t short inventory at prices above what consumers are both willing and able to pay.
Let’s try another scenario. Suppose the government distributed “credits” or “vouchers” to this shop owner’s customers. This would be perceived as an “enlightened” form of welfare for the shop owner’s customers. However, this is yet a different way to subsidize the shop owner, by letting the shop owner sell at artificially high prices. A move like this prices the poorer, non-recipients of “credits” or “vouchers” out of the marketplace. No surprise that education and healthcare – two of the most government subsidized cartels – have also had the highest levels of price inflation. This begets the perception – erreonously – that the problem is a dollar shortage for the one who didn’t receive “stimulus.”
The mistaken conclusion is that we need these subsidies and stimulus rather than understanding that it’s the subsidies and stimulus pricing the little guy out of the marketplace. The poor person has been priced out of the marketplace. The problem isn’t a dollar shortage, but a dollar leakage thanks to promiscuous spending.
I’ve always said that, by rights, the impoverished belong to the free market movement. With the government as large as it is today, would it not be a fair assumption that many people who are poor are so precisely due to big government, whereas many people who are wealthy are so precisely due to big government? You see, big business uses big government to manipulate the marketplace on its behalf.
The flawed assumption made by some progressives is that big government is somehow less dangerous than big business. This begets the erroneous conclusion that the problem is an absence of regulation. It’s paramount to understand that we can’t regulate away insolvency. We can’t regulate away past mistakes. But we sure can regulate everybody except the big cartels out of existence.
Furthermore, it’s loose monetary policy that engenders speculation, as lenders/investors are compelled to hedge against a depreciating currency. Holding (i.e. investing in) dollars guarantees losses. Politicians have no right debasing the currency to then regulate away that behavior. The simple solution is to stop the printing press. Politicians have no right to punish us for their past transgressions through cumbersome regulations. The most efficient way to mitigate excessive risk taking is by letting the market set interest rates pursuant to the true supply of savings. Subsidizing risk taking while privatizing the profits is not a real free market. Size-capping should not be conflated with risk-capping.
Ludwig von Mises and Eugen von Bohm-Bawerk saliently articulated how labor can’t increase its share at the expense of capital. Nobody can argue against capital without arguing for a reduction in their own standard of living. Thus the problem for the progressive should not be with capital per se, but that capital is so inaccessible to the common person.
Why is capital so inaccessible to the common person? Every tax, every regulation, every government program drives up the cost of capital. Politicians love this, because they get power. Big business loves this, because it creates barriers to competition. Big government creates monopolies, as a monopoly is a state of imperfect competition, and imperfect competition is begotten by government interference in the marketplace.
The situation with housing is no different than that of the shop owner I described above. In a market unhampered by government, sellers are sustained by selling inventory. When the government inserts itself into the picture, sellers are no longer dependent upon having to satisfy consumer demands by selling inventory. Sustenance is disconnected from the satisfaction of consumer demands. In the case of housing, the government and the Fed are subsidizing the loan market to to hold back inventory. See: http://www.sfgate.com/cgi-bin/article.cgi?f=/c/a/2009/04/08/MNL516UG90.DTL&type=realestate
Meanwhile, people are simultaneously living in tents. The mission of Joe Heck is literally to keep people homeless. Do not let that kleptocrat masquerade as a philanthropist. It’s not his money he’s spending; it’s your money he’s spending – and on himself. So long as the government keeps trying to prop up prices, as it has done with healthcare and education, real estate won’t clear the market and we won’t have a recovery.
Economic recovery rests upon a smooth-functioning price mechanism, where the market can discover real prices. How is Ben Bernanke, Joe Heck, or anybody else supposed to know what prices of everything are supposed to be? Would Joe Heck mind telling me what housing prices are supposed to be? How is it good to stimulate home building when there are homes on the market not clearing?
The pursuit of price stability means the Fed will constantly be chasing its own tail. The Fed doesn’t want to allow deflation, so it deliberately tries to create inflation. But then the Fed also promises to intervene if inflation surpasses some level that central planners supposedly have the wisdom to know is wrong. This makes no sense. It’s impossible for the Fed to fight both deflation and inflation. If inflation is good, then bring it on Zimbabwe-style. If inflation is bad, and must be turned off after it starts, then why start the inflation to begin with? In other words: central planners have promised to do an intervention on their own intervention.
If prices fall, this isn’t a bad thing. If we had propped up the economy of, say, 1900, we would still be riding around in horses and buggies. While Paul Volcker is right that expanding the money supply by 2% every year wipes out at least half of one generation’s wealth, the Fed should not be pursuing price stability. We should, instead, be concerned with monetary stability.
Inflation is not economic growth. Just as inflation begets a negative RRR (i.e. real rate of return), deflation begets a positive RRR. Falling prices means rising real incomes. No nation has ever succeeded in substituting a printing press for income-generating investment.
Our only ticket out of this mess is to stop the printing press, which will bring false economic activity to an end, allowing for what remains of the productive and profitable elements of the economy to lead us into an economic recovery. The government is leading us over a cliff. There can’t be a systemic collapse without a systemic cause. Until systemic changes are made to Washington (not the private sector), there will be no economic recovery.
Myth: The problem is “toxic” assets (e.g. mortgage-backed securities) which have created systemic risk
When a hospital can’t collect payment, the hospital sells this debt to a collection agency. This doesn’t create booms and busts. The risk is asystemic unless the government bails out every debtor and/or creditor.
Myth: Present problems were caused by bad lending (i.e. sub-prime loans)
Promiscuous lending is a symptom – not a cause – of economic conditions. Take bad lending to its own logical conclusion: creditors give away money as an act of charity, getting nothing in return. Does charity cause booms and busts? No. Promiscuous lending is a symptom of loose monetary policy at the Fed, which tricks the loan market into consummating unjustifiable loans.
It’s primarily through FOMC operations that interest rates are determined (until the Fed loses control, which will eventually happen). By expanding the money supply, this increases the supply of loanable funds without a genuine expansion of real savings. In doing so, the loan market appears to be more solvent than it truly is tricking the loan market into consummating unjustifiable loans. This artificially suppresses nominal interest rates below their natural level (i.e. where they should be pursuant to the true supply of savings). By expanding the money supply, this allows debtors/borrowers to pay lenders/creditors with devalued dollars, thus lowering the real rate of interest.
A credit transaction involves trading present goods for future goods. If there are no present goods (i.e. savings, which isn’t created on a printing press), then credit has to be curtailed. The problem isn’t a credit crunch, but a savings crunch. Investment can only come out of savings because producers must consume in order to sustain the process of production. In order for the baker to make more bread, the baker himself must eat. Thus somebody must forego present consumption in order to fund credit expansion.
The rate of interest is the discount rate of future goods as against present goods. An example would be what an investor pays for a printing press. Suppose the printing press will generate five-hundred thousand dollars in net income throughout a ten-year life. The entrepreneur will certaintly not bid up the price of the capital equipment to five-hundred thousand dollars. The entrepreneur is willing to invest, say, fifty-thousand dollars for the printing press and the vendor is willing to part ways with the printing press in exchange for an immediate fifty-thousand dollars. The entrepreneur and capital equipment vendor mutually settle upon fifty-thousand dollars – a sum far less than the five-hundred thousand dollars – in exchange for the printing press. How much present income (i.e. present goods) is an entrepreneur willing to invest in order to garner five-hundred thousand dollars in future net income (i.e. future goods) over a ten year period? Reflected in the transaction is the rate of interest as determined by time preferences. Interest rates represent an agio on present goods since present goods are more valuable than are future goods. A person would rather eat an apple today than eat an apple ten years from now. Interest rates must be set pursuant to the true supply of savings and are determined by time preferences. If everybody wants to consume without saving, then interest rates must rise to reflect time preferences.
There is no right way to extend credit at a level below the natural rate of interest (i.e. interest rates set pursuant to the true supply of savings). In that case, we are burning through job sustaining capital and savings. Any person, firm, or institution (e.g. government) that’s dependent upon inflationary credit expansion (as opposed to credit extended from the pool of real savings) is, by definition, insolvent (i.e. a non-income generator). Failure has to be an option for bad business decisions. That’s the check on excessive risk taking.
Artifically low interest rates engenders capital outflow. Capital goes racing overseas. The problem isn’t a dollar shortage, but a dollar leakage. The dollars are out there; they’re just piled up in foreign reserves. The way to repatriate these dollars is for the Fed to tighten, interest rates rise, prices collapse to reflect wages, which will then beget capital inflow thus lowering the natural rate of interest. If I give you $10 in exchange for a book and you turn around and give me that $10 in exchange for a DVD, the real means of purchase for the book was the DVD and the real means of purchase for the DVD was the book. So the issue here is not the quantity of dollars. See: http://www.webcommentary.com/php/ShowArticle.php?id=andersonm&date=110509
Myth: The FDIC is good for depositors
The FDIC offers deposit insurance for bank customers, which is really a backdoor way to bailout insolvent banks. Could you imagine being able to run a ponzi scheme (e.g. fractional-reserve banking), knowing that when your insolvency is exposed the government will pay off your customers (i.e. a de facto bailout of you)? This creates yet another layer of moral hazard on top of the central bank injecting “liquidity” into the loan market. Thus FDIC’s true purpose is designed to keep the unsustainable intact.
Needing to insure bank deposits should raise questions in and of itself. Unlike natural disasters, economic risk can’t be pooled. It’s one thing to guarantee one’s solvency should they get wiped out due to, say, a flood. It’s quite another thing to guarantee solvency, per se. It’s impossible to insure against economic miscalculation and loss. If I were to go into business and you offered to insure me against business failure, you become the true entrepreneur in the deal by underwriting/assuming risk.
The FDIC (insolvent) is backed by the Treasury (insolvent) which is backed by the Federal Reserve (insolvent). The Federal Reserve is backed by a printing press which is backed by the savings of Americans. Not only is the concept of insuring economic risk altogether chimerical, but there’s a reason why only a government-backed entity would offer insurance to banks. Inflationary (as opposed to non-inflationary) credit expansion makes banks inherently insolvent. Demand deposits are payable on demand, while banks are lent long. Thus the time structure of assets and liabilities does not match.
At the end of the day, the FDIC/Treasury/Federal Reserve (all three of which are insolvent) can guarantee depositors pull money out of their bank, but there’s no guarantee of the currency’s value. By guaranteeing solvency, this inherently places the currency’s value at risk. Deposits are guaranteed in nominal terms, but not in real terms.
When one scrutinzes the role of the FDIC more closely, they can see that its entire purpose is keeping the good ole’ boy network intact, leaving Americans with nothing. If the free market were allowed to function, the government’s role would be limited to enforcing contracts. If homeowners default, the bank would foreclose. But if the bank defaults, the bank’s creditors – i.e. its depositors – would become receiver for the failed bank’s assets. Thus, in the event of a bank run, depositors have the first legal claim to a bank’s housing inventory.
What does the insolvent FDIC do? If a bank fails, the FDIC sends in federal regulators to protect the bank’s assets from its depositors by becoming receiver for a failed bank’s assets. In many instances, the FDIC has arranged shotgun mergers with investment banks on Wall Street, turning investment banks into bank holding companies.
So we can see this sleight-of-hand trick – under the guise of protecting depositors – is designed to transfer real assets (i.e. housing inventories) from failed banks to Wall Street, while promising depositors nothing more than globs of Ben Bernanke’s “liquidity.”
There’s no way the FDIC/Fed can guarantee the solvency of the banking system or depositors, which will destroy the currency (measure purchasing power in terms of gold) thus destroying the very depositors (anybody holding dollars) those institutions are supposedly designed to protect.
The solution, then, is to put a failed bank’s assets into the receivership of its depositors. Any other efforts to prop up the housing and/or bond market will prevent the market from clearing and block those who have already lost homes from ever regaining possession. We are now doing to the housing market the same thing that has already been done to healthcare and education.
If you want to figure out how to get your homes back, then make an inquiry into where they’ve gone. The Fed is sitting on at least $1 trillion worth of Mortgage Backed Securities. We can go a long ways towards saving the dollar and getting people back into homes by having the Fed liquidate the MBS on its balance sheet.
In my estimation, any other plan will engender homeless people and peopleless homes. What does Congressman Heck say? Does he have a response? Any response?
Brent Cook, editor of Exploration Insights, describes the past 15 years of change in gold, copper and iron. In this exclusive interview with The Gold Report, he shares what he sees as the fatal flaws and opportunities in this complex industry, details the most important factors he looks for before investing, and names companies he believes have the right stuff.
The Gold Report: In the late 1990s, when the gold price was falling steadily lower, you vetted companies for Rick Rule’s company, Global Resource Investments. Could you give us a comparison of what this space was like then versus what it’s like now?
Brent Cook: During 1997–2002, we were probably in the most unloved sector in the whole investment world. Gold had collapsed to less than $250/ounce (oz), copper was under $0.85/pound (lb) and anything that didn’t have a dot-com to its name didn’t get much respect. The idea of blowing up rocks to make metal out of them was an archaic concept clung to by the remnants of the industrial revolution; it was a brave new world. By contrast, today gold is over $1,600/oz, copper is $3.80/lb and iron ore has gone from $12/ton (t), to $140/t; we’re in the 10th year of a commodities boom. Back then, it was very difficult for mining companies to raise money.
Working with Rick, I was fortunate. He’d put together two funds of about $14 million (M), so we had some money. We were pretty much alone in the sector, hence we were able to put some money into really good projects and people. So in retrospect, that was one of the best times of all to be investing, but at the time, it felt horrible in that we’d invest in these companies that we thought were a good value and see the share price continue to fall for a year or so. We were able to buy a company like Virginia Gold Mines Inc. [now Virginia Mines Inc. (VGQ:TSX)] for nearly cash in the bank yet watch it fall to a 20% discount to that cash, and this was a company run by one of the top guys in the industry, Andre Gaumond. Today, however, you have a lot of money chasing everything in this sector, and it’s subsequently tougher to get real bargains on projects or people. It’s important to recognize that because this is such a risky investment sector that to make money at it consistently, you need to buy companies when they are cheap based on legitimate valuation metrics.
TGR: Is it more difficult for a retail investor to make money today in small-cap mining equities or was it more difficult then?
BC: Both time frames have their challenges. It’s always been about finding quality, high-margin mining projects at any stage and buying those at less than what they’re worth. A high-margin deposit is one whose cost of production is in the bottom third of the total production costs curve for that metal. Say the average cash cost to produce one ounce of gold is $700—ideally you want to own properties that can produce substantially below that cost.
There have been periods in this sector where all the turkeys flew and everybody made money, but we’re back to a period where it’s going to be tougher for retail investors to make money if they’re not very selective and knowledgeable about what they’re buying. The big difference between the late 1990s to early 2000s and now is there’s so much more information immediately available to anyone interested, therefore, investors have to research and understand the details of a mineral project before they buy. They need to know why they’re buying it, what they expect, what it could be worth and what the fatal flaws might be. This level of due diligence is critical because we know that most mineral projects are eventually going to fail. That’s a fact of nature and the Earth’s evolution. So, in a way, it’s a bit tougher now, because you need to be so much more educated on what it is you’re actually buying. Following the stuff that comes in the mailbox doesn’t work anymore.
TGR: What are the most typical fatal, or tragic, flaws that are going to lower a share price?
BC: More often than not, it’s the realization that after the first few good drill holes into a project you start putting it together and the geology or the continuity doesn’t hang together. Bear in mind that it costs money to mine waste and a mine is a terrible thing to waste.
Another typical flaw is metallurgy or metal recovery. You want to find out as much as you can about the metallurgy as soon as you can because that factors heavily into what your production costs are going to be. For instance, is the ore oxidize, sulfide, carbonaceous, refractory etc.? If you’re dealing with Carlin-style sulfide gold mineralization, you immediately know that somehow the sulfide has to be broken down to allow recovery of the gold. That’s going to take a roaster or an autoclave of some sort, which is extremely expensive to build and consumes considerable energy. If the project is in the Yukon, an investor has to think about the cost of building an autoclave or roaster. That means the grade has to be quite high to cover the capital expenditures (capex) and power costs. However, in Nevada there is excess capacity for refractory ores, you don’t have to factor in the cost of an autoclave.
TGR: You were recently at the annual Prospectors & Developers Association of Canada mining conference in Toronto. More than 600 companies had booths at that event. What are some trends you noticed?
BC: Companies are starting to recognize that it’s not so much about size as quality of mineral deposits. Grade, or more succinctly margin, is getting more and more important. There are a lot of very large, low-grade deposits out there, and the majors aren’t buying these. That’s a real issue and you have to question why. If the majors don’t buy them, these junior companies with these large, low-grade, low-margin deposits are then doomed to build. I think it’s going to be tough to raise the money, or at least the debt portion, to do that. So I think one trend is toward smaller, higher grade, higher margin deposits.
There are still people out there trying to raise money on new deals, new projects as they move from one busted company to the next one. Unfortunately, for companies with average properties, the music has stopped and they are facing terrible share dilution to fund the exploration on their average projects. As I said earlier, average ain’t going to cut it this year.
There is also a severe shortage of technically qualified people—resource estimators, mining engineers, geologists—to do the work. Company presidents and VPs of exploration are in strong demand. Because there is more work than qualified people, I’m seeing a lot of sloppy preliminary economic analysis (PEAs) and resource reports. That’s a serious and financially dangerous trend. You can no longer blindly rely on a company’s scoping study or its PEA. You need to look at the details. I could tell you some pretty scary stories in this regard.
TGR: What are some of the sloppy things that you’re noticing?
BC: In resource estimates, there is a tendency toward plugging it all into a computer and generating a model without going through the time and detail it takes to fit the model to the geology and structural controls. So grade is being put out into an area of the deposit where there isn’t actually that grade. If these mines eventually go into production or they get down to the very detailed work, these resource estimates are going to be cut back significantly because the model is not honoring the geology or the geostatistics. That’s a serious issue I’m seeing. To quote a friend of mine who does resource estimates, these are “faith-based estimates.”
TGR: Do you think that sort of shoddy work is responsible for some of these one-mine or two-mine operations not performing as well as expected?
BC: Definitely, although we have to bear in mind that they are called estimates for a reason. It’s rare these days that a company goes into production and its production costs are what they were supposed to be according to their PEA and the literature they used to raise money. Nevsun Resources Ltd. (NSU:TSX; NSU:NYSE.A) at its Bisha mine in Eritrea had to cut its gold reserves by about one-third because of a mistake in the resource estimate that related to how poor core recovery was handled in the estimate. Remember, in a resource estimate we are extrapolating a small amount of data, basically a 3-inch tube of core, across hundreds of feet of complex rock and assuming that we can know the grade of that rock. There’s bound to be some uncertainty.
TGR: While you were in Toronto, you made an appearance on BNN where you discussed the lack of big discoveries over the last 17 years. One chart that you used showed that in 1992, the mining industry discovered roughly 100 million ounces (Moz) gold in both copper-gold and primary gold deposits but by 2009 that amount had dropped to about 23 Moz in both types of deposits despite the fact that the industry was spending almost $5 billion (B) annually on exploration. Tell us about that.
BC: That data was put out by Barrick Gold Corp. (ABX:TSX; ABX:NYSE), so it’s pretty good data that pertains to economic deposits. It shows that over time we are discovering fewer large deposits. Basically, we are mining about 83 Moz gold annually yet only finding in the order of 20–30 Moz a year. So there’s a serious gap between production and discovery that we’re not filling.
It’s getting harder and harder to find quality deposits—and we’re talking economic deposits here, not resources that will never make it. Explorationists have pretty well explored most of the Earth’s surface and then some. Therefore, it’s also getting more expensive because we’re going into blind areas and drilling deeper into more complex geologic settings. That is why it’s getting tougher to find these big deposits. Then add to the increased geological difficulty the fact that social, political and environmental realities are pushing way out the time to permit and build a mine and it becomes pretty easy to understand the decreased discovery rate. I don’t see that changing.
The net result of this discovery gap is that when a company, let’s hope it’s a junior company, finds a legitimate, high-margin economic deposit, it is going to be worth a lot more money than you would normally expect. The dearth of new discoveries means that those of us who invested early in a company that proves up an economic deposit stand to make some serious change. So now I’m focusing, as best I can, on high-margin deposits, or at least mineral systems that show the potential to produce those deposits and mostly avoiding geologic setting that don’t offer that shot at a home run.
TGR: Another reason for the lack of discoveries is the high cost of mining, which has gone up dramatically over the last four or five years, given fuel costs and labor costs.
BC: Yes. In 2004, the capex to build Cerro Casale was $1.4B. In 2011, it’s $6B. That’s a huge increase in capital costs that throws a lot of uncertainty onto any big capex project a company is considering. That’s happening across the board. Your average cash cost to produce one ounce of gold 10 years ago was on the order of $340/oz. Today, cash costs alone are closer to $740/oz and your all-in costs, according to a Randgold Resources Ltd. presentation (GOLD:NASDAQ), are closer to $1,200/oz. Cash costs are just what it costs to produce at the mine. They don’t include exploration, depreciation, amortization, royalties, G&A etc.; so it’s gotten a lot more expensive to produce all metals.
TGR: How would you respond to someone who says it’s easier said than done to find early-stage companies with drill results that hint at the potential for high-margin, multimillion-ounce deposits that majors want to buy?
BC: I agree 100%. It is hard to find projects in an early stage that offer the potential of coming up with a major deposit that shows the profit margins and the size that a major company needs to buy. That’s just a function of geology. As the Earth evolves it changes and those changes are recorded as anomalies in the earth’s surface. A volcano forms, erupts a few times, cools down and is covered by the next volcano, over and over again. This process is responsible for millions of geochemical and geophysical anomalies that provide the stories the Vancouver resource market is founded upon. However, very few of these anomalies combine the right geological, geochemical and hydrological characteristics to produce a concentration of metal that has the tons, grade and metallurgy located near surface in a favorable jurisdiction to form an economic deposit.
TGR: If there aren’t enough early-stage, potentially high-margin deposits, won’t companies take the large, low-grade deposits just because that’s what’s available, and they’d bank on rising metal prices to make those deposits worthwhile?
BC: That’s a valid point and investment strategy. It’s a different investment thesis than I go with, but certainly there are a lot of these large, low-grade deposits that are marginally economic at $1,500/oz gold. If your gold price assumption is $3,000/oz, then these are the things to buy. In my personal portfolio, I don’t need 100 companies—I need 10 that have something that I think is of a high enough margin to be economic today.
Lydian International Ltd. (LYD:TSX) is a company that I’ve owned since I first visited the property. At that time, it was $0.76/share. It’s now about $2.45/share. Lydian owns a nice, simple, high-margin deposit in Armenia. Once the world starts to recognize that Armenia is a good place to do business, then this gets bought by a midtier company. It has about 3 Moz. I reckon its cash costs are about $500/oz. The capex isn’t too bad. So that’s a deposit that I see out there that offers the margin that a company needs to make money on, and it’s selling at a discount today.
Atna Resources Ltd. (ATN:TSX) looks like an interesting company, as well. Its Pinson mine is a good grade deposit, and it should be able to produce at a decent price. So you have a decent, high-margin deposit there. Its capital costs are virtually nil because the infrastructure is there and there are a number of options to ship the ore to, so its capex is minor.
Altius Minerals Corporation (ALS:TSX.V) is a great prospect-generating company that’s been incredibly successful. It owns about 32% of Alderon Iron Ore Corp. (ADV:TSX; AXX:NYSE.A; ALDFF:OTCQX); at a cost basis of about $2M, it’s now worth about $100M. Alderon owns an iron deposit in Newfoundland that is a good high-margin deposit. Again, the infrastructure costs are low because it is right in an iron-mining district. I think Alderon has a deposit that somebody else will either buy one day or work out a favorable offtake agreement. So you can buy Altius at a slight discount to its cash, royalties and equity holdings and get a management team that has grown a $20M micro-cap company to about $340M with virtually no share dilution. You’re paying nothing for the upside in Altius, which sort of reminds me of the good old days in the late ’90s.
One way to better your odds at finding a true deposit is to invest in the prospect-generator companies. These are tiny exploration companies that recognize the long odds at success and structure their business models accordingly. They’re very good at generating ideas for mineral deposits, but at the point it’s time to start spending big dollars on drilling, they bring in somebody else to spend the money. So your financial risk is cut down quite a bit, and the high-risk, high-dollar part of it is covered by somebody else. These companies go on and generate new ideas and new targets and bring in new partners, thereby providing shareholders with many more shots at a discovery for your buck. One of the companies doing that quite well now is called Riverside Resources Inc. (RRI:TSX).
TGR: It has an agreement with Chile’s Antofagasta Plc (ANTO:LSE) in British Columbia and one with a steelmaker, Cliffs Natural Resources Inc. (CLF:NYSE) in Mexico.
BC: Exactly. And it has other projects being worked by smaller partners. It has on the order of $10M in the bank plus about $2–3M in equities. Again, $12M has been spent on its properties this year, and its market cap is on the order of $30M.
TGR: In those companies, you need above-average management teams because you have to foster all these different relationships and manage all these different relationships.
BC: Exactly. Eurasian Minerals Inc. (EMX:TSX.V) is another company that has done an exceptional job with that. It has on the order of $35M in the bank. It just bought a royalty that’s going to bring it $7M/year, and it has projects in Turkey, Scandinavia, western U.S., Haiti and Australia that are being worked by major companies, including Freeport-McMoRan Copper & Gold Inc. (FCX:NYSE), Newmont Mining Corp. (NEM:NYSE) and Centamin Plc (CEE:TSX; CEY:LSE)—companies that are looking for major deposits.
TGR: Having a paying royalty often is key, too. When you were on BNN, you talked about Virginia Mines Inc.; its royalty on the Eleanore mine is being developed by Goldcorp Inc. (G:TSX; GG:NYSE). Does Riverside have a royalty that could start paying in the near future?
BC: Virginia does have a callback to a royalty on its projects but, at present, none of them is producing any money. The company does, however, make money in many of the deals it structures by way of shares and management contracts. This income covers a fair portion of its general and administrative expenses. So it makes money back on these deals by working the project. Really smart.
TGR: What about Gold Standard Ventures Corp. (GV:TSX.V; GDVXF:OTCQX)?
BC: We’re going back to high-margin deposits, or at least high-margin potential. Gold Standard’s property is on the Carlin Trend and is a major, very large, Carlin-style gold system. The key to making a big deposit is having a big system—a simple concept that is all too often ignored. Gold Standard’s most recent drill hole intercepted potentially economic mineralization over 43 meters. If it’s successful, this is a deposit that is big enough and high margin enough to attract the attention of Newmont Mining or Barrick or anyone, for that matter.
This is the important part about why I bought Gold Standard. It’s not because of the next few drill holes. It’s because we recognize we’re into a system that’s large enough to produce a mineral deposit, and we know now that this geologic system can produce the grades we need to see. So, it’s still going to be a hit-and-miss exercise until the geologists can do the science well enough to find the exact core of the deposit, if it’s there. The next results might be fantastic; they might be just encouraging. But we know we’re into a big system. You stick with big systems.
TGR: Do you have any parting thoughts for us, in terms of what retail investors should be on the lookout for throughout the rest of this year?
BC: It’s going to be, in general, a tough market to make money in if you’re just throwing darts. You really have to have a handle on what a company’s looking for in terms of deposit type and what that deposit is worth in terms of a net present value on the deposit, if it is successful. Too many companies are out there exploring projects that even if they’re successful, the real values aren’t worth the risk it took looking for it. So stick with intelligent management looking for high-margin or large deposits. The junior mining and exploration business is such a technical and complex science and industry populated by paid touts, scam artists and people of dubious character, that it is well worth the effort to get good, honest advice. And be very selective in what you buy.
TGR: That sounds like great advice. Thank you.
Read Rick Rule’s strategy for taking advantage of volatile precious metals markets here.
Brent Cook brings more than 30 years of experience to his role as a geologist, consultant and investment adviser. His knowledge spans all areas of the mining business, from the conceptual stage through detailed technical and financial modeling related to mine development and production. Cook’s weekly Exploration Insights newsletter focuses on early discovery, high-reward opportunities, primarily among junior mining and exploration companies.
Contrary to what we hear from Republicans, America did not lose its way in the past few years. It lost its way a generation ago when it abandoned its faith in government.
At 8:30 AM Eastern time, the U.S. government will release its weekly Jobless Claims report. The consensus is that there were 350,000 new jobless claims last week, which would would be 2,000 more than the previous week.
At 8:30 AM Eastern time, the final GDP report for the fourth quarter of 2011 will be announced. The consensus is an increase of 3.0% in real GDP and an increase of 0.9% in the GDP price index. The real GDP estimate is the same as the preliminary value for the third quarter of 2011, and the GDP price index is the same.
Also at 8:30 AM Eastern time, the monthly Corporate Profits report from the Bureau of Economic Analysis will be released.
At 9:45 AM Eastern time, 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 Eastern time, the weekly Energy Information Administration Natural Gas Report will be released, giving an update on natural gas inventories in the United States.
At 11:00 AM Eastern time, the Kansas City Fed Manufacturing Index for March will be released.
At 4:30 PM Eastern time, 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 Eastern time, 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.
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Jeff Berwick, chief editor and founder of The Dollar Vigilante and avowed anarchist, holds precious metals for safety and holds their equities for profits. In this exclusive Gold Report interview, he counsels geopolitical diversity and paying close attention to precious metal stocks.
The Gold Report: Your newsletter, The Dollar Vigilante, is the closest thing the newsletter industry has to a comic book superhero. Why the name?
Jeff Berwick: In 2007 a headline, “Where are the bond vigilantes?” started me thinking that you really cannot have bond vigilantes when the central banks can buy as many bonds as they want. There is no point in being a bond vigilante if you cannot influence governments and central banks by selling bonds. I realized that the only way you could do that was by selling dollars.
A dollar vigilante is a free market individual who protests the government monopoly and financial policies, such as fractional reserve banking and unbacked fiat currencies, by selling those same fiat currencies in favor of other assets, including gold and precious metals. We are dollar vigilantes to protect ourselves from what we see is the coming demise of the fiat currency system and the collapse of the socialist, Western nation base as we know it.
TGR: Are you really an anarchist?
JB: Yes, I am 100% anarchist. Anarchy to me is a belief that all transactions, all activity, should be voluntary. It is a peaceful philosophy of not forcing anyone to do anything and not allowing anyone else to force you to do anything. By its nature, governments and taxes are not voluntary. Government actions are violent and coercive, and theft as well. We are against those things.
TGR: In the February issue of The Dollar Vigilante your partner Ed Bugos wrote that 2012 will be the “last hurrah for equity bulls.” Can you explain the rationale behind that?
JB: Ed was reflecting on when he might turn bearish on the stock market in general, after having remained bullish since 2009. He sees 2012 as a “buy everything” kind of year, when bears will be throwing in the towel and trying to call the next “black swan” event.
The bears’ capitulation here, the expanding bullish froth and the withdrawal of the monetary stimulus and other phenomena will set us up for the next wave of the financial crisis, which we believe will likely be in 2013.
TGR: Here’s a statement from Mr. Bugos that sounds positive for the companies our readers are looking for: “The downgrade of our short-term outlook for the U.S. dollar and Treasury bonds. . .falls into line with the rest of our view, the return of the reflation trade disguised as a recovery trade or ‘return to risk.’” How will that happen?
JB: We have been proposing that narrative since we upgraded our stock market outlook in September 2011 to bullish. Our forecast for a sideways gold price looking out 12 months rested on a return of bullish sentiment and stocks in the economy, especially in the U.S., which will result in people liquidating the safe haven assets they ran to last year: U.S. dollars, Japanese yen, Swiss francs, Treasury bonds and gold.
Last year people bought gold and gold stocks expecting a financial calamity, even while the Fed was increasing the money supply by double digits. February 2012 marked the 38th consecutive month in which the annualized money supply in the U.S. grew by more than 10%—an all-time record.
Now, people are beginning to sell gold, again for the wrong reasons; they think the crisis has passed and we are moving on to growth again. But that is a mirage. Instead of growth, this increase in money supply diverts resources to wealth-destructive activities. The central banks have created another boom and investors are falling for it. A good 80% of the recovery in earnings since 2008 is the result of monetary debasement. That is why price/earnings ratios remain so low.
TGR: Should people hold both precious metals and precious metals equities, or lean more toward one or the other?
JB: Personally, I hold both: precious metals for safety and stocks for profit.
The next few years will be dangerous times for investors. During the last inflationary near-collapse of the monetary system in the late 1970s, there was less debt and interest rates could rise to their natural market levels, which turned out to be close to 18%. Today, a 15% interest rate would mean all of the U.S. government’s revenue would be needed just to pay the interest on its debt, guaranteeing a monetary system collapse. So, I own gold and silver to protect my wealth.
TGR: Let’s talk about some of those stocks. Last month The Dollar Vigilante downgraded its outlook on precious metals equities to “neutral.” What is your outlook on precious metals equities for the rest of 2012?
JB: Ed believes the December 2012 lows will be the low on average, especially for the juniors. He sees gold producers and juniors as quite separate. He is quite bullish on the juniors, but not as much on the producers. Our 2012 gold price outlook predicts a 2-in-3 chance of being range bound between $1,500/ounce (oz) and $1,800/oz and maybe 1-in-5 chance of gold declining to $1,350/oz. In any case, he expects a year-end rally to new highs.
We expect the equities that are most sensitive to the gold price in the short term to be at their worst in the next few months. However, we see explorers and emerging juniors recovering and trading higher, after being beaten down last year on what turned out to be a bum call for the deflation trade.
The worst is over for nonproducing juniors, but gold price-sensitive plays, which would include explorers with proved-up ounces at the lower-grade end of the spectrum, might be treading water until June, as gold prices retreat to the lower end of our expected range for 2012.
TGR: In your newsletter, you suggest that Golden Predator Corp. (GPD:TSX) could become a producer sooner than expected. How would that happen?
JB: Its flagship project, Brewery Creek, is a fully permitted mine with two leach pads in place holding 120,000 oz (120 Koz) of gold, 30% of which the company thinks may be recoverable. In the ground, it has an NI 43-101 resource estimate of about 288 Koz gold, half Indicated, half Inferred, some of it in the Proven and Probable category at a grade of about 1.6 grams per ton in near-surface oxides. That estimate will probably grow to 1 million ounces (Moz) once it publishes its updated NI 43-101 in the next few months.
If the leach pads on the property still work, the capital expense (capex) required to fund the project to production should be less than $20 million (M), more if it has to build new leach pads. Golden Predator has a strong balance sheet; it will not have to issue a trillion shares just to get up and running. That is one reason it makes sense to start up with a resource as small as 1 Moz.
Management tells us they are targeting commercial production and positive cash flow within 14 months, starting with small-scale production of 30 Koz/year. Management will use the cash flow to expand over two years to a processing rate of 140 Koz/year.
Its royalty portfolio is strong, with more than a $30M net present value (NPV) in our opinion and a lot of non-core assets it can monetize. It is also looking at debt financing rather than equity.
TGR: Why debt financing?
JB: I do not know, but we are supportive. We would rather see debt financing than dilutive equity financing at this point. Too many of the juniors are stuck having to do heavily dilutive equity financing at the bottom of the market.
TGR: You call Nautilus Minerals Inc. (NUS:TSX) a “must-own piece of a new industry,” the new industry being mining precious metals on the ocean floor. That seems more risky than land-based operations. Why should investors take on that risk?
JB: There are big profits in being first. We disagree in general about the relative risks of land-based mining vis-à-vis underwater based. Naturally, the risks of any new industry will be higher, but we expect there could be massive profits involved here.
As far as the risks go, a lot of the technology being used for undersea mining is borrowed from the technology developed by oil and gas drillers over the last 50 years or so. Remember, this is not drilling deep into the ocean floor. It is dredging and bringing up the sludge, as you see in one of my favorite TV shows, “Bering Sea Gold.”
Critics may also be worried about assaults by environmentalists. We looked into the environmental issue and concluded that the footprint will be smaller than on land.
TGR: This is not all sea floor mud. There also will be hard-rock mining, I believe.
JB: Yes and no. As I said, there are risks, but the rewards are great. Looking at the resource estimates, there is an average value of $1,000/ton (t) at current metals prices, including copper, gold, silver and zinc. But, according to the company’s 2010 study, it will cost only about $100/t to extract them from the sea floor and transport to shore. In our view, the market overestimates the risks of mining the sea floor and underestimates the potential profits.
TGR: You follow Tirex Resources Ltd. (TXX:TSX.V), which owns 90% of the Mirdita copper-gold volcanogenic massive sulphide project in Albania, another jurisdiction unknown to most of our readers. Tell us about that.
JB: Let me start by talking about Albania. One of our strategies is to diversify our gold stocks geopolitically. This is because we believe the world’s financial monetary system is going to collapse and that governments will be the biggest risk to our capital over the next few years.
We want to own gold stocks in many different places because we never know which government will tax or nationalize gold equities. We like Tirex, in part, because we do not see a lot of political risk in Albania.
One of the uncertainties keeping Tirex from breaking away is the issue of permits. Another junior company in Albania ran into some low-level corruption with the local bureaucracy. This scandal cast a shadow over Tirex’s prospects for getting a permit.
Recently, Tirex brought on to its board a high-level fund manager with connections to top-level bureaucrats; this is a good sign that Tirex will not have too much difficulty getting its mining permits.
The company is in a joint venture with a local miner that will trade its facilities in exchange for an interest. Basically, Tirex will be toll milling its way to production once it gets its permits.
TGR: What other companies do follow?
JB: We really like Amarillo Gold Corp. (AGC:TSX.V) and Merrex Gold Inc. (MXI:TSX.V; MXGIF:OTCQX).
Merrex will have 35% of 5–10 Moz at Siribaya in Mali, and that is not even its best target. We believe the market is going the wrong way on this deal. IAMGOLD Corp. (IMG:TSX; IAG:NYSE) has earned its 50% interest in Siribaya one year early, and in 2012 is spending an amount equal to what it spent the previous three years. Based on what we have seen, drilling done in 2011 will increase the resource from 378 Koz to more than 1 Moz. This year’s drilling could triple that in 12 months.
The joint venture has shown continuity on that trend for up to 8 kilometers (km) with more than 50,000 meters of reverse circulation drilling. It will be easy to prove up more than 5 Moz, the amount usually needed to turn the market’s head. The next year or two will be rife with good drills and the potential for a big find. Most of its drilling now is at surface; there is a lot of potential when it goes deeper.
As we speak there is news of a “coup” in Mali. As an anarchist, I am always in favor of governments being overthrown—I just wish they’d stop replacing them with other governments! But in this particular case we have already been in communication with our sources on the ground in Mali. From what we hear it seems, so far, very much a case of “business as usual.” Merrex has no expats in country at present, so no issues there, and IAMGOLD’s in country guy is telling us that this is very much the military being unhappy about its inability to counter the insurgency’s firepower in the far north of Mali, at the Libyan border, and we are getting the same feedback from our Malian associates.
Obviously, we are monitoring the situation but for now we are not doing anything precipitous in the market on the sell side. In fact, we are looking at this at the moment as a buy opportunity. We don’t expect any kind of uprising that would in any way affect foreign business interests adversely.
But, this again points out the importance of geopolitical diversification and not placing all your eggs in one statist basket. Governments are the biggest threat to our liberties and wealth at this time.
TGR: On to Amarillo Gold and its Mara Rosa gold project in Brazil.
JB: The company plans to put Mara Rosa, a 1.3 Moz hosted-load deposit, into production by 2014 or 2015. Its prefeasibility study announced last year that it calculated an after-tax NPV of $178M using a $1,200/oz gold price and proposing an operation yielding 124 Koz/year gold over an initial seven-year mine life. It is moving toward a feasibility study now.
The company has average total cash operating costs of $524/oz and a forecasted preproduction capex of approximately $184M. These economics are robust, but not as robust as originally thought. The capex is twice the estimate in an earlier preliminary economic assessment. Mine life was also shortened. On the other hand, it increased production rates to maximize near-term cash flows and optimize NPV.
The bad news is that the capital requirement equals more than twice its total market cap, which will mean it will have to do a dilutive financing or an equally burdensome debt security. Either way, our $1.75/share valuation assumes full equity dilution as the worst-case scenario. That attributes an NPV of $212M to Mara Rosa, meaning it is $50M toward its exploration portfolio in Brazil.
TGR: What is the next catalyst there?
JB: It will probably have to do a financing fairly soon. But we like what we’ve seen so far.
TGR: Do you have any parting thoughts for our readers?
JB: We believe these are dangerous times for investors. In no more than five years, the U.S. dollar will be in a state of collapse and it will take down all fiat currencies with it. It is more important than ever to be prepared. That means diversifying your gold equities geopolitically.
Diversify your physical gold as well. In 1933, the U.S. government confiscated gold; it could do it again or it could tax it at a high rate. Try to put your physical gold holdings in different jurisdictions. I hold precious metals in more than a dozen countries to limit the political risk.
My overall message is that this is a highly dangerous time. People who are investing in gold and gold stocks are in the right area, but you have to go beyond that. It is more important than ever to do your own research.
If we can get rid of this system controlled by the central banks and move on to a more free market system—which I hope would include gold as money—the world would be a much safer, more prosperous, better place.
TGR: Jeff, thank you for your time.
Jeff Berwick is the chief editor of The Dollar Vigilante newsletter. His background in the financial markets dates back to his founding of Canada’s largest financial website, Stockhouse.com, in 1994. He served as CEO from 1994 until 2002, when he sold the company, and continued on as a director until 2007. To this day more than a million investors use Stockhouse.com for investment information every month. Berwick is also the host of Anarchast, an anarcho-capitalist video podcast; a frequent contributor to numerous financial and precious metal websites; and a speaker at hard-money investment and freedom conferences.
This is all a very hyperlocal and personal musing. The more global readership may want to filter it out.
There are two stories in the PG today that have everything to do with one another, yet have no reference to each other at all. On first glance, the first story may appear to only have a very local interest, but I can assure you that for some impacted it is the single biggest story all year. See: Several Local Catholic Schools to Merge.
That strikes home for me on more levels than you want to read on. For a long time I could find a spot on Liberty Avenue in Bloomfield and without moving look around and document much of my life. I was born at St. Francis Hospital, baptized in St. Joseph’s Church, went to grade school at Immaculate Conception. All were still there, just as many of the storefronts on Liberty Avenue were occupied by the same owners as were there 30, 40, in some cased 50 years earlier. Rare main streets across the nation could maintain such continuity across the 2nd half of the 20th century.
Then came a time when people would tell me Bloomfield was changing. I was like..sure, a bit, but Bloomfield was still Bloomfield was what I really thought. There were too many visual cues telling me things were much the same as always. Even a preponderance of the anecdotal could not overcome my own obstinate memory..and I ought to know better. Maybe I didn’t want to think it any different?
Then there is this story about Garfield changing: Garfield’s main drag is ‘growing up’
Bloomfield and Garfield are apocryphal of Pittsburgh’s inner divisions. By geography Bloomfield and Garfield are the same place. The distance between the main street of Bloomfield (Liberty Ave) and Garfield (Penn Ave) is at points measured in steps. Yet the two neighborhoods have maintained distinct identities as far back as matters. No hills, rivers, valleys or train tracks separate the two neighborhoods… just sheer geographic fate fueled by the self-selection of generations.
So no mention in the latter article on Garfield of the parish consolidations which are central to both Bloomfield and Garfield. The schools being impacted once enrolled most all of the children in the neighborhoods is just the beginning of the linkage.
Yet. It all is connected. There used to be 3 Catholic parishes in Bloomfield and Garfield. The Bloomfield Garfield Corporation was both created by St. Lawrence Pastor Father Leo Henry. That history is relevant to a lot of neighborhood infighting to this day. Why was the BGC as formed not the Garfield Corporation. The geography of the parish probably had a lot to do with it. Technically in canon law St. Lawrence was the territorial parish for both Bloomfield and Garfield. The other parishes in the neighborhood, St. Josephs and Immaculate Conception, even those were actually national (or personal) parishes which means they did not have geographic boundaries. Historically St. Josephs was the church for German immigrants, and Immaculate Conception for Italian immigrants. But when the Bloomfield Garfield corporation was set up,it inherited a name based on the geography of the St. Lawrence Parish..which was technically Bloomfield and Garfield.
Despite their proximity Bloomfield and Garfield have evolved quite distinctly over several decades. The segregation we talk about is as stark as it gets in the dividing line between the two neighborhoods by race. Talk of change not withstanding, actual Garfield residents in 2010 were under 14% white..while Bloomfield is over 81%. The line between the two is about as sharp as such patterns get. Garfield proper has depopulated faster than most anywhere else in the city with one of the fastest declines of any city neighborhood between 2000 and 2010. So as the Garfield focused story today focuses on the main street of the neighborhood, it remains a very open question how much of any of that has pushed into the residential neighborhood.
I have to say though, but any story on the retail main street of Garfield has to mention the two most useful stores in the city. Kraynick’s and also the All Appliance Parts store. If you have not been to both, you really need to stop in. I can’t really point to a web site for either business.. but both are irreplacable in their own ways and I guarantee you many a Pittsburgher has been impacted more by either of them than a lot of other businesses you hear about.
Amazing how all things come around in Pittsburgh. One of the BGC’s first big battles was to try and save a neighborhood supermarket. Giant Eagle once had a supermarket on Penn Ave. Its closing was one of the things that the residents of Garfield fought hard to prevent, but like so many of the other smaller neighborhood level grocery stores it was a losing fight. Cause or effect is too much to get into here, but the closing of the Garfield Giant Eagle was in many ways a correlate of the decline of Garfield. Yet..the news of late is that a supermarket may again move into the neighborhood. Bottom Dollar has an option on a property that was indeed the property the Giant Eagle once used.
So who knows what tomorrow will bring….