Economics Question: Does Poverty Force People to Spend More?

By Thomas Knapp, on April 4th, 2012

Is being poor self-reinforcing because it forces one to spend more on stuff a little bit at a time over time, as opposed to saving up and/or forking over a large sum at once, and eventually spending less?

I don’t consider myself “poor,” but I do have a personal situation that illustrates the question:

I have dental problems. That’s no secret — I’ve talked about it, and other people have talked about it, both to my face and behind my back (no, Sully, it’s not “meth mouth” — I’m not a druggie).

I’ve had these problems for years, and have taken steps toward getting them corrected. A couple of years ago, for example, I had all of my top teeth pulled and got a denture. That ended up costing around a thousand bucks.

The denture only got used for awhile. My remaining bottom teeth are so fragile that if I wear the denture, it breaks them … and I haven’t been able to afford to address the bottom teeth yet.

Essentially, I need another thousand bucks worth of dental work (at a minimum — if I go to one of the $299 denture places, they’ll extract my remaining teeth for $30 a pop, so $600 for two dentures since the old one has long since ceased to fit due to gum shrinkage, and $340 for the extractions).

Since I don’t have a thousand spare bucks to get all that done, I spend money on benzocaine gel, over-the-counter pain relievers and decongestants (I’ve noticed that usually the most painful times are when I’m congested — I guess the sinuses press on the tooth nerves), occasionally on antibiotics, etc.

I can attest with certainty that I’ve also missed out on opportunities to make more money due to this problem. Not only am I embarrassed to be seen this way (which means that I no longer do public speaking engagements, which have been an occasional income source in the past), but I spend probably a week out of each month in severe, sometimes literally blinding, pain that reduces my personal productivity.

And, like I said, I don’t consider myself “poor.” Granted, I personally make little enough that even if I consented to fill out tax returns I’d have little or no liability; and granted, until very recently about half (sometimes more!) of what I made went to a child support obligation; but my significant other makes fairly good money, nobody’s starving at my house, and we do live beyond the bare necessities.

I suspect that laying out a thousand bucks at a whack is a pretty big deal for most people, and out of the question for the truly “poor.”

I also suspect that this is self-reinforcing because various things nickel-and-dime the truly poor to death and stop them from getting out of the hole.

A newer car would set them back three grand, but they can’t manage that … so they trickle out $50 or $100 a month repairing the old clunker because they absolutely have to have it to get to work.

Or they mow two or three yards a week and know they could make good money running a full-time lawn service, but they can’t fork over for the additional equipment and other startup costs, so they just keep on working at Taco Bell.

Or any health problem — mine above is just an example — costs them X days in lost income from being off work each year, but they can’t get the cash together to get it correctly addressed, so they spend a little bit at a time on pain reduction and such and just try to muddle through.

I assume that this is a well-described economic phenomenon, but I thought I’d bring it up for comment. It’s pretty much a matter of needing to post something to the blog, and the only thing on my mind being this damn toothache. So anyway, discuss.



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Big Picture, Small Cap Investing: Jim Letourneau

By The Energy Report, on April 4th, 2012

Jim Letourneau Examining the macro-economic environment is how Jim Letourneau, publisher of the Big Picture Speculator, likes to begin his stock-picking process. However, his understanding goes beyond headline news to reveal surprising investment themes with profit potential. In this exclusive interview with The Energy Report, Letourneau talks about the hype and commodity investment cycles and where to dig for blue-sky stocks.

The Energy Report: You publish the Big Picture Speculator. What does that title imply?

Jim Letourneau: I believe the macro context is often more important than the details about an individual company. I read a broad range of material every day that helps me form my views, and one of my best skills is putting together the big picture and connecting the dots for audiences. A recent example of my method is my coverage of the natural gas sector, which focused on how the abundant supply of natural gas has led to a complete shift in the types of companies that people should be following. Rather than natural gas producers, investors should find companies that are consuming natural gas, like Methanex Corp. (MEOH:NASDAQ; MX:TSX; METHANEX:SSE), Westport Innovations Inc. (WPT:TSX) or Energy Fuels Inc. (EFR:TSX). These companies are in great shape because their costs are significantly lower. That’s a huge big-picture shift, but people get bogged down in all of the debates about fracking and other controversies.

The bottom line is the U.S. now has the cheapest natural gas in the world, and that’s not a horrible problem to have. When I talk to technical people, we just look at each other and think this is a miracle. No one saw this coming.

TER: As a geologist, how does your technical knowledge shape your investment decisions? What do you look for in potential investment opportunities?

JL: Technical knowledge includes pluses and minuses. In general, the types of companies I look for are usually going to have a market cap of under $100 million (M) and for me to get excited about them, they have to have the potential to surmount that $1 billion (B) market cap. So there’s a potential tenbagger upside in them, if everything pans out. That potential could be in the form of a new technology backed by a critical management team or a higher-quality mineral property. Either way, management teams are critical for these types of things to play out.

TER: How far down in market cap do you go when considering investments?

JL: Sometimes I go down too far, but I think $50M is better than $5M. While you can argue that it’s easier for a $5M market-cap company to go to $50M, your odds start to dwindle. It’s a matter of finding that balance point. Obviously, it’s nicer to buy a company cheap and have it grow into something bigger, but the company is usually cheap for a reason. I don’t want to have to write about 50 companies a year that didn’t quite make it. I’d rather go up the food chain a little bit and follow ones that are going to survive, and whose progress we can track year by year.

TER: You spoke at the Cambridge House Energy and Resource Investment Conference in Calgary on March 30 and 31. What subjects did you cover?

JL: My keynote talk was called “Making Money Using Commodity and Hype Cycles.” I overlayed two kinds of cycles: The commodity cycle is a longer cycle that we’ve been in for over 10 years now. Hype cycles refer to heightened public awareness of a new technology or a particular element on the periodic table that hasn’t been speculated on yet. A recent example would be graphite. Uranium is another really good example of a hype cycle; there was a huge amount of interest about eight years ago and hundreds of companies were formed. Investors were making lots of money with uranium stocks. Then it all withered away. There is still opportunity because some of those companies are still around and advancing their businesses.

I also did a workshop called “How to Find Billion-Dollar Companies,” where I mentioned some of the companies I like that have market caps near $100M with the blue-sky potential to get up to the $1B level.

TER: What do you think the potential is on a percentage-wise basis of finding billion-dollar companies?

JL: The odds are challenging. This is more speculative and it’s much higher risk than a nice dividend-paying stock with cash flow. These companies have lower market caps for a reason; there is either skepticism about the technology or a lot of competition. We don’t need 100 new rare earth mines, but maybe we have 100 rare earth companies. So which companies are going to win that race? It’s a bit like horse racing; you pick your favorites. The odds are you’re not going to win on every one of them.

TER: For a company to get to a $1B market cap these days is probably going to involve some acquisitions and consolidations, unless it really has some amazing property or technology.

JL: That’s very true. Sometimes companies just lay it out and if you can see that it can get the sales and the trajectory, it is certainly possible, and it does happen. It’s a challenge, and that’s what we’re looking for.

The other important part of the stock-picking process is the timeframe. The commodity cycle has a long-term timeframe, whereas the hype cycles can be pretty brief. Eventually, the market turns and the interest goes away. The challenge for these companies, if they have something real, is to keep moving the project forward until the next hype cycle comes around, when people get really interested again. If you’re investing in equities related to commodities, you’re speculating both in the market and on commodities. Sometimes you can have the right commodity, but the company you pick doesn’t follow that commodity’s price performance very well.

TER: Can you point to any companies you’ve seen in the last few years that have turned out that way?

JL: There are a few. To be honest, the other part of this strategy is that for every company that I talk about and like, there are probably 100 that I don’t. There’s a lot of screening and filtering to get rid of the ones that don’t have the potential. One company that I like right now is a biotech that I think we’re at a triple on right now called biOasis Technologies Inc. (BTI:TSX.V). It has a protein that can cross the blood-brain barrier. Therapeutic molecules can be conjugated to this protein, allowing it to cross the blood-brain barrier. This can dramatically increase an existing drug’s effectiveness. That’s one. We found it under $0.50, and now it’s in the $1.40–1.50 range.

DNI Metals Inc. (DNI:TSX.V; DG7:FSE) has also performed really well. While it’s down now, it had gone from around $0.20 to more than $0.60. I like it because it’s pushing the frontiers a little bit. It has a very large, black shale metal deposit in northeastern Alberta, a bit north of the oil sands. Historically, very few geologists studied shales, but they’ve become more popular now because of shale oil and gas. The Alberta Geological Survey has done numerous studies going back to the early 1990s that mention an anomalous metal content in the Second White Speckled Shale. The grades are really low, but the deposits are very extensive. There are huge resources in place containing a whole cocktail of meterials, including rare earths, nickel, iron, vanadium, uranium, zinc, copper, cobalt and molybdenum. It’s almost a conceptual play in some ways. Although the grades are not stellar, they are a little bit higher than we’d expect anywhere else.

So it’s a resource-in-place story, but it’s also a technology story because we’ve seen other industries dealing with a low-grade resource that suddenly become economic plays because of technological breakthroughs. The best example of that is probably shale gas, where people knew for a long time that there was gas in these shales, but nobody was really making any money from them. New technology comes along, and suddenly these shale deposits are worth a lot of money.

For DNI Metals, the challenge is how to get the metals out and make money doing it. The best method to extract these metals is pointing to a technology called bioleaching, which is being used by a company called Talvivaara Mining Co. Plc. (TALV:LSE) in Finland. That’s the exciting part that’s pushing the frontiers.

TER: Are these metals pretty much disseminated throughout this whole deposit, or are certain metals concentrated in certain areas?

JL: The metals are widely disseminated within a fairly uniform and consistent material. That makes it similar to coal or potash mining, where the ore bodies are tabular in shape. They may not be exciting, but at least you know what to expect and you can plan very large operations around that.

TER: With bioleaching, is in situ recovery (ISR) an option?

JL: There may be some way to use ISR, but the bioleaching at Talvivaara involves actually digging it up, piling it onto pads and leaching it by letting the bugs do their work and make acid. But there may be a way to apply in-situ technology in the upper zone. Bioleaching in heaps seems to be the approach with the most potential at the moment.

The value of the minerals in this shale is probably $40 per ton (/t). Extracting the metals for less than $30/t is the challenge. No one’s done it before, so there’s a lot of skepticism. I think a really big mining company would eventually take interest in this because it’s the kind of project that, if it can get up and running, has a life-of-mine potential of over 100 years.

TER: You mentioned uranium earlier. Despite Fukushima, people are realizing that nuclear is here to stay and one of our best sources of energy generation for the foreseeable future. Is there still life after its hype cycle has ended?

JL: I think uranium’s future is very bright and it is a critical part of the world’s energy matrix. We can’t really afford to just turn it off. There actually are a lot of benefits to using it. In terms of the actual price of uranium, the market may not be as excited about it yet, but Russia said it will not renew its supply agreement with the U.S. so analysts are anticipating shortages starting in 2013, which isn’t that far away.

TER: What other companies would you like to comment on?

JL: I like the uranium companies that use ISR technology. The main plays I’ve been considering are either in Wyoming or Texas, where you don’t get the really high grades that you find in the Athabasca Basin. There were hundreds of uranium explorers in the Athabasca Basin and the only one that’s really been successful for investors was Hathor Exploration Ltd., which was recently acquired by Rio Tinto (RIO:NYSE; RIO:ASX). With an ISR uranium project, you have a degree of certainty that a company will actually be able to build the mine and get it into production.

There are three companies in that space that I like. Going from the smallest market cap to the biggest, there is Ur-Energy Inc. (URE:TSX; URG:NYSE.A), in Wyoming. It’s on track to be a producer very soon with expected permitting for its Lost Creek mine early this summer. Then it will be able to get its mine into production probably within six months.

Uranerz Energy Corp. (URZ:TSX; URZ:NYSE.A) is a similar company in Wyoming. It has actually started its mine construction and is looking to start producing 600–800 thousand pounds (Klb) uranium/year very shortly. Both are very near-term production stories.

The last one, Uranium Energy Corp. (UEC:NYSE.A), is currently producing in Texas. It has an inventory of projects coming online and the company announced property acquisitions in Paraguay and Arizona earlier this year. These are all companies with uranium resources that, once their facilities are built, enable extremely long production runs. Typically, they’ll have a centralized uranium processing plant and all of the mines around it will be satellite projects.

The challenge for all of these companies has been permitting. The various U.S. government regulatory bodies didn’t really have anyone qualified to evaluate ISR projects because there haven’t been any new ones developed for decades. The absence of a competent regulatory structure has slowed down progress on getting these mines built. These companies have typically spent a year or two longer than they expected on the regulatory process; it’s not a reflection of any gaps in the quality of their projects.

TER: At least the regulators are willing to permit these operations, which apparently was quite a problem for a while.

JL: That’s a very good point. These are viable, useful industries with quite good safety records and low environmental impact. Again, I like to talk about the big picture.

TER: What sort of capital costs do these uranium ISR projects have?

JL: There’s a range, but the costs are usually $20–30/lb. But these companies are pretty comfortable that they can eke out a living at the current uranium price, which is not going to encourage a whole bunch of new projects to come along. They’re anticipating higher longer-term prices, which should make them quite profitable.

TER: Do you have any thoughts on the current gold market?

JL: I just tell people to look at a 12-year gold chart. Gold is probably the best-performing investment product over that timeframe. I personally don’t think gold has that critical a role in the monetary supply, but it is a place to preserve wealth and look for protection. This recent consolidation pullback is probably an opportunity, but people need to remember that bull markets don’t last forever. However, gold still has legs right now, and the trend is your friend.

TER: Looking at the “big picture,” what do you suggest people do to figure out how they should invest their money these days?

JL: Investors have to do their research and be informed. We are in dangerous times. A lot of assets are correlated so it’s hard to find safety. Sometimes maybe the best safety is not even being in the market, which I hate to say. I like finding good companies that are going to grow into viable businesses. But the markets are not kind, and we’ve seen what can happen when the flow of capital gets turned off. The valuations of publicly traded companies, big and small, in all sectors, tend to drop in unison, even precious metals prices. It’s important to be mindful of the downside. I look for upside opportunities because I’m an optimist and I assume that life will go on.

We do have some structural issues in the financial system. If that breaks down, you really don’t want to own anything that’s not tangible. That’s the strongest investment thesis for owning hard assets. That doesn’t mean owning shares in a hard asset company; that means owning the physical hard asset. If you own a car, a house or some gold, those things will still be around no matter what happens to the money supply and currency valuations. The monetary system is a wild card, and that’s the thing that keeps everybody nervous. We can make informed guesses, but nobody really knows how that’s going to play out.

TER: We appreciate your time and input today.

JL: My pleasure.

Jim Letourneau is the founder and editor of the Big Picture Speculator and is a professional registered geologist living in Calgary, Alberta. He has over 20 years of experience in the oil and gas sector.



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Economics and Constitutional Law

By Simon Grey, on April 4th, 2012

Let’s start with the already famous exchange in which Justice Antonin Scalia compared the purchase of health insurance to the purchase of broccoli, with the implication that if the government can compel you to do the former, it can also compel you to do the latter. That comparison horrified health care experts all across America because health insurance is nothing like broccoli.

Why? When people choose not to buy broccoli, they don’t make broccoli unavailable to those who want it. But when people don’t buy health insurance until they get sick — which is what happens in the absence of a mandate — the resulting worsening of the risk pool makes insurance more expensive, and often unaffordable, for those who remain. As a result, unregulated health insurance basically doesn’t work, and never has.

There are at least two ways to address this reality — which is, by the way, very much an issue involving interstate commerce, and hence a valid federal concern. One is to tax everyone — healthy and sick alike — and use the money raised to provide health coverage. That’s what Medicare and Medicaid do. The other is to require that everyone buy insurance, while aiding those for whom this is a financial hardship.

Now, there is no doubt that non-participation in a market has an impact on that market, regardless of whether we’re talking vegetables or health care. Krugman’s conclusion is essentially correct given it’s implicit assumptions and general framework of analysis. However, there are two essential problems with his arguments.

The first problem is that what is generally referred to by most as “health insurance” would be more accurately described as a combination of medical insurance and prepaid health care. Insurance, by definition, does not cover unavoidable risks. For example, homeowner’s insurance does not cover self-caused damage, like arson committed by the homeowner, because such behavior has no risk, in the sense that everyone who intentionally burns their house own does so intentionally, and therefore the odds of someone intentionally burning their house down are either one hundred percent or zero percent (i.e. they either will do it or won’t do it, and in either case the outcome is due to intentional behavior and not random chance).

In a like manner, there are certain medical procedures that are perfectly predictable, like having a cold or needing a physical. These things are routine, and thus predictable. As such, the risk profile for everyone regarding these things is essentially one hundred percent, which is why insurance coverage for these sort of things is so expensive: “insurance” providers know they’re going to pay for these things, so they simply charge them in advance.

Real medical insurance would only insure for things that are both individually unpredictable and personally undesirable (like a broken leg, e.g.). Thus, Krugman is not talking about real insurance, but rather prepaid health care. He is wrong to say that everyone should be forced to buy health insurance, but he is correct to say that everyone should be forced to buy prepaid health care, for the reasons he listed above.

The second problem is that Krugman conflates economic laws with constitutional laws. While it is true, as noted before, that even non-interaction with a market still impacts a market, this simple (and true) observation is irrelevant to the issue at hand.

The question the Supreme Court needs to answer is not whether an individual’s decision to refrain from buying health insurance will at some point impact interstate commerce (it undoubtedly will, seeing as how all aspects of the economy are interrelated). Rather, the question the Supreme Court needs to answer is: what does the constitution mean when it says “interstate commerce”?

The latter question is indeed the more relevant one, particularly in light of the nature of constitutional law. What is the purview of the federal government in light of its authority to regulate interstate commerce? Laws are, in a sense, quite arbitrary in their scope and application, so the answer to the question doesn’t have to make sense to an economist. It need only have an objective and unchanging definition. As such, it behooves Krugman, as well as all nine justices, to spend some time trying to figure out what the authors and ratifiers of the constitution meant when the constitution was written and adopted. It may be interstate commerce refers to direct trade among the states. It may be that interstate commerce refers to any and all economic activity. It may even be the case that interstate commerce refers to economic non-activity or inactivity.

However, it is the original legal definition of the term that matters when considering the application of the law in this case; the rambling opinion of a doddering Keynesian does not. Therefore, Krugman’s argument is wholly irrelevant to the question at hand because the Supreme Court is not trying to write an economics paper but rather interpret the constitution. The two are not the same, and Krugman’s conflation simply reveals that he is quite clearly outside his realm of expertise, and so he should simply move on to other subjects where his ignorance is not as readily apparent.



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Economic Events on April 4, 2012

By B.P.T., on April 4th, 2012

The Mortgage Bankers’ Association purchase index will be released at 7:00 AM Eastern time, providing an update on the quantity of new mortgages and refinancings closed in the last week.

The Challenger Job-Cut Report will be released at 7:30 AM Eastern time, providing an estimate of the number of layoffs in March.

At 8:15 AM Eastern time, the monthly ADP Employment Report will be released.  Investors will be watching this number to get advance notice on the state of the job market in advance of the government’s report on Friday.

Also at 10:00 AM Eastern time, the ISM non-manufacturing index for March will be released.  The consensus estimate is that it decreased by 0.3 points to a value of 57.0, but will continue to signal economic growth as it remains above the mid-point of 50.

At 10:30 AM Eastern time, the weekly Energy Information Administration Petroleum Status Report will be released, giving investors an update on oil inventories in the United States.



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