The “experts” had been talking about oil prices going to $130 per barrel. Now there’s talk of $50–60 per barrel oil. Either end of that spectrum is not sustainable in the long run, says Byron King. In this exclusive interview with The Energy Report, he explains why he believes prices will settle in the $80–100 range. In the meantime, the recent pullback offers some interesting buying opportunities for investors ready to pounce when the market finds a bottom, as well as some names investors can nibble on right now.
The Energy Report: Things have been pretty hectic on the global economic and financial fronts lately and the energy markets seem to be defying the expectations and predictions of many analysts. What’s your take on where we are and where things are headed?
Byron King: We’re living with volatility, most of which is due to international currency and exchange rates. The dramatic decline in the euro has caused a capital flight to the U.S. and a strengthening of the dollar, which results in lower oil prices. The other big macro-type issues include the looming economic slowdown in China. More news stories are coming out about negative demand indicators in China, which will definitely be bad for Chinese consumption growth. The country may use less oil than people forecast. The Saudis are producing at least 1 million barrels per day (MMbbl/d) in excess of what they normally would. So, between the rising dollar, slowing growth and excess production in Saudi Arabia, we’re seeing these gyrating low prices.
TER: One hundred and thirty dollar per barrel oil and $5 a gallon (gal) gasoline failed to materialize as predicted, and now there’s talk of $60/bbl or even $50/bbl oil in the shorter term. Some oil analysts are now predicting $3/gal gasoline by early November. What’s your expectation?
BK: Extremely high or low prices aren’t realistic for the long haul. The world economy will hardly function with $130/bbl oil. The airline industry shuts down right away and much of the rest of the world will suffer accordingly. A $5/gal gasoline price makes for an instant U.S. recession. Whatever economic strength we saw in late winter and early spring got stuck in the mud when gasoline prices went over $4/gal on the East Coast and toward $5/gal in California. All of a sudden, the U.S. economy lost traction, and we’re sliding back into recession.
And while the world economy can’t deal with high oil prices, Credit Suisse’s $50/bbl oil prediction, though it may happen, would not last long. For one thing, the seven sisters of oil exporting—Saudi, Iran, Nigeria, Kuwait, United Arab Emirates, Russia and Venezuela—simply cannot afford under $85/bbl oil because they have their own bills to pay. Those lowball prices could be reached because of events, but they won’t remain because of supply-and-demand economics.
TER: Is the $80–90/bbl range reasonable?
BK: This morning, West Texas Intermediate (WTI) oil was trading in the $78/bbl range. That’s rather low by recent standards. A WTI price of $80/bbl is enough to keep the North American oil industry working. A $90/bbl level for Brent, the international standard, will keep the international oil industry alive. It will tighten things up for the big oil exporting countries, but they’ll be able to avoid bread lines and riots. The number that oil has to find is $80–85 in North America and between $90–100 internationally.
TER: Have upside speculators been chased out of this market at this point?
BK: This is still a trader’s market, with rising prices and falling prices. For people with a really strong stomach and money to play the short term, have at it, boys. This is your market. The last thing the traders want is for oil to stay static at $85/bbl, though the rest of the world might like that for budgeting and projecting purposes. For traders, the last couple of months have been terrific. The people who understand the market and are successful over the long term know that you sell on the way up and buy on the way down. It’s a question of understanding the market dynamics. As Mark Twain said, “If you’re going to throw your eggs in one basket, you have to watch that basket.” When you’re trading at the margins and a move one way or the other could wipe out your capital, you have to keep your eye on things. But the big oil thinkers don’t worry about today’s headlines. They need to think about the very long term.
TER: Big companies are usually able to absorb oil price fluctuations, but what happens with the smaller companies during periods of low prices and volatility?
BK: It’s been a tough world out there for small companies without deep pockets. The energy business, in general, is for companies with money. A small gold miner versus a small oil company carries a difference of at least one or two orders of magnitude. The equivalent of a $20 million ($20M) gold company would be a $200M oil company. With the small guys, the big concerns right now are geographic and economic.
If you’re in the natural gas business in North America, you have to be deeply concerned. Natural gas prices are at historical lows and the cash flow just isn’t there to support much development. A small company may have tens or hundreds of millions of dollars tied up in leases. If you don’t somehow drill or exploit these leases in one way or another, you’re going to lose them. So not only would you not be drilling or extracting, but you’d lose your leases, too. That’s a terrible predicament.
So what will we see in North America? There will be some cutbacks in drilling. It’s already happening, but we’re going to see more of it. It will affect the smaller drillers and service companies first. The big guys—Halliburton (HAL:NYSE), Schlumberger Ltd. (SLB:NYSE) and Baker Hughes Inc. (BHI:NYSE)—will also feel it but, they have much deeper pockets and they’re large and international. So we’ll see some rigs get stacked, but I don’t think we’ll see as many as some of the gloom-and-doomers are forecasting. A lot of these smaller companies have to keep their geologists and engineers working and drilling or all of that money that they spent on leases in the last five to ten years goes down the drain.
Overseas is another story. You almost have to take each country as you find it. Argentina is a disaster with what’s going on with Repsol YPF SA (REP:BMAD). A couple of weeks ago, a company called Pan American Energy LLC saw its operations literally overrun by rioting workers—one of the largest and oldest fields in Argentina was almost shut down because of political issues and labor unrest.
Look at Poland. A lot of people were thinking Poland was going to have its own shale gas revolution, but a couple of weeks ago, Exxon Mobil Corp. (XOM:NYSE) decided to pull out of Poland after a couple of bad wells. Now, the cynics are saying that Exxon is getting better deals from Russia. Russia is the big fish that Exxon wants to land, so it’s going to walk away from Poland.
One more country I’d throw in is Libya, which was a big oil producer. With the recent shale revolution, its exports almost ceased. Now, it has put a lot of things back into shape, but what I hear is that many of those repairs were jerry-rigged and could start breaking down. Secondly, the security situation is not nearly as good as the operators would like to see.
TER: Do you think that there will be enough cutbacks in domestic natural gas production to trigger a price rise in the foreseeable future?
BK: Prices have to rise, and they probably will rise sooner than conventional wisdom suggests. I’m sort of a contrarian by nature, but the fact is they’re giving gas away as it is, so I don’t see much downside from here. I do see upside potential, as well as more demand from more places. We’re already seeing a complete upheaval in the electric-generating industry with coal-fired plants. There are no new ones being built and they’re scaling back on upgrading the old ones because they may not operate long enough to pay back.
That has impacts elsewhere in U.S. industry, such as with companies that do the engineering and supply the parts, engineering and such for upgrading pollution controls on coal plants. They’re about to enter their own mini-recession because of lack of business. Natural gas is also playing havoc with the renewable energy space. Natural gas-fired energy is so cheap that the windmill guys and the solar guys are losing the battle of economics on that alone. I expect to see slightly less gas supply and likely more demand than what people have anticipated.
TER: What are some of the oil and gas majors that would be good shots to weather the ups and downs?
BK: In the international realm, Royal Dutch Shell Plc (RDS.A:NYSE; RDS.B:NYSE) is in very good shape. It is a wonderful, technology-based company that has deep pockets and a very aggressive plan to grow its resources and reserves over the coming years.
Another one that I think is just a spectacularly well-run company is Statoil ASA (STO:NYSE; STL:OSE), of Norway. It is truly one of the world leaders in offshore work and has made a major commitment in North America. People in North America should know there’s a new kid on the block. I think we’re going to see great things from Statoil.
Further down in North American domestic plays, I’m keeping my eye on a company called Denbury Resources Inc. (DNR:NYSE). Denbury is a very advanced independent as independents go—and is making a lot of good moves in the tertiary recovery area using carbon dioxide to get the last drops of oil out of reservoirs.
In Canada, I’ve been following a company called Cenovus Energy Inc. (CVE:TSX; CVE:NYSE) for two years now. It is a very rapidly growing player within the Alberta oil sands play. It has lots of acreage and lots of investment to grow things with very good economics. The one major issue for Cenovus and for all of the Canadian oil sands operators is access to markets. The Keystone Pipeline debacle was not good for the oil sands players. At the same time, the Canadians are moving very firmly toward finding another way of doing it. We may or may not see that northern pipeline get built to the upper Pacific Coast, but there is certainly a plan in place to take some of that Alberta oil sands product down to Vancouver for export, which will be to the long-term, strategic detriment of the U.S. Regardless of who is president next January, we will see some sort of a Keystone Pipeline expansion to move more oil sands product out of Alberta and down into the U.S.
TER: Can you give us a little more detail on the revenues and market caps of Denbury and Cenovus and where you think they might be going?
BK: Cenovus is a $32 billion ($32B) market cap company. The price:earnings (P/E) is around 12. It is making money, and it pays a nice dividend—2.8%. It’s been a bit of a sleeper for many investors, but I think Cenovus is a great choice for investors looking for exposure to the Canadian oil sands plays. It is a good, strong idea with a lot of upside and a lot of growth potential, and it pays a nice dividend while you’re waiting.
Denbury has a $5B market cap. The P/E is about seven, with no dividend. This is a stock where I’m looking for internal growth to bring the capital gains back to investors over the long haul.
TER: What other companies are interesting at these levels?
BK: I’m a big fan of the oil service sector. Right now, Schlumberger is trading down around $60. Schlumberger is one of those companies that almost never gets cheap because too many people know how good it is. When it trades in that low-$50–60 range, I always consider it a buying opportunity. When oil prices recover, that $60 Schlumberger stock is going to be an $80–90 stock. If you can just bear with the market gyrations, it’s almost a guaranteed 40–50% gain.
Right now, with things as volatile as they are, investors want to be very careful about going too deep into these very turbulent waters. To the extent that you do go in, it would be with companies that have a really strong upside such as Cenovus or Schlumberger.
TER: Do you have any thoughts on Encana Corp. (ECA:TSX; ECA:NYSE)?
BK: Encana is also a very strong Canadian firm. It has almost a $14B market cap and a relatively high P/E of 27. But the dividend yield is a nice 4%. If you’re looking for yield, Encana would do it for you, but with a P/E of 27, I think it’s priced more like a growth stock than others. In this oil market, I don’t know if management can really live up to those kinds of expectations. I’m not negative on it; I’m just saying, be careful.
TER: To summarize, what do you think the average investor should be doing these days if they want to play the energy markets?
BK: I would be very wary of most gas plays just because of the economics. I would also be wary of the oil service sector, with the exception of Schlumberger, which happens to be cheap but won’t be cheap for long. In terms of the larger oil plays, I’d suggest Statoil for international and technical competence with a good growth profile in front of it and, in the oil sands, Cenovus. I don’t want to give too long of a list to the investors out there because this is not the time to be too bold.
This market could confound people greatly. We’re at the beginning of a presidential election cycle where government statistics and government announcements will become completely meaningless because everything will become politicized. There are many beaten-down ideas out there. The market is filled with underpriced value, but you want to find the best of the best of those underpriced values. I think I’ve given a few names in this discussion. I’ll be able to sleep well at night if investors act on those.
TER: Should we wait a little bit for the oil market to bottom out before it’s an ideal time to get in or should people be averaging in?
BK: I think people should view the market as trying to find a bottom. Right now, it’s OK to nibble, but it’s better to watch and wait.
TER: You’ve given us a good overview of where you think the market might be headed and some good names to look at. Thanks again for your time.
BK: Thanks for having me.
Byron King writes for Agora Financial’s Daily Resource Hunter. He edits two newsletters, Energy & Scarcity Investor and Outstanding Investments. He studied geology and graduated with honors from Harvard University and holds advanced degrees from the University of Pittsburgh School of Law and the U.S. Naval War College. He has advised the U.S. Department of Defense on national energy policy.
The most important measure of inflation in India is the year-on-year change of the CPI-IW index. This time series, for 120 months, is shown above. From 2006 onwards, India slipped into a new phase of macroeconomic instability, where inflation has strayed far outside the informal target zone of inflation at four-to-five per cent.
Has inflation subsided?
In recent months, there has been a surge of optimism that the inflation crisis is coming to an end. However, a careful look at the seasonally adjusted data reveals that there is cause for concern.
In September 2011, point-on-point seasonally adjusted (annualised) inflation was at 17.49 per cent. The year-on-year inflation was running at 10.06%.
We then had three good months: October, November and December, where the point-on-point seasonally adjusted (annualised) inflation dropped to 2.01, 3.11 and -2.14 per cent. This yielded a sharp decline in the year-on-year inflation to 6.49 per cent in December 2011 and further to 5.32 per cent in January 2012.
But after that, things haven’t gone well. Point-on-point seasonally adjusted inflation, which is the thing to watch for in understanding what is happening every month, is back up to 8.22 per cent in January 2012 and 12.01 per cent in February 2012. Year-on-year inflation is back up to 7.57 per cent in February 2012.
A casual examination of the key graph (shown above) shows that the worst of double digit inflation seems to have ended. But we are not inside the target zone of 4 to 5 per cent, and neither are we likely to achieve this in the rest of this year. It would be unwise to declare victory over the inflation crisis, with this information set in hand.
Looking forward, there are two main problems worth worrying about. The first is the expectations of households. At the heart of India’s inflation spiral is the problem that the man in the street has lost confidence that inflation will stay in the four-to-five per cent target zone. Survey evidence about household expectations has shown double digit values. This generates persistence of inflation; idiosyncratic shocks tend to not quickly die away. The mistrust of households is rooted in the lack of commitment to low and stable inflation at RBI, and this problem is not going to go away quickly. Despite all the problems faced in fighting inflation, RBI continues to communicate, through speeches and official documents, its lack of focus upon inflation.
The second problem is that of the exchange rate. Exchange rate depreciation feeds into tradeables inflation. With a large current account deficit, with policy impediments putting a cloud on capital inflows, rupee depreciation has taken place and may continue to take place. This would be inflationary. Indeed, if RBI chooses to cut rates on the 17th, there will be further weakening of the rupee (since the interest rate differential will go down thus deterring debt flows), which will further exacerbate tradeables inflation.
The media and financial commentators treat it as a given that on 17th, RBI will cut rates. However, the outlook on inflation is worrisome. India’s inflation crisis, which began in 2006, has not ended. Year-on-year CPI-IW inflation has not yet got into the target zone of four-to-five per cent, nor is this likely to happen anytime soon.
Our thinking on this needs to factor in the general elections, which are looming at the horizon in May 2014. Given the salience of inflation in India for the poor, the ruling UPA coalition is likely to be quite concerned about getting inflation back to the informal target zone of four-to-five per cent, well ahead of elections. This also suggests that the time for hawkish monetary policy is now, so as to get inflation under control by mid-2013, well in time for elections in mid-2014.
A historical perspective
Inflation went out of control in 2006/2007 because RBI’s pursuit of the exchange rate peg required very low interest rates at a time when the domestic economy was booming. (The capital controls that were then prevalent failed to deliver monetary policy autonomy; the only way to get towards exchange rate goals was through distortions of monetary policy). Given the lack of anchoring of household expectations, that inflation crisis has not yet gone away. Today, RBI is substantially finished with exchange rate pegging; we are mostly a floating exchange rate. In the future, inflationary expectations will not get unhinged owing to a pursuit of exchange rate policy by RBI. But while a pegged exchange rate pins down monetary policy, a floating exchange rate does not define monetary policy. RBI has yet to articulate what it wants to do with the lever of monetary policy. The first task for the lever of monetary policy should be the conquest of the inflation that is in our midst, owing to the monetary policy stance of 2006/2007.
In the early 1990s, unsterilised intervention in the pursuit of Rs.31.37 a dollar gave an inappropriate stance of monetary policy, which kicked off an inflation. Dr. Rangarajan wrestled it to the ground, even though the monetary policy transmission was weak then. In 2006, we ignited another inflation, once again owing to exceedingly low policy rates in the pursuit of exchange rate policy. Dr. Subbarao’s challenge lies in wrestling this to the ground. His job is easier when compared with what Dr. Rangarajan faced, thanks to the progress which has taken place on financial reforms and capital account decontrol.
You may have already noticed that this one has been going the rounds. The piece is mainly driven by my colleague Jonathan Tepper’s work on the history of currency union breakups and how they work (or don’t).
It is a big piece in its entirety but the different sections can be read as standalone arguments. The summary is pasted below.
Many economists expect catastrophic consequences if any country exits the euro. However,during the past century sixty-nine countries have exited currency areas with little downward economic volatility. The mechanics of currency breakups are complicated but feasible, and historical examples provide a roadmap for exit. The real problem in Europe is that EU peripheral countries face severe, unsustainable imbalances in real effective exchange rates and external debt levels that are higher than most previous emerging market crises. Orderly defaults and debt rescheduling coupled with devaluations are inevitable and even desirable. Exiting from the euro and devaluation would accelerate insolvencies, but would provide a powerful policy tool via flexible exchange rates. The European periphery could then grow again quickly with deleveraged balance sheets and more competitive exchange rates, much like many emerging markets after recent defaults and devaluations (Asia 1997, Russia 1998, and Argentina 2002).
Whether it would be as easy as earlier episodes of currency breakups to dismantle the euro zone is a highly contentious issue. I am not sure that I believe it would be as easy is implied in the piece. But this is not the most important point. We are now in a situation where a breakup or a division of the euro zone into two is no longer a remote theoretical discussion. To this end I think the piece takes up (and describes the mechanics of) some very important processes and issues. Go read!
We know a lot about price controls from the field of exchange rates. Here’s an argument from way back
, in 1998:
When change comes to a stabilised currency, as it must, that change is painful. Change in the long term is inevitable. The random walk doles out a little change every day, which is less painful than sudden large changes.
Currencies which are random walks yield a deeper sort of stability. The steady pace of small changes every day generates realistic expectations about currency risk and continual realignment in production processes in the economy. It avoids sudden changes, and keeps the currency out of the domain of politics. The random walk regime is sustainable without incurring serious distortions in the economy.
In the field of exchange rates, India understood these arguments, and moved to a floating exchange rate. In March 2007, the INR/USD volatility moved up to roughly 9% and from early 2009 onwards, RBI stopped trading in the currency market. This was the biggest achievement of the UPA in economic reforms: In the 2007-2009 period, we got to a market determined rate on the most important price of the economy.
These same ideas are useful in thinking about the price of petrol. A large jump of Rs.1.8 per litre attracts attention. It is far better to let the price fluctuate every day. Ultimately, the price has to adjust. We suffer a lower political cost by letting it adjust every day (through the depoliticised market process). If we bottle up the small changes, then we have to make large changes. These are a bad use of political capital.
According to Edward Karr, CEO of RAMPartners, the band is tuning up and the guests are just starting to arrive. Instead of selling before the party really gets going, he advises keeping a “decent percentage” of cash to take advantage of opportunities to buy both physical gold and junior mining stocks. His real bottom-line advice in this exclusive Gold Report interview? Tap into what makes you happy in life.
The Gold Report: RAMPartners is based in Geneva, Switzerland, a country that made economic news a month ago when the Swiss National Bank capped the Swiss franc at 1.20 francs per euro, slashed interest rates and flooded the market with Swiss francs. Did you agree with those moves and what impact do you think they had on the gold price?
Edward Karr: I emphatically disagree with the move by the Swiss National Bank. To me it makes no sense to peg the Swiss franc at 1.20 to the euro. Switzerland is, in effect, backstopping Greece and all of the other indebted countries in Europe. This is lunacy. Greece or anyone can just hit the Swiss National Bank’s bid at 1.20 and convert into Swiss francs, which it would probably rather have than its euro position.
Since this policy, we’ve seen a psychological shift in markets. People have been rethinking the Swiss franc as a safe-haven currency. The Norwegian kroner looks more like a safe-haven currency now than the Swiss franc. I’m just happy Switzerland is not part of the European Union and not part of the euro. I hope it will understand the foolishness of the 1.20 peg and get rid of it soon.
As to the current effect on the gold price, right around when this happened gold topped and started to sell off. I don’t think they are directly related, but I think it is psychological. If the Swiss franc holds at 1.20 to the euro, if a hedge fund or a corporation hits the Swiss National Bank with a billion euros, it is no big deal. But what about 10 billion, 100 billion, even a trillion? Then it starts becoming a big deal. At some point does Switzerland have to start selling its gold reserves to continue this lunacy? Switzerland now has 1,146 tons of gold. Maybe people are worried that if that gold starts to come out it could put downward pressure on the bullion price; hence, we have seen a little sell off in the overall market.
TGR: Just a few years ago, the Swiss Central Bank had more than 2,000 tons of gold in its reserves. What is your view on the sale of so much of its reserves?
EK: I think it was extremely shortsighted. Switzerland has a long history of fiscal stability and gold has been a very important part of that stability.
Right now, Switzerland has the world’s eighth largest gold reserve, which is quite impressive for such a small country. But, the 1,146 tons of gold it has at current market values is really only about $60 billion. That might seem like a big number, but it is minuscule in comparison to the trillions that global governments are going to have to print to combat this increasing financial crisis.
TRG: Gold has fallen steadily since reaching about $1,900/ounce (oz.) in August. It now sits at about $1,670/oz. Why has it fallen recently?
EK: I think the logical explanation for falling prices is that gold is a relatively liquid asset. Governments, hedge fund managers, bankers and individuals are all facing a severe cash crisis. In that environment you have forced liquidations. Governments are doing all they can to put a positive spin on a terrible environment. But, if you’re a global macro hedge fund manager who has heavy redemptions, you have to sell your liquid assets to raise cash.
Man Investments is one of the biggest hedge fund groups. Last month it announced record redemptions of $7 billion. The firm has to raise cash, so what is it going to do? There are no bids out there for Greek debt, no bids for mortgage-backed securities, no bids for countless other OTC financial derivatives. Gold is liquid; it is easily tradable and has been part of the massive global scramble to cash that we’ve seen in the last two to three months.
TRG: How low could gold go?
EK: That’s a great question. The only credible answer is that gold can go a lot lower than anyone expects. A lot of Johnny-come-latelies have bought into gold in the last few years. A big downdraft will shake out a lot of loose hands.
Europe is on the edge of a cliff. Dexia Bank might fall any day. UniCredit in Italy is right behind. I think we will see a severe domino effect that will make 2008 seem like a walk in the park. If Dexia or UniCredit or the European Central Bank itself had a big major gold position and it had forced liquidation, it will have to sell and the price could go down pretty dramatically.
TRG: Are you willing to be more specific on the price?
EK: It would not surprise me at all if I came in tomorrow and gold was at $1,000/oz., a 60% decline from the current levels. If gold were to fall that dramatically, to $900/oz. or $1,000/oz., it would represent an incredible buying opportunity. That’s when you would want to go all in and buy all you could, because it will snap back like a bungee jump.
When you buy gold, you want to buy it and take physical possession. Owning gold isn’t about the price paid. You shouldn’t look at the price every single day. By the time this crisis is over, it’s going to be about how many ounces you actually have in your possession—under your mattress, in your safe, not in your bank, I hope.
TRG: Your fund holds bullion and junior precious metal equities. How have you changed the way you manage the fund in the midst of this volatility?
EK: We have adjusted our portfolios and we are managing money a little differently. Volatility has certainly increased. In the last month, junior mining stocks are down 40%, 50%. When you get into these high volatility ranges, liquidity drives up as well, delivering a one-two punch. Selling 10,000 or 20,000 shares on a junior mining stock can take it down 25%.
You have to be nimble and you have to be able to stay the course. You don’t want to over-leverage. You want to keep a decent percentage of cash and have some dry gunpowder to take advantage of big sell-off opportunities.
TRG: When I look at my investment portfolio, which consists largely of junior gold explorers, I see nothing but red. I want to sell everything and wait for opportunities. Do you believe that is prudent or do you have better advice?
EK: The investment game is 99% psychological, and it is you against yourself. In my experience, when you feel it is the right time to sell it is exactly the wrong time to sell. I sincerely believe that investors who sell out now are going to miss out on one of the greatest rides of their lives.
Central banks around the world are going to have to put together trillions of dollars. Quantitative Easing (QE) 3 is going to make QE1 and QE2 seem like a little prelude. The Fed is going to have to team up with the European Central Bank and print an incredible amount of money to recapitalize the whole financial system. When they do that, it will set up a moon shot for precious metals and junior mining companies.
This party is just getting started. You can see the house, you can hear the music and see people, but you have not even walked in the front door. Wait for the party; don’t leave before it even begins!
TRG: What are some rules of thumb for investing in junior resource companies during uncertain times?
EK: I like to own good companies with solid management teams and great assets. And then, it all comes down to the timing. The current markets are fantastic for finding attractive entry points. As a general rule, when it feels the worst is usually the best time to buy.
When people get scared, markets and stock prices get way out of line. That is when you need to have the courage to really step in and accumulate. Worst case, if the banks collapse and the ATMs actually do stop working, those who own physical gold will be better off than 99% of the other people out there. But it is more likely that the markets will rebound quickly as QE3 comes in and the ECB and the Fed turbo charge the printing presses. Then, the junior mining stocks and bullion will be off to the races.
TRG: What are some names you have positions in?
EK: I’m quite bullish on Sagebrush Gold Ltd. (SAGE:OTCBB), which trades on over the counter in the U.S. I like the company because it recently acquired a former producing gold mine and mill in Nevada. Nevada is a great jurisdiction; it has rule of law, most of the mines are easily accessible and it has the geology. It is the second most prolific gold zone in the world after the Witwatersrand of South Africa. Sagebrush bought the Relief Canyon mine and its brand-new $30 million (M), state-of-the art facility. It should start production by mid-2012. Relief Canyon currently has a 155 thousand ounce (Koz.) resource and it has an aggressive exploration program on the property right now.
TRG: There are dozens of companies in Nevada. What makes this one different?
EK: A couple of things. Sagebrush has an asset ready to go into production tomorrow. With junior exploration companies that becomes really important. If you have a producing cash-flow asset, you are not as subject to overall market conditions, especially financing, that many junior companies get themselves into. Plus, Sagebrush has strong financial backers including Dr. Philip Frost as a significant shareholder. That gives me a lot of comfort the company will get into production quickly.
Let’s look at the economics of Sagebrush and assume gold holds at $1,500/oz. Sagebrush’s cash costs at Relief Canyon should be about $700/oz. With their 155 Koz. resource, that project could throw off $125M in cash flow over the next two to three years.
And the really exciting part of the Sagebrush story is its very high potential exploration package. The senior exploration geologist is Art Leger, an old hand who has been very successful. I believe he has found upward of 20 million ounces of gold on different crews and discoveries. He came to Sagebrush with a property called Red Rock; a friend who is a legendary natural resource investor told me he felt the Red Rock property was possibly the best exploration address he has ever seen.
Sagebrush’s Red Rock property is surrounded by some of the majors: Newmont Mining Corp. (NEM:NYSE), Barrick Gold Corp. (ABX:NYSE; ABX:TSX), Allied Nevada Gold Corp. (ANV:TSX; ANV:NYSE.A) and Paramount Gold and Silver Corp. (PZG:NYSE.A; PZG:TSX). This is prime exploration real estate and Leger thinks there are several world-class deposits on Red Rock. Sagebrush has a RC rig on property right now. It has done extensive geophysical work, defined drill targets and the drill program is underway.
TRG: Is Sagebrush looking to get listed on the TSX Venture or the TSX main board?
EK: I believe so. It is exploring both the TSX and the AMEX in the U.S. I would like to see the company listed on a more major exchange, where it will get increased visibility and liquidity, probably more research and publishing.
There is a further arbitrage opportunity here. Recently, Sagebrush acquired all of the assets of Continental Resources Group Inc. (CRGC:OTCBB). The deal was 0.8 shares of Sagebrush for every share of Continental. I believe the acquisition is still being worked out and the share swap will happen in the next few weeks. So the big opportunity is to buy the shares of Continental. Effectively, you are getting Sagebrush shares at around $0.31 with the current Continental price of $0.25. Sagebrush is in the $0.50 range, so this is like grabbing dollars for $0.60. Warren Buffet recently said he would buy Berkshire all day long for $0.90 on the dollar. By buying Continental, you get Sagebrush for $0.60 on the dollar. Plus Sagebrush acquired Continental’s portfolio of uranium exploration assets. Uranium is currently really beaten up post-Fukushima, but it is not going away longer term. I believe uranium prices will rally back when the cycle turns and patient investors will be well rewarded on this unique play.
TGR: One interesting note with Sagebrush is that it has Debra Struhsacker, an environmental consultant, as part of the management team. That’s unusual. Would you care to comment on that?
EK: Debra is a fantastic addition to the Sagebrush team. Having the foresight to have an environmental consultant in at this early stage of the company’s evolution really shows the management team is very serious and it is looking to move this project into production as fast as possible.
TGR: You talked about having some powder dry for when you’re ready to strike. What striking opportunities do you see in the market at this point?
EK: I like Nevada, as I mentioned. Another location that I really like is Colombia, which I think is setting itself up to be one of the hottest mining destinations of the future. Colombia is doing all of the right things from a political and economic standpoint. It has incredible undiscovered resources.
We’re a shareholder in a new gold exploration company there called Dicon Gold Inc. It is a Canadian company that is currently private. But I understand that it plans an IPO on the TSX in the next couple of months. Dicon has an incredible management team in place. I think this is really going to be one to watch.
TGR: Did you get in at the capital pool level or as a private placement?
EK: It was a private placement. I don’t think it is a capital pool; it is a straight IPO. We just recently participated in a private placement that was a very, very small round. We want to get involved in a much bigger way on the IPO.
TGR: Do you have one more name?
EK: Going back to Nevada, Yukon-Nevada Gold Corp. (TSX:YNG) is a real interesting opportunity. You’re looking at a stock that is $0.37 a share. I just had the management team in my office and I was very impressed with their presentation. The company has $80M in cash and a $300M market cap. It will re-enter production with one of the few roasting facilities in Nevada capable of producing 300 Koz. a year consistently. It has an autoclave in the recovery circuit.
Yukon-Nevada is an incredible buy. From what I understand, a couple of New York City hedge funds that had a substantial position had heavy redemptions. This stock has sold off from $0.80 down to $0.37 in the open market. We are not a shareholder yet, but we are looking to acquire at these levels.
TGR: Edward, can you leave our readers with some sage Karr wisdom that they can lean on in these unprecedented economic times?
EK: I truly believe that we are heading into a very, very challenging time for humanity in general. The ultimate goal in the financial markets is like the ultimate goal in life—to survive. But you also want to be happy and to prosper. You need to keep it all in perspective.
Your readers are in the top 1% of the global population. And if they own physical gold, they may be in the top one-tenth of the top 1%. A lot of people in the world live hand-to-mouth every day and they remain relatively happy.
I think it is really important to tap into that happiness. Take some time out to be grateful for all you have in life. Enjoy time with your friends and with your family. Spend time on what is important to you. Help people who are less fortunate than you are.
At the end of the day, we’re here for a good time, not for a long time. It is important to enjoy the journey each and every day. Don’t get so worried about the downdraft of your gold position or your junior mining stock. Keep it all in perspective.
TGR: Very wise words. Thank you for talking with us today, Edward.
Edward Karr is the founder of RAMPartners SA–an investment management and investment banking firm based in Geneva. Since 2005, RAMPartners has helped raise more than $100 million for small capitalization companies in fields such as natural resources, high technology, health care and clean energy. Prior to founding RAMPartners, Karr worked for a private Swiss asset management, investment banking and trading firm based in Geneva for six years. At the firm, he was responsible for all of the capital market transactions, investment and marketing activities. Prior to moving to Europe, Karr worked for Prudential Securities in the United States and has been in the financial services industry for 20 years. Before his entry into the financial services arena, Karr was affiliated with the United States Antarctic Program and spent 13 consecutive months working in the Antarctic, receiving the Antarctic Service Medal for his contributions of courage, sacrifice and devotion. Karr studied at Embry-Riddle Aeronautical University and Lansdowne College in London, England, and received a B.S. in economics/finance with Honors from Southern New Hampshire University. He is a licensed pilot and certified master scuba diver as well as a current board member and vice president of the American International Club of Geneva and co-chairman of Republican’s Abroad Switzerland.
The first is an entry titled India which is forthcoming in Elseviers Encyclopaedia of Financial Globalisation, edited by Gerard
Caprio. It’s our attempt at a bird’s eye view of what is known, and not known, about India’s financial globalisation.
The second is a treatment of exchange rates and monetary policy and inflation. There are two well understood phenomena: the `exchange rate passthrough’ (or how prices in India go up when the rupee depreciates) and the `monetary policy transmission’ (or how prices in India go down when RBI raises rates). This paper views these two in a unified fashion. The main finding is
that the channel through which monetary tightening influences domestic prices is mainly through the consequent exchange rate
The third is about explaining the process of firms becoming multinationals. The conventional story told (the Helpman-Melitz-Yeaple
model) is one where firms self-select themselves to become MNCs, where more efficient firms export and the most efficient firms become MNCs. This story is well suited for manufacturing, where costs of transportation are important, where it’s efficient for an Indian firm to make widgets in the UK so as to avoid the costs of transportation of shipping to the UK. But this story does not help us think about services which are `weightless’. We think we have a story which helps us understand MNCs in services, and when
we go test this with data for Indian software companies, it seems to work. Our approach yields the opposite prediction: that less
productive software companies are more likely to become MNCs.
Our stock of papers is at: http://macrofinance.nipfp.org.in/papers.html.
Facebook, the popular social networking site, has raised $500 million from Goldman Sachs and a Russian investor in a deal that values the company at $50 billion.
China’s manufacturing activity eased slightly in December, although it remained in expansion mode, according to a survey of the country’s purchasing managers.
In response, Asian stock markets were higher on the first trading day of 2011, with investor confidence boosted by signs that China’s efforts at keeping a lid on inflation may be working.
Singapore’s economy returned to growth in the fourth-quarter as strength in manufacturing helped offset weakness in the construction sector.
The dollar began the New Year on a stronger note against other major currencies in Asia Monday as investors bought the greenback to position for an expected strong reading in US economic data due later in the day.
Loan refinance rates are declining again with Citibank, Chase and Bank of America all lowering their mortgage rates.
And on Monday, we are likely to see a moderately healthy headline number for the ISM Manufacturing Index for December as the new orders index remains on a recent rebound, posting at 56.6 in November, indicating solid month-to-month growth and a sector that continues to lead a recovery that is now 20 months old.
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Each year The Economist magazine publishes one of my favorite economic indicators – the Big Mac Index. This year The Economist said,
Our Big Mac index, based on the theory of purchasing-power parity, in which exchange rates should equalise the price of a basket of goods across countries, suggests that the yuan is 49% below its fair-value benchmark with the dollar.
Here’s the background. First the theory. In a world of freely floating currency exchange rates, those rates will adjust over time so that a commodity costs the same anywhere in the world. This is called purchasing power parity. An example: Imagine that Brazil finds some way to sell sugar on the global market at a much lower price than everyone else. Right away sugar buyers can buy more sugar with their own currency from Brazil than anywhere else in the world. This will substantially increase Brazil’s exports.
Now, we also know that if a country’s exports increase significantly their currency will increase in value on the international currency market. That is because all these purchases of Brazilian sugar will increase demand for the Brazilian real. As the value of the real rises Brazilian sugar becomes more expensive to foreign buyers – their own, local currency can’t buy as many real as before. At the same time other sugar exporters may see a slight decrease in the value of their currencies, as sugar buyers switch to Brazil. Over time international currency exchange rates will adjust so that a sugar buyer will be able to buy the same amount of sugar anywhere in the world. That’s the theory of purchasing power parity. We know that currency rates don’t float perfectly, and in some cases countries seek to influence the value of their currencies. Enter the Big Mac Index.
A number of years ago staffers from The Economist decided to test purchasing power parity (PPP). Rather than using a boring commodity like sugar, they looked at Big Macs, from McDonalds. Big Macs are as close to a commodity at the definition allows – virtually identical everywhere. They recorded the price of Big Macs in scores of countries, converted those prices to dollars and tested the PPP theory. The results showed a wide range of prices for Big Macs.
Now, these results could disprove the PPP theory. Instead, The Economist staffers maintained that PPP was true, and that various countries’ currencies were either over-valued or under-valued. Let’s use China as an example. Earlier this year a Big Mac cost $3.58 in the United States, but only $1.83 in China (after converting yuan to dollars). If PPP is true, then China’s currency is under-valued by almost 50 percent. And, in fact, there is considerable angst in the international community about China’s efforts to artificially lower the value of its own currency in order to protect its huge export market and supporting industries.
Economists love to forecast, and yet have a very mixed record of success with their forecasting. The Big Mac Index can be used as a rough forecasting tool. In the March, 2010 article the Euro was 29% over-valued. Over the last six months the Euro has declined in value against the U.S. – just what the Big Mac Index would predict.
Who says economists don’t have fun?
From the mid 1990s onwards, the US trade balance has steadily become bigger. This is a centrepiece of the problem of `global imbalances’. Starting from values of roughly zero, this got all the way to values like $70 billion a month, where the US was importing over $2 billion a day of capital to pay for the trade deficit. Here’s the picture:
|The US trade balance (goods+services, per month, seasonally adjusted)
This was termed as the `Bretton Woods II’ configuration, where exporting countries like China gave loans to the US, in a form of suppliers’ credit, and the US bought Chinese goods. This magnitude of capital import was unsustainable for the US. Something had to give.
Warning for Indian readers: In India, the term `trade balance’ pertains only to merchandise trade. In the US, the monthly trade data covers both goods and services. So it is a meaningful measure of what is going on in international trade, unlike the corresponding Indian data.
Bretton Woods II first broke down in the financial crisis. In the downturn, the mighty American consumer purchased fewer 50″ television sets. The US trade deficit dropped nicely all the way to $25 billion per month. Alongside a rise in the US savings rate, this looked like a world which was rebalancing. In recent months, this movement reversed itself and the US trade deficit once again started getting worse. A deterioration of $20 billion per month is visible; i.e. a deterioration of $240 billion a year. Suddenly, the story of global imbalances righting themselves came under question. The present US run rate is around $40 billion a month or $0.5 trillion a year.
Alongside this, we have news that the Chinese reserves rose by $194 billion in Q3 2010. The Chinese seem to have also passed on some of their problems of exchange rate pegging upon their neighbours by purchasing Japanese, South Korean and Indonesian assets. I am not aware of such behaviour having been observed prior to this in human history. Japan, South Korea and Indonesia have taken unkindly to this behaviour. Given the opacity of the Chinese regime, one can’t help wonder if similar things are going on through less visible channels – e.g. a Chinese sovereign wealth fund buys $10 billion of OTC derivatives on Nifty.
So we seem to be headed for quite some escalation of conflict over the Chinese exchange rate regime. Here are some interesting readings on the subject:
There is a lot of talk about capital inflows, rupee appreciation, concerns about export competitiveness, etc. It made me pull up the data to look at what is going on. The graph shows the nominal and real effective exchange rate of the rupee. The source is the BIS: the best computation of these indexes presently available.
|Real and Nominal effective exchange rate of the Indian Rupee
There is one constraint of this data: it ends in August. The picture shown there is rather benign. Over the five year period shown in the graph, modest REER fluctuations are visible. Over the recent period of roughly a year, where RBI intervention has subsided, it isn’t clear that something dramatic shifted.
And, I like to always remind everyone that the REER is a rather weak way to think about export competitiveness, so even if there was a sharp rise in the REER, we’d have to be cautious in rushing to conclusions about what it is saying.
The people making the case for currency trading by RBI have to cross four hurdles:
- Is there a crisis on export competitiveness that is rooted in exchange rate misalignment?
- How can controlling nominal things (the exchange rate) influence real things (the real rate)?
- Given a choice of using the tool of monetary policy for the purpose of delivering low and stable inflation (which benefits every citizen of India), versus the purpose of delivering some modification of the nominal exchange rate (which benefits a sectarian interest at best), what is the best choice?
- How can RBI be held accountable to maximise the interests of the people of India, if it is to do active trading on the currency market? What checks and balances, and what accountability mechanisms, need to be put into place in order to run a trading room in the government sector?
It is not so long ago (until early 2007) that RBI was actively trading in the currency market, championing the cause of India’s exporters, and we saw how much trouble it got them in. In some ways, our inflation crisis today is the legacy of the unprecedented credit boom of the Y V Reddy years. Today’s India is only more open than the India where Y V Reddy’s regime tripped up on currency trading, so the challenges in embarking on that path today are even more daunting.
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