This story caught my eye:
Now another revolution on wheels is on the horizon: the driverless car. Nobody is sure when it will arrive. Google, which is testing a fleet of autonomous cars, thinks in maybe a decade, others reckon longer. A report from KPMG and the Centre for Automotive Research in Michigan concludes that it will come “sooner than you think”. And, when it does, the self-driving car, like the ordinary kind, could bring profound change.
Just imagine. It could, for a start, save the motor industry from stagnation. Carmakers are fretting at signs that smartphone-obsessed teenagers these days do not rush to get a driving licence and buy their first car, as their parents did. Their fear is that the long love affair with the car is fading. But once they are spared the trouble and expense of taking lessons and passing a test, young adults might rediscover the joys of the open road. Another worry for the motor industry is that car use seems to be peaking in the most congested cities. Yet automated cars would drive nose-to-tail, increasing the capacity of existing roads; and since they would be able to drop off their passengers and drive away, the lack of parking spaces in town might not matter so much.
I’ve written before about how government regulation causes the traffic problem instead of solving it (see here). In one post, I even noted how the current solution to fixing the problem yields results similar to a laissez-faire approach. One thing that’s important to note from that prior post is how unfettered humans have already attained a solution that the many are still striving towards. This makes for an interesting question: if the goal is more efficient traffic, why not simply give people freedom by eliminating traffic laws?
This may not be the right question, though, since it’s based on the assumption that result is more important than process. To put it another way, by asking the above question, I’m implicitly assuming that reducing traffic is more important than having a problem to solve.
This then brings me to me theory of regulation. People want to feel like they’ve accomplished something important, which generally means overcoming a difficult hurdle. Some things are inherently easy, so the only way to make accomplishments seem more important is to add a handicap. An example of this can be seen way back when cake mixes were first introduced. At first, the only thing you needed to do to bake a cake from a box was simply add water. Sales never took off, so the marketing team for early cake mixes decided to add more steps, like adding eggs and oil. Once cake mixes became more difficult to prepare, sales took off because consumers viewed making cakes from a mix to be difficult enough to be meaningful. Before the recipe change, cake mixes were viewed as too easy, and therefore insulting, as if the recipient didn’t merit much effort.
In my theory, regulation exists as a handicap to make life more difficult, and therefore more meaningful. After all, how meaningful can life be when there is no problem to solve? Regulation provides meaning to life by making life more difficult. You can’t solve the traffic problem if traffic doesn’t even exist.
Of course, the driverless-car solution will be difficult—if not impossible—to implement because of the sheer amount of technical data that is necessary, not to mention the sheer scale of implementation. To centralize the process of driving everyone around, you will need tons of data, a network on which this data can be shared, and a minimum of automotive troubles. Furthermore, you will need people to act according to a fairly rigid schedule, since driverless cars necessarily live by arbitrary rules (like speed limits). This system will be less-spontaneous and more rigid, and will likely malfunction on a regular basis because humans are still very much a part of the system.
Nonetheless, the driverless car is a remarkably difficult solution that should engage a large number of otherwise bored people for a rather significant amount of time, without much hope of actually attaining a practical solution. If you view traffic as the problem, trying to build a driverless car is not the solution. If you view intelligent people being bored as the problem, trying to build a driverless car is the solution.
What’s pernicious about this whole system is that it concerns itself with the emotional state of technocrats. These are the sort of people who constantly dwell on solving problems, and get bored if there are no problems to solve. These are the sort of people who will invent problems out of whole cloth, or define features as bugs, or, worse yet, actually go about creating problems in order to have a problem to solve. It doesn’t actually matter if they solve the problem; it matters that they have something to solve.
To this end, regulation is helpful in creating problems to solve because it gums up the works of functioning societies. Most people are capable of acting in their own best interest as well as cooperating with other people. While human relationships and motives can be quite messy at times, they tend to work generally well, especially among those who make a point of functioning as adults. This naturally leads to a rather boring society, as most people don’t look for perpetual problems to complain about. If you need to get from point A to point B, you take the easiest path and negotiate clearly with others who share the road with you. And if a given path is not efficient, take another one. Technocrats see this as boring, because there is no recurring problem to solve, and so they first invent a problem (someone’s going to fast), then invent more problems, until they’ve created real problems, which they happily set about solving.
As can be guessed, this is a pretty dysfunctional way of going about things, since it necessarily imposes wasteful costs on society. On the plus side, though, society is able to afford it—for the time being—so social wastefulness is, to be optimistic, a sign of great social wealth. Still, it is sickening that there are some who are so bored that the only way to alleviate their boredom is to waste social resources.
Anyhow, that’s my theory of regulation. There’s a good chance it’s nothing more than intellectual onanism, so feel free to take it apart in the comments.
I have a very serious question… a question that can’t really be answered of course.
What was worse for the future of Pittsburgh in the long run? The decline of the steel industry in the 1980’s or Michael Jordan’s dismemberment of that which was known as Westinghouse in Pittsburgh?
The question obviously arises on the understated news that Westinghouse Nuclear (just one piece of what was the big W) moves out of Monroeville. Westinghouse through history has meant more than ever really documented to the economy of Pittsburgh. In particular the vast Westinghouse Research and Development operation centered here was a unique source of innovation and entrepreneurship that would in many decades be missing elsewhere in the region. Lots of what we tout today as part of the ‘new’ Pittsburgh economy trace back directly to Westinghouse and would likely not be here if Westinghouse had not been here for so long.
Put another way, what would the economy be in Pittsburgh today if Westinghouse had not collapsed? Remember, Westinghouse was not the casualty of the vast economic restructuring of American heavy industry. It was entirely a voluntary immolation on the part of Westinghouse’s corporate governance. Michael Jordan came to town…. decided to buy CBS (yes, the TV network… maybe he watched too much of the original Dallas?) and then had Westinghouse became CBS in what may have been the most misguided reverse merger in history. That which was once Westinghouse was sold off, closed or otherwise deconstructed.. Michael Jordan took with him if not a lot of Pittsburgh, then a lot of its future and probably didn’t lose any sleep over the fate of the Turtle Creek Valley. Jamie Dimon in comparison will likely only make a few big JP Morgan equity owners unhappy.
The recent history of how the economy today connects to W is hard enough to capture, but the W history is in itself over a century long now. What was the first ’spinoff’ (a term I doubt was used at the time) from Westinghouse’s research?
Trying to fix my water heater recently I think I found an answer to that? The electric water heater was invented in Pittsburgh. Who knew? One Edwin Ruud was a Norwegian immigrant who wound up in Pittsburgh working for George Westinghouse and along the way invented the water heater. You might recognize Ruud as possibly being the name on your water heater today.
More from the Pittsburgh Press: Man with a heater or the patent itself, 19th century innovation at its finest, or a great ad from the Pittsburgh Press in 1922 for Ruud tankless water heaters.
And with became of his water heater fortune? Most of it was given away to his workers, but also some created a music scholarship extant to this day and some went to found a hospital back in his native Norway that also seems to be around in some form.
but yeah…. it was all J.R.’s fault.
The central thesis of Cowen’s book is that the recent economic downturn is mostly due to the law of diminishing marginal returns. The metaphor he uses to explain this is that of an orchard. In any orchard, some of the hanging fruit is closer to the ground than other fruit. The natural tendency is to first pick the low-hanging fruit, then move on to the fruit that is harder to reach. In the same way, the natural tendency in any macro economy is to make easier, more obvious innovations before making more complex (and more expensive) innovations. There is a kernel of truth to this, in that there are always diminishing marginal returns in any endeavor.
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In particular, Cowen advances the argument that it is becoming more difficult to innovate, as evidenced by the decline in the patents per researcher rate. This argument is problematic for two reasons.
First, not all inventions and innovations get patented (and some patent attempts are rejected). There has been a rather slight, though appreciable decline in the patent per researcher rate of the last several decades, but there is no research indicating whether any of this is due to the effects of various open society movements. These “open” movements are generally predicated on either the belief that ideas are free (in which case patents, copyrights, and other forms of intellectual property are null and void) or on the belief that ideas should be free (the open source movement is predicated on this). Perhaps the movement away from patenting every last innovation might explain some, most, or all of the rate decline.
Second, there is no attempt to discern whether patent law itself is the cause of declining innovation and invention. It is assumed, perhaps because this is the constitutional view, that patents encourage innovation. However, patent law has often been used to bludgeon one’s competition from copying one’s ideas and business practices. Jeff Bezos’ use of patent law to block other businesses from using one-click shopping is an example of the more extreme tendencies of patent law abuse. The continual lawsuit wars between Apple, Google, and Microsoft are another. In this case, innovations are being squelched because a) it is unprofitable to innovate if your profits simply go to your competitor and b) it is more lucrative to litigate than innovate. When litigation is more profitable than innovation, it should not be surprising that people and firms prefer litigation to innovation. Thus, it may be that the recent downturn in innovation is due not to diminishing returns but due to inept government market interference.
One bright spot in Cowen’s book is his critique of macroeconomic measuring tools. In particular, his criticism of counting government costs at face value when determining GDP is well thought-out and intelligently argued. The insight that government spending is likely subject to diminishing returns isn’t exactly brilliant, but the conclusion that perhaps government costs are inflating the real value of GDP output is quite useful. His critique of educational spending is similarly insightful, in that he notes in brief that while educational spending has roughly doubled in inflation-adjusted terms, the output, measured in terms of educational testing and economic output, has not budged much. He makes a similar case for health care as well. Ultimately, his conclusion is that our economy hasn’t really grown; it’s just that the numbers measuring it have been inflated. Unfortunately, his analysis is not yet able to indicate how much inflation currently exists in economic growth estimates, but at least he’s pointed his fellow economists down the right path.
Cowen also spends some time considering innovation in the online sphere. He notes that this is classic low-hanging fruit, to use his metaphor, but that this is not likely to lead to economic growth because of the net’s scalability.
One interesting point that he makes as evidence of the internet being low-hanging fruit is that there are a lot of amateurs driving innovation. The widespread presence of amateurs, then, is a signal that there is plenty of room for innovation.
As an aside, there is one sector in the US economy that has a significant amateur presence, and that is the automotive sector. The presence of amateurs, though, is relatively small, and confined primarily to the area of kit cars. Kit cars are a sort of DIY car manufacturing project wherein one purchases a frame and body components from a manufacturer, plus whatever accessories one wishes to buy, then goes out and purchases a separate transmission and engine, and assembles the car oneself. This is not a significant portion of the market, but there is a decent amount of innovation within this subset that is absent from the more general automotive production market. Perhaps coincidentally, kit cars do not face as much regulation as production cars. Likewise, the internet is, relative to other sectors, remarkably unregulated. One possible conclusion to be drawn, which Cowen fails to do, is that perhaps the issue is not that we lack low-hanging fruit but that the government forbids us from picking it.
From there, Cowen observes that the growth of government size and scope is largely tied to technological growth. This would suggest that government’s attempts to regulate, and thus hamper technological growth will ultimately hamper the growth of the state.
Cowen also dedicates a chapter to explaining the current economic crisis. His explanation for the crisis is that “we thought we were richer than we were.” This might seem glib at first, but it is correct. Basically, all the investments that feel through did so because they were overvalued. Banks overestimated the wealth and income of marginal lendees. Investment groups overvalued stocks, bonds, funds, CDOs, and all sorts of other financial instruments. Cowen does delve a little bit into pop psychology when explaining why we overvalued things. He relies on an argument about human beings’ tendency to follow other people and rely on signals instead of direct sources. He doesn’t spend much time discussing policies that gave the illusion of wealth, which would in turn lead to overconfidence.
The book concludes with Cowen asking what, if anything, can be done to fix the problem. His policy prescription is this: raise the status of scientists. This strikes me as an incredibly foolish policy. First, some scientists are likely to resist this. Richard Dawkins and PZ Meyers come to mind. Both have the social skills of an autistic eight-year-old, as evidenced by the fact that they routinely mock and denigrate the belief system held many people, even though the issue of the existence of God is well outside the scope of their respective scientific disciplines. Basically, these scientists (and several others as well) are complete assholes that few people will ever come to like or respect.
That aside, there is a second concern. Namely, that scientists in general are not trustworthy. The relatively recent scandal at East Anglia suggests that there are some scientist who are more committed to ideology than scientific truth. They can be trusted or respected, and it is unwise to give any form of power to these sort of charlatans. (Of course, giving power to charlatans is the foundation of democracy anyway, amirite?) Worse still, even when scientists are being sincere and honest in their research, most of it cannot be replicated and therefore cannot be trusted. Does it make sense to give status to those who can’t be trusted even when they are sincere?
Furthermore, it was scientists that produced the atomic bomb. Scientists were behind the technocratic drive of Nazi Germany. Scientists supported the efforts of central planning in the USSR. This is not to say that all scientists are evil. It only to point out that scientists are human, just like everyone else and, as such, are prone to the same problems and imperfections of the rest of us.
Finally, it should be noted that pure science does not lead to as many contributions and innovations as engineering. Perhaps Cowen conflates scientists and engineers (and that is certainly his right, though it would be helpful to clarify that). Even so, the better solution would be to give higher status to engineers and other “hands-on” producers and workers that generate the bulk of day-to-day innovations.
In all, this book is generally a mixed bag of obvious truths, shortsighted analysis, and mildly brilliant insights which makes for an interesting, if uneven read. It’s short and fun and thought-provoking, and seems at times that it’s designed to pick fights.
Tabarrok focuses on four policy areas in which changes could yield very positive results. He kicks off the short eBook by focusing first on patent reform, noting that many areas of patent coverage (software, technical processes e.g.) have low innovation costs and, as such, are not worthy of patent protection. In fact, his recommended patent reform is basically total abolition of all patents, save for medicine and a handful of other fields. This seems rather viable given that most inventions and innovations are generally cheap and likely inevitable. He also has a few short steps that would help as well, like requiring a functioning prototype and capping terms to seven or fourteen years depending on category.
He next turns his sights on to a prize system for innovation. His proposed policies are well-intentioned but naïve. He proposes that the government fund sizeable prizes (to the tune of millions or billions of dollars per prize) with specific goals—not methods—in mind. This should work in theory, but the fundamental problem with this method is that it fails to discern how the government would go about setting the most economic goals and prizes. This process could become highly politicized, as anything involving billions of federal dollars tends to. However, venture capitalists and innovation firms should take note of this recommendation and implement it.
Tabarrok closes his short book by looking briefly at education—both public and post-secondary. Regarding the former, he recommends reform. Why this is preferable to privatization is unstated, but perhaps that is beyond the scope of the book. One curious thing about is argument is how he claims that there is a correlation between high school graduation rates and GDP growth. While statistical analysis bears this out, it is worth noting that there is no proven causal relationship between the two. It could be that GDP growth causes increases in the rate of High School graduation as families become wealthier, and better able to secure leisure time for their children, thus reducing teenagers’ need to work.
It is worth pointing out, though, that public education in the US is crap, and is entirely too test-driven, thanks in large part to No Child Left Behind.
Tabarrok doesn’t dwell much on this, which seems to be a bit of an oversight.Finally, Tabarrok turns his sights on to college education, noting that there is undoubtedly a college bubble and that there should thus be fewer college students.
Government reform is recommended, since that is a source of the current malinvestment.
Better education as to the benefits of a post-secondary education is also recommended, though this seems largely fruitless.
In all, this short book is a rather thought-provoking read. Readers are not likely to agree with all the answers, but the questions are worth mulling over. In fact, the questions the book asks make it worth the purchase. There is a lot to consider and debate, thanks to this book, and the answers Tabarrok provides are considerably less hackneyed than what has been heretofore seen. As such, the book is a recommended read.
President Obama today signed into law the Leahy-Smith America Invents Act (H.R. 1249) a bipartisan, bicameral bill that updates our patent system to encourage innovation, job creation and economic growth. Both Houses of Congress overwhelmingly supported the proposal, which was sponsored by House Judiciary Committee Chairman Lamar Smith (R-Texas). The House of Representatives passed H.R. 1249 by a vote of 304-117 earlier this year. The Senate passed the bill by a vote of 89-9. Senator Patrick Leahy (D-Vermont) partnered with Chairman Smith on the legislation. Congressman Smith led the House efforts on patent reform for more than six years.
Much-needed reforms to our patent system are long overdue. The last major patent reform was nearly 60 years ago. The House patent reform bill implements a first-inventor-to-file standard for patent approval, creates a post-grant review system to weed out bad patents, and helps the Patent and Trademark Office (PTO) address the backlog of patent applications. This bill is supported by local companies as well as many national organizations and businesses.
I’m not sure what to think of this.
On the one hand, this streamlines the patent system, which I begrudgingly support.
The first-to-file standard makes resolving multiple claims dead simple:
Who got to the patent office first.
And weeding out bad patents is also good, especially in light of the standards (distinct, non-obvious, etc.).However, this legislation could very well increase the occurrences of patent-trolling. This would actually discourage invention and innovation in the long run because inventors would more than likely seek to avoid paying royalties to produce their own inventions, so they would have to create modifications to their own product in order to sell them. I imagine this effect would be more prominent among large corporations than among individual inventors because corporations tend to be more susceptible to industrial/commercial espionage.
At the end of the day, though, the simplest and most effective reform is to simply abolish the patent system altogether.There’s little evidence that the costs of the patent system outweigh the benefits thereof.
Rare earth elements have made possible improvements in everything from smart phones and plasma televisions to clean energy technology. In this exclusive interview with The Critical Metals Report, Jason Burack, independent investor and cofounder of Wall St. for Main St., and Kevin Kerr, commodities trader and president of Kerr Trading, share the names of the rare earth element companies to watch as the market grows.
The Critical Metals Report: The rare earth element (REE) space is the most complicated space in the mining and metals sector. Mining these elements is complex, often involving permitting and infrastructure issues. Once mined, separating REEs to high manufacturer purity levels is even more complex. Then selling the isolated REEs often involves highly specialized marketing. Why should an investor place money in the REE space?
Jason Burack: REEs have an amazing amount of innovation upside right now. Because of the innovations coming down the pipeline, the market has the potential to exhibit an annual double-digit growth rate, which offers far more upside than most other commodity sectors. It’s an amazing growth opportunity for investors because the REEs are going to play an important role in making high-end technologies efficient and also in supporting new innovations. In new high-end technologies, REEs are the secret sauce.
Kevin Kerr: These are the metals of the future. There are applications with these metals that we can’t even conceive of yet. It’s very exciting to be involved in these elements. I think part of the benefit of REE mines is that they are limited. There are few players out there that really have all those elements and are innovating. The ones that do have all the pieces in place offer good opportunities for investors. There’s always risk with anything new, but the risk/reward balance is very good in this sector.
TCMR: Can you comment on some of the recent innovations?
KK: For years, REEs were just wasting away; they were not really considered a good investment until engineers realized they were vital to some of the things we use every day—everything from specialized glass to green energy technologies and special batteries to super magnets. The list goes on, including developing technologies like water purification systems, which I believe Molycorp Minerals (NYSE:MCP) is exploring. Prices have exploded.
JB: The primary use for REEs for a long time was the europium in color TV sets. Molycorp, which was supplying much of this demand, had decades’ worth of used tailings sitting around doing nothing. The Chinese saw the potential of this market and spent a lot of time and money to build out uses for the other REEs mined alongside the europium.
TCMR: The United States and Mexico have filed a Memorandum of Understanding with the World Trade Organization over China’s protectionism regarding REEs. China controls about 95% of the world’s REE supply today. The Chinese government increased tariffs and reduced exports, while cracking down on illegal miners. This will further limit the supply and tighten their grip on prices. Do you think the U.S. and Mexico are going to get anywhere by filing complaints against China? Or are we just going to have to wait for another supply of REEs to come to market?
JB: I would prefer a free market solution to government intervention, but REEs are not a free market right now. China has a monopoly on supply and processing, but the government seems to be willing to reduce control. What China cares most about is the high-end value chain products because they saw what oil processing and related innovations did for the U.S. economy. China cares most about the higher value-added product jobs. That is why they are limiting export. They want the manufacturers to come to them.
As a result, you are going to see these other deposits, like Mountain Pass, coming back online. You are going to see Lynas Corporation’s (ASX:LYC) Mount Weld and Great Western Minerals Group Ltd. (TSX.V:GWG; OTCQX:GWMGF) come online. The supply problems, at least in the light rare earth elements (LREEs), will start to resolve themselves over the next couple years. The problem with the heavy rare earth elements (HREEs) is in supply. China is going to guard their higher-end jobs because they want that value-added industry.
KK: China certainly has a monopoly on HREEs. The question is how long will it take to build the next HREE processing facility outside of China? The answer is a long time, mainly because of environmental and regional problems. Also, who’s going to partner up to build this facility? The red tape, whether it’s in the EU or the U.S. or Mexico, is far more extensive than it is in China. They are years and years ahead of us in the game of producing HREEs.
TCMR: Kevin, you’ve spent 23 years as a commodity trader. What does that experience tell you about the REE space? And what’s the path for investors to make money here?
KK: This is one of the opportunities that a trader will see only once in a lifetime. A lot of people say, “This is just a bubble.” I don’t agree. I’ve seen many contracts and future markets come and go, but with REEs, it’s different. These are vital commodities that we are all using every day. We don’t want to lose our ultra-light cell phones and go back to the Gordon Gekko–style phones with the big battery. These things are only going to be more in demand, especially as the world population grows.
Investors can see it as a monumental opportunity. There’s certainly risk, and that’s important to stress. Anytime you’re trading in something new, you have to look out for those risks. But ultimately these markets are going to be some of the leaders in the 21st century.
JB: Because of the innovation upside as more people switch to newer smart phones and to alternative energy technologies, as the military becomes more efficient with less manpower and more unmanned vehicles, REEs play an important role. And the REEs market can grow a lot per year as the pie gets bigger with new innovations.
TCMR: You suggest in your Dragon Metals Report that three metals reign supreme among REEs. What are those and what are their primary uses?
JB: Well, if I was rewriting the Dragon Metals Report today I would actually expand the three to six: three lights and three heavies. The number-one LREE is neodymium, which is used in the neodymium-iron-boron magnet, a permanent magnet technology. Neodymium-iron-boron magnet technology has allowed for miniaturization of a lot of high-end electronics. It has literally made everything smaller, thinner and lighter. Consumers just love the fact that their iPad is so thin now. People talk about the operating systems and the processing speeds and all their applications, and they love them. They wouldn’t have any of this without the neodymium-iron-boron magnets.
The next two are lanthanum and cerium. Lanthanum will have a humongous industrial demand increase in petroleum refining. Oil and REEs are linked in this aspect. You will see a humongous increase as lanthanum is used very heavily in the refining process to crack heavy sour crude oil. The other one is cerium, which is used in car catalytic converters. Also, you’re going to see Molycorp bring on this XSORBX water filter, which combines cerium and nanotechnology. It’s the only filter that’s capable of removing pathogens and pharmaceuticals that the modern municipal water filtration systems cannot remove.
The heavies tend to be more prevalent on the Department of Energy’s Critical Metals Strategy list, so they have even better supply/demand fundamentals than the lights. Dysprosium is used in a trace amount in the neodymium–iron–boron magnet, but the magnet wouldn’t be as good as it is without the dysprosium in it. Dysprosium is not very common in terms of the percentage amounts in most REE deposits. It’s the most critical on the entire Department of Energy’s Critical Metals Strategy list because it’s rare and it’s very important to clean energy. The other couple of heavies that people should learn the names of are terbium and europium. Terbium is used in compact fluorescent light bulbs as well as in smart phones. Europium is going into smart phones too.
TCMR: In many cases REE production in China has caused vast environmental degradation. Some Chinese farmers can’t safely plant crops near the mine sites, and drinking water in these areas can sometimes be deadly. Nonetheless, Molycorp plans to mine 20,000 tons per year of REEs in California, which is not considered a “mine friendly” state. What makes you think Mountain Pass will be permitted?
JB: Molycorp is using innovative technologies in their processing facilities now. Yes, California does have environmental concerns, but California wants to transition to clean energy and the state has been subsidizing that. Molycorp has to demonstrate that it can operate in an environmentally responsible way and that they can do it at scale. The company has the capital and the know-how to be able to do it. It’s already a previously mined ore body with decades of data, so that’s an advantage. The infrastructure is there.
There is new technology to process the REEs safely and do all the refining. It’s going to cost a little bit more money up front, but Molycorp management is saying their production costs are going to be even lower than China’s costs. It’ll be an impressive feat if Molycorp management actually delivers on these promises.
TCMR: It’s possible that these companies spending hundreds of millions of dollars to bring their mines into production and build the facilities to properly separate those metals from one another could be jeopardized if China opens the tap, floods the market with heavies. How are companies going to deal with that?
JB: We don’t have a free REE market. Governments will probably buy REEs for a secure supply to protect REE miners bringing production online. In fact, Japan, the U.S. and the EU have all recommended that their governments start stockpiling a safe and secure REE supply to protect themselves from the Chinese monopolizing the industry.
KK: This is a real concern. China could dump pretty much anything on the market, and they do once in a while. They’re shrewd traders. No one can say for sure what they will do, but the stockpiling that’s gone on will have some effect as well.
TCMR: In early August, we witnessed a massive selloff of REE names. On August 8, names like Quest Rare Minerals Ltd. (TSX.V:QRM; NYSE.A:QRM) and Avalon Rare Metals Inc. (TSX:AVL; NYSE.A:AVL; OTCQX:AVARF) fell at more than 10% and 13% respectively. Are these so cheap now that it’s time to fill your boots?
JB: If I was building a model REE portfolio and I had to concentrate the majority of my money into three companies, they would be Neo Material Technologies (TSX:NEM), Molycorp and Great Western Minerals. Then I would sprinkle some of the other top juniors like Quest, Avalon, Tasman Metals Ltd. (TSX.V:TSM; OTCPK:TASXF; Fkft:T61), Stans Energy Corp. (TSX.V:HRE) or Ucore Rare Metals Inc. (TSX.V:UCU; OTCQX:UURAF). Lynas and Rare Element Resources Ltd. (TSX:RES; NYSE.A:REE), which might have some more heavies in the deposit, are wait and sees.
Investors really need to be discriminatory with their capital. If they are going to put a model REEs portfolio together, I think the heavy concentration should be in Neo Material Technologies, which is already profitable. They don’t have to worry about the prices of the supply, and they make a value-added product so their profit margins are safer. Molycorp has the funding in place already, and it already knows its ore body. I think Molycorp and Great Western Minerals Group Ltd. are going to end up consolidating the sector with some of these other juniors.
TCMR: You’ve said “for this industry to flourish over the longer term it will have to consolidate.” What are consolidators going to be looking for in companies that are just below them on the food chain?
KK: The race is on to figure out who’s going to team up and create the next HREE processing facility outside of China. Everyone is looking for who has the cash, who has the supplies and the infrastructure. We’ve already seen some consolidation in the last nine months, and we’re going to see a lot more.
JB: If I was looking to consolidate the industry, I’d stick with my vertical integration strategy, focus on those making the higher value-added products. There aren’t a lot of people around that have the technical know-how to do it. And there aren’t a lot of these facilities in the world. Only a handful of facilities exist outside of China. I think one of them in France just sold for a big amount of money. Great Western Minerals has a couple of them and so does Neo Materials Technologies.
So, if I was looking to acquire and consolidate the space, I think Molycorp is going to end up being the control stock here, like PotashCorp (TSX:POT; NYSE:POT) has become in the fertilizer industry. I think Molycorp will go after Ucore for some of the heavy deposits and then the processing facilities like Stans Energy. Then maybe they’ll go after some other processing companies or do a joint venture with Neo Material Technologies further up the value chain.
TCMR: Ucore was just given “priority permitting assistance” from the U.S. Department of Agriculture. What does that mean for the stock?
JB: Ucore is going to be a big winner. I project the supply crisis in LREEs will be solved by the 2014-2015 timeframe depending on what true demand turns out to be. Then only the heavies will be in true supply deficit/crisis mode. For a company like Molycorp, which is going to be a lower cost producer, that’s going to be fine. Some of these other juniors that are planning on bringing production online from 2015 to 2017, primarily with light and very little heavies, are going to see a lot of trouble. Ucore has an infrastructure advantage, so they can be online and producing probably before 2015, probably the end of 2013 if everything goes according to plan.
TCMR: What about Ucore’s Bokan Mountain in terms of its HREE versus LREE content? Is this the kind of play that might suit a Molycorp?
JB: Yes, Bokan has higher heavies than lights compared to some of the other deposits. The infrastructure advantage is so good that the capital expenditure (capex) to get Bokan Mountain back into production is going to be minimal compared to some of these other mining projects.
TCMR: Molycorp, Lynas and Great Western are projected to be the first REE miners to reach production. But what are some companies that you think could surprise you and our readers?
JB: Commerce Resources Corp. (TSX.V:CCE; Fkft:D7H; OTCQX:CMRZF) and Medallion Resources Ltd. (TSX.V:MDL; OTCQX:MLLOF) could surprise along with Greenland Minerals & Energy Ltd. (ASX:GGG).
Greenland is a developing country. Most of the country’s revenue is coming from fishing and it is just starting to develop natural resource plays. If it is done environmentally responsibly, I think there will be less red tape in Greenland. And the deposit in Greenland is absolutely massive. The question is about the infrastructure because it’s a developing country.
In general, though, I wouldn’t risk putting a lot of capital into the plays below the cuff, the top two tiers of companies I suggested in my model REE portfolio, because the supply issues are going to solve themselves, especially in the lights, by 2014 or 2015.
TCMR: Kevin, what are you hearing about Stans Energy in Estonia and about the feasibility study on the Kutessay II project in the fourth quarter?
KK: It depends on who you talk to and when you talk to them about Stans. The concerns are legitimate about how much control Russia has over Stans and what they want, what the facility’s condition is, et cetera. I’m holding my judgment until I see it for myself. They are certainly one to be watched.
JB: The positives include a tremendous infrastructure advantage. Stans has the processing facility there; it just needs to be renovated, so the capex is not going to be absolutely massive. The company can probably keep the capex below a couple hundred million bucks. That’s a big advantage. And, it also has a technical advantage because the people who used to work at the facility still live around there. The company also has an innovation deal with a renowned Russian laboratory that specializes in REEs to separate them and innovate with them.
On the negative side, the company’s total grade of the ore body is low. That means the margin for error is very low on the mining side. Stans will have to make up for it on the processing side. And then you have the geopolitical risk on top of that. Investors are going to have to weigh these risks and rewards to determine if they are comfortable with Stans.
TCMR: Are you following any other companies that you think investors should be interested in?
JB: I think the most undervalued one right now is Great Western Minerals. It just announced a breakthrough deal with an already established and successful Chinese REE processor to team up to build another REE processing facility in South Africa closer to its Steenkampskraal Mine. Great Western Minerals is the only non-Chinese future REE miner to announce such a deal. It adds a lot of credibility to the company.
TCMR: How can people get your Dragon Metals Report and find out more about you both?
KK: We actually have our own website, dragonmetalsreport.com, where people can pick up the report and watch a video interview. They’ll be able to see samples of the report before they purchase it.
TCMR: Do you have some parting thoughts on the REE space before we let you go?
KK: I really believe this is a once-in-a-lifetime trader’s opportunity. I’ve never seen a market that has so much innovation potential that we can’t even conceive of yet. I probably won’t see a market like it again in my lifetime.
TCMR: Thank you for your insights.
Kevin Kerr has had over two decades of intensive industry and trading experience as a floor trader and broker as well as an OTC derivatives broker in New York and London. He travels the globe in search of resource opportunities and is the author of A Maniac Commodity Trader’s Guide to Making a Fortune: A Not-So Crazy Road Map to Riches, which was published by John Wiley and Sons. Kevin has appeared on Cavuto on Fox, Kudlow & Co. on CNBC, The Daily Show on the Comedy Channel, Fox Business News, NBC, ABC, CNN, and many more. He has acted as an analyst and trading advisor for publications at prestigious publishers like Weiss Research, Dow Jones Newswire, and Agora Financial. Kevin’s website, www.kerrtrade.com, offers visitors his blog and video blog, media page and events schedule, and political and economic commentary.
Jason Burack is an investor, entrepreneur, financial historian, Austrian School economist, and contrarian. Jason co-founded the startup financial education company Wall St for Main St, LLC, to try to help the people of Main Street by teaching them the knowledge, skills, research methods, and investing expertise of Wall Street. You can also find Jason’s work at his blog website at www.jasonburack.com
In the rare story that ends with George Lucas not getting money, George Lucas has lost a copyright case before the British Supreme Court in which he sought to stop his former Star Wars prop designer Andrew Ainsworth, who came up with the original iconic Stormtrooper helmets, from selling replicas of his most famous work online. Lucas had successfully blocked Ainsworth from doing business in the U.S., arguing that profiting from a decades-old George Lucas creation should be the sole province of George Lucas. However, while the British court recognized that selling the helmets in America would be a copyright violation, according to the judgment there, it ultimately decided that ruling shouldn’t also apply in the U.K., as the props were considered functional, rather than artistic works.
I have two questions, one each for those who defend IP on ethical grounds (i.e. those who claim IP is a natural extension of natural rights) and for those who defend IP on utilitarian grounds (i.e. those who claim that IP is necessary to encourage innovation).
For the former: How much of the original idea is owned by Lucas and how much is owned by Ainsworth? (Note: there appears to be no clause in Ainsworth contract indicating that Lucas owned the copyright on the specific appearance of the helmets produced.) Lucas certainly came up with the concept of stormtroopers and presumably came up with an idea of how their helmets should look, but it was Ainsworth, ultimately, who came up with the specific design and idea of what the helmets would look like. How do you split natural ownership in this case?
For the latter: Given that Lucas has a net worth of over $3 billion, is collecting licensing fees from Ainsworth really going to inspire him to be more creative? Remember, the whole point of IP is to encourage creativity. Would Lucas really be more creative if he got paid a fee for every Star Wars tie-in? If not, what modifications should be made to the law to make it less detrimental to consumers?
Similarly, the kinds of innovation activities and intellectual property rights that make sense depend on available institutions and technologies. I’m happy to admit that today intellectual property (IP) is not obviously a good idea. Such property can create large “anti-commons” transaction and enforcement costs that greatly raise the cost of combining old ideas into valuable new ideas. Such costs often outweigh the social benefits of the incentives to create IP, in order to sell it. Today, it is often better to rely on other social incentives to innovate, incentives that don’t require such expensive support.
But if true, this is a sad fact about our limited abilities, not a fundamental natural law or right. You have no fundamental right to enjoy the innovations produced by others without compensating them. You owe them, at least your gratitude. Yes for now it may be best to let you take innovations freely without paying, since the alternative seems too expensive. But you have no right to expect that situation to last forever, any more than ranchers had a right to expect they could forever let their animals trample nearby farms.
The problem with Hanson’s comparison of IP rights to real property rights is that intellectual production is not tangible whereas real property is, and one can adapt another’s idea without in any way diminishing its usage by its originator. As Jefferson aptly observed centuries ago, as it is possible to use another’s candle to light one’s own without diminishing the other’s flame, so too can one use another’s idea as one’s own without diminishing the other’s usage of their idea. Taking another person’s ideas and using them does not any way prevent him from using his own ideas in whatever way he sees fit. Since using another’s ideas does not trample upon his rights, it is absurd to compare this to cows trampling a neighbor’s fields. Using an idea is not inherently deprivatory in the way that using property is, and so the comparison is false.
At any rate, since ideas are not tangible, there is no conceivable limit to their spread save for demand. Basically, demand, not supply, is the limiting factor for the production of any given idea and, as such, there is no need for prices or any other limitation of ideas. Prices indicate scarcity relative to demand, and attempting to attach prices to ideas is essentially an attempt to attach scarcity to ideas. Since there are an infinite number of ideas and production costs of ideas are close to nil (or at least so close to infinity and nil respectively that the upper bound makes a price schedule impossible), the only effect that bringing costs to ideas would be to limit something that is naturally unlimited.
Also, note that Hanson’s claims that “you have no fundamental right to enjoy the innovations produced by others without compensating them” and “you owe them, at least your gratitude” are both spurious. The first is false, but only because of how he qualifies it. He is correct in saying that no one has the right to enjoy the innovations of others. No one has the right to anything save for life, liberty, the pursuit of property, and any derivatives thereof. But it does not stand to reason that anyone deserves to be paid for what they produce, whether it be an idea or a physical object. Quite simply, no one has a right to an income of any sort. If you wish to be paid, convince consumers that you deserve it, whether it be on the technical merits of your product or whether it be on the ease of purchase relative to the cost of piracy. In keeping with this, if one does not have a right to income for producing something, then one certainly does not deserve gratitude either. Again, if a producer wants something from consumers, he must make or do something that causes consumers to respond favorably.
As can be seen, Hanson’s argument is riddled with plenty of intellectual errors, leading to erroneous conclusions. He would do well to simply acknowledge that IP is a myth, and that no one is inherently deserving of anything just because they happened to produce something.
We are richer than our ancestors mostly because of innovation. But most of the innovation benefits we receive are externalities – we only pay our ancestors (or those to whom they transferred their property rights) for a small fraction of that benefit. If we instead had better property rights for innovation, we’d pay a large fraction of our income as compensation for past innovation. That would increase incentives to innovate, the rate of innovation, and the fraction of the economy devoted to innovation. With good institutions, I could imagine more than half of all income being paid to the innovation industry.
There are several problems with this paragraph. First, as net-based pirates have shown, there are plenty of people who try to avoid paying for rights to use IP,* which invalidates his claim that “we’d pay a large fraction of our income for past innovation.” We’d likely pay more, to be sure, but given man’s tendency to avoid paying these sort of things, it foolish to say with any degree of certainty that we would pay a lot.
Second, there is absolutely no basis for saying that there would be more incentive to innovate. Since we have tried IP rights, we cannot tell what the rate of innovation would be in their absence, and cannot therefore properly compare the rate innovation under a system of IP to a system with no IP rights. Any attempt to do so is pure conjecture. Furthermore, all innovation is derivative, so even if people were more inclined to innovate more, IP law would more than likely prevent them from doing so since they would either have to license the product being innovated or be forcibly prevented from innovating.
Third, the stifling nature of IP enforcement, as noted before, would (and has) actually stifled innovation. Patent jumpers have forced people to redesign improvements because their proposed solution would infringe on their patent. This hardly encourages innovation, and it is hard to see how more of this would do so.
Alas, it is devilishly hard to design good innovation property rights. Patents are supposedly the best we have now, and they are often terrible. But over the next few centuries, we might just create better institutions (e.g., futarchy) to better encourage institution design, and within those institutions, folks may well come up with better designs for institutions to encourage innovation. Optimist that I am, my best guess is that we will succeed at this.
Perhaps the reason it is so difficult to design good innovation property rights is due to the fact that innovation is not actually property, and thus cannot be protected with rights. It is hard to see how copying someone or something diminishes them in any way. Some might argue foregone income, but this argument is riddled with errors (for one, there is no guarantee that a given consumer would have purchased from the innovator anyway, and no one has a “right” to be paid anyway).
Of course, it is possible that “society” will create institutions that actually incentivize innovation. I would bet that said institutions will consist mostly of educating people how IP is a myth, and does not deserve any form of monopoly or protection from the government.
Of course in the long run innovation must run out, and then we’ll have a long stable future with little innovation. But I expect the innovation era to last a few more centuries at least, with the best innovation yet to come.
I will deal with this in a separate post.
* Note: it is assumed that Hanson’s call for property rights on innovation either largely resembles patent and possibly some forms of copyright, at least in principle.
What is good for the U.S. economy is good for gold. John Kaiser, editor of Kaiser Research Online, has proposed a graphic model that relates the value of all above-ground gold stock to global Gross Domestic Product (GDP), thereby explaining why higher real gold prices—even with a recovering American economy—will be the new reality. In this exclusive interview with The Gold Report, he shares his projections about where both gold prices and the U.S. economy could be going in the future.
The Gold Report: Intel Cofounder Andy Grove wrote an article in BusinessWeek bemoaning the fact that U.S. entrepreneurs in both the hightech and cleantech realm have become inefficient in the return of jobs created per investment dollar basis. He said companies hire fewer employees as more work is done by outside contractors, usually in Asia. He suggested this is a problem not only for low-grade production jobs but also robs the U.S. of its innovation edge, hurting the country’s overall economic prospects for the future. Your economic research illustrates this manufacturing decline and shows the value of gold stock values over the last four decades mirroring the U.S. GDP. Why is consolidating manufacturing and research important for U.S. and global growth and how is it linked to the price of gold?
John Kaiser: A lack of physical manufacturing stifles innovation because without access to support facilities, machine shops, test labs and other resources normally associated with a full-scale manufacturing operation, creative people don’t see problems, quickly test solutions and have the ability to bring products to scale in a controlled environment. Cut off from manufacturing operations, development stalls.
The American economy is still the largest in the world with a $14.7 trillion dollar GDP followed now by China at nearly $6 trillion. The problem is that the employment structure of the U.S. economy has, in the last 30 years, shifted very much to service jobs in the healthcare, retail, financial and professional sectors, away from making physical goods, that are increasingly imported. We also have a serious oil addiction, which contributes significantly to the trade deficit as we import oil to keep our cars moving. So what are we actually shipping abroad that allows us to offset all the stuff that we import? The jobs we see in the United States today produce less exportable output. That has not hurt economic growth, but it has been achieved through a drawdown of the wealth accumulated during the last century, a drawdown that accelerated during the last decade when a huge debt expansion party bubbled through the economy. But that party ended in 2008. We have now had two rounds of quantitative easing designed to keep the economy from collapsing. In order for the United States to deal with its long-term structural debts and deficits, it needs to demonstrate that there is something American workers can do that is of value to the rest of the world. The core has to be manufacturing.
TGR: Is your argument that we should ignore the lower cost structure we can achieve overseas, bring assembly jobs back to the U.S. and start manufacturing here? Wouldn’t the cost of goods go up and spur on inflation at a more rapid pace than we’re expecting just because of quantitative easing?
JK: There could be some interim higher costs from bringing manufacturing back to the United States. However, inflation with regard to imported goods due to increasing transportation costs, higher Chinese workspace and emission standards, generally higher wages and the rising value of the Chinese Renminbi is coming anyway. We can’t wait to react until we are stuck paying their higher prices with no domestic alternative because we have lost the manufacturing and R&D infrastructure at home. We need to anticipate this higher overseas cost structure and act now.
TGR: Won’t those jobs just go to another lower-cost Asian country like Vietnam or Thailand?
JK: Those countries have considerably smaller populations and without super-automation they don’t have the capacity to absorb a large-scale influx of manufacturing capacity. If the solution is super-automation, then you are reducing labor costs anyway so why not do it in the U.S. and avoid the political upheaval that could disrupt the production? Two outcomes of the 30-year decline in U.S. manufacturing are that the power of labor unions has diminished, and much of the legacy manufacturing infrastructure has disappeared. To a large degree American legacy production methods were simply shifted overseas where there was an abundance of cheap and willing labor. If manufacturing is to make a comeback in the U.S. it will be in a highly automated form with newly trained employees drawn from the younger generation, not the current boomer generation or their near-retirement parents. If boomers hope to receive their entitlements when they retire, it cannot be paid for by taxing young workers doing little more than fulfilling those entitlement expectations through service jobs.
TGR: Is supply chain and geopolitical security part of what’s driving this consolidation of research and the manufacturing?
JK: Yes. Long term, as China becomes stronger, it will flex its muscles. It’s just refurbished an old Soviet aircraft carrier so that it can park itself in the South China Sea and exert its military presence. If the United States ceases to produce anything, it will become irrelevant and lose influence anywhere in the world.
TGR: Are major companies bringing manufacturing back based on the reasons you just outlined?
JK: Yes, one example is Boeing, which is way over budget and delivery deadline on its new generation of composite materials-based 787 Dreamliner airplanes. Because the company had outsourced construction of every component, including design, the pieces didn’t fit during the assembly process in Seattle. It didn’t work. The company is now looking at changing its outsourcing strategy by developing a centralized industrial park in which its subcontractors will be required to have a physical presence. That way engineers can see first hand if a piece fits.
TGR: Does that mean consolidation of design and manufacturing domestically will be driven by private enterprise operating in their best long-term interest rather than the government mandating it though trade tariffs?
JK: Yes. Protectionism in the old style is not going to fly. Instead, individuals and companies will have to voluntarily adopt total cost accounting. Instead of just looking for a cheap price, consumers will have to consider all the costs associated, including safety standards, environmental factors and sustainability. By adding in the costs that have literally been dumped on somebody else, we do the responsible thing. We have to stop being parasites, hurting others for our own cheap goods. This total cost view will create jobs and make the country stronger in the long run.
From a corporate perspective, the opportunity cost posed by supply chain disruptions needs to be factored into the cost-benefit analysis before they happen, not just ignored and then suffered when natural disasters or political upheavals happen overseas such as recently happened in Japan. If we stop assuming eternally cheap transportation costs, building and operating factories close to destination markets starts to make sense. It’s also time to ditch the narrow-minded self-interest of the libertarian school and borrow a page from Henry Ford’s book of enlightened self-interest: if you want consumers to buy your product, they need to pay with money earned through productive jobs, not entitlement spending.
TGR: While we’re talking about consolidation and the global shift, please comment on the Barrick Gold Corp. (TSX:ABX; NYSE:ABX)/Equinox Minerals Ltd. (TSX:EQN; ASX:EQN) deal. You predicted gold in the thousands last year. Why do you think Barrick Gold purchased Equinox Minerals, a copper play in Chile, when gold is at an all-time high right now?
JK: First, gold is not at an all-time high in inflation-adjusted terms, which would be about $2,300 using the $850 peak in 1980 as a base. It is only two-thirds of the way to an all-time high. But if we use $400 where gold settled in 1980 as a base, the inflation-adjusted price is about $1,024. That means today’s gold price of $1,500 is about 50% higher than in 1980 in real price terms. But rather than look at the gold price, I look at the value of the above-ground gold stock. About 3.2 billion ounces (Boz.) existed in 1980; today that number is about 5.8 Boz. It is remarkable that during a 30-year period the mining industry nearly doubled a gold stock, which had taken several thousand years to build. This was possible because between 1970 and 1980 gold underwent a tenfold price increase. That equaled a 500% real increase for a mining industry locked in a $35/oz. mindset. Once gold was released from its monetary prison, it established a new relationship to the value of the global economy expressed in U.S. dollars, which I have graphed.
Models are based on each country’s GDP converted into U.S. dollars. While a 50% devaluation of the U.S. dollar should not change the nominal U.S. GDP, the U.S. dollar GDP of all other countries would rise, boosting global U.S. dollar GDP sharply to $110 trillion without any real growth. That would translate into a $2,100/oz. gold price if the gold stock stays valued at 10% of global GDP. Of course, the cost of everything would increase correspondingly and gold companies would be no better off than they are now at $1,500 gold. The model also accounts for the inflation of the gold stock through mine supply. A higher real price will boost gold production, which CPM Group projects as growing from 83 Moz. in 2011 to 103 Moz. by 2016.
I took the above-ground stock of gold that existed in each year and multiplied it by the average price of gold during that year to get the value of all the gold that existed in each year. Then I divided it by the nominal GDP of the world for each corresponding year. That produces an interesting chart. It shows gold going from about 3% of GDP in the 1970s to a peak of 20% during the 1980 bubble and then crashing all the way back down to 4% in 2002 at the bottom of the gold market. Now it is 10%, which is about halfway to what you might regard as a bubble peak. I think gold will stabilize at these levels and go up as GDP grows.
The International Monetary Fund is predicting that our $62 trillion GDP from last year will be almost $90 trillion globally by 2016. So, if you take 10% as the norm, gold should be stable within a $1,400/oz. to $1,700/oz. range over the next six years. That’s a sustainable price assuming the world is growing. Growth would also result in increased copper demand. Barrick is diversifying its revenue base and treating both gold and copper as commodities. Copper, because it is mined to serve as a means to an end rather than as an end in itself as is the case with gold, does not have the arbitrary price volatility of gold. If suddenly the world decided it didn’t need the gold anymore and wanted to convert it into some other form of asset, it would be worth a lot less. Because copper is useful for construction, there is a limit as to how low it can go. Barrick sent a signal that it thinks the global economy is going to grow, that we are not dealing with either a looming depression or hyperinflation. I welcome that because it means gold and copper will have a strong future for the next five years.
TGR: Do you foresee more mergers and acquisitions in precious metals? Is this the start of a trend?
JK: Yes. As companies focus on advancing projects, it will take large capital investment. It will be difficult for a stand-alone project to raise $500M+ without being absorbed by a bigger company that already has production in place and is generating cashflow. This is an opportunity for large, liquid companies to acquire these assets without paying a big premium, particularly if it uses its paper as currency. It is a one plus one equals three situation because as the acquiring company diversifies its revenue base, its catastrophe risk declines. As the market gets more comfortable with gold at current levels, we will see mergers and acquisitions step up and more money coming into the market.
TGR: So, you see economic growth as price drivers for both gold and copper?
JK: In the case of gold, yes. In the case of copper, the question is whether $4 copper is the new reality on which we can base mine development decisions, given a low inflation scenario. The key thing that has happened in the last decade is that China has become a significant economic force. It has now displaced Japan as the second-largest economy with a billion-plus population base and relatively low per-capita GDP. It could grow substantially and eventually become larger than the U.S. economy. But, China is still an unusual political entity; it is a hybrid communist-capitalist country. As they get stronger, we have no idea how they will behave on the global stage. Therefore, people are shifting capital into gold as part of their long-term security plans. As GDP grows, it will probably grow faster than the ability to bring new gold supply on stream. Therefore, gold will rise in price as it tracks the strength of the global economy.
TGR: If you’re expecting the price of gold to track nominal GDP, which is growing 2% to 4%, won’t you see money coming out of gold and going into equities that would probably represent a higher potential return?
JK: All the gold in the world is about 5.3 Boz., worth about $8 trillion. That’s really a fraction of the estimated net worth of all other assets, which is about $130 trillion. Most gold is held as a long-term asset. So even if the crazy gold bugs start selling to buy stocks, they are a small minority and won’t make a huge difference. I believe the value of gold stock as 10% of GDP is a reasonable level. Make it a lot higher and gold owners will look to convert it into other assets such as land, buildings, resources and dividend- or interest-yielding instruments capable of generating a cash flow as opposed to a capital gain. What would the new owner’s reason be for buying? The only return generated by gold is psychological stress relief. However, if gold prices surge to 20% of GDP as it did in 1980, it will be because of an unstable global situation. Under such conditions, gold ownership is not likely to offer much stress relief, especially if government confiscation or a breakdown of law and order become risks. At 20% of GDP, the value of the gold stock would imply a price of about $2,400 in real terms (as opposed to a price rise generated by excessive inflation or a major devaluation of the U.S. dollar against other currencies). In 1980, when gold was 20% of GDP, some thought the United States had reached the end of the line. But the United States survived that crisis and went on to win the Cold War, unleash globalization and accelerate time through the Internet communications revolution. Short of a calamitous collapse in China, I see the center of gravity for global economic and military power gradually shifting away from the United States during the coming decades. On the other hand, I do not see the value of the gold stock dropping back to 5% of GDP because this would require a major decrease in our uncertainty about the future global order.
TGR: What does this mean for silver? Both gold and silver had a setback recently.
JK: Silver has been the worst performing metal for decades. What it’s doing now is a bit of a catch up. Although most of the above-ground silver stock of 46 Boz. is fabricated into some useful form, unlike gold, silver is gaining popularity, especially in emerging economies. The above-ground silver stock value went from 1.5% of GDP in 1970 to a peak of 6% in 1980. But by 2002 the silver stock was worth only 0.5% of GDP. Right now it’s between 2% and 3%. I believe silver can parallel gold’s role as a hedge against the uncertainty associated with the long-term relative decline of the United States and the gradual disappearance of the U.S. dollar as the world’s reserve currency. If we assume the silver stock will establish a value as 3% of global GDP, the price will base out in the $30–$40 range this year, which will grow to $47–$57 by 2016. If it goes to $100/oz., that would indicate a bubble reflecting the inflation-adjusted equivalent of the $50 peak in 1980. Because the recent price growth looks exponential, the markets have fought back and a bear attack is pushing silver back down. But I believe $30–$50/oz. will be the new long-term reality, which opens up some good buying opportunities among silver companies in the next couple of months.
TGR: Since the pullback is happening right now and it has been pretty dramatic, wouldn’t the buying opportunity be now? What will be different in two months?
JK: I’m not a big fan of catching falling knives and anvils. I like to see them bounce around first so I know they’re not going to hurt me. Especially this time of year, it might be best to see where silver and gold stabilize.
TGR: What do all these new economic drivers mean for gold, copper and silver mining companies? And what companies could capitalize on these changes?
JK: Well, the pessimism embedded in the market right now about the U.S. economy and, ultimately, the global economy that still very much depends on the U.S. economy, has discouraged the market from taking current metal prices seriously. If you plug in $1,500/oz. gold and $4/oz. copper into the discounted cash-flow models for these development projects, you get some very sexy numbers compared to what the stocks are trading at. For example, take Geologix Explorations Inc. (TSX:GIX). It has the Tepal Project, a copper/gold play. It’s not super high grade or very large. But, right now the stock’s trading below $0.50. Conservative numbers like $2.75/lb. copper and $1,100/oz. gold result in a value of about $1.10 a share, which is not very exciting. But plug in current prices, $4/lb. copper and $1,500/oz. gold, and the target blossoms into the $3/lb.–$4/lb. range.
We see this across the board, an unwillingness to plug current metal prices into the valuations because of an assumption that we’re going to see copper back below $2/lb. or gold back to $1,000/oz. And, yes, if we end up in a global depression we will certainly see the metal prices go back down. But I see the global economy trending upward, causing gold and copper to stay strong, thereby leading to an inflection point when the market realizes this pessimistic attitude is all wrong. Then the market will take these prices seriously and put capital into mining projects to mobilize new metal supplies. The problem with mine development is it takes three to five years to realize. That is why we need to start going after these huge profit margins now instead of perpetually waiting for signs of an enduring recovery. The irony of the inflation we are seeing in raw material prices today, which threaten to destabilize emerging market economies, is that it is due to the reluctance of capital markets to take the IMF GDP growth projections seriously and deploy capital to mobilize new mine supply.
TGR: What companies are making those investments today?
JK: Sandspring Resources Ltd. (TSX.V:SSP) is an example. It started off as an alluvial gold operation in Guyana. The company ended up going public and raising capital to focus on the bedrock potential, thereby developing a large gold resource with a minor copper credit. Sandspring just completed a preliminary economic assessment using current pricing that suggests the project is worth about $900M. Yet the market valuation is about $300M. That gives you three to five times upside potential if there are no glitches in the pre-feasibility study and current metal prices get nailed to the wall.
Exeter Resource Corp. (TSX:XRC; NYSE.A:XRA; Fkft:EXB) is another example. The company discovered the Caspiche deposit in Chile. It has a large copper resource. It also has a low-grade gold-oxide resource on top. The copper resource is too big for Exeter to develop on its own and in view of the capital cost escalation being suffered by similar large deposits bought out before the 2008 crash and the skepticism that $3–$4 copper is the new reality, Exeter will have a hard time attracting a buyout by a major in the near term. So, to create value while it bides time, the company is now focusing on developing a gold-oxide leaching operation to take advantage of the 1.4 Moz. resource sitting on top of this system.
TGR: Any other companies that could take advantage of the new pricing reality either in the gold, the copper or the silver area?
JK: Grade is very important in the gold sector. Last year Osisko (TSX:OSK) took over Brett Resources Inc. (TSX.V:BBR) and its Hammond Reef Deposit in Ontario, which is just under 1 g/t and about 7 Moz., at about $4. Now that the market is getting more comfortable with the idea of gold north of $1,200/oz., other similar low-grade projects are looking attractive.
Northern Gold Mining Inc. (TSX.V:NGM) is an example. The company’s 700 Koz. Garrcon Project wasn’t very interesting when gold was below $1,000/oz. But, at current prices, the company has an incentive to do step out drilling and lower the cutoff grade in an effort to boost that resource to a 2 to 4 Moz. Open pit mineable. This $40M market cap company could undergo a fivefold increase if Northern Gold triples the resource and delivers a positive prefeasibility study.
TGR: Are you saying that whether we are in a depression as some believe or a recovery as you have outlined, we’ve already seen the floor of $1,200/oz. for gold and these companies are a low-risk return investment?
JK: Not exactly. In the scenario where gold rises because the American economy is in a death spiral, the solution is to pursue a hyperinflation strategy that results in costs rising in conjunction with the price of gold. So, that is of no benefit to the companies. If the alternative is to just curl up in a fetal position and suck one’s thumb and prepare for the end, that will result in gold prices going down. The best alternative for resource juniors is if the world avoids both a deflation-linked depression and hyperinflation scenarios, the American economy gets back on track with a revival of manufacturing on U.S. soil and the global economy continues to grow. That will be good for raw material demand and gold and silver prices.
TGR: Thanks, John. Enlightening as always.
John Kaiser, a mining analyst with over 25 years’ experience, is editor of Kaiser Research Online. He specializes in high-risk speculative Canadian securities and the resource sector is the primary focus for an investment approach he developed that combines his “bottom-fishing strategy” with his “rational speculation model.” Kaiser began work in January 1983 as a research assistant with Continental Carlisle Douglas, a Vancouver brokerage firm that specialized in Vancouver Stock Exchange listed securities. In 1989 he moved to Pacific International Securities Inc., where he was research director until April 1994 when he moved to the United States with his family. He launched the Kaiser Bottom-Fishing Report (now Kaiser Research Online) as an independent publication in October 1994 and developed it into an online commentary and information portal. He has written extensively about the junior resource sector, is frequently quoted by the media, and is a regular speaker at investment conferences. Since 2008 he has developed a focus on security of supply issues and how they relate to critical metals such as rare earths.