I’ve found many people are particularly energized about predicting a hard landing for China’s economy, but I believe the country is no sinking ship. China isn’t fast-approaching an iceberg in the dark of the night like the Titanic. Beijing has long been anticipating the ice chunks and subtly adjusting the rudder around inflation without steering the economic ship too far off course.

China’s government angled its vessel away from inflation by increasing the required reserve ratio (RRR) every month for the first six months of 2011 and raising interest rates three times. Once inflation was sufficiently under control, the country began to steer in a direction of growth again.

Recent results show how positive this easing has been. In its latest research this week, BCA Research reported that despite the policy tightening of 2011, the “most recent economic data out of China has all but confirmed that the economy remained incredibly resilient.”

One significant data point is the sharp increase in money supply. After the country hit a low level of monthly money supply growth, the three-month change in M-2 money supply climbed to record levels during the final month of the year, says Greg Weldon of Weldon Financial. He says that money supply “pegged at +6.419 trillion, easily exceeding the previous record 3-month increase, seen at the peak of the global crisis, in March of 2009.

Easing in China is expected to continue through 2012, with ISI Group anticipating a potential RRR cut after Chinese New Year celebrations in February, then possibly again in April, June and August. Also, loans “have become more readily available in recent weeks,” says ISI. This should all be bullish for commodities, such as copper, oil and gold, and also trickle down to boost share prices of natural resources equities.

Chinese Copper Inventories Increase

Base metals were the laggards among commodities last year, with copper one of the worst performers, losing 21 percent.

Global consumption of copper increased only 4 percent in 2011, which is lower than the 10 percent growth in 2010, but higher than the decade-average of around 3 percent, says Macquarie Research. China’s consumption of copper—which makes up 40 percent of the global demand—was a primary reason for decreased consumption, as the country was drawing down on its own supply throughout the year.

This can’t continue forever, Macquarie says, adding that “demand made on new supply direct from producers would need to rise, with positive implications for prices.” Europe’s largest copper fabricator agrees with that sentiment, indicating that it anticipated China’s copper demand would be strong in 2012, according to Barclays.

A recent rise in copper imports is likely the result of restocking China’s depleted copper inventories. As is typical for China, after the metal fell in price last fall, the world’s largest buyer of the metal advantageously scooped up copper to replenish its cupboard, says Barclays Capital. As shown below, copper inventories into China reached a record low in 2011, but have sharply reversed recently.

An increase in copper demand places pressure on the supply side, which continues to experience shortfalls in mine output versus forecasts. These are caused by a variety of factors, such as weather, labor strikes, or simply a poor grade deposit. While Macquarie says there’s a possibility the world’s two largest copper mines, the Los Bronces mine in Indonesia and Peru’s Escondida mine, could deliver year-over-year increases in production, it concludes “it is highly unlikely that miners will succeed in delivering this level of additional output in total.”

While Chinese demand growth for commodities is not expected to be as robust as it has been historically, demand is expected to pick up throughout 2012. As confidence returns, Macquarie says there should be “a slow gradient of recovery in the near term before gathering pace into the mid-year.”

Increasing Reliance on Energy Imports

China’s rapid growth and increasing reliance on other countries for key resources has made a powerful case for commodities over the past several years. These three charts from BCA Research illustrate that once the country shifted from exporting to importing a commodity, there was no looking back.

You can see in all three how dramatically the energy balance has shifted to an ever-increasing dependence on imports. In each major commodity, after China began importing, growth took off.

China became a net importer of crude oil in 1994, and today, is the second-largest oil importer in the world. BCA forecasts the country is expected to surpass the U.S. as the largest oil importer in only a few years.

To obtain more natural gas, China spent years building massive pipelines to transport the commodity from Russia and other western Asian counties, and since 2006, natural gas imports have “gone vertical,” says BCA.

Coal, which accounts for the majority of total energy consumption in China has also been imported since 2008, and since that time, imports rose substantially.

Even with these imports, energy consumption is only a fraction of developed countries. The China story is just getting started: Urbanization just surpassed the 50-percent mark, hitting what I believe to be the pivotal moment that dramatically shifts buying patterns, driving an enormous demand for housing, consumer staples and durable goods. You ain’t seen nothing yet!

Happy Chinese New Year!

This weekend, the world’s largest annual migration takes place. Millions of people in China head home to celebrate Chinese New Year and welcome in the Year of the Dragon. U.S. Global Investors’ research analyst and Shanghai native Xian Liang recently talked about the significance of the dragon in Chinese culture:

“Unlike its western counterpart portrayed as evil, the Chinese dragon is an imaginary, mythical creature. Its body parts are from nine animals, including the horns of a deer, mouth of an ox, nose of a dog, trunk of a snake, and claws of an eagle. It has auspicious power because it can make itself invisible or visible at any time. It can both fly and swim. It makes clouds and rain. Because of these magnificent things, the dragon is associated with royal powers as well.”

After bounding through a tough Year of the Rabbit, we anticipate the Year of the Dragon will breathe fire back into Chinese markets in 2012. Kung hei fat choy!

Regards,

Frank Holmes,
for The Daily Reckoning

P.S. For more updates on global investing from me and the U.S. Global Investors team, visit my investment blog, Frank Talk.

It May Take a Dragon to Breathe Fire Into Markets originally appeared in the Daily Reckoning. The Daily Reckoning, published by Agora Financial provides over 400,000 global readers economic news, market analysis, and contrarian investment ideas.

Also of interest is the fact that the price of crude oil has been trending higher, even while the prices of most other commodities have been drifting lower.

The US is the world’s largest consumer of oil. It’s not growing much. Yet there oil sits, with a three-figured handle. I think it is a sign that challenges on the energy front will prove more stubborn than in the past.

One day last week, I found it interesting that the main two financial dailies I read every morning both featured special pullouts on energy.

The Financial Times report had a number of good nuggets:

• This is the first year the average oil price is $100 a barrel. In real terms, it’s the highest oil price since 1984.
• US consumers are on track to spend $200 billion more on oil this year than in 2010.
• Exxon Mobil’s capital spending budget for the first 9 months — $26.7 billion — was a record.
• Supply is tight; production from non-OPEC countries (such as Russia) has been disappointing.
• The US is an exception. It is reversing a four-decade decline in production and imports are down to 50% of consumption, instead of 60% as recently as 2005. (Canada is increasing production, too.)
• Tight government budgets are leading to lower subsidies for alternative energy. The brunt of this will be felt most acutely in Europe.
• China is the exception; subsidies for alternative energy have actually increased there.
• The nuclear renaissance is still a long way off. One article discussed the various phase-outs going on around the world.
• There is a new enthusiasm for LNG tankers.

Consider the portrait these bullets paint. To me, they speak to the challenge in producing enough energy to make a dent in prices. There are also some opportunities in these bullets — producing good old-fashioned oil still looks to be a good business.

The Wall Street Journal called its report “Big Oil Heads Back Home.” Some main points:

• Oil is shifting its attention from the Middle East to the West — oil sands in Canada, deep-water oil in Brazil and the Gulf of Mexico and shale oil in the US.
• By 2020, shale oil and gas will make up a third of US production, which could shift power away from OPEC. (The Saudis are worried.)
• Smart grids are coming. There was an article about energy-monitoring devices and other means to increase efficiency and save money.
• Interesting article on Churchill County in Nevada, which is enjoying a boom in geothermal energy.
• Biofuel companies are getting into other markets, selling stuff for skin care and beauty products. (Biofuels, like other renewables, are in trouble.)
• US battery companies are having a hard time trying to survive as they get strong competition from overseas and the adoption of electric vehicles remains slow.
• Townsville, Australia, plans to lay a cable to take hydropower from Papua New Guinea, some 600 miles away.
• How China slowing its nuclear program over safety worries is creating opportunities for some firms.
• How “clean coal” is a boon to companies selling filters and other means to reduce emissions.

This report was more focused on the ways in which people are changing their behavior, about how people are figuring out new ways to create energy and to get it where it needs to go. It’s also more about the frontiers of energy and how they will contribute meaningful slices to the pie.

It also makes me think about how energy is as much about place as it is about any particular source. In Nevada, they can tap geothermal. In Australia, they are trying an innovative way to tap a river in Papua New Guinea for hydro-power.

You can’t really say geothermal is a great energy source. It is in some places, yet it won’t work in others. Ditto, hydro-power. But these stories show you how innovative people can be. And they show you how things can happen that no one would’ve guessed even a handful of years ago. I mean, US oil and gas production up enough to threaten the Saudis? That would’ve been a surprising prediction not too long ago. Yet it’s happening.

These stories also show how political energy is. Everywhere. Government policy has a big impact on the energy mix pursued. Big subsidies for solar, particularly in Europe, essentially built that industry to a point it would never have reached without the help. But now, with austerity measures and tight budgets, a shift in policy can destroy it.

An energy investor has to keep an eye on a lot of things. Technologies change. Consumer patterns change. Government policies change. But the overall backdrop is pretty strong for the producers of energy. The most powerful evidence is the most obvious: Amidst all the turmoil and slow growth in the big markets of the US and the EU, oil is over $100 a barrel.

Regards,

Chris Mayer
for The Daily Reckoning

$100 – The New Floor for Crude Oil originally appeared in the Daily Reckoning. The Daily Reckoning, published by Agora Financial provides over 400,000 global readers economic news, market analysis, and contrarian investment ideas.

That’s the curious thing about water. There always seems to be either too much of it or not enough. What follows is another look at my favorite commodity and the opportunities of investing in it.

At breakfast at the Raffles in Phnom Penh, I read a story about how Levi Strauss is trying to minimize its water use. A pair of blue jeans will consume over 900 gallons of water in its lifetime. That includes everything from the water to irrigate the cotton crop to multiple washings of the jeans.

The pressure is mounting on Levi, and other companies, to reduce their water footprint. Miners, food companies, tobacco companies and beverage makers all face pressure to use less water. In many places where they operate — such as India or China or Africa — fresh water is in short supply. This forces a re-examination of everything — from favoring drought-resistant crops to creating new ways to sanitize things.

Companies are also looking to use all of this to their advantage in marketing. Imagine idyllic farms in India with a smiling farmer using new efficient irrigation methods financed by Levi Strauss. However it may reflect reality, such an ad would appeal to the feel-good consumers of today.

The one part of the story that caught my eye was on a 15-acre cotton farm some 90 miles west of Mumbai. The farmer uses drip irrigation, a method of delivering water and fertilizer piped through veins spread over his fields. It’s vastly more efficient than flood plain irrigation, as the water gets right where it needs to go. There are also fewer weeds and less need for power, a not small consideration in a country in which periodic blackouts, however brief, are as common as flies. The farmer reports his water use is down 70% since using drip irrigation.

A group called the Better Cotton Initiative installed the irrigation equipment. The founders are a group of organizations and retailers, including Gap, Ikea and Adidas. Ikea hopes to use only “better cotton” by 2015. Adidas promises to do so by 2018. You can see how this is appealing to the companies.

There was a time when US companies didn’t really want to know what went on in their factories overseas. That time has passed, probably for the better. In an age when any competitive edge can be a difference-maker, why not try to gain an edge in customers’ minds this way and do some good for the world in the process?

The market is saying it approves. Early research indicates customers like to think they are changing the world for the better. Products that meet that need will enjoy an edge over those that don’t.

Given all of this, I think it is a profitable exercise to think about what kinds of companies benefit in such a world. What kinds of companies enable such a world? As it turns out, there are plenty of them.

Water is a $500 billion industry. You could break that into two giant buckets.

The first is water infrastructure. These include the water utilities — some 250,000 of them globally. These are necessary assets of vital importance wherever they are. They absorb a steady amount of spending that tends to be pretty resilient, regardless of what’s going on in the economy. Population growth drives the creation of new utilities every year. See the chart below on US water and sewer construction spending.

If anything, we’ve underinvested in these facilities over time, leading to leaky pipes and contaminated water. There will be a lot of pressure here to gain efficiencies.

The second big bucket is applied water. You can think of this as irrigation and industrial water uses (such as those used in the manufacturing process). Irrigation is a big one, representing some 70% of applied water use.

Emerging markets play a big role in all of this. Just over the next five years, China alone will spend nearly $50 billion on water, mostly on water treatment systems and flood control projects. In India, there are plans for 30-plus power plants by 2017 — all of which will use heavy amounts of water for cooling. India also has large irrigation projects on the docket, which will divert rivers and soak parched farmland. In Africa, where mining companies are busy cracking open the earth to get at much-sought goodies, there will be a great need to manage the water use of these projects.

As you can see, water touches almost everything — from energy and mining to basic food production and manufacturing. You want to talk about shale gas and the great revolution in American energy? Well, water management is going to play a big role there — testing it, filtering it, recycling it. You want to talk about feeding 9 billion people by 2050? We’re going to need to manage our water assets more intelligently. You want to talk about technology? New smart phones, computers and lifesaving drugs? All of the companies that make these things use tremendous amounts of water. And they need the water to be pure and meet strict standards.

The beauty of water as an investment theme is that “inevitables” power these trends. There is really no way to get around it. If you think about the pressures applied by population growth and urbanization, you can readily see how important efficiency and sustainability will be.

You don’t have to get a lot of things right, either. You don’t need to know what the world’s favored energy source will be in the future — coal, natural gas, nuclear or alternative energy — it doesn’t matter. They all use water, and lots of it.

Water was the key theme that kicked off my Mayer’s Special Situations newsletter in the summer of 2006. The original Blue Gold Portfolio unveiled five stocks with exposure to powerful trends emerging in water — the need to purify it, preserve it and move it. That portfolio delivered an 87% return in its first year and has been a solid winner ever since. We’ve added names since then and over time have sold off some or watched them get bought out. Now only two stocks remain, both part of the original set.

Water remains one of my most favorite investment sectors.

Regards,

Chris Mayer,
for The Daily Reckoning

Water – Still Blue Gold originally appeared in the Daily Reckoning. The Daily Reckoning, published by Agora Financial provides over 400,000 global readers economic news, market analysis, and contrarian investment ideas.

My friend Brad Farquhar is the co-founder and vice president of Assiniboia Capital, which invests in farmland. We had just driven through a canola farm some 50 miles outside of Regina, Saskatchewan. And apparently, the canola crop can get sucked in the car engine and cause a fire.

Worried about a smoky smell, we pulled over to check it out. But we were clean.

You may recall I wrote about Brad and canola investing in the August 2010 issue. (Note: Assiniboia’s canola partnerships are open only to non-US citizens. Blame the SEC and IRS for the draconian rules they impose.) What follows is an update, plus, a pair of new ideas from my Saskatchewan field trip.

The yellow flowers of the canola plant dotted the Saskatchewan prairies while I was there. The plants were full and tall under deep blue skies. Prices for canola are healthy. “This should translate into a net return to investors of between 20-25% for this year,” Brad told me. “We won’t know the final numbers until the crop is completely harvested and shipped, but about 80% of the variables are now removed. The final results may even edge up a bit more as some pretty good-looking fields get combined.”

Last year was a tough year, a kind of worst-case scenario. Excessive rains soaked the prairies. It tested Assiniboia’s business model, which aims to keep risks low by using crop insurance to cover the downside. The partnership broke even, a victory given the conditions. In a best-case scenario, the partnership could double its money in a season. Not a bad set of outcomes.

I like these kinds of ideas, and not only for the payoffs. Whatever happens in Europe
or in the debt markets, the intrinsic usefulness of farmland and food crops seems to offer a relative safe house — with a good shot at making a lot of money as well.

There is another reason, though, to favor such assets. It has to do with something called EROEI, which stands for “energy return on energy invested.” It is an expression of the idea that it takes energy to create energy.

Stephen Johnston at Agcapita is another one doing similar activities up here. I know Stephen as well, and he pens an interesting free monthly letter. (You can get it here.) In his September letter, Stephen talked about “EROEI decay.”

“I feel confident that EROEI is an acronym that will receive much wider recognition over the next decade,” he writes. “Because we are in the process of transitioning from high EROEI sources of hydrocarbon energy to low EROEI sources — think Saudi Arabia versus the Alberta oil sands.”

Stephen points out that more and more of our energy is coming from sources that require more and more energy to extract. He gives us some approximate EROEI ratios for various energy sources:

1970s oil and gas discoveries: 30 to 1
Current conventional oil and gas discoveries: 20 to 1
Oil sands: 5 to 1
Nuclear: 4 to 1
Photovoltaic: 4 to 1
Biofuel: 2 to 1.

Currently, the world produces around 86 million barrels of oil per day. But 86 million from high EROEI sources is much different than 86 million from less-efficient sources. “Effectively,” Stephen goes on, “the net energy left over to drive economic growth is significantly lower in the latter scenario.”

Why does this matter? Simply put, a lower mix of EROEI sources means higher prices for many commodities, because it will take more energy to produce them. This doesn’t automatically mean commodity producers win, however, because people can adjust their behavior.

For instance, when gasoline prices get too high, people cut back on their driving and find ways to save on gasoline. Economists call this the “elasticity of demand.” It means that demand can give and bend, like an elastic band, limiting how high prices will go.

But not all commodities bend so easily. Food is one. EROEI predicts higher food prices, because modern agriculture depends heavily on fossil fuels for irrigation, fertilizers, herbicides, storage and transportation.

Stephen gives examples. The most striking is with irrigation. “Irrigation accounts for approximately 20% of US farm energy use,” Stephen writes. In areas where water is scarce, such as in India, over half of all farm energy use simply drives irrigation pumps.

So in a world in which EROEI is on the decline, those assets with lower energy intensity will enjoy an advantage over less-efficient competitors. Might Canadian prairie farmland, which has no need for irrigation and low fertilizer needs, thrive in such a world?

I believe so. And this is one reason I’ve directed readers of my Mayer’s Special Situations letter toward investments in the province. Most of my field notes on Saskatchewan wound up in that letter, because we own a pair of companies based there.

One is a company called Viterra. It is one of my favorite long-term agribusiness holdings. Viterra processes grain, getting it from the farm to markets worldwide, as well as storing grains in a network of silos and sheds. It also sells seed, fertilizers and equipment to farmers. It also turns raw materials into animal feed and food ingredients. The stock is under my buy price of C$11 per share and trades for about 12 times earnings.

Viterra’s headquarters are in Regina. In fact, its main building was only a few blocks from my hotel. But it has a global presence with trading hubs, terminals and processors in Asia, Australia and Europe.

I like Viterra as a play on Saskatchewan’s bountiful harvests. And recent market woes have put the stock on sale.

Regards,

Chris Mayer,
for The Daily Reckoning

Crack This Code: EROEI originally appeared in the Daily Reckoning. The Daily Reckoning, published by Agora Financial provides over 400,000 global readers economic news, market analysis, and contrarian investment ideas.

Unfortunately, the weakest link of all-electric powertrains is the energy storage medium: batteries.

Even with the best technology available, batteries are expensive and bulky and have a low energy density. The result is more-expensive vehicles with lower range between fill ups. Since batteries can’t be topped off in a few minutes like fuel tanks can, the ability to easily extend range also suffers.

Innovators are taking a look at some of the oldest-known technologies as alternatives to batteries. In a sense, they are reinventing the wheel — the flywheel, that is.

The flywheel idea is an old one that dates back to the potter’s wheel: A heavy wheel was used to store rotational energy so that the potter could form symmetrical shapes out of clay.

Unlike batteries, which are a chemical form of energy storage, flywheels store energy mechanically in a rotating device. Flywheels can store more energy than batteries in a package a fraction of the size.

Flywheels were used as a form of energy storage in Swiss “gyrobus” electric buses of the 1950s. Developed for use on bus routes where overhead power lines weren’t available, gyrobuses charged their mechanical “batteries” at passenger stops or terminals.

At these stops, the buses would connect to an electric power source and a motor would spin the flywheel at speeds up to 3,000 revolutions per minute. Upon leaving the stop, the motor would act as a generator instead, using the stored spin energy to deliver electrical power to motors driving the wheels. On a full charge, gyrobuses could travel 3.7 miles at speeds of up to 37 miles per hour.

Unfortunately, flywheel energy storage has had its shortcomings. Energy losses from friction limited the utility of the concept. Older flywheel designs used mechanical bearings and conventional materials, which curtailed the speed at which the wheels could be spun. Since the flywheel housings themselves weren’t vacuum sealed, there were also significant friction losses from spinning against atmospheric gases. However, new technologies are addressing these problems, and there is a resurgence of interest in the concept.

Formula One racing teams, for example, have been using a flywheel-based Kinetic Energy Recovery System (KERS) since 2009. KERS uses a flywheel to recover deceleration energy lost through braking. When the F1 race car exits a sharp turn into a straightaway, the energy, stored in a flywheel, can be released for higher acceleration. The driver has a special boost button he can engage whenever he wants an extra burst of power.

The original 2009 design, named Flybrid, was made of a steel/carbon fiber composite rotating at 60,000 rpm inside a vacuum chamber. The unit is good for 80 horsepower over a period of 6.67 seconds per lap and can decrease the time spent on a lap by up to four-tenths of a second. Four-tenths of a second is make or break in the highly competitive sport. Furthermore, since there is no energy conversion loss as in battery-based recovery systems (which must convert kinetic energy to electrical and then back again), the system is inherently more efficient.

Flybrid and Torotrak PLC, which is the licenser behind much of the technology in the F1 KERS system, is partnering the technology with major automakers. Volvo, for example, is looking at taking flywheel energy storage beyond the race circuit and into everyday automobiles.

Thanks to advanced materials technology, the flywheel Volvo is testing weighs a mere 13 pounds and has a diameter of only 7.8 inches. It also spins in a vacuum to minimize friction losses.

Volvo believes it can be produced at a much higher volume than the battery-based energy recovery technology used in today’s crop of hybrid vehicles. Knowing what we do about resource constraints (whether real or politically caused) affecting the mass production of rare earth permanent magnet motors and lithium-ion batteries, this is a big deal.

According to Volvo, flywheel technology has the potential to deliver double-digit gains in fuel economy and makes a four-cylinder car feel like a six-cylinder.

You may have played with friction-motor toy cars as a child. I had one with a flywheel you would wind up with a zip cord. Once set down on the floor, it would zip to the opposite end of the room. These days, the concept is expanding into more practical uses. Volvo plans to demo a flywheel-enhanced vehicle this fall, and in a few years, your next vehicle might feature the technology.

Regards,

Ray Blanco,
for The Daily Reckoning

Reinventing the Wheel for Greater Energy Efficiency originally appeared in the Daily Reckoning. The Daily Reckoning, published by Agora Financial provides over 400,000 global readers economic news, market analysis, and contrarian investment ideas.

“China is temporarily shutting down most of the industry,” reports The New York Times — closing or nationalizing dozens of rare earth producers.

Considering China already accounts for 97% of world production, that’s putting a squeeze on the producers of everything from wind turbines to hybrid car batteries to ballistic missiles. Oh, and those new compact fluorescent light bulbs.

Betcha didn’t know this contains rare earths…

The average price of a CFL bulb has jumped 37% this year, according to the National Electrical Manufacturers Association.

The increase comes before a federally mandated phase-out of old-fashioned incandescent light bulbs. Come next year, the 100-watt incandescents will be illegal to manufacture or distribute. Come 2013, 75-watt bulbs go bye-bye. And in 2014, even the 40-watt varieties will be no more.

Strictly speaking, the old-style bulbs were not banned under the legislation signed in 2007 by President Bush. Rather, the law set “energy efficiency” standards that incandescents can’t reach.

Think of it as one of the many gifts Uncle Sam bestows on General Electric.

GE, for its part, is defending the rising price of CFL bulbs by pointing out that the price it pays for a rare earth called europium oxide has risen 1,128% in the last 12 months. Things are tough all over.

So what’s behind China’s “temporary shutdown” of rare earths production?

“They’re busting the rare earths mafia in China,” said Byron King in this space on Jan. 20 of this year. That is, many of the mines were operating illegally, dumping loads of toxic chemicals into the soil and the water supply.

What’s more, the black market accounted for up to 40% of China’s rare earth production.

“Both of these are entirely unacceptable” to China, Byron said, “especially in a communist state with a nominally ‘planned’ economy. China leadership truly views rare earths as a strategic center of gravity for national economic development, future tech of many forms and, of course, military power.”

Fast-forward to last month: “Most of the country’s rare earth factories have been closed since early August,” the Times reports, “including those under government control, to allow for installation of pollution control equipment that must be in place by Oct. 1.”

At the same time, the government is consolidating dozens of rare earth companies, public and private, under the umbrella of four companies tightly controlled by Beijing.

So rare earths supplies that were already tight are getting tighter. The shutdown comes on the heels of years of tariffs and export quotas that have forced rare earth prices to rise as much as 40-fold.

You might think recent developments are bullish for rare earth stocks. And if you did, you would be wrong. An ETF made up of rare earth stocks, REMX, got hurt worse than the broad market in the August sell-off… and it’s been far slower to recover.

So what gives? “I’ve reviewed pretty much all of the RE plays out there,” says Byron. “I’ve looked at the web sites, reviewed the technical data, perused the 43-101s [regulatory documents], attended presentations and even met with management of many firms.

“There are a lot of good, sincere people out there, all working very hard to build out their respective projects. Any number of these rare earth companies will pull through, eventually.

“But ‘eventually’ may be a very long time.”

Dave Gonigam
for The Daily Reckoning

Awaiting the Eventual Return of the Rare Earths Market originally appeared in the Daily Reckoning. The Daily Reckoning, published by Agora Financial provides over 400,000 global readers economic news, market analysis, and contrarian investment ideas.

The disaster in Japan slammed the uranium sector…and it still has not recovered. But this washout looks like a buying opportunity, as long as you’re not in a hurry to make a big gain.

I won’t go into the Japan-specific details, but for our purposes, it’s a safe bet that the Japan disaster means that we may not see a large-scale “nuclear renaissance” during the next generation.

Why not? Well, just consider the ability of people to mobilize opposition to large-scale energy development — especially something with the media-driven fear factor of nuclear power. Looking ahead, it’ll be hard for any new nuclear program, anywhere, to make headway. Yes, we’ll see developments here and there — more in China, say, than in the US. But we probably won’t see a global breakout into the nuclear power space.

Still, the fact is that the world has an installed base of over 400 nuclear power reactors, and these systems generate almost 20% of the world’s electricity. The problem is there’s not enough new uranium coming out of the mines and mills of the world to keep these plants running. One key source of nuclear fuel for the past decade has been decommissioned atomic warheads from the Cold War era. But that source is soon about to dry up — in 2013, to be precise.

The investment point is there’s a looming uranium shortage, within the next two years. Two years? That may as well be tomorrow in terms of finding new sources of industrial supply. Two years really means “now,” as in today. This means that the existing players have to step up the pace. It also means that there’s room for new players and growth within the primary uranium and yellowcake spaces.

In my investment letter, Oustanding Investments, I recommended Cameco Corp. (NYSE:CCJ) early in 2006. The stock is down 40% since then! You see, even the nation’s #1-rated investment letter misfires from time to time. Usually, I would suggest cutting losses long before a stock had fallen this much. But I think Cameco is an exception. It is a blue chip company that has faced some very bad luck.

Canada-based Cameco is one of the world’s largest uranium producers. Its shares were trading at over $42 each early in 2011, but crashed to below $30 after the Japan disaster in March. Then, over the past summer, Cameco shares have continued drifting lower. Today, they trade for $21.75.

Last week, Cameco launched a $520 million hostile takeover bid for a much smaller uranium firm named Hathor Exploration. Cameco wants to get hold of Hathor’s high-grade “Roughrider” deposit in Saskatchewan’s prolific Athabasca Basin. Whatever the technical merits of the transaction, this news just dropped Cameco shares to near $20.

At the current share price, Cameco has a price-earnings ratio of 18, with a dividend yield of 1.9%. Yet if uranium pricing firms up over the next year — leading up to the post-2013 looming shortage — Cameco’s earnings could and should increase strongly. So here’s a large company whose shares, on the fundamentals, are poised for a recovery.

Yes, there’s a downside with Cameco from here. But in my view, there’s a strong upside to Cameco as well. Indeed, I think the chances of Cameco going to $30 are better than the chances the share price will drift too far below $20. Cameco is a buy.

Regards,

Byron King
for The Daily Reckoning

Looking at Uranium…Again originally appeared in the Daily Reckoning. The Daily Reckoning, published by Agora Financial provides over 400,000 global readers economic news, market analysis, and contrarian investment ideas.

So what’s happening? Is it 2008 redux? Or are things now worse than 2008 and we just don’t know it yet? Oh, for a copy of a tomorrow’s newspaper! Still, let’s do the best we can with what we’ve got.

Let’s start with oil. In an eerie similarity to 2008, oil prices ran up for much of 2011. Posted US oil prices were well over $100 per barrel for a while. Then prices faded a bit, and traded in a $90-100 range. In August, oil prices suddenly dropped nearly 17% within a couple of days, into the high $70s. US oil prices are now in the mid $80s per barrel.

To state the obvious, there’s a lot of money in play. Here’s the raw math. The US consumes over 20 million barrels of oil per day, while world consumption is over 90 million barrels per day. So roughly, a $10 price decrease per barrel pulls $200 million per day out of the cash flow of the domestic oil industry. That same $10 price decrease pulls about $900 million per day from the cash flow of the global energy industry, from everything from independent oil companies to large state-owned actors.

Thus, if oil prices just stay where they are for any length of time, we’ll see lower top-line numbers across the energy industry, and likely lower bottom-line numbers, as well. Oil producers tend not to make large capital decisions based on temporary price swings, and most of the current cap ex will likely remain programmed. But at least some companies will scale back expenditures where and when possible. So the large, quick oil price swing we’re experiencing could make a major difference to energy sector investors over time.

What’s driving this gyrating action in the oil trading pits? Start with the run-up. Earlier in 2011, events in the Middle East — unrest in Tunisia, Egypt, Yemen, etc., as well as civil war in Libya — contributed to supply fears and higher oil prices. Oil prices climbed a wall of worry, with a particular focus on the perennially worrisome Middle East.

Rising oil prices aren’t all bad, of course. High oil prices support capital investment in energy projects, from shale gas to oil sands to offshore projects and more. So along the way, with rising oil prices, we had nice run-ups in the oil and oil service sectors. But recently, market retreats have taken almost everything down across the board.

Now we’re witness to share price massacres, even for the normally long-term oil business. A broad-based stock market calamity is accomplishing what nothing else has been able to do this year — take down oil prices and pull the support from related share prices in the energy sector. Heck, even the Obama administration’s ill-advised sale of oil from the US Strategic Petroleum Reserve in midsummer didn’t have a fraction of the oil price effect we see in the current market crash.

The precipitous decline in oil prices has given crew cuts to some of the best names in the energy sector — Schlumberger (NYSE:SLB), Baker Hughes (NYSE:BHI), FMC Technologies (NYSE:FTI) and more. The nominal losses in share value seem bad now, but when the dust settles, you’ll have bargains galore in this sector. You’ll have a chance to pad your portfolio with the best of the best names.

It’s hard to say this during a market meltdown, but don’t fear investing in the energy sector. Things will get better because energy sector fundamentals are solid. That is, keep in mind that the oil price crash isn’t due to a sudden increase in global supply, let alone a sudden drop in global demand. It’s much more due to speculators despeculating, which I’ll address below.

First, let’s look at the supply side. Most of the world’s daily oil output comes from legacy fields — some of which are decades old, and “not getting younger,” if you get my drift. For all the new technology that’s bringing “new” oil upward, the global industry still faces the same old issues of inexorable depletion.

On the demand side, there’s also no significant negative change. The general economy may stink, and people may even be rioting in the streets — as in London and other places. Yet one of the last things people do anywhere is cut back on fuel usage. Once people get used to living with the convenience of gasoline, diesel and jet fuel, they won’t give it up easily.

The US Energy Information Agency (EIA) recently confirmed this point about inelastic oil demand. The EIA just released a report stating that worldwide oil consumption will increase in 2011 and 2012, spurred by increasing demand in developing countries. In other words, rising demand is baked into the cake via worldwide growth, no matter what happens in the sclerotic Western economies.

Thus with this in mind, why did we see an oil price crash, and oil share takedown? The bottom line is that oil prices and share prices for oil and service companies are sliding due to massive liquidations of positions by traders and speculators (especially hedge funds) that are caught in a price downdraft. The traders and hedgers have to fire sell positions just to raise cash to cover margin calls.

Looking ahead, the energy sector is destined to recover. I expect oil prices to drift back upward, restoring the otherwise missing cash flows to producers. I believe that oil prices, and share prices within the energy sector, will recover sooner than most other parts of the economy and stock market.

Regards,

Byron King,
for The Daily Reckoning

2008, Redux originally appeared in the Daily Reckoning. The Daily Reckoning, published by Agora Financial provides over 400,000 global readers economic news, market analysis, and contrarian investment ideas.

The thesis of the clip is that economic growth as we know it is over… and when looking at new alternatives it makes sense to note which options are most sustainable.

It’s without a doubt touchy-feely, and it’s also light on detail to support a specific new economic pathway — which makes the whole exercise seem a bit unrealistic — but, it clearly notes that the economic problems we face are grounded in the overwhelmingly consumer- and debt-driven culture. As well as a political worldview that puts GDP growth ahead of almost all else.

Is there another yardstick worth considering? It’s the only reputable one we’ve got now, but perhaps there ought to be.

This is from a recent article by the video’s author Richard Heinberg:

“Although soaring numbers lead to financial euphoria, they can hide social ills like growing inequality; moreover, GDP fails to distinguish between waste, luxury, and the satisfaction of basic human needs. Perversely, GDP often rises during wars or after environmental disasters, due to increased government spending. Despite criticisms, economists and policy makers have stuck with GDP—perhaps because tracking a single number makes their jobs easier.

“But now, the US may have reached its practical GDP limit. The bursting of a once-in-a-lifetime credit bubble, the maxing out of consumer borrowing and spending capacity, and tightening global resource constraints (showing up as stubbornly high oil prices) have caught national economic output in an undertow. Much of the rest of the world is being drawn in, with Greece, Ireland, Portugal, Spain, and Italy swirling ever closer to the drain. During the past two years, Americans bought an anemic recovery—a few hundred billion dollars’ worth of GDP growth—but at the cost of trillions in added government debt.

“Now, as Washington descends deeper into partisan acrimony, efforts to generate further growth with yet more debt have become political orphans that no Republican and few Democrats will claim as their own. If the “recovery” was all smoke and mirrors, we’ve just run out of mirrors.”

And the video:

More on the potential alternatives to GDP that Heinberg considers — including the Genuine Progress Indicator, or GPI, which adjusts GDP for resource depletion, income distribution, crime, leisure, infrastructure lifespan, and so forth — can be found in his Just International post on how GDP is dead.

Best,

Rocky Vega,
The Daily Reckoning

There Is No Recovery… It’s All Been Just More Debt originally appeared in the Daily Reckoning. The Daily Reckoning, published by Agora Financial provides over 400,000 global readers economic news, market analysis, and contrarian investment ideas.

There was more “blood in the streets” Monday as the world continued to digest S&P’s downgrade of U.S. debt, the two-week market selloff, and the likelihood the U.S. economy could possibly slide back into recession. These concerns, combined with continued political/economic struggles in the eurozone from socialist policies, have created a potent concoction of fear across global markets and sent volatility skyrocketing Monday to its highest level since the May 2010 “Flash Crash.” While many investors are running for the exits, others have chosen to ride the wave of volatility or buy depressed shares.

The S&P 500 Index has fallen 11 percent over the past three trading sessions. This has only happened fives times since 1960: The 1987 Crash, the Asian financial crisis in 1998 and twice in 2008, according to research from Desjardins. In each of these instances, markets gained an average 9 percent the following month.

The CBOE Volatility Index (VIX) rose more than 46 percent to break the key 40 level, signaling an extreme event, and is up over 164 percent for the year. In general, any time the VIX reads above 30 means conditions are volatile. Above 40, it’s clear the only thing at a premium in this market is fear.

The S&P 500 isn’t the only investment that’s been experiencing extremes. A flood of safe-haven buying sent gold prices up more than $50 an ounce (more than 3 percent) to $1,715.40 at market close Monday. Gold continued its climb early Tuesday morning, rising another $34 an ounce. Gold prices are up over 46 percent for the past year and roughly 13 percent the past 30 days. The increase over the past month is roughly equal to gold’s normal volatility over an entire year and is a short-term risk for a minor correction in a secular bull market.

Meanwhile, oil (along with oil-related equities) has been bludgeoned down to price levels not seen in a year—off almost 30 percent from April 2011 highs. Other commodities such as copper, wheat and cotton have also taken sizable haircuts over the past two weeks.

Such market turmoil creates a real challenge for investors who are in it for the long haul. Investors must control their emotional response and remain on the lookout for opportunities. Equity performance and fear-driven volatility carry a strong inverse correlation. This chart shows sharp spikes in the VIX trigger an autonomic selloff in the S&P 500. However, these selloffs have historically resulted in strong rebounds, thus providing an opportunity for clever investors who like to buy their summer clothes during a winter sale and their winter clothes during the summer.

Before Monday, the VIX closed above the 40 level five times since 1995, and in all but one occurrence the market was at higher levels just three months later. The exception is 2008, when the VIX passed 40 on its way to 90 and remained elevated for months during the worst financial crisis since the Great Depression.

You can see from the table that the market has rebounded roughly 6 percent on average over the three-month period after hitting the 40 mark. Short-term reactions are more mixed. The market has swung 11 percent in either direction during the next month of trading and the average gain is only 80 basis points.

For the purposes of this exercise, the analysis is based on weekly data from August 8, 1995 through August 8, 2011. There were stretches of time, such as in 2008, when the VIX remained above 40, but we’re only counting the initial breach.

Market selloffs are actually common this time of year. According to the Stock Trader’s Almanac, August has been the second-worst month of the year for the Dow Jones and S&P 500 since the 1987 crash. The 7.2 percent decline for the S&P 500 last week was the worst week ever recorded during the month of August, beating out another dismal week for performance in 1974.

With this in mind, investors must remember there are some good opportunities out there and we’re working relentlessly to find them. Some of the best are in great American companies, whose balance sheets are the envy of Washington, with many carrying dividend yields above the 10-year Treasury bill. Currently, the 2.28 percent yield for the S&P 500 is the highest level since July 2009, Desjardins says.

A similar phenomenon took place following banking crises in France, Sweden and the U.S. during the 1990s. Without the ability to tap banks for additional capital, companies moved to large positive cash-flow positions and self-financed their growth, GaveKal research said in a note this morning. These strong capital structures provided the foundation for the market’s bull run during the back half of the decade.

This opportunity has largely been ignored as investors have fled like lemmings to the “safety” of cash, government bonds and money market funds. These investments “afford zero prospects for capital gains and only microscopic income,” says Murray Pollitt from Pollitt & Co.

This mad dash for cash is driven by fear and investor desperation to preserve their money rather than make any. Naysayers have been flippantly labeling gold a bubble since it reached $500 an ounce, but have turned a blind eye to the unprecedented amount of “money pouring into government bits of paper” that is the “biggest bubble of all time,” says Pollitt.

History is filled with cycles and each asset class carries its own DNA of volatility. Those who are highly leveraged or those forced to sell in order to raise capital are experiencing the most pain right now. Investors not in those two camps must remember that the markets are cyclical, just like the tide, which comes in and out each day, and the moon, which cycles every 29 days.

One area with potential is gold equities, which have lagged bullion significantly this year, pushing the gold-to-XAU ratio to the second-lowest level in nearly 30 years in June. Gold stocks also have a history of performing well when the U.S. economy hits a bump in the road. Depression-era babies might remember gold stocks’ strong performance during the 1930s.

This lag sets the stage for a possible strong rally in gold equities relative to bullion once mean reversion to historical levels kicks in, just like it has done time and time again. Desjardins notes that one current catalyst for a rebound in gold stocks is increased profitability from rising gold prices and decreased input costs due to oil’s 28 percent decline off of 2011 highs.

In addition, many quality gold companies are “paying investors to wait” by increasing dividend yield rates above those of money funds. This creates a cash incentive to hold shares of the company and allows investors to participate in rising earnings.

A key question for the global economy is: Who will lead a recovery in global markets? Where will growth come from?

With trillions of dollars in debt acting as a ball-and-chain for much of Europe, the U.S. and the rest of the developed world, must detoxify their balance sheets before hitting the ground running. On the other hand, emerging market economies carry low levels of debt and operate like a cash business, making them the final frontier for strong economic growth.

A key reason is emerging market governments have the long-term policies in place to facilitate growth of their economies. GaveKal points out it’s unlikely we’ll get a second dose of large stimulus like we did in 2008-2009 because of inflationary pressures, but that magnitude of assistance isn’t needed. Because China and other emerging market governments focused their stimulus on job creation and infrastructure development, their roads to economic growth have already been paved.

This will allow them to flex their economic muscles during short-term instability and insulate them from the turmoil. This is why we think emerging markets will continue to shine for many years to come.

Take China’s $300+ billion commitment to construct a nationwide high speed rail network, for example. The project is already paid for and will invigorate consumption across all sectors of the economy by connecting 700 million people across 250 cities. The recent accident was a terrible tragedy but the country is not going to abandon its plans. Rather, China will learn from the setback and push forward with better safety standards.

While the investment herd rushes into CDs and other “zero” yielding investments, nimble-minded investors can use these cycles to seize current opportunities and position portfolios for when the bull market tide returns.

Regards,

Frank  Holmes,
for The  Daily Reckoning

P.S. For more updates on global investing from me and the U.S. Global Investors team, visit my investment blog, Frank Talk.

Run, Ride or Buy? What Should Investors Do? Don’t Sell on Mondays! originally appeared in the Daily Reckoning. The Daily Reckoning, published by Agora Financial provides over 400,000 global readers economic news, market analysis, and contrarian investment ideas.