Geopolitical risk has become a significant factor affecting markets as the  levels of uncertainty and surprises that are emanating from the European Crisis have sent markets both reeling or soaring. Recently former Greek Prime Minister  Papandreou suddenly announced they Greece was going to have a referendum  and stock markets in  North America took a beating. This week it was Italy center stage. Tyler Bollhorn,  in Michael Campbell’s opinion, has done a fabulous job of educating investors on markets, trading markets and managing risk. Michael caught up with Tyler Bollhorn and asked him about Geopolitical  uncertainty.

Tyler: Actually I think that you can use that to your advantage. Normally when we think about investing, we think about whether to buy stock, commodities that sort of thing and historically playing the hot market is what has allowed you to make money. Over the years and I made a lot of money during Bre-X years in mining stocks, a lot of money in Tech stocks up until March of 2000 and then of course real estate was just an amazing market until 2007. The question now is what is the hot market and the hot market today is uncertainty. Really what that means is price volatility and nowadays because of ETF’s and all these derivatives that we have in the world, you can trade volatility whereas normally you would trade stock or commodities. The hot thing to trade now is volatility and that’s what I was doing all this week with great success.

Michael: That level of uncertainty is translating into huge volatility, how specifically are you playing that?

Tyler: You’ve probably heard of the VIX the Chicago Board Options Exchange Market Volatility Index which is based on implied option volatility and there is an ETF. The most popular one is S&P 500 VIX Short-Term Futures ETF (VIXX) which trades in American stock exchange but there’s many derivatives of that. Here in Canada on the Toronto exchange there’s something with the same symbol VIXX and then there is also a Horizon fund which is a leveraged version where you get two to one leverage, the symbol for that is HVU.TO. So those are the things that I trade for volatility. Now believe it or not that market is predictable, when you talk about Berlusconi stepping down or the referendum being called the market told that story the day before, that volatility was coming. We have to keep in mind that there’re millions of people playing the stock market and there’re some people that have insight that you and I never have and certainly big hedge funds that follow what’s going on over in Europe. They get an inkling that something is going on and they start to hedge their bets in the options market and that shows up on the VIXX. So when I traded, I don’t claim to be an expert on options. I just focus on the VIXX ETF and the different derivatives of it, that’s how I’m trading and I had great result last week doing that.

Michael: Well one of the things that we have to admit is that it’s not business as usual and the most toxic part of that is people who continue to see the world through the same political lens for the last 20, 30, 40 years are missing opportunities with their investments. You can’t just say I don’t do options or I just don’t do exchange traded funds. These are some of the tools you need because they create opportunity and they may create protection by reducing risk.  The message I am hearing from you is you have to use some of these tools to be successful in investments, and take the time to learn them too.

Tyler: Actually the nature of markets is that people always doubt the hot market in its early phase. I can remember so many doubters about gold. Your show was encouraging people to look at gold and silver but because gold had been a dead investment for so long people doubted it. The same can be said of just about any hot market so that’s good because it is eventually the psychology that drives the market higher as more and more people jump on the bandwagon. Well if you jump on the bandwagon late in the trend then you get burned because you end up holding the bag at the end. What’s important to think about is what the hot market is now and get into it now. Also learn how to manage risk because you’re not always going to pick the right thing. Right now the hot market is volatility. I’m also sensing that there’s a bit of heat coming into the oil market, its not quite there yet but it’s getting there so that’s what important.

Michael: It’s interesting to hear you talk about these different markets and that oil is on your radar screen but you’re not ready to commit money to it yet.

Tyler: Right, I spend hundreds of hours coming up with strategies and at the end of the day the strategies are very simple. But how you apply them and where you apply them is what takes that time to figure out. When I do my talk at your conference next week I’m going to go through the process of how I came to know that volatility is the thing to trade right now. Also how I arrive at my rules to trade and how I arrive at my rules to manage risk. Leverage is a double edged sword you have to be very careful with. I’ll also demonstrate how I use leverage because if you pick the right market and have the right strategy you can make a lot more money because of it.

Michael: The market is just such a fabulous thing.  There’s so much depth, it’s just layer upon layer. I think it was George Goodman who said that if you don’t know who you are, the market’s a very expensive place to find out. Your experience of not only handling your own money, studying the market for hours on end,  training so many people and hearing their stories all goes into your bank of experience and how to play the market.

Tyler: It’s such an education for me to teach people because you really get a sense of what drives people’s decision making. After teaching a few 1000 people I really get a sense that people are generally all the same. We all have an emotional attachment to money for the most part and we make mistakes because of that. We tend to sell our winners too early and hold on to our losers. Those tendencies are very predictable and if you understand that they are predictable then you can understand how you can make money from them. They tend to play out in the market and how markets move so when I look at something like the oil ETF I’m looking at that behavior. I’m doing it through the lens of having taught so many people because I know how human psychology is going to react as the market goes up, retraces, hits a bottom then goes up again. These are very predictable cycles and you don’t have to have a tool box full of very complex tools. You can use some really simple things,  but you have to play the hot market. If you play the hot market anyone can make money, you just have to have some simple ways to do it.

Michael: I’m always astounded by how many times I have repeated the same mistakes in my own account and I’m not being phony. What I find about professionals in the investment business is that there is a level of humility that comes with it because there are significant lessons to learn. One of them, Tyler’s outlined a moment ago,  is if you can get over yourself. That’s probably the biggest one. That maybe true in all areas of life but in this one we get a score card on a regular basis. We are also in a phenomenally difficult environment given the level of uncertainty and the level of unknowable fact. You suddenly get a Japanese earthquake, or this geo-political risk when you can suddenly get an announcement that will really impact your investments.

Tyler, you made a trade this year and I’d like you to give us some background on it.

Tyler: The first question is what defines the best trade? I mean I think most people would say it was the trade that made the most money, but I don’t think that’s necessarily all that a best trade is about. I talk a lot about battling emotion, I’m always struggling with fear and greed, should I hang onto this position even though its telling me to sell or am I selling this thing too early because I want to lock in that profit. So to me the best trade I made this year was a short trade I did on gold in mid August. It was only a two or three day trade and not only was it right and I made a great profit,  I executed it according to my plan to mere perfection.  By that I mean I entered when the market told me to as gold was hitting new highs and even though the headlines at the time were saying gold was going onto a 2200/2500. I remember Goldman Sachs put out some research saying gold is continuing higher but the market told me that gold was going to break down and go lower and so I shorted gold. Two or three days later I covered that short made a great profit. I covered it when the market told me to, I executed my plan perfectly and that to me is what makes a great trade.

Michael: You have a methodology, you have an approach, you blocked out all the other noise and you followed your plan to a T and obviously it worked. That’s the challenge that we all have.

Tyler: I have been trading for over 20 years, I don’t want anyone to think that’s its ever easy. It is a challenge every day.  I mean reading the market is not hard, applying a set of rules is not hard, but managing your emotion and overcoming fear and greed, I don’t care how long you have been trading that’s always difficult and the best traders are the ones that overcome that. Don’t think that I don’t battle that every day.

The rare earth elements sector is poised for long-term growth, but Brian Chin, a research analyst with Gabelli & Company Inc., recommends investors opt for near-term producers. In The Critical Metals Report, he shares his top picks.

The Energy Report: There is much speculation in the rare earth elements (REE) realm about China’s export quotas in 2012. Is Gabelli & Company expecting further quota cuts?

Brian Chin: The trend is clear that China has been reducing its quotas over the last six years. In 2009 export quotas were set at just over 50 thousand tons (Kt), which was subsequently reduced by about 40% to a little over 30 Kt in 2010. Quotas were slightly lower in 2011.

Even if we assume quotas for 2012 remain constant, a gap remains between global supply and demand. It’s clear that China is trying to control and restrict supply coming out of China. In addition to reducing quotas, China is consolidating the industry to control production. Baotou Steel Rare Earth recently announced a suspension of its REE processing in an effort to stabilize spot prices.

TER: What is China’s reasoning behind these policies? Do you think China wants to restrict its rare earth sector for domestic use only?

BC: China’s export reductions seek to encourage domestic production of higher-value, end-use products. Prices for rare earth oxides within China average 50% below export prices, which certainly benefits companies operating within China. Some are even predicting that China will become a net importer of rare earths as soon as 2015. That means the country would not export any of its rare earths.

TER: One of the key drivers in this segment is electric vehicles (EVs). The Chevrolet Volt, for instance, uses about seven pounds of REE magnets. What other major end uses drive REE demand?

BC: Electric cars are obviously one of the key end markets for rare earths, but there are many other end-use products. Traditional uses involve catalytic converters, and there are other highly specialized applications as well—for example, REEs are used in car windows to reduce UV exposure. Technology-driven uses include a myriad of products, such as magnets in gearless wind turbines as well as a variety of smaller electronics such as iPhones, Blackberrys, etc. Because rare earths are used in such a wide range of markets, REE use is not overly dependent on any individual market.

TER: We recently learned that Lynas Corp. (LYC:ASX) will delay production at its Malaysian plant until 2012. This isn’t the first delay. What’s going on there and will the delay affect REE prices?

BC: Lynas originally projected that its processing plant in Malaysia would be running in the second half of 2011 but cited delays in its equipment orders that pushed back completion by about three months. In addition, there’s been local opposition to the plant that has delayed licensing from the Malaysian government to import ores the company extracts out of Australia. The company claims that even if Lynas is unable to secure the permit, it will still be able to process ore from its Mount Weld deposit with another partner, but it’s obviously an overhang on the stock.

TER: There are approximately 300 REE projects in the world. Molycorp Inc. (MCP:NYSE) is now producing some light rare earths (LREEs), and many other companies are frequently reporting new resource estimates. Total REE demand for 2011 was forecast at around 40 Kt, and actual demand fell well short of that. How are these companies going to make money?

BC: The simple answer is they won’t. Since the boom in REE prices, there’s been a scramble to find new deposits. But the fact is that many of these projects contain low ore grades and are in remote locations that will require tremendous capital investment. It’s not hard to find rare earths in the ground, but it’s hard to find them in a high enough concentration and grade to make projects economically viable. Understanding the metallurgy in each of these different deposits is not an easy task, as it varies considerably. Developing a separation process is also a very complicated undertaking. I don’t see a lot of these projects coming into production.

Having the first-mover advantage is very important for these REE companies because the market isn’t very large, but there is going to be demand from customers looking for secure sources of supply outside of China. The companies that are going to be able to get to production first and secure supply contracts are the ones that are going to be successful.

TER: Dacha Strategic Metals Inc. (DSM:TSX.V; DCHAF:OTCQX) has taken a “middleman” approach to the rare earths market by acquiring and stockpiling REEs in Asian warehouses. The model, however, assumes that limited supplies will continue to push REE prices higher. Prices have fallen dramatically in recent months, and more companies are scheduled to start producing rare earths in 2012. What’s the shelf life of Dacha’s model?

BC: Different governments around the world—Japan, Korea, the U.S. and the E.U.—have considered stockpiling. Supply is tight right now, and although there will be some additional supply coming online outside of China in 2012, many projects are years away from production. Dacha’s model has some credence for at least the near-term, until additional supply comes on-line outside of China.

In general, I think the challenge with Dacha’s model is the off-loading. If they have off-take agreements already in place, then it shouldn’t be a problem. But if the company just stockpiles and has no buyers, then the value of the company is just in the material reserves. It takes buyers to realize that value.

TER: Dacha has an inventory of heavy rare earths (HREEs), most of which are in high demand, and says its inventory is worth roughly $120 million (M). But Dacha needs to make sales each quarter, and doesn’t that put the REE buyers at an advantage?

BC: The demand is there. The reason prices have gone down recently is people are waiting on the sidelines hoping that the prices are going to go down further. At the same time, especially within China, because of the export quotas, companies need to unload their quotas by the end of the year or else they risk not being assigned a quota for the following year.

TER: You wrote a positive research report on Molycorp in April, when its shares were trading at about $72. Molycorp now trades at less than half that, even though it has started to produce some rare earths from stockpiles. What’s your view now?

BC: In late April I actually downgraded the stock to a hold because of the run up in the stock price at the time and the fact that it was trading near my Private Market Value (PMV) for the company and didn’t provide enough margin of safety. I still think Molycorp is the best way to gain exposure to the rare earths industry. The company has a high-grade ore body in a convenient location. These are two keys to a successful REE project. In addition, Molycorp used to be one of the dominant REE producers, so it has expertise. I think its mine-to-magnet strategy will allow the company to realize incremental value across the supply chain. When it comes into production in 2012, it’s going to be the lowest-cost producer in the industry. That adds an extra layer of safety to the company, given how volatile prices have been.

TER: The knock on Molycorp’s past deposit is its lack of HREEs like terbium, yttrium and dysprosium. Molycorp says it’s exploring an HREE deposit near Mountain Pass. What do you know about that?

BC: Molycorp recently announced that it was looking at four potential rare earth deposits with a composition skewed more towards the HREEs. All four of the deposits have high ore grades greater than 4% and can be processed at Molycorp’s Mountain Pass facility. The company realizes that because its deposit is more LREE-rich, having a complementary HREE deposit would be beneficial.

TER: Molycorp’s trying to get a few different loan agreements with the Department of Energy, but has so far been unsuccessful. Is that worrisome red flag for investors?

BC: In speaking with the company about that, I think it was trying to get those loans back when it was still looking to get fully financed for its project. Since then, it has been able to work out a number of different agreements with suppliers, and it was able to secure alternative funding on its own.

TER: Aside from Molycorp, what are some other companies that have piqued your interest?

BC: Quest Rare Minerals Ltd. (QRM:TSX.V; QRM:NYSE.A) Strange Lake project in Quebec and Avalon Rare Metals Inc. (TSX:AVL; NYSE.A:AVL; OTCQX:AVARF) Thor Lake project both have large resource estimates and compositions skewed toward HREEs. Strange Lake has a resource estimate of approximately 230 million tons (Mt) at 0.9% ore grade, and Thor Lake has 315 Mt at about 1.4% ore grade.

TER: Quest just added George Potter to the company. Potter was in a senior executive position with AngloGold Ashanti Ltd. (AU:NYSE; ANG:JSE; AGG:ASX; AGD:LSE). When he came on board, Quest’s share price was not far above $2 and now it’s well over $3. The market seems to like the move. What are your thoughts?

BC: It’s positive that the company was able to bring in people with good experience, and it has a very large resource estimate at its Strange Lake site. The problem is that it is in a very remote location, and it’s going to take a lot of capital to get the infrastructure in place to build up a mine.

TER: Nonetheless, in Canada, those two projects always seem to take center stage when rare earths are discussed. Matamec Explorations Inc. (MAT:TSX.V; MRHEF:OTCQX) Zeus Project may beat both of those companies to production. How did Matamec come out of nowhere to lead the race?

BC: I wouldn’t say that it’s leading the rare earth race per se, but it’s another contestant in the race. Matamec has a very attractive composition weighted toward the more valuable HREEs and a resource measurement of 16 Mt but at a relatively low ore grade of 0.5%. It is projecting that it will be in production by 2016. A lot of questions remain, including whether it can actually be economically feasible to mine and process with such a low ore grade.

TER: In comparison with Avalon and Quest, Matamec is much closer to infrastructure and established mining camps.

BC: That’s one of the key things for a project’s feasibility, and in this area Matamec has an advantage.

TER: Matamec has seen recovery of 95% of REEs from its ores, so that is certainly a positive as well.

BC: That is definitely another important thing. Metallurgy varies from deposit to deposit so recovery is important.

TER: Matamec will soon release a preliminary economic assessment on the Kipawa deposit; do you expect that study to boost the share price?

BC: If the company has a positive study that shows it can extract and process REEs and that its resources are there, then that should be positive for the company, even given the volatility in the markets.

TER: What do you make of that volatility? Since August or so, the share prices across the board have often been halved or worse.

BC: Uncertainty in the macro-environment has hit the commodity and REE space harder than the rest of the overall market. Investors are a little skittish, and there has also been a lot of news about companies seeking different ways to substitute REEs, whether it’s electric cars or other end-use applications. However, I was in Japan recently meeting with companies, and the demand is still there. REEs have unique properties that allow for lighter, more efficient and smaller end products. In the near term, there is going to be volatility and uncertainty in the overall global environment, but in the long term, alternative suppliers need to come on-line to supply the rest of the world’s markets, and their ongoing rare earth needs.

TER: You studied Applied Value Investing at Columbia Business School. Are you seeing a lot of value in this space right now?

BC: Depending on your risk tolerance, I do see value in the space. Right now a lot of the stocks are trading at discounts to their intrinsic value. Molycorp is the best positioned in the space—I have a 2012 PMV of $67 and it is currently trading at a pretty steep discount to this.

TER: What are your top three picks in this space?

BC: I like Molycorp. That would be my first choice. Lynas, even with its problems, would be my second choice, because of its high-grade ore deposit. Third is tough; there are a bunch of projects in Canada and Australia that all vying to become that other supplier in this space. But they are all many years away from getting into production, so I think it’s hard to choose one of them.

TER: You prefer the near-term producers with high-grade deposits?

BC: Yes, and then I would go with a deposit that is heavily skewed toward HREEs.

TER: Thanks you for your insights, Brian.

Brian Chin joined the firm in 2010 as a research analyst covering Natural Resources. Brian began his business career as an investment consultant and then became an investment banking analyst focused on mergers and acquisitions for middle-market healthcare service companies. Brian graduated from Amherst College with a Bachelor of Arts in economics and received a Master of Business Administration from Columbia Business School with a concentration in applied value investing.

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While bubble-spotting among equity investing tilts is often futile, the ever-increasing call for investors to buy high-quality dividend-paying stocks has become as over-used a term as ‘long-term investor’, and ‘buy-the-dips’. It seems the general belief is that a 3-5% dividend yield will provide ‘protection’ to cushion volatility as it offers income above Treasuries. Back in September we highlighted both the apples-to-unicorns comparison that is dividend yields to TSY yields and moreover, how risk (and ultimately capital loss) should play a critical part in the decision of asset allocation. Today we take a quick look at dividend stock performance over the last few years and find something intriguing – and not often mentioned – that dividend stock portfolios appear to significantly underperform in sell-offs and marginally underperform in rallies. So if you want a high beta crowded trade, admittedly with some carry, buy high quality dividend-paying stocks.

Between gold and silver, silver of late has exhibited some resilience. So for someone who wants to pick and choose between gold and silver, which commodity would you like to endorse?

I would prefer silver because it is still depressed on a historic basis. Silver is 30% below its all-time high. Gold is 10% below its all-time high. I would prefer one just on relative value, silver is probably better. I am not buying either today, but I am certainly not selling. If they go down, I will buy more.

The base metals have seen a good October. Support is also coming in from a decline in inventories, consolidating US economic data and China buying. Would you turn a buyer in this space?

I own mainly precious metals and agriculture. I own all commodities, including base metals. So certainly base metals have a huge wonderful future. People have not been opening many metal mines in the past 25 or 30 years. There has only been one lead mine for instance opened in the past 30 years. So base metals have a terrific future.

….read more about metals & Europe HERE

In waking a tiger, use a long stick.

– Mao Tse-tung

Well, it looks like it could finally be happening. The Chinese housing bubble could well be bursting right before our eyes.

The bubble has long been present for all to see, with news reports popping up earlier this year about ‘ghost cities’ and ‘ghost malls’. Indeed, it’s been so visible and so well observed that even the mainstream media picked up on it. That’s right, folks… you heard me right: the mainstream media picked up on it! God, it must be serious!

People have been calling the bursting of this bubble for a while now. But this is the first real indication I’ve seen that this particular house of cards – excuse the pun – is beginning to topple.