“Right how we are seeing a major catch up going for undervalued asset based companies in the precious metals space. This part of the up tick could surprise even rabid bulls. Some more speculative companies that had been strong gainers appear to be flagging because of this, but that won’t be permanent. Speculative gains should be moved to companies with more solid outlines, but as the asset based companies get closer to full price funds will flow back to specs.”

Gold’s New Friends

Press rumors of planning meetings to shift crude pricing away from the US$, plus a 0.25% increase in Australia’s bank rate, has put some serious bounce in gold and silver prices. The yellow metal has convincingly moved past its old high, in US$ terms, and we expect that move to continue.  Whether the details of the meetings reported in London’s The Independent are accurate in every detail or not, markets have had no problem accepting the basic point that the greenback cannot expect long term support as the globe’s reserve currency.

Commodity prices, especially gold and silver, are very much currency stories. The US Dollar continues to lose face for a variety of reasons, with more rapid growth in the creditor and resource producing nations being the latest. This, not inflation concerns, has been our focus. Australia’s increase in its bank rate may be duplicated in a number of other economies before Washington gets around to it. This would continue the downtrend in the Dollar and uptrend in precious metals no matter what inflation looks like.

Lack of high yield alternatives, plenty of frustrated money on the sidelines and the potential for “good” earnings (at least by comparison with the past 12 months) may drive the major bourses higher yet. This will add more strength to the already outperforming metals sector.

The biggest potential short term risk is that Dollar Distaste reaches the bond market and drives yields higher. That could turn the Dollar and the stock markets around quickly. Be happy, but keep an eye on those Treasury yields.

Copper stocks continue to pile up while the red metal sustains price against US$ weakness.  Over half the stockpile taken down earlier in the year has now come back into the market. Some of the stock on offer would likely disappear on a price decline, or if the current Dollar weakness turns into a rout. But that has to happen before we are comfortable with this year’s price gains. The message since mid July has clearly that users think the price move has been “too far—too fast”.

That remains the case for most commodities. Traders are playing musical chairs to a tune of weak Dollar fundamentals against a melody of uncertainty for demand sustainability. Notwithstanding our belief that the greenback’s decline is a longer term phenomenon, we don’t look for anything to trade in one direction permanently and this move will be to a new trading level. We doubt the guy in the last chair of this round will celebrate for very long before shifting direction with the herd. 

We should note again the continuing calls by the government for closure of Chinese smelters. This is due to both inefficiency and overcapacity.  Current stockpiles aside, excess smelting capacity is not the same as excess metal producing capacity. The two roughly equate for some metals, such as aluminum for which there is a ready supply of input minerals in coastal regions that could use development funding.

Foundry capacity, or overcapacity, will not govern iron ore supply for the time being. Most prospective ore regions need infrastructure to coastal shipping ahead of any expansion. Longer term iron ore supply will come from regions that put that infrastructure, and longer term contracts, in place. We do still see opportunity in iron ore, partially because of the politics that surrounds it.

Medium and longer term copper capacity will be governed by mine supply, and the long time frames for large copper mines to come on stream.  Smelters can’t process concentrates unless mine supply is sustained. The same holds for zinc and to a lesser extent nickel. We don’t view China’s push to reduce smelting capacity as a sign the metals bull has run out of steam. It simply makes sense for China to shut in costly, polluting smelters when there is capacity next door in more efficient Korea and Japan.

Japan’s new government has referenced abandoning the weak Yen policies of its predecessor several times now. Given it is supposed to be part of the talks cited by The Independent and that the Yen (along with gold and the Yuan) are supposed to be part of a new “basket” for oil settlement, that stance is making more sense.

More importantly, Japan’s new leadership has stated it favors stimulating domestic spending in order to end a deflationary malaise the country has lived with for most of the past two decades. Cheaper inputs for its resource poor citizens are therefore more important to it than cheapening the exports market of its high end producers by devaluing its currency.

These pronouncements have aided the cause of price support for Dollar denominated global goods. But, markets are and will continue to have a tough time with deflation’s poster child righting itself in the current environment. That is entirely reasonable given deflation’s shadow slowly creeps over the western landscape. However, PM Hatoyama is quite deliberately shifting sentiment away from a western focus of the past half century.  

At worst this is pragmatic recognition that the customer base for Japan’s goods has ended its buying spree. The real message is that Japan is wealthy and able to chart its own course, once it has detoxified its bureaucracy from spinning funds into their retirement companies. There will be no quick fix from this policy shift, but it makes more sense than a failed policy requiring western sales points for its goods.

We can’t overstate the potential importance of these moves in Japan. This is the second largest economy on the planet in nominal terms, and yet one for which concern that a lack of raw materials supply could hamper its growth spurt is very much a living memory. It has also seen a massive growth in ore processing to meet this concern overtaken in large measure by neighboring South Korea. We believe a shift is building in Japan to a much greater emphasis on its domestic economy, and equally to more focus on its regional economy. That should mark a major shift in the geography of country risk, and a greater acceptance that “Asia rising” is the global boon we perceive it to be.  

So, how does that impact the current gold boom?  It should simply give it a greater head of steam. Missing from the weakening Dollar equation was how the other side of that equation shapes up. Much of Europe was happy to jump on the cheap debt = housing boom bandwagon, and so is in no better shape than the US.  So the Euro can sustain only so much upward pressure. Currencies in the less weakened industrialized “west” — AUS, CDN, NZ— simply don’t have the scale for the job. There has been only one sensible answer.

We have said in the past that the only equation that made sense was Yen strength as a proxy for Asian growth economies. Most wrote off the notion because of Japan’s export model.  Now that Japan has a government that is willing to play that card, the pieces are truly in place for quick shifts in the FX market. Gold and silver will benefit smartly from that, and no the world is going to end as part of the process.

Right how we are seeing a major catch up going for undervalued asset based companies in the precious metals space. This part of the up tick could surprise even rabid bulls. Some more speculative companies that had been strong gainers appear to be flagging because of this, but that won’t be permanent. Speculative gains should be moved to companies with more solid outlines, but as the asset based companies get closer to full price funds will flow back to specs.

If you are a trader, the shift from one play to the next could get dizzying. If you aren’t, then view this as a “stay the course” moment for precious metals. Expect some significant pull backs as traders take gains, but these will be in the context of a rising market for some while yet.

David Coffin and Eric Coffin

*****

David Coffin and Eric Coffin produce the Hard Rock Analyst publications, newsletters that focus on metals explorers, developers and producers as well as metals and equity markets in general. If you would like to be learn more about HRA publications, please visit us HERE to view our track record, see sample publications and other articles of interest. You can also add yourself to the HRA FREE MAILING LIST to get notifications about articles like this and other free analyses and reports.

The HRA – Journal, HRA-Dispatch and HRA- Special Delivery are independent publications produced and distributed by Stockwork Consulting Ltd, which is committed to providing timely and factual analysis of junior mining, resource, and other venture capital companies.  Companies are chosen on the basis of a speculative potential for significant upside gains resulting from asset-base expansion.  These are generally high-risk securities, and opinions contained herein are time and market sensitive.  No statement or expression of opinion, or any other matter herein, directly or indirectly, is an offer, solicitation or recommendation to buy or sell any securities mentioned.  While we believe all sources of information to be factual and reliable we in no way represent or guarantee the accuracy thereof, nor of the statements made herein.  We do not receive or request compensation in any form in order to feature companies in these publications.  We may, or may not, own securities and/or options to acquire securities of the companies mentioned herein. This document is protected by the copyright laws of Canada and the U.S. and may not be reproduced in any form for other than for personal use without the prior written consent of the publisher.  This document may be quoted, in context, provided proper credit is given.

Before the Oil Derrick

Did you know that workers were extracting oil out of the ground before the oil derrick made its first appearance?

But it was a small industry made up of small companies and serving a small market. What changed it?

Technology. Before an enterprising oil worker saw derricks operating in a salt flat and thought that just maybe it could work for oil, digging for oil was a long and difficult endeavor. Up until that point oil was used to light lamps plus some other small uses.

The oil was always there in the ground. The industry was held back from growing beyond those modest applications because oilmen could only tap into a small percentage of the underground oil.

The introduction of derricks into the oil industry changed everything. It allowed the oil industry to grow into a major business. In fact, the growth of modern industry and the growth of oil went hand in hand.

Still About Change

The oil industry has gone back to its roots. For the first time in about 100 years, it’s seeing limits on its growth for the very same reason as a century ago. Oilmen can only tap into a limited portion of the oil in the ground.

That’s about to change. Once again technology is about to spark another oil boom.

How would you like to be an oil baron? When derricks first came on the oil scene, nobody believed in them. Derricks were just a lucky thing the oil industry stumbled on. They were too good to be true. An accident.

Don’t be one of those disbelievers. Technology transformed the industry once. And it’s about to do it again.

Left-Over Oil

Oil companies typically abandon their fields with a lot of oil left in the ground…around 60% it’s estimated. Why so much?

In most oil reservoirs, the oil resides in porous rock that are tens of meters thick but stretch for miles. A conventional oil well is a vertical shaft. It’s in contact with only a narrow cross section of the reservoir. Such a well depends on oil percolating through microscopic pores over long distances. A lot of the oil is stranded inside the irregular geometry of the oil field.

Fire in the Hole

Water flooding and carbon dioxide injection can force some of this trapped oil out. But IDE’s Dr. Rusty McDougal has found a technology which does much better than water flooding. It actually creates a controlled fire down the oil hole. The fire produces steam and heat, creating a wall of unbelievable pressure which drives the remaining oil out of the hole.

This could change the whole calculus of oil field development and production. Schlumberger, for example, has recently been making most of its money from improving existing wells (instead of developing wells), such as fracturing rock underground to improve oil production. Dynamite is last century’s technology. Forcing water and steam down a hole is also 20-year old technology.

Oil companies are also beginning to use “smart wells” with sophisticated sensors that can detect, for example, when water (instead of oil) is being pulled into the well. But the upfront costs are high and sensors only provide more information. They don’t directly increase oil production.

The company’s “controlled fire” technology promises to enhance oil recovery at a time when the oil majors are having trouble increasing their output. The need for this technology has never been greater than it is right now.

Rusty says the technology is perfectly safe… “The process is established sufficiently to pose no safety issues (it is being done in California, no less). The fire continually burns and more and more oxygen is injected for continued production. You put out the fire by ceasing to inject oxygen.”

Some estimates say that this technology can double or triple the output of a field and extend the life of a field for several more years. This technology is clearly a game changer. 

Rusty recommends the company offering this technology in his last issue of The Resource Speculator. He also says that this recommendation “has moonshot written all over it.” If you want more information on Rusty’s resource picks, click here.

Keeping Your Eyes on the Road

Imagine getting on the highway as you drive to work and traffic is brutal. But as you weave in and out of traffic, your attention is drawn to the big 18-wheeler which is trailing you. You keep looking behind you to see where it is, what it’s doing, if it’s getting closer. In fact, you spend more time looking out your rear window than you do looking ahead. The inevitable then happens. You hit the car that had just cut in front of you. You curse. You should’ve seen it coming, but you took your eyes off the road.

The most common mistake investors make? Taking their eyes off the road. Investors are the most distracted group of people I know. They’re constantly looking backwards, trying to figure out why the market acted the way it did yesterday or last month or last year. But to drive your investments to their most profitable gains, you should be looking ahead and not backwards.

Case in point: Instead of trying to figure out how we got into our current crisis, you should be trying to figure out how we’re getting out. On the highway to profits, it’s not what exit you got on but what exit you’re getting off which matters. For example, if you think that housing will lead us out, then you should consider getting into housing assets, like REITs, early.

But housing isn’t leading us out. The banks aren’t leading us out. High-tech isn’t leading us out. And energy isn’t leading us out. 

Brave New World

What was successful in the past won’t be successful in the future. In today’s investment world you have to clear your head of the belief system that drove your investments during the past two decades. It’s a different world with different opportunities and different risks.

If you have trouble understanding that, just think of Florida, one of our rich states where the housing bubble blew the hottest. Housing prices are expected to fall further by 27% in Orlando and 26.8% in Naples by June 2010. You really think Florida will be one of the first states in America to get healthy?

Wells Fargo’s commercial loan group doesn’t. They just hired five more guys and still can’t keep up with the volume of defaults. One of the worst hit areas?  “Southeast Florida and Tampa are serious trouble spots,” they say.

Now imagine poor and scrappy Alaska. It doesn’t exactly conjure up images of suntanned 30-somethings driving around Lamborghinis, does it? But Alaska’s oil revenues are keeping the state from racking up debt. And its Alaska Production Tax passed in 2007 is squeezing even more money from oil producers.

In contrast to Florida, housing prices are expected to rise 2.5% in Fairbanks and 2.1% in Anchorage by the middle of next year.

I’d much rather buy Alaskan than Floridian bonds these days.

IDE’s Steve McDonald has been talking about this new brave world of investing for years now. His investments cover the gamut of stocks, bonds, covered calls, and global opportunities. If you want to invest safely and opportunistically, check out Steve’s Sound Profits right here.

Invest Safely,

Bob Irish
Investment Director
Investor’s Daily Edge

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