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September 12, 2006
Are barrels or ounces the weightier problem, Tues., Sept. 12, 2006, 2:31 PM
Is the world running out of oil, or merely shifting to a new pricing paradigm that is based on the increased cost of finding, processing and distributing oil?
If the world is truly running out of oil reserves, then oil prices will ultimately run much higher than $100 a barrel, and stay there for many years until acceptable alternatives are produced for the mass market.
But if there really exists plenty of oil including heavy oil from the tar sands, then the price is likely to stay in a new trading range of say $50 to $75 a barrel. That keeps the price just under the economic options, and covers the cost run-up due to inflation factors.
Another pricing factor is the derivatives market, which has driven the precious metal prices crazy this year. But in the case of crude oil, the product is a consumable, whereas the precious metals are not consumed but continue to exist in one form or another.
So unless a syndicate of traders could stop oil production from coming to market, the derivatives market is not likely to have a long-term impact " one way or the other. Therefore I think that the oil market is likely to stay in its present trading range for years to come.
But gold is a storehouse of value, which as Professor Fekete has pointed out in his two-part article "When Atlas Shrugs," has become the centerpiece of struggles by central bankers around the world to help the U.S. Administration retain its debtor status without destroying the value of the $USD.
Too low a $USD price will bring an end to U.S. purchases of foreign goods and services. It will also end the direct investment by Americans in these other countries.
So the plan is to keep the $USD as strong as possible. Part of the plan is to print money in these countries just a little faster than the U.S.
As long as countries can buy gold at an acceptable price, they will do so in order to have adequate supply to sell at higher prices when it appears that the gold price is likely to overwhelm the $USD. So they need to buy that gold, but their problem is that the demand for physical gold outstrips production, so if the bankers had to buy gold in the spot (cash) market, the price would zoom.
That leads us of course to the futures market. Companies like Barrick have sold in-situ gold, which are supposedly mineable reserves, in forward contracts. In other words, Barrick is getting paid now for their promise to deliver production later. Of course, the delivery never happens because the contracts are rolled over.
In a primary Bull market for gold, this selling forward is a loser's game " unless periodically your client -- the central bankers -- give you a helping hand. Let's say they help you get out the story that you are de-hedging, which drives the price above $700 where you hedge more by forward selling, then squeeze those buyers by various central banker tactics to where the gold price drops to below $600 where you buy those contracts back.
One hand helps the other. You know?
Another tactic, and this really concerns me is that recently the bankers have changed the gold miner valuation paradigm from being cash flow based, like it used to be and should be, to being reserves based.
And that leads us to the problem. The bankers now can say, "Oh, your reserves are now 2x million ounces " sight unseen of course " so we'll lend you 2X USD or finance your shares at 2x normal PE.
But what are reserves anyway? They are estimates defined as (a) proven, (b) probable, (c) possible and (d) postulated. The "postulated" of course is a joke because even category (a), which is the "proven," is a guess. Instead of "postulated," I could have used "any or all of the above".
But, hey, no problem if you happen to be working on the same team.
So what's going on today is that gold miner market capitalizations are being driven not by fundamental value but by postulated value " or should I say contrived value.
But look who's doing the contriving. Not just the companies (many are the gnomes I often write about), but the bankers and the governments of all nations. It's that old triumvirate (gang) again.
The hypothesis works of course because the bankers need gold contracts to buy so they can at convenient times sell for cash and futures in order to buy $USD and U.S. bonds.
This game goes for as long as the "increased reserves" story can be sold to the public, and as long as governments and bankers can find willing gnomes prepared to play the hedging game.
The gold mining industry has pretty much figured this out, so they refuse to go along with the hedging practice. That's good.
Now traders have to get their act together too. If you happen to be one of these, you need to do some things such as:
(i) buy physical gold rather than bullion-based ETF's
(ii) buy spot contracts, not futures (causing backwardation)
(iii) refuse to buy shares of gold miners that do not state unambiguously their management does not and will not trade in the futures market,
(iv) refuse to lend your miner shares to your broker or banker, and put them into cash accounts where your broker has no control,
(v) refuse to buy shares of the miners who constantly upgrade their reserve totals without validation from the world's best-known independent consultants, and
(vi) send letters to your elected representatives (in the U.S.) demanding that the federal government (a) eliminate the Fed, and (b) produce M3 money data, so that (a) government is responsible for the money supply of the nation, and (b) the voters and taxpayers who have a right to know get to know about such important data.
I'll write about these points at a later day.
We're at that point though where we have to understand if the weightier problem is barrels or ounces? I think its ounces because I relate it to $USD and U.S. Treasury Bonds and the credit bubble.
Posted by Posted by Bill Cara on September 12, 2006 02:31:24 PM | Category: Cara Today in the Market
Discourse
Many oil companies claim they are not going to be able to keep up with demand unless new discoveries in deposits are found.
Check out Slide 8
http://tinyurl.com/h3pqw
(From ENSCO's September 5, 2006 - Lehman Brothers CEO Energy/Power Conference)
Posted by: NYUgrad ![[TypeKey Profile Page]](http://www.billcara.com/nav-commenters.gif)
at
September 12, 2006 2:55 PM [link]
Kudos to Kimu the ALOHA person ... it appears more of us have been reading you than you might have imagined ;)
Posted by: C.Note at
September 12, 2006 3:19 PM [link]
It seems that oil is the subject du jour considering the price action.
I suspect there are some speculative positions being liquidated as all the geopolitical problems that put a premium on the price of oil are still there.
The equity rally seems to have some legs -- I just take as a great opportunity to sell. Things may run even higher, but we may see lower prices before the end of the year. I believe we may go through another scare/panic/etc before we celebrate 2007.
Thoughts
Posted by: JP at
September 12, 2006 3:24 PM [link]
Bill:
After reading all the downside of owning ETF GLD etc. and now you suggesting owning the real stuff, are you going to sell physical Gold from the Island Paradise when you are up and running?
Posted by: C.Note at
September 12, 2006 3:59 PM [link]
Bill:
Buying physical gold entails expensive transactions and storage costs. Would unhedged miners such as GoldCorp not be the better way to trade the metals?
Posted by: 2nd_ave at
September 12, 2006 4:05 PM [link]
Bill --
How can you be sure a given miner isn't playing in the futures market? They could always do so through an invisible affiliated offshore enron-style SPE or "special purpose entity".
I think it all comes back to the integrity of the management - to knowing the management, because you can never rely upon financial statements, or accountants.
This applies particularly to junior prospectors and producers, which is why I think your idea of a strudy group dedicated to such miners is so immportant.
I always keep in mind my fellow Missourian Mark Twain's definition of a gold mine: "a hole in the ground with a liar standing next to it"! LOL
Jock, You are absolutely correct regarding integrity of management, but the point is that management wouldn't lie on an SEC filing unless they were foolish. Every miner that does not sell forward ought to make a voluntary statement in the 10-Q's and 10-K's, and traders should embrace the shares of those companies, and reject the rest.
But please don't knock the independent auditors. I may have personally rejected my two professional accounting credentials (I am after all an eccentric), but I have the utmost respect for the integrity of that profession. I don't like the way they run their business at the association level, but that's a different issue.
2nd_ave, I think that all of us needs to have a small cash position, and part of that should be in gold and silver coins and bars, particularly when global inflation is on the rise -- rather than ETF's. The majority of the precious metals related equities positions I think ought to be in shares of unhedged miners.
C.Note, Yes, I've been thinking of setting up a gold bank in Bahamas. But that's a matter I'd have to discuss with the authorities there. I'll submit your name as lead investor and interim chairman if you wish. :-)
JP, I agree with you that oil is the talk of the day. Actually the energy futures market is the story. I wonder how many improperly-hedged hedge funds are in trouble now?
Posted by: Bill Cara at
September 12, 2006 5:05 PM [link]
Bill,
I recall your friend's comment earlier this year:
I was alerted to zinc by various speakers at this year's PDAC and by my friend Murph who tracks the juniors and small caps. Murph says: “I hate to pay more than the price of a postage stamp for a mining stock,� so that pretty much sums up his approach to trading.
Please let us know if you or your friend Murph see any promising stamps to collect at this weekend's Gold convention.
My forward looking crystal ball is always labeled eccentric and here is what I see...
The US is playing into the hands of Russia and to an extent China. Russia needs to get theirs as much as the central bankers and all their friends. Thus, it is in Russia's interest to promote high commodity prices. China is an emerging superpower who has America addicted to cheap goods. Thus, it is in the Chinese interest to promote buying US debt.
The deeper the US debt goes, the more fragile this scenario gets. At some point, as the dollar continues to lose value China will say enough. China needs commodities and Russia has them.
At what point does China divert their owned US debt toward Russian consumables or hard assets? As you have pointed out, the house of cards will tumble.
Does anyone else have any thoughts on China/Russia/US dynamic in the world economy. I would really like to hear others thoughts on this subject?
Posted by: cb at
September 12, 2006 11:10 PM [link]
This article cites short covering of Yen and falling crude prices for the weakness in gold. Called 580 as floor on Monday.....
Posted by: cb at
September 12, 2006 11:14 PM [link]
cb,
9/13/06 - Here are thoughs on China. Not my thoughts. Can't recall the author off-hand…could go dig it up.
China's core problem, the inability to allocate capital efficiently, is embedded in its development model. The goals of that model -- rapid urbanization, mass employment and maximization of capital flow -- have been met, but to the detriment of profitability and return on capital.
In time, China is likely to find itself undone not only by its failures, but also by its successes.
In the minds of Jiang and his generation (previous “administration�) of leaders, the belief was that only rapid economic growth -- defined as that in excess of 8 percent annually -- could contain growing unemployment and urbanization pressures and thus hold social instability at bay.
OF NOTE: China consumes 12 percent of global energy, 25 percent of aluminum, 28 percent of steel and 42 percent of cement -- but is responsible for only 4.3 percent of total global economic output.
Ultimately, while "solution" espoused by Jiang's generation did forestall a civil breakdown, it also saddled China with thousands of new non-competitive projects, even more bad debt, and a culture of corruption so deep that cases of applied capital punishment for graft and embezzlement have soared into the thousands.
growth will continue, along with the attendant rise in commodity prices -- but at the cost of growing income disparity and environmental degradation.
The likely outcome of such "success" would be a broad rebellion by the country's interior regions as money becomes increasingly concentrated in the coastal regions long favored by Jiang. And that is assuming the financial system does not collapse first under its own weight.
Local rebellions in China's rural regions have already become common...
As the central government gradually increases its pressure on the assets and power of China's coastal lords,
there is a danger that those in the coastal regions will do what anyone would in such a situation: reach out for whatever allies -- economic and political -- might become available. And if China's history is any guide, they will not stop reaching simply because they reach the ocean.
NOTE: Mr. Paulson…? Putin and commodity-rich Russia…?
The last time China's coastal provinces rebelled, they achieved de facto independence -- by helping foreign powers secure spheres of influence -- during the Boxer Rebellion. This resulted, among things, in a near-total breakdown of central authority.
China's apparently stunning economic success stems from the pursuit and implementation of the quintessential Asian economic plan, which can be summed up as "growth for the sake of growth." Japan, South Korea, most of the Southeast Asian "tigers" and China all facilitated their economic "miracles" by focusing on the flow-through of capital, without regard for profits.
As long as money was flowing in, there could be jobs. As long as there were jobs, there was a stabilizing social force. There was also an overall rise in personal wealth, though rarely was it evenly spread.
The booming coastal economies created clear opportunities for corruption.
With the central government fixated on growth, the best-performing local leaders were rewarded. The more foreign capital they were able to attract, the greater their personal influence and takings. These officials were not measured on efficiency or profitability, but on total flow-through of capital, rates of growth, employment and social stability.
Beijing's choice, then, is between taking no action against local governments, out of fears of triggering massive capital flight or inadvertently crippling investment and export activity, or rallying the rural masses -- which would be another avenue toward recentralizing control.
For this, Beijing needs to make it utterly clear what risks the local government leaders face. Threats of prosecution and even the token executions of some officials have not worked, but the potential for more and larger social uprisings might.
This means Beijing needs to allow, if not subtly encourage, more localized demonstrations.
And that apparently is where Hu and Wen intend to go.
The Chinese economy is on very shaky ground, despite published high growth rates and a seemingly untarnishable shine.
The fundamental structure of Asian economics -- based on growth rather than profitability -- leaves China in a position not unlike that of Japan in the late 1980s and Korea and Southeast Asia in the mid-1990s. Beijing fears massive social instability if the economic system unravels, and the ACFTU can serve as a tool of control.
But Beijing has one alternative. If cracks in the economic system give rise to social troubles, the central government may reach for a tried and true tool of domestic manipulation: Blame the foreigners. The ACFTU can quickly serve both as an information source and a rallying point for selective targeting of foreign firms, making them "examples" and releasing some of the pent-up pressure in society.
It is an easy case to make; the foreign-backed enterprise, in collusion with corrupt local officials, is exploiting and mistreating the hard-working Chinese laborer. This can be painted as the cause of China's economic troubles, relieving blame from the central government, at least temporarily.
Already we see the Hu government turning to the Chinese rural masses, seeking to gain their support and appease their concerns.
When it comes down to it, the central government's primary focus is in maintaining the power of the Communist Party and the territorial integrity of the Chinese nation.
Thus, it sees the 300 million-strong middle class as a nicety, but the real power, as is always the case in China, comes from the 900 million to 1 billion rural Chinese.
If the central government and the core Party leaders see their fragile economic web unraveling, and social stability with it, it is not the foreign businesses that they will seek to protect.
---------------
Here's Russia in a nutshell:
Russia Buys Into World's Largest Titanium Producer
http://www.rferl.org/featuresarticle/2006/9/5CFD8E81-432C-43BA-9473-AD0A147A8D7B.html
The sale is seen as a further step in the government's drive to increase state control over strategic industries.
Can you say “Putin?� Third term…?!!
-----------------
As to the US, I'm just beginning to pay attention. And, there are far too many sources of opinion that I have yet to find three that I will rely on daily, although I'm getting very close.
That being said, I continue to have a keen interest in China as they will pick-up the super-power baton in twenty years, or less. And, I'd say Putin ain't no slouch.
Posted by: duey at
September 13, 2006 4:03 AM [link]
ALOHA !!
cb ... Putin is one coronation away from being the new Czar Of Russia and he wants "payback" for what the USA did to Russia during the Cold War. I believe he has a foolproof plan to get it via the Russian natural resources and the Ruble.
The Russians already have an oil bourse in full operation trading in Rubles. Last week it was announced that Russia is now the number one oil producer and Saudi Arabia is number two. Russia already supplies some 30% of natural gas to Europe. Putin's next move is to reclaim the Balkans and the oil and natural gas fields there. Look for him to move into Georgia first on the precedent setting Bush tactic of "pre-emptive terrorist threat nullification". I'm sure Putin has his "Mission Accomplished" banner ready to fly!
Strengthen the Ruble by trading oil and natural gas to Europe payable in Rubles. Strengthen the Ruble by building up gold reserves. Strengthen the Ruble by paying off 1980 debt ... All of the above are coming to fruition. Militarily the USA cannot touch Russia and Russia has so far backed every enemy of Washington DC/Bush. Putin has become the CEO of the largest oil and gas and base metal company in the World ... Russia! Putin is way more astute in the tactics of economic warfare than his predecesors were, after all he learned from the best ... the USA! I believe Putin secretly is laughing at Bush mired in Afghanistan and Iraq like Russia was back in the 80's. I am sure he thinks our leaders are idiots for falling in the same trap set by the same guy ... Osama!
Just as a side note. Putin sent his Assitant Finance Minister to the biggest gold market(NON BANK)conference in the World last July in Dawson City, AK ... The GoldRush 21 Conference. Why would he do that? Why does Putin think gold is so important?
Russia recently broke off joint military manuevers with the USA yet has close military ties with the Chinese and signed a joint agreement with Iran. When will Saudi Arabia get onboard since it seems the Russian Mafia is gaining influence over the US Mafia ... Our Founding Fathers must be rolling over in their graves at the total lunacy of the US Foreign Policy ... Pre-emptive what?
I believe Russia will once again become an enemy of the state, but this time it will be the USA that has to pay the Piper.
Russia is a wild card for the USA ... We have no influence at all aside from the occassional insults that Cheney ever so wisely hurls at Putin ... If I were Cheney I would not accept any hunting invitations from Putin!
Posted by: kaimu at
September 13, 2006 4:13 AM [link]
It is not clear to me why owning a bullion etf such as IAU ( yes, I do) is different than owning the physical gold. Rereading the prospectus, the ETF claims to have the physical gold to back the ETF.
What am I not understanding?
Rick
Posted by: RickC at
September 13, 2006 8:09 AM [link]
Duey,
Thank you for sharing your thoughts on China. You have much more insight into the day to day life there which is important for all of us to understand. Please keep posting with these insights.
Kaimu,
I am agreement with you on most thoughts. While I do not think Putin's goal is to "get back at" or become more of a power than the US, he appears to be building the empire back up for the benefit of himself and friends. Bottom line is that Russia is commodity rich while the US is "franchise" rich.
As you mentioned, a key indicator for me is the continued lack of support from Russia and China of US foreign policy with regards to Iran and Iraq. Both countries appear to find US foreign policy arrogant and are not afraid to stand on the opposite side of the aisle. The next twenty years are going to be very interesting to say the least.
Posted by: cb at
September 13, 2006 12:43 PM [link]
Another article on Russia "getting theirs" in opposition to US foreign policy (thanks for the earlier link to this site)...
http://www.rferl.org/featuresarticle/2006/08/e73ec3d3-9d04-47d6-9c8d-d9e8230b0a3f.html
Posted by: cb at
September 13, 2006 12:56 PM [link]
cb,
Kaimu is darn close to the mark regarding Czar Putin, IMO.
Posted by: duey at
September 13, 2006 3:03 PM [link]
re central bank gold sales, this comes from the blog: themessthatgreenspanmade
But there's a reason why central banks sell gold as they do.
"In his memoirs, Paul Volcker, Federal Reserve Chairman back in the 1980s, lamented the inaction on the part of central banks to sell enough of their supply to contain the gold price. He said that soaring gold prices in the late 1970s and early 1980s "knocked the psychological props out from under the dollar"."
Jock, I think your quote of Volcker's admission of not selling enough gold to keep up confidence the dollar is where the US will get itself into big trouble by selling its reserves to Russia and China to maintain the dollar. This is the only negative factor I see in gold.
Regarding Russia, I see them as a much more viable economic threat to the USA as they do not have the same co-dependant relationship with the USA as China. CHina is addicted to our consumerism, just as we are addicted to their cheap stuff. I believe that CHina understands how important our economy is to them and would act accordingly to help maintain it should a fallout occur. However Russia is not a significant trade partner with the US of A and would have a lot less to lose should our economy tank. Factor in their tremoundous gold and US currency reserves (I read they have almost two-thirds of all foreign $100 bills), the potential of the petro-ruble and add in the fact that Russia is not afraid of the US military makes them a much bigger threat to the US economy.
Posted by: rick s at
September 14, 2006 2:19 AM [link]
Re point (iv) - doesn't a GTC limit order on shares in a margin account effectively prevent them from being loaned? Or is this a bogus rookie assumption?
t4k
Posted by: trade4keeps![[TypeKey Profile Page]](http://www.billcara.com/nav-commenters.gif)
at
September 12, 2006 2:52 PM [link]