Of rocks and stocks ,and streams of consciousness

This post is destined to be a string of tenuously connected thoughts, all starting with some folks down Texas way I happened acrosst.

The Texas Hedge Report observed "For most of this month, the physical prices of gold and silver have been rising nearly every day, yet the mining stocks have been stagnating and in some cases falling. Over the last 3 months, the operational leverage that mining stocks are supposed to provide has not been seen." And then asks, "What gives?"

Guambat has previously pointed out that, though you might own a gold producing stock, you may only get the shaft.

The Texans set out to answer their "What gives" question and make similar observations:

[L]et us reiterate that long term we are extremely bullish on the prices of gold and silver. They are the only two currencies in the world that are not someone else’s liability. In a world of fiat money chaos and destruction, the long-standing monetary stability and finite supply of both gold and silver will be increasingly desired by investors around the globe. In recent days, the rally has corrected twice, but for long-term investors, we think the U.S. Dollar’s imminent and unrelenting weakness will be the catalyst for much higher prices on both metals over time.

If one is bullish on the precious metals, the question then becomes how best to play their upcoming appreciation? Is it stocks, futures, options on futures, or simply owning the metal itself through ETFs or physical storage? Mining stocks we felt had greater upside, but also greater downside than the physical. We wanted to own the metal stocks of established miners as we were partial to the operational leverage they provided to investors. A 1% increase in the price of gold for instance; often times meant a 2% or greater increase in net earnings for these mining companies. Junior miners were and still are too speculative for our blood – though certain juniors may offer spectacular returns, many others will go up in smoke.

However, over the last 3 months, the physical prices of both gold and silver have done far better than the mining stocks. Gold has tacked on nearly $100 to its price and silver has jumped even more percentage-wise recently, yet many components of the XAU and HUI haven’t budged or are barely up in the same time frame.

We think the reason for this divergence is several fold. First, the gold and silver stocks may have gotten a bit ahead of themselves as the underlying earnings of the companies need to play catch-up with their stock prices.

[This can happen if, e.g., you decide to use spot metal prices to value the company instead of the company's own wisdom: "As the commodity price climb has steepened, brokers have exploited a discrepancy between analysts' target prices for resource companies and the "spot" prices at which those companies sold the ores they dig out of the ground. The gap exists because analysts tend to base forecasts on prices over time rather than on more volatile spot prices. As a result, their valuations typically lag a price boom. Brokers call this tendency to undervalue resource stocks "the biggest opportunity in world equity markets"." So, if you've paid top price for something, not to worry; you just got ahead of yourself. Everything will be A-OK.]

Secondly, a lot of the miners have shot themselves in the foot with higher than expected cash costs due to oil and production shortfalls that have limited to some extent the EPS growth achieved with higher physical prices to gold and silver. [E.g., "oops, I've been getting so much more for my rocks, I forgot that I'd have to pay so much more for the other guys' rocks."]

Third, places like Latin America with recent left-leaning presidential elections in Bolivia and Peru have turned increasingly hostile towards producers. The growth of Hugo Chavez type dictators in Latin America could conceivably be beneficial to the actual metal prices as supply is reduced, but negative towards the foreign miners that occupy Latin American mines that now run the risk of higher taxes or perhaps even nationalization.

Fourth, many mining companies are (in our opinion) extremely poorly run – perhaps more so than any other industry we follow. Most mining companies seek to grow their production profile at any cost. This means issuing a great deal of heavily dilutive shares annually to “build the business”. Coeur d’Alene (ticker: CDE) , for example, has seen its share count grow about 30% per annum from 1997 thru 2005 – providing a constant headwind to shareholder returns. Coeur has further diluted shareholders by over 10% since the start of 2006! As one could imagine, Coeur’s silver production hasn’t grown anywhere near 30% per annum over the last decade, which means that shareholder dilution in terms of falling metal production on a per share basis has been real. This is not to single out Coeur alone (we have no position in the name), as nearly every mining company has perpetrated this offense on shareholders. [Whilst others are busily and happily buying back their shares.]

Lastly, the reason that has perhaps been the greatest contributor to mining underperformance of late is skepticism. Gold and silver are going up and a great deal of the crowd is anticipating a large pullback. Like in the oil complex a few years ago, higher highs in the price of the commodity are met with a great deal of disbelief by a young Wall Street crowd that was in diapers the last time commodities really performed well.

It was that third observation that fired me up. CNN had a similar worry when it recently ran a story about "5 things to watch in energy: here's what's moving the market over the next few weeks". One of the five things was "Nationalization". Now I'm not usually asleep over the morning Sydney Morning Herald, but I must have missed the huge nationalization movement that is sweeping the world of oil (and maybe other commodities?). This is what CNN said about that:

Venezuela is most often in the news with plans to nationalize oil industries, a move many say discourages international investment in that country's infrastructure, hurting production.

A news report Monday said that Venezuela's left-leaning president, Hugo Chavez, is making plans to sharply raise taxes and royalties on foreign oil operations in the country.

Analysts fully expect the trend toward nationalization to continue for the foreseeable future and say its happening in not just Venezuela but across most of South America and in Russia as well.

And you can add another country to the list: Mexico.

So, Guambat burrowed into Google and found that there is, indeed, a nationalization blip on the market radar, mostly in South America, but with models for Russia, AsiaPacific islands and who knows where else.

Washington's worst nightmare: Bolivian President Evo Morales, during his recent successful campaign, repeatedly described himself as Washington's “worst nightmare.” Ollanta Humala Tasso, the front-runner at the end of the first round of the Peruvian presidential race, could well be Washington's next “worst nightmare.” Sharing a political philosophy with Bolivia's Morales and Venezuela's Hugo Chávez, Humala promises to move Peru in a very different direction than that followed by outgoing President Alejandro Toledo Manrique.

Other components of Humala's still hazy economic policy include state participation in “strategic sectors” of the economy, the renegotiation of multinational contracts, and a windfall profits tax on foreign mining companies. Humala Tasso has also criticized the Camisea natural gas line, a centerpiece project of the Toledo administration, calling for a revision of the contract and higher royalties for the government.

[The president said,] “There are some people who think, just because they have money, they have the right to intervene in the democratic process,”. [Oops, that quote was from the outgoing President and not from the incoming one. And he wasn't complaining about Washington, but Caracas.]

And so it does indeed seem that we are on the brink of yet another outbreak of bleeding heart commie socialist revolutions in South America. And just in time, too, because all those old Che t-shirts are wearing pretty thin. [See, I warned you the thoughts here were going to stream.]

There is a very supportive picture of the revolutionaries in this article: "Bolivia, Evo Morales and the Progressive Mandate in Latin America" To give you a taste of this comprehensive overview of the so-called mandate, here are a couple of excerpts:

On January 21, on a hill outside of La Paz, a traditional ceremony marked both a major shift in Bolivian politics and a milestone for the growing New Left in Latin America. At Tiwanaku, a site of pre-Incan ruins significant to the country's indigenous populations, Evo Morales, barefoot and dressed in a red tunic, received a silver and gold staff from leaders of the Aymara people.

It was the first time in 500 years that this ritual transfer of leadership had been performed in Bolivia. With a surprising 54 percent of the vote in a multi-party race, Morales not only secured the margin needed to avoid a run-off vote, he obtained the largest mandate ever given a president in Bolivian history. [Somehow I always figured a mandate would involve at least 3/4ths of the people, but there've been pollies world over who would have me believe otherwise.]

He takes power as the first indigenous president in a country where nearly two-thirds of the population identifies with the Aymara, Quechua, or other indigenous groups. The same fraction of the country lives in poverty and the divide between rich and poor closely follows racial lines.

Morales has announced plans to nationalize the country's gas reserves, rewrite the constitution in a popular assembly, redistribute land to poor farmers, and change the rules of the U.S.-led war on drugs in Bolivia. If he helps spur on the radical change that his social movement base demands, he will face pressure from corporate investors and from the White House. If he chooses a more moderate path, Bolivia's social movements have pledged to organize the same type of strikes and protests that have ousted two previous presidents in the past two years.

For their part, social movements supported Morales as the best option in the electoral contest. However, their allegiance to the state remains limited. "The [54 percent] isn't a blank check, it's a loan," said political analyst Helena Argirakis to Los Tiempos, Cochabamba's daily newspaper. Her colleague Fernando García added, "The social movements' support of Morales will always be conditional."

At the same time, Morales faces severe external pressure if he antagonizes foreign creditors. Conservatives in the United States have been horrified by the success of Morales whom they regularly slander as a narco-terrorist because of his support of coca growers. (Although coca can be used to produce cocaine, the natural plant leaves are used to make tea, have traditional importance for the country's indigenous people, and are almost impossible to abuse in their natural form.)

Bolivia owes large debts to international financial institutions, including the World Bank, the IMF, and the Inter-American Development Bank. This gives the U.S. an effective veto over future loans to the country and thus the potential to plunge Bolivia's shaky economy into economic crisis. Domestic right-wing factions, centered in the wealthy province of Santa Cruz (the heartland of Bolivia's energy industry), are threatening to secede if resource extraction is nationalized. These conservatives are ready to side with the U.S. and the IMF against Morales should an international showdown take place.

The article goes on to look at the rest of the South American countries leaning the same way. I'm sure I'd have been much better educated if I had read the whole thing. Let me know what it says, OK?

And as we try (from each according to his level of sleep to each according to his care factor) to come to an understanding of the complexity of this situation, it bears repeating that all these events have particular regional and character issues. This is not some monolithic South American Caliphate. Even the left is critical (and there have always been revolutionaries more revolutionary than thou), as this article points out:

Macho Men and State Capitalism - Is Another World Possible?

Chavez is drumming up support in a rhetoric that seeks to reminisce of those days of glory when Simon Bolivar intended to unite Latin America. Chavez' Boliviarian revolution suddenly seems the only viable option, not only among the non-elite in Latin America but also gathering support among once disillusioned leftists worldwide.

However, the true democratic debate has been silenced in this simplified two-sided fight between the projects of macho men. While Chavistas and anti-Chavistas tirelessly battle and Venezuelan families are divided, little space seems to be left for alternatives and critiques of the supposed Chavista revolution, without being labeled anti-revolutionary. While the anti-imperial and anti-capitalist discourse of Chavez attracts supporters worldwide, including even such world famous writers as Noam Chomsky and Eduardo Galeano, Chavez is busy making direct business contracts with oil giants such as Petrobras, ChevronTexaco, BP, ExxonMobil, and Shell. As Chavez claims to represent the indigenous population of his country, many questions remain about these mega-corporate ventures, as indigenous voices from over all over the continent speak of the effects of these oil empires, that is, if anyone wants to listen. Where are the dissident feminist, environmental, and indigenous voices to create a real revolution?

Chavez has teamed up with Brazil's now scandalous Lula to create the world's largest oil corporation PetroAmerica, the combination of the two state owned companies PetroVenezuela (Pdvsa) and Petrobras. While Chavez is sending cheap oil to poor Latino immigrants on U.S. soil, he ignores the lives of indigenous people at home and his ventures, if continued, will lead to their eventual extinction.

With all that homegrown action down South America way, there is bound to be plenty of opportunity for Monroe Doctrine chest beating up North America way. Poor old Georgie, though, won't be able to have much to say about it because his tongue will be tied by the immigration debate. Even he knows he can't get away with making us happy with Mexican immigration at the same time he'd be serving up images of Pancho Villa.

But that won't stop others, like this chap, Ronald Bailey, at ReasonOnline:

The problem is that the vast majority of the world’s remaining oil reserves are not possessed by private enterprises. Seventy-seven percent of known reserves belong to government-owned companies. That means oil will be produced with all the efficiency associated with central planning. Michael Economides estimates, for example, that it will take $4 billion in investment to keep Venezuela’s oil production at current levels. Yet that country’s Castro-wannabe president, Hugo Chavez, is investing just half that.

If ChevronTexaco, ExxonMobil, or other private companies actually owned the reserves, the world would be in a much more secure position with regard to oil production. Instead, we are subject to the whims of figures like Chavez, Russia’s Vladimir Putin, and Iran’s Mahmoud Ahmadinejad, and must worry about the doubtful stability of their personalities and regimes.

Say what you will of his preference for private ownership of oil production, I think he was entirely remiss in not mentioning the government-owned companies of OPEC when he spoke of Venezuela, Russia and Iran. While Iran and Venezuela are OPEC members, the total list includes:
OPEC National Oil Companies (NOCs):
Algeria, Indonesia, Iran, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, United Arab Emirates, and Venezuela