Alright, here’s the first question we’re going to close the week with: is the boom in exploration and capital spending on Aussie resources a sign of another top in the commodity cycle, or a sign of higher commodity prices to come? In today’s Markets and Money, we take up that question and much, much more.
Marius Kloppers had his numbers wrong. He said there were 74 resource projects in Australia at an advanced stage worth $80 billion. Yesterday, the Australian Bureau of Agricultural and Resource Economics (ABARE) said it was 74 projects for $112 billion. That’s a 67% increase from this time last year. Is it inflation? Or just Gorgon?
These were projects already in the pipeline before the commodity price correction of 2008. The Gorgon gas project off the Northwest Shelf alone is a $43 billion project (nearly 40% of the total). Energy projects make up 38 of the 74 projects and 72% of total capital spending – which is why in both Australian Small Cap Investigator and Diggers and Drillers, Kris and Alex are recommending both conventional and unconventional energy shares.
But usually the companies doling out billions in new cap ex are larger companies with deeper pockets. That doesn’t mean they aren’t shares you want to own, or that their share prices aren’t correlated with rising commodity prices. But we reckon you’re going to find bigger cap ex related gains from the companies getting some of the contracts related to projects like Gorgon. These are the “pick and shovel” companies of the cap ex spending boom.
Or you can look at the other end of Resource City, to the explorers and developers. ABARE reports that last year set another record in resource exploration spending in Australia. Some of it was brownfield exploration (old sites or mines being redeveloped) and some was greenfield (brand new sites or mines). All up, there was $6 billion in exploration spending in Australia last year.
More than half of that was a frenzy of small companies drilling for new oil. $3.8 billion was spent on petroleum exploration. That tells you what the industry thinks about oil prices: they are going higher. Coal exploration spending was up 27%, with iron ore exploration up 30%.
The big shocker was that uranium exploration and gold exploration spending were both down by double digits in the last year. The uranium exploration spend was down 20% and gold down 26%. Yet the price forecasts for both commodities look, at least according to Alex’s research, pretty damn bullish. So why aren’t the explorers out kicking rocks and taking names?
It turns out they are, just not in Australia. The ABARE numbers measure exploration spending within Australia. But many Australian-listed firms are looking for gold and uranium in other places, especially in Africa. They’re doing so because production costs are lower there, even if political risk is higher (although in some places, it’s more than acceptable for the projects on offer).
They’re also doing so because if you find a country with an acceptable level of political risk, you can also find greenfields mines to develop and build. Granted, that takes a lot of capital. But some of the developers never plan on running the mine anyway. What they’re looking for is an economic deposit (high ore grades that can be produced easily) leveraged to higher commodity prices. They can then sell that off to a producer without ever turning a shovel in anger.
Just this morning, Aussie-listed Impact Resources said it believes it’s found a large new uranium province Botswana. In a possible case of “nearology,” Impact said the new province has similar characteristics to A-Cap Resources 98 million pound inferred resource in the same neighbourhood.
We have no idea what the facts are for either company. What we do know is that Alex told us two things (in his November letter) that you should look for with Aussie uranium companies: they need to have a resource big enough to produce a given amount of uranium each year and they need to be in production by 2012-2013. Impact’s resource, according to Alex’s research, was not big enough to qualify on the first measure.
As to the second measure, that’s when Alex believes a shortage could hit the uranium market, thanks to interrupted mine supply at BHP’s Olympic Dam and Cigar Lake in Canada. That, plus the removal of Russian-supplied recycled nuclear warheads. And that’s just on the supply side. On the demand side, well, you’ve probably heard that story so we won’t go into it.
Of course all this fuss about oil, gas, gold, and uranium presumes there will be a functioning world economy needing and/or wanting these things next year. Maybe not so, says a report from Societe Generale!
The French bank published a note to clients warning them to be ready for a possible “global economic collapse.” In its report, “Worst case debt scenario,” the bank said what we’ve been saying for the last month: the transfer of private sector debts to government balance sheets threatens a sovereign debt crisis (which is really a kind of debt-induced fatal heart attack for the fiscal welfare state).
The bank shows that overall debt-to-GDP ratio in the U.S. (when you include government, business, and households) is 350%. Bank analyst Daniel Fermon says in his report that even without more fiscal stimulus, government debt-to-GDP ratios will, within two years, be at 105% of GDP in the UK, 125% in the U.S. and Eurozone, and 270% in Japan.
This massive global debt burden is more than the underlying assets can bear. That is, the assets (collateral and the tax base) will not generate sufficient income to service the debt. It’s global Ponzi Finance. What’s in store, then, is another great forced deleveraging where debts are liquidated and asset values are forcibly written down.
That’s not anyone’s idea of a good time. “Under the French bank’s ‘Bear Case’ scenario,” writes Ambrose Evans-Pritchard in the Telegraph, “the dollar would slide further and global equities would retest March lows. Property prices would tumble again. Oil would fall back to $50 in 2010.”
Hmm. Doomer porn? Or prudent preparation? You decide!
Rock-star bank analyst Meredith Whitney has already made up her mind. She told CNBC in an interview, “I haven’t been this bearish in a year…There’s nowhere to hide at this point…The Fed and the Treasury have to get the banks to pay back TARP. That means the banks are going to raise capital again.”
She was asked if the banks are adequately capitalised? “No way,” she answered evasively. “All this said…I don’t know what’s going on in the market right now ’cause it makes no sense to me. There’s no root in fundamentals.”
That’s the trouble with a market trading on liquidity alone. Valuations don’t make sense. But that’s doesn’t keep people from making them, or having an opinion anyway. Take gold (or pay $1,143.20/oz. for it).
Another report from Societe Generale – this one from analyst Dylan Grice – says that if the U.S. dollar were fully backed by gold, as it was in during the peak of the 1970s gold bull – it would trade for $6,300 per ounce. That makes gold, er, cheap at these prices.
Is this a case of gold entering its mania phase? Are analysts now starting to outdo each other with gold predictions? Maybe.
But Grice makes a sensible case. He writes that, “The U.S. owns nearly 263 million troy ounces of gold (the world’s biggest holder) while the Fed’s monetary base is $1.7 trillion. So the price of gold at which the U.S. dollar would be fully gold-backed is currently around $6,300. Gold is very cheap – at current prices, the USD is only 15 percent gold-backed.”
If gold goes to $6,300, a lot of things will have gone wrong. Uber-bear Nouriel Roubini fears things are about to go from worse to much worse. He writes in an op-ed that the American unemployment picture is harbinger of bad times ahead.
“This is very bad news but we must face facts,” Roubini writes. “Many of the lost jobs are gone forever, including construction jobs, finance jobs and manufacturing jobs. Recent studies suggest that a quarter of U.S. jobs are fully out-sourceable over time to other countries.”
“As a result of these terribly weak labour markets, we can expect weak recovery of consumption and economic growth; larger budget deficits; greater delinquencies in residential and commercial real estate and greater fall in home and commercial real estate prices; greater losses for banks and financial institutions on residential and commercial real estate mortgages, and in credit cards, auto loans and student loans and thus a greater rate of failures of banks; and greater protectionist pressures.”
It’s pretty gloomy. But at least now, at the end of the week, the status quo seems to have clarified itself. We think we know what the opposing forces are in the market and just what’s at stake.
In the red corner is the spectre of another massive forced deleveraging (debt deflation). Banks are undercapitalised. Assets are overvalued (shares, property, commodities, and most definitely most government bonds). This fighter will pummel stock markets and asset prices much lower as the world comes to grips with too much debt that produced too few productive assets and real income.
And in the blue corner is Helicopter Ben Bernanke. His mission, should he choose to accept it, is to devalue the U.S. dollar (and all those currencies currently pegged to it) and create more new money faster than deleveraging can wipe out debt. In theory, Bernanke is just the man for the job. Why?
He’s an avowed deflation fighter. And, again in theory, there is no limit to how much money the Fed can create. Through monetary policy and other methods, the Fed can continue to shovel liquidity into the banking sector to keep it fictitiously capitalised and nominally solvent. In this fight, the Fed expands its balance sheet two to three times its current size (at least).
Of course if the Fed does begin growing its balance sheet at that rate one thing will happen and another thing might happen. First, gold will get closer to $6,300 as global dollar holders realise the Fed’s intentions toward the dollar (not honourable). But there is another possibility.
The other possibility is that the U.S. Congress, not understanding anything, but seeing the fiscal deficit explode and the dollar plunge, begins to call for Bernanke’s head on a pike. Or, to be more precise, bill’s stripping the Fed of its independence and calling for a formal audit might began garnering support in the Congress.
There might even be some elected representatives of the American people who try and prevent a further currency calamity for Americans (who are rapidly realising that a weaker dollar means a lower standard of living and rising prices for imports). Don’t hold your breath, though.
Congress get tough with the Fed? Granted, it’s a stretch. My colleague Dan Amoss back in the States suggests Bernanke’s political strategy could be to let a little deflation creep back into asset markets. A drop of 10-15% on the Dow would get Congress good and worried again, and mid-term elections are not far off are they? With another spell of deleveraging, Congress might just back off and let Chairman Bernanke continue his long-slow, back-door re-capitalisation of the zombie American banking sector.
You have to wonder, though, if the markets will be so compliant with the Fed’s plans (assuming the Fed’s plans are anything like we’ve described). You have to wonder if normal people are beginning to lose confidence that the so-called authorities have our best interests at heart, of even know what they’re doing.
Above all, you have to keep really tight trailing stops to lock in your equity gains, increase your allocation to cash, and keep an eye on element number 79 in the periodic table. It’s telling you exactly what to expect.
A final possibility is that the United States is ripe for a populist demagogue who either rails against the unfairness of China’s currency policy and/or tells Americans it’s time to close the borders, repudiate the debt, and get the fiscal house in order…with a big broom…and some pitchforks.
for Markets and Money