By Brad Zigler
Yesterday’s Desktop ("Risk ‘ON’ For Gold Stocks") highlighted investors’ sharpening appetite for risk made manifest by a boom in junior mining stocks.
Where risk abides, the actuarily inclined will set up shop to deal in insurance. For gold investments, insurance comes in the form of options. Put options, in particular, provide protection for their buyers against catastrophic declines in the price of their investments by locking in a sale price for the duration of the contract.
Insurance costs jump when demand — sparked by the perception of increasing risk — rises. Gold put prices spiked higher yesterday after easing for four trading sessions. You wouldn’t have noticed the anomaly if you were tracking the CBOE Gold Volatility Index (GVZ).
CBOE Gold Volatility Index vs. Gold Insurance Cost Index
(Click to enlarge)
Why? Because GVZ tracks a universe of gold options — more specifically, contracts on the SPDR Gold Shares Trust (GLD) — that includes calls and puts. Over the past week, GVZ rose in stair-step fashion from 20.16 to 22.45, to approach the indicator’s high watermark set in mid-October. GVZ’s value is a percentage and represents the annualized volatility, or price variance, expected by option traders. The volatility is parsed from option premiums after factoring out other risk factors associated with time to expiration, the trust’s current share price and interest rates. Overall, the GVZ indicator has been telling us that option prices have been goosed up this week. There’s a direction relationship between option prices and their embedded volatility assumptions, so if you jack up "the vol," you crank up option premiums.
The trouble is, GVZ doesn’t make a distinction between calls and puts. The Gold Insurance Cost Index does. That’s because it’s based solely on the price of puts — the insurance you’d buy if you owned gold, or a gold proxy such as GLD shares.
The fact that GVZ went up for four trading days while the insurance index fell tells you that the price hike was centered on calls, not puts. That is, until yesterday. Yesterday, option traders scrambled for downside price protection and bid up put prices.
And why not? Today, of course, is Election Day. Weird things can happen on Election Day. For some investors, insurance premiums, though inflated from last week’s level, are still relatively cheap compared with the unhedged risk of owning metal when the electorate and the Fed, meeting over the next two days, are swinging their influence.
That makes Wednesday even more interesting than before.
Disclosure: No position
Rare Earth Warning: Is the Gold Rush Over?
November 2nd, 2010 | Posted by Global InvestorsJust a month ago I predicted a global "Gold Rush" in the race to discover new sources of rare earth metals. Since then, America’s main players in the rare earth game Molycorp, Inc. (MCP) and Rare Element Resources Ltd. (REE) have shot up in value. Molycorp is up more than 32 percent and Rare Element Resources is up more than 40 percent. But both are off their highs, and it has been a very volatile ride for investors. The question now is whether to stay invested for the long run, or take the money and run.
(Click to enlarge)
It is important to recap the background on this story. Rare earth elements are a family of minerals crucial to the production on high-tech goods. They are essential for the powerful magnets used in wind turbines. They are also crucial to the manufacture of batteries used in electric cars. And, some rare earths are essential to transistor and chip makers.
Rare earths are at the heart of modern products. But China currently has a 97 percent monopoly in the field. China’s hold on the rare earth industry wasn’t a problem until this year. During a bitter dispute between China and Japan over the ownership of remote islands in the South China Sea, things got very ugly. While diplomatic tensions and street demonstrations flared up in both countries over the issue, Japan claimed that China had suddenly cut off deliveries of rare earths.
China said that wasn’t true. But in the ensuing confusion, China did cut global export quotas on rare earths for 2010 by a stunning 40 per cent. Then the US got into the fray during an angry dispute with China over currencies. Suddenly there were complaints that Chinese shipments of minerals to the US had been cut off. Furious politicians claimed that China was using its rare earth monopoly as a weapon.
As October came to an end, Germany also claimed that it had been cut off from Chinese rare earth shipments. Was China blackmailing the world? Not really. The Chinese simply said they had filled their export quota for the year.
Will Rare Earth Metals Become Rarer?
As the furor over China’s clampdown on rare earth shipments continued, an ETF hit the market to take advantage of the scramble. That spiked stocks even further. The Market Vectors Rare Earth/Strategic Metals ETF (REMX) claims to offer investors exposure to equities of companies engaged in producing, refining, and recycling "rare earth/strategic metals." It’s important to note that REMX has holding among many miners that have nothing to do with rare earth minerals. The ETF’s creator says:
49 elements in the periodic table are considered rare earth/strategic metals… Strategic metals are used in a variety of technologies including jet engines, steel alloys, wind turbines, flat screen televisions and cell phones. Rare earth metals, a subset of strategic metals, are a collection of 17 chemical elements that are essential in many of today’s most advanced technologies.
The launch of the ETF did cause a spike in the stocks of rare earth developers and miners. But these remain highly speculative stocks. Unlike most competitors, Molycorp actually has a mine. Although it was shut down in 1999, the company is now racing to reopen the facility. Is rare earth mining a wise investment at today’s prices?
Molycorp is now valued at almost $3 billion. It has no income – only expenses, and potential profits. With no P/E multiple as a guide, this is clearly something of a gamble. Stocks of other rare earth resource developers appear to be equally speculative, but there is much less information about their ability to deliver the resource.
Questions and Answers From China
Hilary Clinton, the US Secretary of State, has pushed the rare earth issue to the top of the agenda. A few days ago she called on America and its partners to reduce their dependence on Chinese rare earth production. And on Saturday, China pledged that it would not withhold the crucial minerals from the world market. That should cool speculative fever for a short time. But China did not promise to increase its quota for 2010. That means possible shortages this year.
In fact, China long ago told the world to develop alternate rare earth sources. The Chinese intend to reserve their own rare earth stockpile for internal consumption. To be fair to Beijing, this is not an aggressive move. Cutthroat competition by rare earth miners in China cut prices so steeply over the past decade that mines like Molycorp’s old Mountain Pass mine simply couldn’t compete and they closed own.
As a result, the Chinese gained a world monopoly but not a very profitable one. The Japanese took advantage by stockpiling huge amounts of raw minerals, to be refined and manufactured only in Japan. As the globe’s sole supplier, China suddenly saw itself at risk of running out of rare earths. The metals are important to China’s strategic goals and that is why reduced export quotas were decreed by Beijing. Since then, rare earth prices have risen sharply.
The Bottom Line
At this time of chaotic change, it is hard to make any accurate prediction about the true value of raw or refined rare earth resources. New sources have been found in the US, Canada and Australia. There is the possibility of long term oversupply as a result of the current scramble to develop new mines.
Keep in mind also that rare earths are not really very rare. But they are hard to refine. It is challenging to separate trace elements of minerals from large amounts of ore in an environmentally safe way. Production costs will be high.
All of this means that the profit and loss potential of new rare earth ventures is very uncertain. As tensions with China ease, the frenzy over rare earth metals may cool. My advice is to take profits if you invested in the field when I wrote about it last month. If you don’t have a position in rare earth minerals, I would advise extreme caution as these stocks test their peak values.
Disclosure: No positions
The Lessons of Homestake Mining in Gold Bull and Bear Markets
November 2nd, 2010 | Posted by Global InvestorsIn a prior article on gold titled “On the Brink of a Secular Bull Market in Precious Metals” we gave an example of how gold stocks in general suffered their biggest percentage loss from 1924 to 1932. However, in that same period, one gold stock, Homestake Mining (HM), managed to not only defy the declining trend but increased in value beyond all expectation. In the period from 1891 to 1987, Homestake Mining increased in value from $9 over $5000 per share. Because it is our assertion that gold and gold stocks rise and fall with the general market (either leading or slightly lagging), we will demonstrate that Homestake Mining is the exception that proves the rule.
This article will address several specific reasons why Homestake Mining was able to increase in value from $71 to $528 in the period from 1920 to 1940. It is important to note that of the reasons that we provide, no one factor could answer for the rise of Homestake Mining. However, the extent of the combined characteristics far outweighed the concerns gold investors had about the alternative gold stocks during the same period, especially from 1924 to 1933.
(Click to enlarge)
There are two kinds of factors that affected the price of Homestake Mining. One set are those that Homestake Mining cannot control while the second set are those that can be controlled. Those matters not in the control of the management of Homestake Mining helped to provide a support for the price of the stock. At the same time, those actions taken by the management of Homestake helped to significantly boost the price of Homestake Mining. The combination of the two elements allowed Homestake to emerge as the best performing gold stock in the worst possible markets.
We’ll first address the issues that were not in the control of Homestake Mining. The most important matter not in the control of Homestake management was the fixing of the gold price. With the price of gold being fixed, the share price and earnings of gold stocks were considered to be stable. This was especially true when the price of other commodities were falling. Few gold bugs will take on the seemingly tabooed topic of the price of gold being fixed as the reason gold and gold stocks were a refuge to investors. However, this alone, being fixed, is the basis by which all myths of gold being a safe haven are built upon.
In more recent times, without a guaranteed price for gold, the commodity has fallen precipitously while gold stocks have been decimated. Some eternal gold bulls would say that during the market decline of 2007 to 2009 with the price of gold “only” falling 25%, in contrast to the Dow Industrials falling 40%, then it was an appropriate hedge. However, using the Philadelphia Gold and Silver Stock index (XAU), (a comparison of equity index to equity index) the decline was nearly 70% in a span of less than 1 year from March 2008 to November 2008. Gold was far from a source of stability during market panics of centuries past.
The next issue not in Homestake’s control was the limiting of the ability of the public to actually own (hoard) gold through the use of Executive Order 6102 issued by Franklin D. Roosevelt on April 5, 1933. This forced investors and savers in the US to seek out the only alternative that existed which was gold equities. When markets seem to be falling apart, investors will seek out whatever happens to be the most stable option. Since owning gold wasn’t available the next best alternative was publicly traded gold stocks.
Also in 1933, President Franklin D. Roosevelt, through Executive Order 6260, authorized the US Treasury to purchase gold at the highest traded world price allowing gold mining companies to increase their earnings by almost 50%. The purpose of this was to incentivize domestic producers to increase their output to shore up the US government’s large outflow of gold that took place from 1929 to 1933.
Factors that were in the control of the management of Homestake Mining were many and especially effective in getting the stock price to increase in value. The cornerstone of Homestake’s success was their dividend policy. 53 years of continuous dividend payments helped Homestake grow to become the default choice for gold stock investments. The only year that Homestake didn’t pay a dividend was in 1920 which was a reflection of the state of the market for that year.
During times of crisis or when it was felt that the monetary situation was weakening, the management of Homestake Mining would increase the dividend or they would pay an extra dividend. This kind of proactive behavior boosted demand for the stock from institutions and the public even when the dividend exceeded the actual earnings. As an example, after Great Britain abandoned the gold standard, Homestake increased the dividend from $6 to $7.80 in 1931.
On other occasions, Homestake would routinely declare an extra dividend of $1. This dividend would typically come each September, which was in addition to the previously declared payments. While not guaranteed, the $1 extra dividend was paid almost every year and sometimes two or three times within a single year.
Inevitably the payments of dividends would only go so far. Without a profitable business, Homestake would be broke. To resolve this issue, Homestake Mining management was aggressive at increasing efficiencies. In the span of a five-year period, Homestake management was able to nearly double the gold recovery from $3.77 in 1925 to $6.17 in 1930.
The final piece that was essential to the incredible increase of Homestake Mining was the fact that the stock was thinly traded. This critical element, along with the others mentioned before, ensured that a gold mine in the Dakota territory, initially started by George Hearst (father of William Randolph Hearst), Lloyd Tevis and J.B. Haggin, would increase from $9 in 1891 to well over $5000 (unadjusted) by 1987.
8 for 1 1937
2 for 1 1968
2 for 1 1974
3 for 2 1980
2 for 1 1983
2 for 1 1987
The lessons of Homestake Mining may simply be a matter of circumstance, unfair labor practices, below market wages and the acquisition of land in the most unscrupulous fashion. However, some lessons about how Homestake management operated are likely to prove useful to the understanding the reasons why Homestake’s stock price continued to go up in value when others didn’t, but should have.
Source Citations:
Disclosure: Author long gold bullion and junk silver
Disclosure: Disclosure: holder of gold bullion and junk silver
Gold Prices Higher on QE2, Election Concerns
November 2nd, 2010 | Posted by Global InvestorsGold
Gold prices are higher today as the dollar is again under pressure ahead of the US elections and the Federal Reserve’s decision regarding the scale of QE2. Oil prices above $83 a barrel is supporting gold and oil prices are up 9% in the last 30 days which will contribute to increasing inflation pressures.
Gold is currently trading at $1,357.30/oz, €971.72/oz, £849.96/oz.
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US Dollar Index – 5 Years (Daily).
Markets await the important decision of the US people in their elections and Ben Bernanke regarding QE2 and whether the Federal Reserve will create $500 billion or $1 trillion of new dollars to buy government bonds. US Republicans look set to make significant gains on voter anger over the stuttering economic recovery.
The election outcome should not have any material impact on the precious metal markets as the size of the fiscal and economic challenges facing Democrats and Republicans is such that gold should be supported no matter who gains power. Should QE2 be less than expected then there could be an initial sell off in all markets (equity, commodity, bond and the gold and silver markets). A higher amount (close to $1 trillion) would likely see further gains in all these markets. Any sell off in the gold market is likely to be greeted by eager buyers who continue to buy on the dips.
Gold in USD and Gold in Euros – 5 Year (Daily – Rebased to 100).
The long term ramifications of QE2 and of the possibility of QE3, QE4 et cetera is that the inflation genie is likely to be let out of the bottle and there is a real risk of further falls in the value of the dollar and other fiat currencies leading to high inflation and indeed stagflation. The Federal Reserve is attempting for the first time to create inflation and it will likely succeed – the danger is that once inflation gains control it is extremely difficult to contain. Only sharp interest rate rises, as seen in the 1970s, would succeed in containing inflation but they would be a recipe for disaster. Especially as debt levels remain very high and property and mortgage markets are still under pressure in much of the western world.
Gold in euros continues to trade just below the €1,000/oz level and appears to be consolidating above €940/oz prior to resuming its clear upward trend (see chart above). With sovereign debt risks in the eurozone rising again, this trend does not look like abating anytime soon. With the dollar, the euro and all fiat currencies being created with reckless abandon, they will likely continue to depreciate against hard assets and particularly against gold.
Silver
Silver is currently trading at $24.74/oz, €17.71/oz and £15.49/oz.
Platinum Group Metals
Platinum is trading at $1,709.60/oz, palladium is at $651/oz and rhodium is at $2,175/oz.
Disclosure: No positions
Why Gold’s Going Up, Mania or Not
November 2nd, 2010 | Posted by Global InvestorsObviously just a coincidence but two reports on the potential gold mania reached me today. One sees clear signs of a mania which could bring gold at $3,800 in 3 years. The other one, from gold’s uber-marketer, demonstrates that there are “unambiguously” no signs of a bubble in the gold market but, don’t worry, the price of gold will likely keep rising since there is “ample scope for continued robust growth in gold market demand.” Sounds like a win-win situation to me. Here are the stories:
RBC Capital Markets summarizes three general features that have often set the stage for past investment manias and place today’s gold market within this context:
1) The asset must be difficult to value. Gold generates no income and is of little economic use, unlike other commodities such as copper or oil. Meanwhile, the fundamental anchor for gold appears to be a nebulous concept tied to the loss in faith of paper currency. While this latter psychological construct is real, it is also impossible to measure except by the reaction of the gold price itself. Gold is morphing into a “no lose” asset class, benefitting from the scenarios of inflation, deflation and variants in between.
2) A story of “limitless” potential. Wireless in the 1990s and accessibility to the internet by 1994 offered the major displacements that worked in the stock market’s favor. Limitless stories for gold have been passing across our desk with increasing frequency these days. One story points to the deep under-ownership of gold among both the investing public and the official sector. Another is linked to the monetization of government deficits to accommodate the effects of the “Great Recession.” In any event, this narrative provides the fertilizer necessary for trees to grow to the sky.
3) Channels that easily allow for social contagion. For most historical manias, this really wasn’t a problem since all you’d have to do is to place a call to your local broker to buy your favorite publicly listed Nifty Fifty, Japanese or dot.com stock. We think the introduction of the gold bullion ETFs has made it much easier for large and small investors to catch the gold bug.
So, how far could bullion prices run? We have determined the best fit between the recent gold price dynamic and a price index which summarizes the average path followed by several historical and well-known investment manias. These past euphoric episodes have usually generated a 10-fold increase in the price of the underlying asset. If history rhymes, this fun little exercise tells us that a terminal gold price of close to $3,800/oz could be achieved within the next three years.
Gold Tracking the "Bubble Index"
Click images below to enlarge
If convinced that gold is in the early stages of a bubble, most investors would want to participate and jump on the bandwagon before it is too late. That, in itself, helps feed the latter stages of a bubble. In the case of gold, signs of a self-feeding bubble process are already apparent. In spite of the fact that few, if any, investors can rationalize the price of gold, investment demand for gold is rising in sync with the price of gold.
Meanwhile, non-investment demand gradually decreases as jewelry prices rise. Trailing 12-month gold jewelry demand is currently 1882 tonnes. This is 24% less than the yearly average for 2002-2008, and 41% less than the 2000 level.
Jewelry Demand
When the more rational users are being replaced by less or non rational buyers, and in ever greater quantities the more the price rises, this sure looks like a bubble in the making.
Yet, the World Gold Council, the marketing arm of the gold industry, is arguing that there is no bubble in sight. Instead, it is helping investors rationalize buying gold:
While reserve managers and investors are increasingly recognizing the strategic case for including gold in a portfolio due to its diversification benefits and the protection it can afford against macroeconomic risks, successive new records in the gold price have increased concerns that gold may be overvalued relative to other assets. Some investors and market commentators have even questioned whether the gold market is in a “bubble.”
In a recent report entitled The 10-year gold bull market in perspective, the WGC explored this question and using econometric tools analysed the recent developments in the gold market. Unambiguously, the results showed that gold price developments do not resemble the statistical characteristics of past bubbles, including those of the US housing market, the Nasdaq technology bubble, and the Japanese Nikkei equity market bubble. Additionally, the report found that the gold price is consistent with its long-run average-level compared with a range of different assets including equity indices and hard assets like oil.
It also demonstrated that there is ample scope for continued robust growth in gold market demand, due among other reasons, to the strength of emerging markets, a fundamental shift in the behaviour of central banks.
Moreover, the WGC also explored the role that gold plays to help manage risk more effectively in a portfolio by protecting against infrequent or unlikely but consequential negative events, often referred to as “tail risks’. In Gold: Hedging against Tail Risk, the WGC shows that gold can be an integral part of cost-effective strategies which provide protection without sacrificing return for both short- and long-term investors. For example, it finds that unlike other assets, gold tends to exhibit lower volatility for negative returns than it does for positive returns and that gold also tends to have little correlation with many asset classes, thus making it a strong candidate for portfolio diversification. It also shows that, conversely to other assets which are typically considered diversifiers, gold’s correlation to other assets tends to change in a way that benefits portfolio returns.
So, the bubble process is on. If this is not, currently, a bubble as per RBC Capital, the WGC sees gold demand and price rising. This would likely, eventually, create the bubble.
Just in case, RBC Capital provides a potential negative scenario:
What might short-circuit the gold story? Noted acceleration in U.S. GDP growth and/or a signal by the Federal Reserve that its next move is to tighten might place gold in the penalty box. In our opinion, this would most likely raise the opportunity cost of holding gold by placing upward pressure on real interest rates. We view this as an unlikely scenario over the next 6-9 months.
Jewelry buyers, the longer term investors, are running away while suppliers like miners and recyclers are feeding the pipeline with ever greater quantities as the price is rising. When the price of gold turns down and sentiment reverses, many investors will find that the exit door has gotten pretty narrow. For now, however, there is nothing to fear but the lack of fear.
Disclosure: No positions
Invest in Technology With Commodities
November 2nd, 2010 | Posted by Global Investors
Silvercorp Metals: Top Silver Play in Today’s Market
November 2nd, 2010 | Posted by Global Investorsby Mike Turner
A historic Federal Open Market Committee [FOMC] meeting is being held this week. The results of that meeting could have a significant impact on what the market does for the month of November and beyond.
We get the results of the meeting Wednesday afternoon, but the Federal Reserve has telegraphed it intends to put a lot of money into the market. Estimates range between $500 billion and $1 trillion. This is real money, although it is created out of thin air, and should have a major impact on the market.
With the Fed‘s QE2, the results of the mid-term elections and the jobs report this week, the market could see a lot of volatility. I suspect most of it will be to the upside.
My top silver trade for this week is Silvercorp Metals (NYSE: SVM).
If my forecast charts are correct and if the Fed continues to "juice" the market with hundreds of billions of dollars, then the odds are high that precious metals stocks will do well. And SVM is my top silver play in this market right now.
The fundamentals for Silvercorp Metals are strong. The fundamentals that had the largest impact on my systems include:
The technicals for are equally promising. Below are some specific technical observations for SVM:
Based on the analysis above, I think SVM is a good trade to put on now with a limit order at $9.40 and an initial stop loss at $7.82. If the trade reaches my target price of $14.00, traders would see a profit of close to +50%.
Disclosure: Neither Mike Turner nor StreetAuthority, LLC hold positions in any securities mentioned in this article.
Mainstream Financial Media Doesn’t Understand Gold
November 2nd, 2010 | Posted by Global InvestorsGold’s Bull Run began in 1999. There’s no question about it. Just take a look at this 13 year chart of gold prices:
So…it’s confusing for the esteemed editors of The Wall Street Journal to say that buying the metal in 2007 meant that you were “early to the gold trade.”
But this past weekend’s story in The Journal titled “A Gold Bull and His Prediction: $10,000 an Ounce” makes just such a claim about Shayne McGuire, a pension manager with $330 million worth of gold held in the Teacher Retirement System of Texas.
The fact that The Wall Street Journal – arguably the most respected financial publication in existence – can make such a glaring misstatement about gold tells me that gold has far to go before a significant portion of the mainstream investing public even considers buying it.
Don’t get me wrong – I’m not saying that 2007 was an especially late period to enter the gold trade, but it’s kind of indicative of how the mainstream media, and even the mainstream financial media, can be so off the mark with their understanding of gold.
For an interesting look at some relevant prognosticators who were earlier to the gold trade than Mr. McGuire, I recommend taking a look at an article published in the New York Times Magazine called "Believing (and Believing and Believing) in Bullion."
This story quotes a number of gold bulls whom I’m sure you’re familiar with: Doug Casey, Gary North and Jim Sinclair.
These guys easily beat Mr. McGuire to the party by 5-10 years.
You might be familiar with Mr. Sinclair’s notorious bet about the price of gold. In April, 2008 he made a standing $1 million bet that gold’s price would be above $1,650 sometime before January 14, 2011.
With only 10 weeks and about $300 left for Mr. Sinclair’s bet to conclude, I’m guessing that he’s feeling a little under the gun.
After all, the last time gold shot up $300 in less than three months was at the final stage of the 1979-1980 bull run. In other words, in order for Mr. Sinclair to win his bet, gold would have to experience the kind of run-up that capped off the end of the bull market in gold.
I don’t know if he believes that gold will tumble after it hits $1,650 an ounce, so if I had to make a prediction, I’d say that he’s going to lose the bet. But that doesn’t mean I’m betting against gold.
As I discussed last week, I’m looking at any substantial dip in gold’s price as another buying opportunity.
And I believe we could see a huge opportunity to buy the dips in the next couple days. That’s because Federal Reserve Chairman Ben Bernanke will be unveiling the next round of money printing, aka quantitative easing, on November 3rd at the next Federal Open Market Committee meeting.
This FOMC meeting really has very little impact on my long-term view for precious metals. I just have a hunch that it could present a short-term buying opportunity. I hope you’ll be able to take advantage of the dips if they come this week.
Disclosure: long silver and gold
Mainstream Financial Media Doesn’t Understand Gold
November 2nd, 2010 | Posted by Global InvestorsGold’s Bull Run began in 1999. There’s no question about it. Just take a look at this 13 year chart of gold prices:
So…it’s confusing for the esteemed editors of The Wall Street Journal to say that buying the metal in 2007 meant that you were “early to the gold trade.”
But this past weekend’s story in The Journal titled “A Gold Bull and His Prediction: $10,000 an Ounce” makes just such a claim about Shayne McGuire, a pension manager with $330 million worth of gold held in the Teacher Retirement System of Texas.
The fact that The Wall Street Journal – arguably the most respected financial publication in existence – can make such a glaring misstatement about gold tells me that gold has far to go before a significant portion of the mainstream investing public even considers buying it.
Don’t get me wrong – I’m not saying that 2007 was an especially late period to enter the gold trade, but it’s kind of indicative of how the mainstream media, and even the mainstream financial media, can be so off the mark with their understanding of gold.
For an interesting look at some relevant prognosticators who were earlier to the gold trade than Mr. McGuire, I recommend taking a look at an article published in the New York Times Magazine called "Believing (and Believing and Believing) in Bullion."
This story quotes a number of gold bulls whom I’m sure you’re familiar with: Doug Casey, Gary North and Jim Sinclair.
These guys easily beat Mr. McGuire to the party by 5-10 years.
You might be familiar with Mr. Sinclair’s notorious bet about the price of gold. In April, 2008 he made a standing $1 million bet that gold’s price would be above $1,650 sometime before January 14, 2011.
With only 10 weeks and about $300 left for Mr. Sinclair’s bet to conclude, I’m guessing that he’s feeling a little under the gun.
After all, the last time gold shot up $300 in less than three months was at the final stage of the 1979-1980 bull run. In other words, in order for Mr. Sinclair to win his bet, gold would have to experience the kind of run-up that capped off the end of the bull market in gold.
I don’t know if he believes that gold will tumble after it hits $1,650 an ounce, so if I had to make a prediction, I’d say that he’s going to lose the bet. But that doesn’t mean I’m betting against gold.
As I discussed last week, I’m looking at any substantial dip in gold’s price as another buying opportunity.
And I believe we could see a huge opportunity to buy the dips in the next couple days. That’s because Federal Reserve Chairman Ben Bernanke will be unveiling the next round of money printing, aka quantitative easing, on November 3rd at the next Federal Open Market Committee meeting.
This FOMC meeting really has very little impact on my long-term view for precious metals. I just have a hunch that it could present a short-term buying opportunity. I hope you’ll be able to take advantage of the dips if they come this week.
Disclosure: long silver and gold
Metalico CEO Discusses Q3 2010 Results – Earnings Call Transcript
November 2nd, 2010 | Posted by Global InvestorsExecutives
Carlos Aguero – Chairman of the Board, President, CEO and Director
Michael Drury – EVP & Director
Analysts
Richard Paget – Morgan Joseph
Eric Glover – Canaccord
Brent Thielman – D.A. Davidson
Matthew Lerner – Platts
Gregory Macosko – Lord Abbett
Metalico, Inc. (MEA) Q3 2010 Earnings Call October 29, 2010 10:00 am ET
Operator
Good morning, my name is Sandra and I will be your operator for today’s call. At this time I would like to welcome everyone to the Metalico 2010, third quarter results call. All lines have been placed on mute to prevent any back ground noise. After the speaker remarks there will be will be a question-and-answer period. I would like to remind you that today’s call is being recorded for transcription purposes. Our purpose of today’s call is to discuss the result of the company’s operations for the quarter ended September 30th, 2010.
Earlier today, Metalico issued a press release announcing third quarter results and filed a report on Form 8-K in connection with the release. You can access copies of Metalico’s filings through the SEC’s Edgar online files or directly through the company’s website at www.metalico.com.
Just log on to the website, click on Investors at the top of the home page and then click on SEC filings in the left column, then click to download the report. Metalico’s filings are also available at the SEC’s website at www.sec.gov. In addition, an audio replay of the call will also be available at 888-843-7419 or 630-652-3042 for the first week after the call’s conclusion. To access the recording, callers will be required to enter the conference identification number of 28184786.
As is customary, let me reiterate the Safe Harbor statement under the Private Securities Litigation Reform Act of 1995. The following discussion contains forward-looking statements that are subject to risks and uncertainties including those risks set forth in Metalico’s filings with the SEC. These risks could cause actual results for the current period and beyond to differ materially from those expressed in the forward-looking statements made by or on behalf of the company.
We refer you to Metalico’s periodic reports that are filed from time to time with the SEC. For a more detailed discussion of the forward-looking statements and a discussion of the factors that could cause results to differ materially from the discussion today, please refer to the risk factor discussion and Metalico’s Form 10-K for 2009, which is also available online.
In addition, during the course of this conference call, certain non-GAAP financial measures maybe described which should be considered in addition to and not in lieu of comparable GAAP financial measures.
The company has provided reconciliations of these non-GAAP measures to what it believes are the most directly comparable GAAP measures in the earnings release. Thank you, ladies and gentlemen. I would now like to turn the call over to Mr. Carlos Aguero, President and Chief Executive Officer of Metalico. Please go ahead.
Carlos Aguero
Good morning and thank you for joining today’s call. With me here today is Michael Drury, our Executive Vice President. Following the presentation, we’ll be available to answer any questions. We will also post a transcript of our remarks and the question-and-answer session on the Metalico website when the transcript becomes available after the call.
This morning Metalico released financial results for the third quarter of 2010 showing improvement in sales, revenue, operating income and EBITDA as compared to the same period in 2009. The results also show improvements over the second quarter 2010 in operating income, EBITDA and net income even with the small decline in sales. This marks our third consecutive period of increase in net income since the declared end of the economic crisis.
Let’s go to quarter’s highlights compared to 2009. Sales increased 50% to 137 million, an increase of $45.5 million or 91.5 million reported. EBITDA rose 22% to 13.8 compared to 11.3, operating income increased 25% to 9.6 million compared to operating income of 7.7. Net income was 4.5 million or $0.10 per diluted share compared to adjusted net income of 2.7 or $0.08 per diluted share. The prior year’s reported net income of 5.1 million or $0.12 benefited from one-time gain, net of income taxes and fair value adjustments totaling $2.4 million representing $0.04 per share compared to a benefit of $168,000 for similar items that occurred in the current quarter.
Unit volume shipped increased 14% for ferrous scrap and 34% for non-ferrous scrap. Platinum group metals, PGM’s unit volumes increased total 32% and product shipments decreased by 15% however operating income in the lead segment increased by 57%. The company’s scrap metal segment generated 8.6 million in operating income in the quarter compared to 7.8 million last year. The lead fabricating segment generated 1.1 million of operating income compared to 700,000 in the prior year and 15% fewer shipments.
Compared sequentially with the second quarter of 2010, sales declined slightly but most measures of operating performance improved. Sales of $137 million decreased 5% from 144.6, EBITDA increased 29% to 13.8 from 10.7. Operating income increased 43% to $9.6 million from 6.7. Net income of $4.5 million increased slightly from net income of 4.4 million which had benefited by a $2.1 million financial instrument fair value of adjustment.
Unit volumes shipped increased 16% for ferrous scrap and 1% for non-ferrous scrap. PGM unit volumes purchased and shipped fell by 13 and 19% respectively. Lead fabricating segment operating income improved substantially on a 2% reduction in product shipments. Compared to last year, interest expense fell by 4.8 million while total debt increased $9.7 million since last September, reflecting lower borrowing costs under our new revolving credit facility.
Metalico’s networking capital increased by $26 million to 99.5 million since the beginning of the year. Today’s availability on a revolver stands at approximately $24 million. Capital expenditure for the quarter was 1.3 million compared to 2.5 million. We utilized 1.1 million for the scrap metal recycling segment and 200,000 for the lead fabricating thing. The additions was primarily for cranes, trucks and aluminum furnace upgrades.
As of September 30, Metalico has approximately 46.5 million common shares issued in outstanding, our shareholders’ equity increased by 15 million to 165.3 million as of the date from yearend of 2009.
Let’s breakdown the quarter and as usual, starting with the scrap metal segment first, scrap segment sales were $120.3 million, up 62% from $74.3 million posted in the third quarter of 2009. We derived 36% of our scrap revenue in the quarter from ferrous and 64% from all non-ferrous metals which include the PGMs.
Operating profit for the scrap segment rose to 8.6 compared to 7.8 in the same quarter last year. Year-over-year, we saw a 35% increase in our average ferrous price to $363 for gross ton, up by $94 compared to an average of $269 per gross ton, that’s compared to second quarter ferrous pricing fell $29 per gross ton. The average selling price of non-ferrous scrap in the quarter was $1.20 a pound compared to $0.98 per pound last year and $1.11 per pound in the second quarter of this year.
We realized an average PGM selling price of $986 per troy ounce compared to last year’s $707 and our second quarter selling price average of $1122 per troy ounce. Metalico’s volume of metal sold for the third quarter included a 119,700 gross tons of ferrous scrap to the 14% increase over the 105,000 gross tons sold in Q3 of 2009 and a 16% increase sequentially.
We shipped 36.6 million pounds of non-ferrous metal in the quarter, a year-over-year jump of 34% from this 27.3 million pounds last year and a small increase over this year’s second quarter.
Aluminum, stainless steel, nickel-based alloys, copper, brass, tungsten and molybdenum continue to be the primary contributors to our non-PGM volumes. The companies sold 31,400 troy ounces of PGM in the quarter, which was 32% more than last year but 19% less than the second quarter of this year primarily due to shipping delays.
Now let’s look at the lead fabricating segments. In this year’s third quarter we generated sales of $16.7 million compared to $17.2 million last year. Lead product have accounted for approximately 12% of our total sales year-to-date. We generated operating income of $1.1 million compared to operating income of $700,000 for the third quarter of last year on 15% less units shipped.
Demand in market, such as medical treatment facilities, diagnostic of therapy equipment and the nuclear pharmacy industry continues to improve. The average lead products selling price was $1.33 per pound in the quarter compared to $1.17 per pound last year and $1.42 in this year’s second quarter.
Volume fell just 2% sequentially to 12.5 million pounds and was 15% lower than last year. In last year’s quarter we had benefited from the strong market for ammunition related products although that demand fell off shortly thereafter.
The third quarter results like those of the second quarter are evidence of our assets to reduce borrowing cost, controlled operating and overhead cost and to focus on profits over size.
Now a word on guidance and the forward-looking statements. Metalico’s practice like many others in our industry is not to provide guidance or earnings estimates. The scrap recycling industry is highly cyclical, commodity metal markets are often very erratic. We believe that earnings estimates could be unreliable because of unpredictability, the duration and magnitude of commodity pricing.
Now for our third quarter recap and market outlook. During the third quarter ferrous scrap selling prices and related domestic steel demand decreased slightly while buy prices moderated and showed stability in the midst of fierce industry competition and a tight scrap generation environment. Non-ferrous volumes remain firm while prices rose modestly. The slow industrial demolition and obsolete scrap generation rate combined with the recovering US and global metal demand should provide a favorable scrap price environment during the first half of next year.
Breaking down our outlook by product category; ferrous scrap, we believe after a small price correction early in the fourth quarter industry expectation are for ferrous pricing to stabilize and slowly go up towards year end. Domestic mills will likely curtail melting schedules in the fourth quarter which should be offset by tight supplies of many grades of prime scrap.
Our non-ferrous scrap, non-ferrous commodity pricing should likely be firm to rising for the remainder of 2010 and into 2011. Volumes purchased and sold should be slightly lower reflecting normal seasonal fluctuations, characteristic of the slowest quarter of the year. Demand for non-ferrous scrap particularly aluminum and copper remains strong as diminished supply and strong export markets continue to pressure available scrap.
On the aluminum dioxide, demand is moderating along with recent declines in steel production. Selling prices have been rising due to a higher demand from aluminum product manufacturers and continued scrap supply. Declines in steel industry capacity utilization in the fourth quarter could be offset early 2011 and provide ongoing support for the deox prices.
Moving on to PGM, pricings of PGM should positively influenced by continued weakness in the US Dollar and expanding regulation as well as demand for precious metal industrial from industrial and increased global ore production. Particularly with Palladium, we anticipated depletion of inventories and growing utilization could result in shortages that could cause prices to rise further amidst increased volatility.
We plan to increase our material processing and shipments during the fourth quarter. Historically, as PGM prices rise, more material comes to market. However, increased prices also attract increased competition. On the lead fabricating side and Metalico’s segment expects to build upon its good quarter successes in penetrating new markets, introducing new value-added products and continuing improvements in operating efficiencies. Our lead scrap purchase and refining program is generating increased yields and continues to help lower our average cost and improve our competitive position.
Metalico results reflect the high quality of operation and define men and women, consistently execute and perform in an environment marked by price volatility and constantly changing conditions. I want to applaud all of our employees for their commitment to safety, to hard work and dedication to making Metalico better.
We focused on growth through acquisitions and investing in organic development. More recently we are seeing increased M&A activity and attractive acquisition opportunities are again becoming available. We plan to continue participating in our initial consolidation conditions.
Finally we look ahead to the fourth quarter and to 2011, optimistic that market conditions will be stable and that the economic recovery will continue to gain momentum.
This concludes our remarks, and with that operator I like to open the call for any questions.
Question-and-Answer Session
Operator
Thank you. We will now begin the question-and-answer session. (Operators Instructions). The first question is from Richard Paget from Morgan Joseph. Please go ahead.
Richard Paget – Morgan Joseph
I wondered if you could talk a little bit more about profitability in the lead segment. I mean, I know you mentioned there are some new product lines, and you’re increasing plant efficiency. But, on these volumes doing over $1 million, is that a trend that can be sustainable? Was there any kind of one-time benefits in there? Just trying to get a sense of how we should look at that particular segment going forward.
Michael Drury
Listen there were no one-time benefits in the number. I think the number is reflective of as we’ve discussed in the past, an effort is to move into more value-added products and we are seeing some success there, and we expanded our services into new industries such as the nuclear pharmacy industry. Our expectation is that we’ll continue to see continuing improvement in results but of course there’s no guarantees there but we are very optimistic in the outlook for lead going forward.
Richard Paget – Morgan Joseph
And then just with the tax rate a little bit higher than usual, wondered if you could explain that and then give us a sense of what tax rate we should be using going forward?
Carlos Aguero
Richard, if you look it, the statutory federal rate is 35%, and then you have a blended state rate of, call it to 3% to 4%. So we’re somewhere in 38%, 39%, maybe 40% rate depending on issues that come up at the changes in deferred tax assets or liabilities. So, 41% may be a little high, but 38% is probably a good number.
Richard Paget – Morgan Joseph
And then finally before I get back in queue, what was the cash balance at the end of the quarter?
Carlos Aguero
It was roughly $5 million; I don’t have it front of me but, $4.3 million. Sorry.
Operator
Thank you. The next question is from Eric Glover from Canaccord. Please go ahead.
Eric Glover – Canaccord
You mentioned that Platinum Group’s volume shipments were lower sequentially in the quarter due to timing issues. I was wondering if that was something that you did intentionally or are there some other factor there?
Michael Drury
It wasn’t intentional. We had some issue late in quarter with getting trucking when we needed it to get some material after-market and that was the issue.
Eric Glover – Canaccord
Can you quantify what amount of shipments were held back in the quarter?
Michael Drury
It was about 2,600 ounces.
Carlos Aguero
More than those.
Michael Drury
Yes, it went to 2.5, 2.7 in revenues. And it wasn’t held back, it just didn’t get out.
Carlos Aguero
The truck didn’t get to the docking time or actually the truck.
Eric Glover – Canaccord
And then just looking at the ferrous business, I was impressed by the shipment volumes there. Was that your ability to ship more to exporters in the quarter or what was exactly driving the strength there?
Carlos Aguero
There was a little bit of export, but really we are still focused on the domestic market. The bulk of our shipments are still in the, let’s call it the Ohio Valley and not necessarily exports, so it’s really is just more of the same and no change to our prior patterns of being primarily domestic oriented.
Eric Glover – Canaccord
It sounds like the domestic mills are going to be buying a bit less scrap in the fourth quarter. So is there a potential for you guys to increase your shipments to the exporters if the demand is there?
Carlos Aguero
It depends if the market is available and you have to bear in mind given our locations to get to the port is a fair amount of freight cost, so the export market have to be high enough to be able to contend with the higher cost of getting it out to the ports. So we’ll just have to wait and see but we are now trying to predict one way or the other which way that’s going to go. But we do expect probably we will see lower shipments in the quarter just because of the domestic industry primarily.
Eric Glover – Canaccord
And finally, SG&A seems to be bouncing around a bit here. Should we assume about $6 million for the December quarter?
Michael Drury
That’s probably a pretty fair number, Eric
Carlos Aguero
Yes (inaudible), plus or minus 5% probably
Operator
(Operator Instructions). The next question is from Brent Thielman from D.A. Davidson.
Brent Thielman – D.A. Davidson
I guess a larger player in the market had talked about using that sort of September quarter as sort of a buying opportunity in front of a supply tight Q4. I’m just wondering, do you have much carryover maybe in lower costs and into where we’re heading to this fourth quarter as we see scrap prices improve? Just trying to get a sense of margin expansion potential.
Carlos Aguero
Well our inventory didn’t change much at all from the prior quarter, we feel that once again we are in pretty good shape heading into the fourth quarter to have ample inventory in all of the categories that we work to be able to meet market demand, so we think we are in good shape and the costs are adequate to be able to generate expected profits on it.
Brent Thielman – D.A. Davidson
Just thinking about your internal target of 10% EBITDA, is that sustainable on a quarterly basis if we do see ferrous prices at current levels?
Carlos Aguero
Well we believe it is and if you look historically we have been able to generate that. We’re there year-to-date and prior periods other than the dislocation of the current prices we all had a while back, we are maintaining or exceeding that number, so that is our internal target on a consolidated basis and we certainly expect that not every quarter, but on an ongoing cumulative basis, we would be able to meet or exceed that
Brent Thielman – D.A. Davidson
I guess there does seem to be a fair level of pessimism among the domestic mills right now. And I just wanted to sort of look ahead and look for acquisitions. Is it more focused on supporting some of those big exporters? Or how do you look at your growth strategy there to sort of?
Carlos Aguero
No our strategy is not geared towards supporting large exporters, it is geared to supporting as much as we can market conditions being what they are and supporting the domestic markets because of geographic location of most of our facilities were much nearer to the mini mills and to the integrated in the Ohio valley, so that’s really our focus.
Operator
The next question is from Matthew Lerner from Platts.
Matthew Lerner – Platts
In terms of acquisitions, I’m lead to believe that asset valuations right now are fairly expensive in everything from iron ore to copper. When you look at targets, what are you seeing in terms of valuations? Are assets expensive now?
Carlos Aguero
Well, it depends on region by region and depend on the dynamics of the market place, I would say that generally speaking, the valuations have not come down to what we would have expected, but they have moderated and the expectations or so have moderated and that particularly in areas that we want to grow. We believe that there are some interesting opportunities that are out there that are available and we’ll work on those to see if we can make some of those happen.
Operator
(Operators Instructions). The next question is from [Earl Cornett] from ABC Consulting. Please go ahead.
Unidentified Analyst
I notice that manufacturing has improved for 14 straight quarters. This should be good for Metalico in acquisition of raw materials. Are you seeing that a bit?
Carlos Aguero
Well you know the flow into the yards has not recovered to levels before the downturn. There are pockets of strengths in some of the areas where we operate, but I wouldn’t say that it blankets for all region. There are areas that are slower than others, there are products that are not in demand as much, for example construction products and the steel industry are weak while some products in the tubing and oil and gas industry are very strong and while certainly automotive is improving somewhat.
Appliance demand because of lack of construction and the weak housing market doesn’t seem to be improving that much. So I would say it’s more of a mixed picture than it is wholesale improvement across the whole economy. The foundry business seems to be very busy, but they tend to be more specialized in the scenario such as heavy construction equipment and mining equipments in the like which are all doing very well.
Operator
The next question is from Gregory Macosko from Lord Abbett. Please go ahead.
Gregory Macosko – Lord Abbett
You mentioned the shipping delays. Was it only the PGM area? Was there anything else that saw any delays?
Carlos Aguero
There was a little bit on the ferrous side that didn’t meet the cutoff requirements that will fall into the fourth quarter, but it wasn’t significant, it may have been 1,000 tons or so, but it wasn’t a huge item.
Gregory Macosko – Lord Abbett
And so all of those shipments just to kind of the next quarter, you didn’t lose any sales as a result.
Carlos Aguero
Right, carry them over to the next.
Gregory Macosko – Lord Abbett
And then you talked about the customers in the Ohio Valley and shipping there and not really exporting. Could you talk about this review for me how the relationship works for the mills and the contracts and the like? Are you basically shipping to them on a sort of as-needed or as-requested basis, and doing it at a kind of price defined maybe by a market index or anything like that?
Carlos Aguero
Well we’re doing it basically on a monthly purchase order. We talk to each of the mills on monthly basis and we agree on a price, and that price stays firm for the entire month. Occasionally, you’ll have instances where mills will step up in mid month and will be looking for additional material and we’ll negotiate a separate purchase order on that, and that’s pretty much a way it works. It’s usually a monthly purchase order and occasional mid-month requirements also.
Gregory Macosko – Lord Abbett
And how much kind of negotiation is involved? I mean, is there really a lot of sensitivity relative to movement in your price?
Michael Drury
The mills publish a price monthly and each supplier then determines what volume they want to ship against their price. There may be some minor adjustments for transportation but pretty much everyone regardless of size ships again for same pricing. It’s not a specific negotiation supplier by supplier.
And just clarifying the other point, if the domestic ferrous market were to be significantly impacted were much slower than it is today and the export markets I am sorry were strong, we wouldn’t hesitate to ship domestically. I’m sorry we wouldn’t hesitate to ship exports. We chose to support the domestic market when the pricing is comparable to the export market unlike some of the big companies’ better old business here to export. So there’s a choice but its choice that the economic conditions on favorable domestic markets we will go export hence to chase the highest revenue available to us.
Gregory Macosko – Lord Abbett
I understand. But back to the steel mills then, at the published price, if there is 120% of volume to ship at that price, what happens? It’s all prorated as to the amounts among them? How is it determined what volumes are shipped by the various suppliers that are offering to ship?
Carlos Aguero
Once the mill is established what they are willing to pay for that month for the different grades of scrap then they would take orders from the different suppliers to meet their demand and then might be and they may have five suppliers, 10 suppliers, whatever it is and they will buy a small amount from each. Well it be a 1,000, 5,000 tons from each until they have purchased allotted quantity that they are looking for to melt that particular month or to add to inventory. So they determine the price, they determine the overall purchasing, and then they start talking to the suppliers and see who has what available and is willing to sell at that price or not, and they’ll buy until they have met their requirements and then they stop, abruptly stop for that month.
Gregory Macosko – Lord Abbett
But the point is that they determine the share that given everybody, there’s a lot of availability there and they pay that price, they determine your share or whoever’s share based on what its been in past?
Carlos Aguero
Not necessarily. A lot of times it’s almost the first come, first serve too. So there is a lot factors that go into. It not just out here and say we are going to buy 10,000 tons and we are going to break it up and everybody is going to get 10% or 20% of it. A lot of times its, they come up with the price and we are contacting them, you say I can 5,000 of what your needs are and if you’re there, and you take the order, and you are in good shape, and if you happen to be the last one to call or to be in contact with the mill, and they have already met their requirements, then you are out of luck and you won’t be able to sell to that mill that month
Gregory Macosko – Lord Abbett
And are the deliveries then staged over the month?
Carlos Aguero
Yes, yes, they are definitely staged out over the month.
Gregory Macosko – Lord Abbett
And the point, and then just thinking about those customers today, the point I sense is that their inventories are pretty full or in good shape and so that the likelihood given some mill volume decline say in the fourth quarter, they would buy less.
Carlos Aguero
Every mill has their own strategy how they want to pursue their inventory practices and a lot of it depends on their order book, other is whether they have a maintenance schedule coming up or what have you and whether it have a lot of on the ground or not, or companies establishes their own buying strategy and follow that through the course of the month based on their particular issues whether they are busy or not, whether they have downtime or not and whether they have a lot of inventory or not, those are the main factors that would go into it.
Gregory Macosko – Lord Abbett
And finally how is Youngstown going?
Carlos Aguero
Going fine.
Gregory Macosko – Lord Abbett
What’s the volume? I mean, is it at sort of buy, I mean normal capacity or volume, or that you would expect? It’s all kind of up and running?
Carlos Aguero
Its operating as we expected it would operate when we purchased it. Then certainly no change there in terms of our expectations versus the way that it’s operating.
Operator
(Operators Instructions). At this time there are no further questions.
Carlos Aguero
Operator, we’ll give it the proverbial 60 second timeframe to see if any other questions arise and if not then we’ll conclude the call.
Operator
(Operators Instructions). And there are no questions at this time.
Carlos Aguero
Okay, very well. We just want to thank all of you for joining us today on our call and for your continued interest in Metalico and its results and developments. And we certainly look forward to speaking with you again when we present our results for the year 2010 in the fourth quarter which should be sometime in March of 2011. And until then be well, be healthy and be safe. Good bye.
Operator
Thank you ladies and gentlemen. This concludes today’s conference. Thank you for participating. You may now disconnect.
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