Casey
Files:
Lost Principles
Olivier Garret
Casey
Energy Opportunities
Casey Research
Nov 27, 2008
As the economic crisis continues
to unfold, recently a sense of uncertainty has begun to pervade
the market. Even dyed-in-the-wool risk takers admit that they
don't know what to think anymore. Inflation, deflation, recession
or depression - there are so many vagaries that it appears to
be anyone's guess what will happen next.
Despite the current, volatile
environment, though, our expert team at Casey
Research maintain their core prediction: that a highly inflationary
cycle is not far off. While we, along with several external experts,
continuously review our assumptions and conclusions and encourage
dissenting opinions and analysis to avoid biased conclusions,
so far we keep returning to our views about what's coming. That
said, the hardest thing to predict is not what will happen,
but when.
The way I see it, the swift,
far-reaching and mostly ill-conceived reactions from most of
the world's governments under the leadership of two apprentice
sorcerers (Bernanke and Paulson) have until now resulted in a
widespread run for an exit to nowhere, a deep credit freeze,
and total and indiscriminate mistrust in the market and all of
its players.
The fact remains that in the
last year, many principles that have long been rooted in the
success of capitalism have been thrown out of the window.
- First, market players discovered
that the longest-lasting asset bubble in recent history was made
possible by poor regulations (as opposed to lack thereof), greed,
and the misunderstood and misrepresented risks of credit derivatives.
.
- Second, we found out the real
meaning of "too big to fail." If a business is large
enough and has enough clout, it doesn't matter how poorly managed
it has been, it will be bailed out at the expense of taxpayers
(us) and investors (us again).
.
- Third, we found that the rating
systems the financial markets had been relying on have been misleading
investors and failing to identify some of the riskiest asset
classes. As a result, investors and all other economic agents
are left with no means of evaluating risk as they conduct business,
hence the credit freeze and rush to cash.
.
- Fourth, to add to the confusion,
the U.S. Fed and Treasury, followed by many other central banks,
have been altering the rules of the game by the minute (buying
toxic waste at face value, bailing out certain financial institutions
but not others, becoming shareholders of several behemoths in
the banking and insurance industry, and trumping all accepted
rules of creditors' and stakeholders' priority, prohibiting the
shorting of certain classes of assets on a moment's notice).
.
- Last but not least, the U.S.
presidency, weakened by almost eight years of mismanagement,
has continued to show total lack of leadership. It has empowered
a couple of technocrats to run the country's finances without
leadership until a new administration gets in and, hopefully
quickly, figures out what to do. To make matters worse, the EU
has shown its ugliest face and demonstrated a fact we all truly
knew but didn't want to recognize until recently -- that economic
unity and coordination is easy in good times but almost impossible
when the going gets tough.
No wonder economic actors are
wreaking havoc as they race for shelter.
Add to this the fact that all
natural resources have been hammered by the combination of a
credit freeze and lower real and anticipated demand from most
industrial nations.
Finally, junior exploration
stocks - being very thinly traded and rightfully considered to
be in a higher risk class -- have been hammered twice as hard
as the rest of the markets (hence the performance of the TSX-V,
which has lost 76% in the last year and 30% in the past 30 days
alone). The fact that many hedge funds had to unwind large positions
in such a small market certainly did not help values.
What does this mean for investors
in this market?
We all have suffered significant
losses in our portfolios, and although our choices may have reduced
some of the downside, quality companies have been hit almost
as hard as fly-by-night juniors with no future.
Several of our companies are
trading at or below cash value and get no goodwill for the significant
assets and outstanding management teams they have assembled.
Although there is no way to
tell when we will hit a bottom in these markets, we believe that
once tax-loss selling season is over and reality settles in,
we will see the beginning of a slow recovery process for the
best of the juniors. Investors who have the ability to stay the
course and are invested in the highest-quality juniors will recover
from their losses and benefit from what will eventually be another
bull market in commodities.
Precious metals and agriculture,
followed by certain segments of the energy sector, will lead
the way to widespread price increases across the range of commodities.
While we can't predict the exact timing of this run, the fundamentals
are in place once the world economies take a turn for the better
or at least stabilize somewhat.
Here is why:
- The current crisis is taking
tremendous amounts of needed capacity off the supply pipeline.
Whether it be energy, base metals, or agricultural goods, projects
to bring online expensive oilfields and alternative fuel sources
are being shelved and will take years to get back on track. Mines
are closing and projects are being canceled, thereby removing
much of the supply; the credit squeeze is cutting down on agricultural
investment, and working capital constraints will dramatically
limit supply.
.
- The world's demographics are
not changing, nor are the aspirations of a hard-working, fast-growing
middle class in emerging economies. The changes that drove commodity
markets up for the last few years are long lasting and real.
.
- Peak Oil and peak-everything.
There is limited supply for many commodities, and although there
are alternatives (curbing consumption and finding alternative
sources of energy), it takes large investments to do so. In current
markets, many of these investments are going to be put aside
until the next crisis/shortage hits - at which point we will
have years of a commodities bull run before an equilibrium is
reached.
.
- We anticipate that China,
Russia, and India will take advantage of low commodity prices
to secure very large, long-term supply commitments while the
Western world licks its wounds and tries to recover. By the time
we do, an even larger portion of the world's available resources
may no longer be available on the markets, for example oil and
gas.
In the last edition of Casey
Energy Opportunities, Marin
Katusa pondered how the U.S. is going to replace the supply of
uranium when the HEU program with Russia is set to expire in
2013. The answer is that the U.S. will struggle to replace 40%
of its needs, and this will benefit a handful of U.S. suppliers
with proven reserves. Currently shares of these companies, which
have the cash to develop resources or are already producing with
positive cash flows, are incredibly cheap - a win-win situation.
Eventually similar opportunities will come from copper and strategic
metals.
- We can expect the world to
continue to be a very unstable place, where regional conflicts
can quickly spread and spin out of control, with obvious impact
on the smooth supply of key commodities (Gulf region, Nigeria,
former Soviet republics, to name a few). In fact, a widespread
financial crisis could precipitate those events as conflicts
are often linked to economic hardship.
.
- The unprecedented deficits,
a wave of bailouts, and growth in the money creation by central
banks in the Western world will eventually lead to massive inflation.
In the U.S. alone, the monetary supply has increased by 50% since
early September. This will unequivocally reverse the current
short-term deflationary pressures and lead to a steep devaluation
of the dollar and other major currencies. At that point, precious
metals and all tangible assets are poised for a strong recovery.
So, if you ask me if I am still
bullish on the resource sector, my answer yes, now more than
ever. Juniors are juniors, and when things go wrong, they get
beaten down. The strong ones with great teams and lots of cash
will survive and prosper, the others will disappear. When commodities
come back with a vengeance, there will be fewer companies, almost
all with good projects and those who are invested in these few
companies will see a very sizeable appreciation of their capital
as the broader public returns.
It's very hard to be a contrarian
investor, especially when all forces seem to be against you,
but one thing the markets have taught me is that memory on the
Street is unbelievably short, and they will come back.
Not only is the economy presently
going haywire, there's also still the boogeyman of Peak Oil looming
on the horizon. While oil prices are at a low not seen for a
while, it is all but certain that this sweet relief for motorists
won't last very long.
When oil prices come roaring
back, the energy market will virtually explode and, if you are
safely positioned in the right stocks by then, your bank account
will too. Learn more about how being a contrarian investor can
earn you a fortune - click
here.
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