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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.
Olivier Garret
Caseyresearch.com
Olivier Garret is CEO of Casey Research, LLC., one
of the nation’s oldest and most respected organizations dedicated to
providing independent investors with unbiased research on opportunities to earn
extraordinary profits by being just ahead of the crowd.
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