The latter part of this editorial contains comments
on resources stocks and metals. Notwithstanding those comments, the current
situation in Europe will overwhelm everything else in the market near term so
we will comment on that first.
We’ll preface those comments in turn by
stressing the debt crisis in Europe is very fluid. This is a
crisis of confidence as much as anything else. Markets will be highly
volatile and subject to reversals on every bit of news, rumor or innuendo
until traders decide to take a time out. We’re about to find out
how good Europe’s political class really is at calming a crowd. Their
track record hasn’t been great but if nothing else the latest market
dives should add some immediacy and focus to the political tussles.
That’s a good thing, even coming at the expense of a market drop.
The Bond Vigilantes are making the rounds again in
Europe. You could almost hear them saying “you’re next” to
Italy as they continued to trash other PIIGS sovereign debt issues. The chart
below depicts the percentage change in bond yields for the hardest hit EU
members over the last three years. Italy’s bonds look stable by
comparison but that is misleading;
Italian bond yields have risen about 50% in the past
week. As this issue was being completed Italy sold one year bills at a yield
of 3.67%. This compares to a yield of 2.15% at the last auction a month
ago. The fact that both the Euro and the Milan stock exchange moved up
smartly after this auction tells you how much fear there is in the markets.
Yields on 10 year Italian bonds ran up through the 6%
level that is considered unsustainable prior to the auction, though it has
fallen back since. The Euro has continued to rally, as have other markets and
gold after Italy’s leadership promised to get serious (again) about
austerity measures.
Yields on Greek and Irish debt indicate traders
expect both of these countries to default, period. That outcome would not
surprise us. We expected, and saw, a deal in Greece but no one other than a
handful of core EU political leaders and Eurocrats
view this as more than extend and pretend.
Italy is a much bigger potential problem, having far
larger debt balances, but it’s really not in quite the dire straits
that Greece and Ireland are. Italy has larger domestic ownership of its
debt load and higher savings rates that could allow it to take over more of
the outstanding debt. That said, it also has low
growth and productivity and a political class that is a running farce more
adept at providing titillation than leadership. Italy is in a better
position to convince the markets that its Mediterranean neighbors, if its
stops dodging and dawdling and gets on with it. Italy’s finance
minister, who seems the most capable guy in the room by far, pledged to pass
austerity measure by the end of the week rather than the end of the
summer.
We lay these issues out first because they are going
to dominate trading and, in the final analysis they are all about
politics. We could do reams of number crunching and prognostication but
it would be meaningless without seeing how the politics get settled.
Italians have to decide if they will get serious
about fixing their finances. Northern and central Europeans have to decide
whether they suck it up and just pay allowance to Greece, and Ireland and
whomever. They can afford to do it. The real question hinges on whether they
are willing to do it. The debt numbers involved with those two
countries are not large in relation to the EU economy but an actual decision
needs to be made and stuck to.
It comes down to whether the populace in the better
managed countries is willing to pay to keep the EU as presently constituted
together. If not, they should cut loose the fiscal basket cases and let
them devalue their way back to mediocrity and be done with it. Until we see
how that question is decided no one really knows what the ultimate fallout
is. Lest anyone have any illusions, a similar set of decisions faces
Americans and there too the situation is completely politicized. With our
rant du jour out of the way, we’ll move on to the specific of the
sectors we’re dealing with.
The best reason to pick up juniors on the cheap
during the summer months is that market issues are behind them. We
still wouldn't say that the market should be comfortable about either western
debt or eastern inflation fighting. However, the second reason for
summertime bargain hunting is share prices so badly beaten down they are too
cheap to ignore even if you are thinking medium term. Lately, quite a few
traders seem to have come to that conclusion, though they are making the
judgment about specific companies, not the sector as a whole.
That works if sellers finished offing before pulling
out beach towels. The macroeconomic realities actually made this more likely
as sellers don't want to wait for September when thinking about the mess
outlined above. That does imply higher market risk this coming autumn,
but looking at valuations and forward to eastern growth we think selective
bargain hunting can begin. If the past week is any gauge, at least the
algorithms that increasingly trade even small companies are willing to take
the risk.
With Portugal joining Greece on the Euro bail out 2
(BOII) list we don't think the recent run in the copper price has a
lot to do with recovery, per se. There are however unusually heavy snow
in Chile and strikes in Indonesia that are slowing supply of mine
product to smelters, and until Japan sorts out its power situation smelting
capacity is below the glut level miners were enjoying before the tsunami took
down generators.
Market listed stocks of the red metal in Shanghai
moved up 10K to 90K tonnes in the past week while
the light decline of LME listed stocks begun a month ago has become a trend
line. Barring a large shift in the macro picture, the copper price has
found a range above $4/pound pending news of how demand will be impacted by
eastern inflation fighters.
China hasn't yet seen a peak number on the inflation
front and we expect at least some further tightening there. Harmony (or
’peace’ according to Premier Wen’s recent comments in
London, which may be more to the point) will demand costs for lower wage
Chinese drive policy.
If it were simply a matter slowing domestic demand
China’s growth could decline measurably enough to dampen inflation with
little impact on metal prices. However, in the context of global trade
and western uncertainties some over compensating is more possible.
One area where governments’ policy has
maintained good order is, so far, on keeping trade liberal. So long as beggar
thy neighbor doesn't rear its ugly head in trade rules any inflation-related
slowing in China and other growth economies should be short lived. If
trade was to become a political football the copper support from
supply/demand balance plus a new role as a paper money hedge would slip. That
would mean hunkering down, but traders would look for lower support levels
rather than a cascade as they did in late ’08-early ‘09.
We think gold has similarly found a trading
base from the $1500 level, pending in this case whether the Euro or the
Dollar gest more distain going forward. We’d be more comfortable
if the prices gains were less about fear buying, but that has always been
part of the gold market. The rerating of senior gold producers also appears
to have reached a bottoming point. There has been some tearing of cloth
over the fact that gold producers haven't kept up with gold for price
gains. We think that seeming anomaly should now be done.
Barrick and Newmont are up about
350% from both 10 years ago and Credit Crunch bottoms, while growth oriented
Goldcorp has gained more like 450% over those periods. The metal is up
600% over 10 years and 100% from Crunch lows. Comparing these to the copper
space is uninspiring, but there were no copper bugs to support weak bottom
lines during the bear market. Base metal companies were badly hit during the
“commodities are dead” Tech Bubble, and typically recovered first
when this secular bull started.
As we have said before weak gold equities is a case
of ’be-careful-what-you-wish-for’. Gold companies are becoming
a normal part of portfolio planning, which means they are also being priced
to normal valuation levels — you can’t anticipate higher gold
prices after they have arrived. The Credit Crunch rebased everything,
but it came before gold producers had finished rebalancing output to more
realistic cost assumptions.
Yes, we did go through this not so long ago.
However, we thought it worth repeating since the notion of retying national
currencies to gold is getting a bigger listen these days in some quarters.
We aren't convinced that is good for gold over the longer run. Gold, copper,
oil and other commodities are already effectively part of the monetary
system. Trying to fix a part of the system that isn't broken we can do
without. The notion may be good for gold companies near term though and is
worth keeping an eye on.
As far as more local major markets go, traders will
have to depend on earnings season to keep interest up. Job numbers in the US
have been awful. We can only hope that situation improves but no one will
believe until it happens at this point.
While the market hasn’t priced in European
calamity, it’s set up for positive earnings surprises. The chart above
from Bespoke Investment Group shows the weeks with either positive or
negative earnings revisions by analysts going back three
years. We’re currently in the longest successive streak of
negative earnings revisions in the whole period. With all the scary stuff out
there analysts have been cutting earnings estimates constantly since the last
earnings season. This is actually positive news. Its evidence that
market sentiment is gloomy and substantially increases the odds that earnings
surprises will be positive rather than negative. Odds are the earnings
season we are entering will help support broader markets in the current
range, assuming the world’s political class doesn’t screw things
up yet again.
David and Eric Coffin
Editors, HRA Journal
If you would like to be added to the HRA FREE mailing list to get notifications
about articles like this and other free analyses and reports please click HERE.
The HRA – Journal, HRA-Dispatch
and HRA- Special Delivery are independent publications produced and distributed
by Stockwork Consulting Ltd, which is committed to
providing timely and factual analysis of junior mining, resource, and
other venture capital companies. Companies are chosen on the basis of a
speculative potential for significant upside gains resulting from asset-base expansion. These are generally high-risk
securities, and opinions contained herein are time and market
sensitive. No statement or expression of opinion, or any other matter
herein, directly or indirectly, is an offer, solicitation or recommendation
to buy or sell any securities mentioned. While we believe all sources
of information to be factual and reliable we in no
way represent or guarantee the accuracy thereof, nor of the statements made
herein. We do not receive or request compensation in any form in order
to feature companies in these publications. We may, or may not, own
securities and/or options to acquire securities of the companies mentioned
herein. This document is protected by the copyright laws of Canada and the
U.S. and may not be reproduced in any form for other than for personal use
without the prior written consent of the publisher. This document may
be quoted, in context, provided proper credit is given.
©2008 Stockwork
Consulting Ltd. All Rights Reserved.
|