Agora Financial’s Rude Awakening

Jump to Comments

Dubai, UAE

• Mining for bargains in the commodity sector,
  
• Taking stock of nickel and zinc,
  
• The passing of a close friend and plenty more…

Joel Bowman, reporting from Dubai in the Persian Gulf…

Last night, at approximately 10:15 local time, our trusty steed died. He’d been ill for some time now, and even though the passing was expected, it still came as a shock.

Yes, after 27 months, 32 countries and more than 650 editions of this humble letter, the loyal laptop we’ve carted around the world finally packed it in.

As your editor frantically attempted to rescue his files from the fading light of his dying computer, he remembered some of the good times they had together. They traveled in step over the Rocky Mountains in Colorado, searched for wireless signals together in the backstreets of Kuala Lumpar, listened to music at more Starbucks cafes than we can count. If he is to be truly honest, your editor must confess to spending more time with his laptop over the past few years than with all his family and friends combined.

All things die, it is true. Animals, markets, currencies and computers all eventually return to the dust, factories and Federal Reserve printing presses from whence they came. But from that dust comes rebirth, from the ashes, hope.

Today we welcome a new laptop into the family. We only hope he serves us as gallantly as his ancestors.

We’re still a little choked up over the whole incident, and struggling to familiarize ourselves with the strange interface on our new machine, so we’ll turn it over to Dan Amoss and Chris Mayer to talk about all things financial. We used to check the markets regularly with our old mate…no, no…it’s just to soon.

In the column that follows, Dan, the mind behind the Strategic Short Report, gives us his insights into the rough and tumble world of commodity investing. Please enjoy and email us with your insights at the address below…

— Protect Your Assets: The Strategic Short Report —-

Urgent Wealth Protection Release:

Fannie and Freddie Have Been Seized. Taxpayers Are on the Hook for the Bill.

With the Government making a grab for your hard-earned dollars, perhaps it’s time to employ the best safety measure in the business.

Introducing: The Bear Market Strategy So Powerful, Governments Have Tried – and Failed – to OUTLAW It At Least Three Times.

Last year, this strategy made as much as $10.96 million per day for one astute investor… Now, right when this little known mechanism is about to kick into overdrive, we’re revealing the five-step secret that lets you get in on the ground floor… Details Here

——————————————

The Commodity Washout – Gift or Curse?
By Dan Amoss

It has been a brutal couple of months for commodities investors. Prices may have temporarily overshot fundamentals on the upside in June. But the opposite situation now exists. The commodity sector wipeout of the last two months has obliterated any froth or excess. And now, prices may overshoot to the downside. One thing is clear; fear and forced selling are driving the commodity markets right now…not underlying fundamentals.

A few days ago, Ospraie Management, a large manager of commodity hedge funds announced the closure of its largest funds. It will return capital to shareholders in stages. Ospraie’s funds had been performing well for years, until some wrong-footed trades in natural gas and copper futures led to deep losses in July and August.

Ospraie had a big presence in commodity futures, so its heavy selling has clearly intensified the recent price declines. Rapid price declines have fueled speculation that the commodity bull market is over. I very much doubt that it’s over, because in most cases, commodity supplies are too tight to meet strong, long-term demand from a growing world population — a population governed by politicians who can create both deficits and unlimited amounts of paper money. Governments and central banks will not sit idly by and allow a debt liquidation to destroy the banking system.

On the supply side of the equation, which most headline writers and pundits totally ignore, some commodity producers are shutting down projects that cannot produce at a profit. In a few commodity markets, prices are falling below the cost of production!

The fundamentals of supply and demand will matter again once current fears ebb. They always do. Energy and commodities have solid long-term fundamentals that rest on a foundation of human need. By contrast, financial companies are still facing ugly fundamentals, like plunging collateral values, rising defaults, and capital shortages.

Central banks will prevent the worst-case scenario of uncontrollable, self-reinforcing defaults. But their money-printing efforts will not bring about a re-inflation of the housing and credit bubbles. We probably won’t see another credit bubble for at least a decade. Once the fall in housing and mortgage securities slows down, excess liquidity created by central banks will find its way back into inflation hedges like gold and oil, potentially creating a future bubble in commodity-oriented investments.

As for the rest of 2008, my research leads me to the following most likely outcome: The stock market remains weak until the Federal Reserve totally abandons its “inflation fighting” stance. The Fed may even cut rates further as unemployment rises. At that point, commodity-oriented stocks will probably regain their position of leadership.

The recent decline in commodity prices allows the Fed to conjure up another “deflation” scare. This would provide cover to slash rates and inject reserves more aggressively into the banking system. Then, the U.S. dollar would resume its descent, while gold and commodities would resume their ascent.

The Fed’s current inflation campaign has been very modest thus far. Rather than expand its balance sheet and flood the banking system with liquidity, it has concentrated on swapping U.S. Treasuries for dodgy mortgage securities.

Central bankers on the other side of the Atlantic, though, seem to care more about what’s backing their currency. The European Central Bank just announced that it’s going to limit its role as a dumping ground for impaired mortgage securities. The Financial Times explains:

“[ECB President Jean-Claude] Trichet announced a series of measures to increase the cost of using asset-backed securities to obtain ECB funds and to exclude some such deals when underlying mortgages or other loans are not denominated in euros. The announcement follows comments by ECB council member Yves Mersch last month. He said there were still cases where ‘you see dangers of gaming the system.’

“This year, it emerged Macquarie Bank had constructed a deal backed by Australian car loans that could be used at the ECB and Lehman Brothers had formed a huge collateralized loan obligation of risky buyout debt to use at the central bank.

“Mr. Trichet said the ‘general character’ of its broad-based operations remained unaffected. ‘We’re not changing it, we’re refining it,’ he said.

“Only a ’small fraction’ of collateral would be affected. Banks’ ability to take part in its financing operations would be unimpaired, the ECB president said.

I see the ECB’s decision as a tactic to convince savers and investors that the euro will not be forever backed by securities of dubious quality. But European politics may eventually overwhelm the ECB’s fairly disciplined monetary record. Voters will demand easy money.

In the U.S., fiscal and monetary policy will likely be influenced more and more by big investors and foreign creditors. Bill Gross, manager of a huge bond portfolio, is concerned about the potential for “financial tsunamis” and “debt liquidations.” He thinks that the Treasury Department (i.e., taxpayers) has not done enough to stop the bleeding in mortgage securities. In his latest “Economic Outlook,” Gross describes how institutional mortgage buyers may sit on their hands until the Treasury Dept. initiates a new, huge bailout.

Whether taxpayers like it or not, Gross’ plea for a new bailout will probably be answered. The leverage in the banking system has grown beyond the point of no return. There’s no way the Fed and Treasury would allow a spiraling liquidation of debts. One way or another, mortgage losses will be partially “socialized.” Most of the burden will fall on savers because over the next decade, more paper money will be created than would otherwise have been created.

Think of paper money as a shock absorber for losses in the financial system. In times of crisis, central banks try to calm fears about bank runs. They spread losses from bad loans around to everyone who holds paper money. This game can keep going until the holders of that paper money lose confidence in its function as a store of value.

But don’t interpret a new bailout plan for mortgage investors as a sign that the financial stock bear market is over. It’s not — at least not for banks holding the worst credit exposures. Over time, these institutions will have to confess losses; take write-downs; and raise new, dilutive capital. Many will be taken over by the FDIC, which wipes out shareholders.

During times like these, investors do well to remember that the commodity sector never requires a “lending facility” from the Fed or a bailout plan for the Treasury.

[Joel’s Note: And now that Dan’s readers raked in 372% on their Lehman Brothers play, they’ll be flush to jump into all the commodity trades they like. In yesterday’s column we published a list of moribund financial institutions and ill-begotten banks. To find out what’s on Dan’s short list, check out his unique trading strategy and portfolio right here.

——————————————-

Did You Notice – Buy When There’s Blood in the Mine
By Chris Mayer

The old-timers of commodity investing like to say the best time to buy commodity companies is when the industry is losing money. The old-timers have scar tissue to prove it. The idea is that miners will start to cut back on production, which gradually leads to a recovery in prices, profits and, ultimately, stock prices.

Such times come around every so often, as when the cost to produce nickel rises above the price at which you can sell nickel. Even the slow wits of the business see that you can’t make that up in volume. To keep digging under such prices is like digging your own financial grave.

So they shake their heads, lick the ends of their pencils and recheck the math. Then they order the mining to stop.

And so we see that nickel prices are down 30% this year and down 60% from mid-2007 highs. All the while, mining costs are rising. So Xstrata says it will shut down its 30,000-metric-ton nickel operation in the Dominican Republic. Russia’s Industrial Metallurgical Holding shuts down 30% of its nickel capacity. BHP’s big Ravensthorpe mine, once a potential big moneymaker, looks as if it might never make any money. The industry shelves expansion projects. And new mines that looked promising suddenly look less so.

It’s not just the nickel industry that suddenly bleeds red ink. Zinc prices are also down more than 60% from their highs. OZ Minerals, one of the largest suppliers of zinc, reported a first-half loss last week in its zinc business.

In fact, it’s been a brutally tough summer all around in commodity land. Through June, commodities were sitting pretty. The first six months of 2008 were the best in 35 years, according to The Economist . In July, it was giveback time, and commodities posted their worst month in 10 years. The carnage has continues into August and September.

Commodity stock prices have fallen even further, as investors in the sector know too well. Many stocks have not merely stumbled, they’ve collapse altogether.

But if you can’t buy commodity stocks now, you may never be able to pull the trigger.

The long-term thesis behind the names seems firmly in place. It has a lot to do with China and India and the rest of the emerging market crowd — but especially China.

For example, China represents almost all of the new growth in copper demand. Across the commodity spectrum, what happens in China makes big waves across the globe.

So far, industry has met that demand, which is why prices have been dropping. But challenges remain on the supply side — declines in the quality of mining seams, shortages of equipment and skilled people, power shortages and bottlenecks in distribution.

The conclusion of all this is not particularly novel, but sometimes forgotten. The fate of the commodity investors hinges largely on those rapidly growing emerging markets. China is the lead pony, though, and the main one to watch.

Stocks in the commodity sector might continue sliding for a while longer, but even so, long-term investors might want to consider dipping a non-essential digit into the water.

—- A Special Report from Capital & Crisis Research —-

Urgent Retire-Easy Alert:

Introducing the Single Best Way to Make Sure You’ll Never Run Out of Money…

The Endless “PAYCHECK PORTFOLIO”

In three simple steps, unleash a steady flow of work-free income… starting with up to 75 automatic “paychecks” deposited directly into your account. Act now or risk missing the next “payday”…*

*Qualify for two “paychecks” per day on at least 24 of the days listed. Continued here

——————————————-

[Rude Endnote: If anyone wants us, we’ll be at the bar, drowning our sorrows.

Until tomorrow…

Cheers,

Joel Bowman

The Rude Awakening
aussiejoel@the-rude-awakening.com