Wednesday, April 30, 2008

The Best Investment Opportunities Are Hard to Hold On!

A fantastic breaking news from PAL, North American Palladium, on the evening of April 29, 2008 prompted me to write this article. Mean while the agriculture sell off in the past two days requires some explanation since my last article. Of course, all eyes are on FSLR on Wednesday for their earnings release. You remember that I predict that FSLR could go out of business altogether in a few years, due to a global tellurium shortage. Goldman Saches (GS) sold off virtually their entire stake in FSLR at the end of last year, while Piper Jaffray (PJC) issued an upgrade on FSLR. This market is a strange place, isn't it? But we all know today's market is extremely rigged. If PJC upgraded FSLR to $340 target, then it will be pumped to that target. But the reality will prevail at the end of day. How many people even bother to contact FSLR and asked for a quantitative clarification on their tellurium supply? I am still waiting for a response from them and I am ready to acknowledge mistake if they can show me with data they have adequate tellurium supply. I encourage them to go public on the tellurium issue!

But first the breaking news, a rare world record breaking event that does not happen often. With no fanfair at all, PAL announced the drilling result from their Offset High Grade Zone (OHGZ), and listed a bounch of boring numbers. Few people paid attention. But those are truly stunning numbers that made me fall off the chair. Because those results exceeded the wildest dream. They break the old record of the highest grade PGM mine bodies. PAL can now proudly claim they now own the richest PGM mine in the whole world, in terms of grams of PGM metals per ton ores. And it's right in their backyard, just a few hundred feet away!!!

Let me explain it in lay man's term. Drill hole 07-007, for example, reveals PGM grade as high as 29.69 grams per ton, or almost one troy ounce per ton. 29.69 grams per ton!!!

How good is that grade? We know South Africa is the world's largest PGM metal producer, supplies 85% of the world's platinum and 35% of palladium. But typical ore grade of South African PGM ores are no more than 4 to 5 grams of PGM per ton ores. They are making handsome profit only thanks to a much higher percentage of platinum versus palladium. The Russian Norilsk (NILSY) nickel mine, the largest palladium producer in the whole world, boasts a PGM grade more than twice that of South African's. but Norilsk mine's PGM grade is only 10 grams per ton.

The Stillwater Mining Company, SWC, mines a structure called J-M Reef, proudly declared on their web site that they own the world's highest-grade known ore body of platinum group metals. So how high is highest? In recent quarterly reports SWC was strugglng with ore grade of approximately 0.46 to 0.50 ounces of PGM per ton, or 15 grams per ton. That ore grade made SWC the world's No. 1 in PGM ore grade.

PAL is producing metals from ores as low as 5.66 grams per ton in its underground mine, and 2 grams per ton in its open pit mine. The operation wouldn't even be economical if not because of the much higher base metal contents. But now this poor Cinderella suddenly becomes a princess! PAL will be mining up to 30 grams per ton of ore, instead of 2 grams/ton, in the near future! That completely changed the picture.

What a dramatic new development, right at a time when PAL stock price was hammered to the ground by mindless short sellers in recent weeks. I have been holding my PAL shares tight and now the patience paid off. People! It's time. Rush in to buy! It's rare to have an opportunity to buy the world's richest PGM mine, and at a price so dirt cheap it's barely above book value!

No wonder PAL insiders have been quietly buying up shares from open market, according to recent filings. They are not shy to tell the world that they have full confidence in this company's bright future. The new discovery of the world's richest PGM mines, is just icing on the cake!

The stock price of PAL has seem some nerve wrecking movement in recent months. From the high of $12+ in may 2007 when Cramer pitched PAL as the best nickel player, to the heart breaking plummet to the low $3-ish in mid December, 07, the struggle on the bottom till mid January, 08, and then a dramatic and powerful rally all the way to $9, and then fall back in the metals correction to the current low of $4.62. I have been holding firm during all the time, and struggled to add shares.

Why do I hold PAL so firm during the turbulent volatility? Because I truly believe in Warren Buffett's investment philosophy, and because I learned my lessons in PCU, and most recently in JRCC. Both stocks were some of my best holdings and I made money in them, but far from what I could have made, just becaue I could not hold for long term.

I researched copper companies in early 2006 after I discovered the topic of "Peak Copper". I was stunned to find PCU, at an incredibly low P/E of only 7.0, plus it pays a dividend as high as 10% a year. I just couldn't believe my eyes. After verifying the facts I immediately put more than half of my money into PCU. That was a split and dividend adjusted price of $28.50. Today PCU is at $111.53. Did I made 391% from PCU? No. I was scared off during the commodity correction in the summer of 2006, and sold off. Made probably 25%. Not much after paying Uncle Sam. In early 2007 I bought PCU again, and then sold in a few weeks for a 10% gain, because I perceive there were better opportunities in something else. PCU proceeded to more than doubled from where I last sold it. So PCU was a very good stock to own but I barely get much return from it because I could not hold for long term.

The most heart breaking example is the recent JRCC, a coal mining company. I watched it for a few months and finally spend 1/3 of my 401K to load up JRCC at $4. Perfect timing. Then as JRCC approached $8, I figured there may be a correction and so I sold before it hit $8. Again perfect timing. I missed the peak by just one day. JRCC proceeded to correct all the way down to $4.76 on Nov. 19, losing almost all of its gain since $4. I was watching it that day, and figured it should be a buying opportunity. But I was not in a position to buy although the timing looked good. JRCC never looked back and rallyed all the way to $25+ recently, and I could only watch it empty handed. What a heart breaking lesson learned! Greatest investors like Warren Buffett kept telling us, do your own due diligence study, understand what you buy, and do not be swayed by irrational reactions of Mr. Market, hold patiently for long term. Blindly following the mobs, the prefered style of investment for the majority of market participants, is not much better than gambling. Fundamental based long term investment strategy is the only successful money making investment strategy. Patience is easily said than done. Holding at happy times is no patience. Being able to hold through the lows, that is what's called patience. Why there is only one Warren Buffett? It is not because he is particularly smart. He looks like an average IQ guy. But his iron cold patience in investing is nobody's match.

Now, back to the agriculture sector. In the previous article, I point out that food grain products have limited room for upward price movement, because food is quite price elastic. Poorest population, which is the majority, MUST cut back on higher prices, because they simply do not have enough money to purchase food. Likewise, I believe the fertilizers are probably over-prices, and that stocks like POT, MOS, AGU etc., are probably already over-priced as the investor's perception is based on perception of unlimited growth of these companies, which is simply not realistic. I also suspected that the global potash cartels deliberately limit production in order to raise price, which could hurt them in long term.

It looks like in the past few days, food grains see a big sell off, as well as the fertilizer sector. Even though I expressed skepticism in the first place, I do not believe recent market move is a confirmation of my skepticism yet. My vew is it's just some normal market volatility and correction, not a trend shift. Has the global food supply suddenly become abundant, or the fertilizers? Definitely NOT. I see grain prices to continue to remain high and volatile. The situation will NOT change until the coming harvest. Likewise, fertilizer players are likely to rally again. Now is not time to short any fertilizer players. The best time will probably be around harvest time. So let's wait and see.

I see POT, MOS, AGU has some more room to go up. But I would rather stick to PAL, thanks to the stunning announcement of the drill result yesterday. Remember, SWC will announce Q1,08 earnings on May 8th, and PAL on May 12th. For the first time, the great PGM metals rally which took off at late January, will finally be reflected in the quarterly performance. So now is really the best time to get on board. Nothing in the bullish fundamentals of the metals has been changed. We will be going higher for several years.

P.S. The author is heavily invested in PAL and SWC, and currently hold no short position in FSLR but will be shorting FSLR soon.

Saturday, April 12, 2008

Investing In a Resource Constrained World Part Four

Recent developments in the general market make it necessary for me to continue this serial article about investing in a resource constrained world. I will be talking about food, agriculture and energy related investment topics this time.

In the part three article, I debunked Mr. Epstein's commodity bubble burst theory. The market quickly proved me right in a strong return of the commodity bull. Oil price jumped to record breaking $118 a barrel. Retail gasoline price now almost $4 a gallon. Food prices worldwide, leading by rice, rocket up and there's panic buying and hoarding of rice and other essential food all over the world. I bought 10 bags of rice three weeks ago before they were all gone. My rice bags made it into national headline news, thanks to Mr. Josh Gerstein. It wasn't a matter of me trying to save a few bucks. It's a matter of availability. Folks holding FSLR stocks tried to argue with me that tellurium is still quite affordable to FSLR. They do not understand it's a matter of availability, not affordability. Why don't folks contact FSLR and demand a specific and quantitative answer on their tellurium supply?

The availability vs. affordability debate will always bring up a very unpleasant topic that must be told, Demand Destruction, and an even more unpleasant but absolutely true topic, Malthusian Catastrophe on population growth. I will talk about it in more details in later articles.

We are entering a phase of severe global economic recession, triggered by the global credit crisis. Normally an economic recession means reduced demand on commodities. But it's different this time. I mentioned that for the first time, we are hitting the natural limit of supply on many non-renewable natural resources. The current crisis is caused not just due to imbalance in the economy, but also due to depletion of natural resources like petroleum, precious metals and base metals. If you are unfamiliar with the topic of Peak Oil, I advise you to buy a copy of Twilight in the Desert and visit In simple language, when exactly half of a non-renewable natural resource has been consumed, trying to produce the remaining half becomes every increasingly difficult and the annual production will be ever declining, until it's all gone.

Not only oil has peaked, a lot of other natural resources have peaked, or will be peaking soon. Those include helium, which has peaked long ago. You might consider APD for helium play. Copper has peaked and there is only 27 years worth of identified copper reserves left. Nickel has peaked as well. Silver production has long peaked and now there is only 13 years worth of silver left to be mined, based on USGS data.

The PGM (platinum group metals), on the other hand, is no where near peak yet. But I happen to believe the PGM will be the best natural resource play in short and long term, due to rapidly expanding usages and price inelastic nature of both supply and demand. That's why I like the only two primary palladium mining company in the whole world, PAL and SWC, as my most favorite stocks. Please read VM Group's recent research paper on PGM metals.

I have now heavily invested my 401K account into just two stocks, mainly PAL, and then some SWC, as price of both have dropped to a very attractive level, and all the bullish factors remain intact. The South African electricity crisis is becoming worse as they approach winter now, greatly impacting PGM metals production. Not only regularly scheduled load shedding is carried out daily, but ESKOM now stopped releasing info on power alert indicator or the total amount of load shedding, probably for fear of disclosing bad news. Auto sales in China grows at 25% or higher pace, now reaching 10.32 million per annum while the sale in the US only dropped 0.4%. That's a great boost of auto catalyst demand on PGM metals. Year 2008 is a huge Chinese wedding year and lots of ladies will purchase platinum or palladium diamond wedding rings.

I don't understand why people sell off platinum and palladium, knowing there is an industry deficit for both metals. Why should the stock of PAL be pushed to near multi-year low, while the metal prices are near multi-year highs? Dirt cheap stock price of a company of bullish outlook is an excellent buying opportunity. Insiders of PAL, North American Palladium, are buying shares of their own company from open market, according to recent filings found on SEDI.CA. At a time when most company insiders are selling their stocks like crazy, it's refreshing to see PAL insiders buying from the open market with their own money.

Most market participants are incapable of doing quality due diligence research and can only blindly chase stock price momentums, at the end of day the mobs always lose and savvy investors who stick to fundamentals win big time. At this time I do not even own FSLR short positions and have nothing to gain if FSLR suddenly collapses tomorrow. But I must insist on telling the truth of my research on the global tellurium shortage. If you hold FSLR, it's in your own interest to do your own research to find out what's going on, or at least push for FSLR to reveal quantitative information on their tellurium supply and usage. I believe that insisting on objective discussions of facts and logic helps return the market to a healthy state where companies are more fairly priced to their real valuation, instead of being rigged by professional market manipulators on the Wall Street. Do we need more ENRONs or BSCs?

Now return to commodities. Oddly, none of the best performing commodities in recent times are near any geological peak. Food, of course, leads all commodities in recent rally, as well as fertilizers. Price of coal skyrocketed, although the world still has plenty of coal left. Thanks to the coal price rally, stocks like ACI, BTU, BUCY, CNX, JRCC and MEE boomed. JRCC rallied from $4, where I purchased some, to a recent high of $25.37. When I purchased JRCC I figured that coal price may soon start to go up and JRCC may start to turn profitable. It is my belief that when a company goes from not profitable to profitable, the stock price appreciates fastest during the transition period. I figured that JRCC could go to $40 and it would take three years to get there. But the strong coal rally took me by a big surprise. I sold JRCC way too early and was never able to buy JRCC back. A lost opportunity and lesson learned that when you locked onto a bullish stock, you should never be swayed into selling by some temporary corrections.

Related to the global food shortage and food price rally, agriculture stocks are also on fire. Particularly in the fertilizer sector, we see some incredible rally in stocks like POT, MOS, AGU. The rally do seems to be justified, as the global fertilizer prices skyrocketed. What is worth noting is POT, which is the the largest potash fertilizer producer in the world, at about 9 million tons per year production scale.

How high will the rice and other grain prices go? How high can prices of fertilizers like potash go? Even though my 10 bags rice hoarding went on national news, my opinion is the boom and burst cycle of food grain will be relatively short, as proven time and again by history. A great famine is always followed by a great harvest. Oddly, historic records rarely show skyhigh food prices during famines. The reason is food prices are very price elastic. Most foods are consumed by poor people, the majority of the global population. They have no choice but cut back in face of higher prices, because they have limited money to spend. Instead of paying more, which they can't, they buy less, eat something else more affordable, or worse, die off due to hungry and malnutrition. Demand destruction at its cruelest. The population thus is reduced to the level where the available food can sustain. If a global natural disaster destroys half of the world's harvest in one year, then the poorest half of the world's 6 billion population will die off. Next year a good harvest may bring the food production back to normal level but there is no longer 6 billion mouths to feed, and food prices may collapse.

Some argue that as living standard of China and India improves, people eat more meat, hence mandating more food consumption to feed the animals and hence food price must continue to go higher. But food grains are merely taken away from the mouths of the poorest people in order to feed the animals. Wealthy people always eat meat and poor people never have enough to eat. The world is never fair to begin with.

Food is both perishable and completely renewable. The world will never run out of food. The next harvest is always less than 6 months away. So the grain bull market can not last for much more than a year or so. The food price can not go up indefinitely, either. When the food prices exceed the level where the poorest people can afford, they stop going up further. Rich people have money but they only have one stomach. So although I agree with Jim Rogers who predicts many more years of commodity bull market despite of the coming recession, I disagree with his emphasis on agriculture as the most bullish of all commodities.

Relating to the booming food prices, is the booming fertilizer prices. Players in this sector includes POT, MOS, AGU, TRA and a recent IPI. What is particular worth noting is POT, Potash Corporation of Saskatchew, No. 1 of the world in potash fertilizers, No. 2 in nitrate and No. 3 in phosphorite. The skyrocketing stock price of POT is mainly due to skyrocketing potash price. As recent as in year 2002 potash price was as low as $75 per short ton, now the news just break that the Chinese are paying $355 per ton more, raising from last year's $270 to now $625 per metric ton, for a total of 0.75 million metric tons worth of potash. More recent news says $1000 per ton is possible for the second half of the year. Such stunning news of course pushed POT share price to all time high of $216. Michael Pento discussed the agriculture boom and proudly declared that there is no bubble here in POT.

I beg to opine differently. When every one is talking about fertilizers and what a great company POT is, it's already too late for late comers and there might be a bubble forming. The world's population has been growing and has been eating for decades. Artificial fertilizers have been used for many decades. Potash supply, demand and price has been flat for three decades. So what has been changed in recent three years? A flooded mine in Russia last year and POT took the monopoly advantage and suspended sale, causing panic amongst the unprepared fertilizer buyers in the third world countries. The global potash market is tightly controled by two entities, Canpotex and BPC, leaving the major fertilizer buyers of China, India and Brazil no bargaining power at all. It's a good lesson learned that major countries like China and India MUST establish national strategic stockpile of fertilizers worth at least 3 years consumption. It is not just a matter of food security, but gives these countries greater bargaining power. I notice that POT has 13.25 million tons annual potash production capacity, but currently produces only 9 million tons. This looks like they use their monopoly power to limit supply and price gauge the global potash market.

I think POT is abusing its dominance power for the short term gain, but will hurt itself in the long term, like killing a hen to retrieve all the eggs at once. Natural plantations grow without potash fertilizer, because dead plants decompose on the spot, releasing potash back to the soil. Traditional agriculture removes only a very small eatable portion of the grain plantations, and return the bulk of the plant bodies to the fields, after decomposition or burning as cooking fuel. So the fields remain fertile. In recent years, Chinese farmers abandoned the traditional methods in favor of the easier potash fertilizer, due to increased income and affordability. Excessive application of fertilizers do not always result in the expected result, as potash is quite solveable in water. Rain water washes off the excessive amount of fertilizers, polluting major rivers. Will the Chinese farmers return to more sustainable traditional husbandary methods, in face of skyrocketing potash price? We will see.

The earth is plentiful in the potassium element. But rich, cheaply produceable potash resources concentrate in only a handful spots. At today's high potash price, many previous uneconomical potash resources all over the world can now be produced profitably. Many countries, including China, has been producing potash fertilizers from salty lakes. For decades, Isreal and Jordan are producing a combined 3.77 million tons of potash from the Dead Sea, which is only 8 times saltier than the ocean. All of the salty lakes of the world provide great opportunities to expand potash production. If the price remain even at half of today's price, I don't see why can't any one start to produce potash from the ocean itself. I see a potash price bubble bursting in the next year or two as the world adapts. POT, a company which has limited room to increase either the production, or the unit price, currently at a high P/E reserved only for companies perceived to have unlimited growth potential, is a clearly over-priced bubble. I would NOT short it here yet because I know the giant inertia force of group mentality of investors. But watch closely for an opportunity to short after the harvest season.

Watch JRCC and other coal mining company for opportunities to buy on the dip, as coal price is still cheap and has some more room to go up. But I believe the PGM metals, my favorite, has way much bigger room for price gain. Just look at rhodium. Went up from $300 to $9000 per ounce in 4 short years. Is this a peak already? Hardly! That's what a commodity of extreme price inelasticity can do.

PGM metals are extremely price inelastic, because few places in the world produce these metals. Russia's Norilsk mine has been produced for decades and now is in steppy decline. Largest PGM producer, South Africa, is crippled by a destructive electricity crisis. It can't even maintain current production, let alone expand capacity in the next few years. Outside Russia and South Africa, SWC and PAL are the only primary PGM metals producers. That's the price inelasticity on the supply side. On the demand side, the PGM demand in various applications are booming: auto catalyst; catalyst for oil refinery, chemical industry and fertilizer production; electronic application in MLCC (multi-layer ceramic capacitor), which see one trillion annual production and growing, and in LCD big screen TVs, etc.; Palladium dental fillings; palladium food inserts for preservation; fuel cell applications, etc. etc. PGM metals must be used in all these industries, there is virtually no replacement available, and quantity used per unit of product is usually small so the cost is not a big factor.

Take the dominant PGM metal usage, auto catalyst, for example. Some believe an economic recession may reduce automobile demand and hence autocatalyst demand. But according to this article, China's auto sale is growing at 21% or higher annual growth rate and now reaches 10.32 million units per year, that compare to a mere 0.4% drop in the US market. If you look at recent gasoline prices, you know the whole world has an insatiable demand on oil, and an insatiable demand on automobiles, and hence an insatiable demand on autocatalyst and the PGM metals used. Bad economic times also encourage catalyst converter thefts, leading to increased demand on replacements.

Vehicles must have catalyst converters that comply to tightening environmental control regulations, for good reasons. Global air pollution causes more than 4 million unnatural deaths per year, far more than traffic accident deaths. Without catalyst converters reducing the air pollution, the air pollution related deaths could triple to 12 million per year. So the annual consumption of 8 million ounces of platinum and palladium in auto catalyst applications saved 8 million lives a year. One life saved per ounce of metal. How much is one human life worth? How much is once ounce of platinum or palladium worth? No wonder the 2007 Nobel Chemistry Prize was awarded to the work that leaded to the invention of PGM based auto catalyst converters. The scientist have saved a population several times the total deaths of WW II. I am humbled to say that is the most deserving Nobel Prize awarded to a noble research work on the noble metals.

Unlike food, which every one eats, rich or poor, automobiles are only for those wealthy enough to afford them. And unlike fertilizers, for which plants can grow with less or with alternatives, PGM metal usage in auto catalyst converters can not be reduced. Decades of research have already exhausted most thrifting opportunities. Tightening environment regulations probably mean more metals need to be used in order to improve efficiency. It's ridiculous for some industry vest interesters to spread unsubstantiated technology news, making claims like silver based catalyst converters replacing PGM metals. We all know silver readily reacts with sulphur dioxide in the exhaust gas, rendering it useless. People who can afford to buy a car surely can afford to pay for a few extra grams of noble PGM metals, for the noble cause of save some human lives from air pollution. We are supposed to believe that silver catalyst converters will go into commercial usage in 2012. By that time, every one will have forgotten the story.

With such bullish outlook of the PGM metals price, how could I not get heavily invested in the only two PGM metals players in North America, PAL and SWC? Especially at such ridiculous low prices. I see nothing better to buy. I am a firm believer of Warren Buffett philosophy. He said if you really know what you are buying, there is no need for diversification.

Update April 25,08: Mitsui Mining now back stepped from their original silver catalyst converter claim, and now says it's "for use in farming and construction machinery, rather than car engines" WHAT A SCAM! Jack Lifton also commented on the story.

P.S. The author is heavily invested in the PAL and SWC stocks at the time of writting.

Wednesday, April 9, 2008

The Tellurium Supernova Has Erupted

In my previous article, The Tellurium Supernova, I discussed the rapidly expanding new applications of the extremely rare metal tellurium, and that looming global shortage of tellurium could threaten the very survival of the red hot solar company, First Solar Inc., which produces solar PV panels based on the CdTe (cadmium telluride) semiconductor material.

The Tellurium Supernova article caused quite some disturbance on the internet. Not every one agrees with me. But I am happy that Mr. Free Market does seem to agree with me. The chart show that tellurium price staged an incredible rally since mid January, raising from 860 yuan to 2100 yuan per kilogram, or US$300 per kilogram, a raise of 2.44 fold in less than three months. Tellurium went from US$10 a kilogram in 2004 to now over US$300. If such a stellar price rally does not indicate a severe global shortage of tellurium, then I don't know what does.

The Tellurium Supernova has erupted!

Does First Solar feel the squeeze of a tellurium shortage? Maybe not. The CFO claimed(22:58) "We have identified terawatts levels of tellurium availability"! So the ultimate limit to the growth is one terawatts? No! The CEO proudly declared "Are there issues there that limit the ultimate size of the company? We think the answer to that is NO." Wow! I only knew that Wall-E could go to infinity and even beyond. I never knew that FSLR can grow with no ultimate limit of size, even though they rely on a metal with extremely limited supply.

FSLR, as well as their dominant raw material supplier, 5N Plus Inc. (VNP), repeatedly reassured people that they are not worried about tellurium availability and they are actively "managing it". But I noticed that they would NEVER divulge anything specific or anything quantitative when it comes to their tellurium supply. In multiple occasions, analysts, including Michael Molnar from GS, explicitly demanded specific and quantitative answers, but got only the vague go-around answers. Why are they not willing to reveal any data on tellurium?

Fortunately, now VNP, the virtually exclusive high purity CdTe and CdS supplier to FSLR, is now a publicly traded company and must file regular financial reports, allowing us to dig out some useful information. You can go to and search for "5N Plus" to find all VNP regulatory filings. I think the VNP's Dec. 12, 2007 prospectus document is worth reading through carefully. It discusses a lot of details of the industrial use of high purity tellurium, and its relationship with FSLR. You might also listen to latest conference call. A few important things to note from the prospectus:

  1. VNP is the first to enter the market of high purity tellurium metal and compounds. They have years of expertise, large scale production capacity, business relationship with tellurium sources. They are the world's dominant CdTe supplier and all CdTe solar PV manufacturers purchase CdTe from them.

  2. VNP is a virtual monopoly in this niche market. The barrier of entry is too high for a second major CdTe supplier, the market is too narrow to provide enough economic incentive for competitors to enter this small niche market and compete with VNP. FSLR desperately wanted to diversify their CdTe sources but there is just no significant secondary supplier in existance in the world. They refuse to name the secondary supplier. Does it even exist at all? VNP already named all of their few potential competitors.

  3. It is safe to say FSLR gets virtually all of its CdTe supply from VNP. VNP has plenty of production capacity, 100 metric tons of CdTe annually, and under contracts with FSLR, they are building a new Germany facility, bringing the annual capacity to 200 metric tons and eventually reach 350 metric tons a year. Why would VNP expand if FSLR does not continue to heavily depend on VNP for supply?

  4. VNP noted rapidly expanding industry demand on tellurium. They meantioned 300 metric tons start metals per year for thermoelectrics applications (page 21). That number really strikes me. According to USGS, global tellurium supply can not be much more than 200 metric tons per year. Thermoelectrics usage of tellurium wasn't even meantioned a few years ago. Now that market alone consumes 143.4 metric tons of tellurium alone (48% of the Bi2Te3 thermoelectrics material is tellurium)
So we can pretty accurately estimate FSLR's raw material supply by looking at how much CdTe that VNP is selling to FSLR. VNP refused to provide numbers in kilograms, but they gave a price range of $300 to $500 per kilogram during the Q2 conference call, and suggested in Q3 conference call that the price may exceed the top of the range now. So using $500 per kilogram one can get some reasonable numbers. VNP also revealed that 60% of sales was to FSLR, and 65% to 70% in latest quarter.

Let me list VNP's quarterly sales revenue, as well as cost of goolds sold (in bracket) below. Note their fiscal year 2008 starts on June 1st, 2007. Q3,08 is the quarter ending Feb. 29, 08.

Q3,08 $8.359M ($3.905M) OP. Margin $4.454M
Q2,08 $6.796M ($3.519M) OP. Margin $3.277M
Q1,08 $6.394M ($3.417M) OP. Margin $2.977M
Q4,07 $6.549M ($3.442M) OP. Margin $3.107M
Q3,07 $5.555M ($3.419M) OP. Margin $2.136M
Q2,07 $4.890M ($2.779M) OP. Margin $2.111M
Q1,07 $4.903M ($3.122M) OP. Margin $1.781M

I noticed one thing curious. During the past quarters, even though the sales revenue see some growth, the growth is not impressive at all. The cost of goods sold see virtually no growth at all, while the operating profit jumps up rapidly!

Put it in a chart you can see the data more clearly. In the chart, black is FSLR's rapidly ramped up quarterly production in MWs, red is VNP's cost of goods sold, blue is sales revenue, green is gross operating profit.

Notice the gigantic contrast between how quick FSLR's production ramped up, and how there is virtually no increase in VNP's cost of goods sold? Logically, as FSLR ramps up production, they need to purchase way much more CdTe semiconductor material from VNP. And hence VNP needs to spend more money to purchase the raw tellurium feedstock, not to meantion the unit price of the feedstock raw material must increase dramatically as tellurium price went up a lot. Something is not right here! The rapid growth of VNP's gross operating profit, without much increase in the production cost, further enhances the logical wisdom that VNP enjoys absolute monopoly in this small niche market of high purity CdTe supply, and hence can demand higher unit price as they see fit, and FSLR has no where to go but purchase the bulk of their CdTe supply from VNP.

My suspicion is FSLR is not getting all the CdTe they need for their production. At 3 microns CdTe layer thickness, there's about 15 grams of CdTe per 2 feet x 4 feet panel of 70 watts. Allow some production waste, 0.25 grams/watt CdTe is reasonable. FSLR produced 77 MW in Q4,07, that's a consumption of roughly 19.25 metric tons of CdTe. At over US$500 per kilogram, that's worth $9.625M of purchase from VNP. Add CdS, which also came from VNP, total purchase should be almost US$11M for the quarter.

VNP's latest quarterly revenue is only $8.359M, with 65% going to FSLR that's $5.433M. Split it into $4.8M for CdTe and the rest for CdS, at over $500/kilogram, they sold about 9.6 metric tons of CdTe to FSLR. That's only about HALF of what FSLR would need!

From the VNP's cost point of view, about half of cost is salary, machinery and other fixed cost. Let's say $2M of the $3.905M cost in the quarter is on raw material purchase. FSLR's portion takes 65%, or $1.3M, tellurium price during the quarter probably averaged $250/kilogram. So that gives 5.2 metric tons of tellurium, enough to make 9.8 metric tons of CdTe for FSLR, consistent with the above estimate, and inconsistent with FSLR's 19.25 metric tons requirement for quarterly production.

My conclusion, based on the best information available to me, and the most logical and reasonable estimate, is that FSLR has already run into a raw material supply shortage, due to the global shortage of tellurium. They are either now producing from the raw material inventory, or they probably booked quarterly sales but really could not produce and deliver the quantity of products they sold. Later this year and next, when their new Malaysia factories start production, I really have no idea how they are going to get the tellurium supply they need.

I contacted FSLR investor relationships and raised the CdTe supply issues more than a month ago and asked for a clarification, and never got any response. I am hoping that FSLR can come out and clarify how and where they are getting their critical material supply, how much they have secured, and how much they need. Of course, if there really is a shortage, the investor community has every right to demand that the FSLR management disclose the information fully and publicly, as soon as they know it, as required by the SEC regulations.

P.S. The author is heavily invested in the stocks of PAL and SWC but holds a small short position in FSLR since April 4th. I plan to add to my short position when time is right.