Tuesday, June 10, 2008

Investing In a Resource Constrained World Part Five

In a previous article I touched the topic of Peak Oil and even meantioned the Malthus Theory. The validity of both theories can not be disputed because both are extremely simply and perfectly logical derivatives of mathematics. In the case of Peak Oil, it's been validated by the peaking of individual giant oil fields, and we are just now experiencing the peaking of global oil supply. In the case of Malthus Theory, it has been validated by hundreds of historic events thoughout the human history.

The purpose of my articles is to talk about investments. But it is necessary to divert away a little bit to talk about the paradigm shift of our society first, before I come back to talk about investment ideas.

We are experiencing some gigantic paradigm shift as crisis unfold right in front of our eyes, due to natural resource depletion. It is important for individual investors to understand what are those crisis and how do we cope it, in order to survive and prosper in the looming crisis.

Unlike most Peak Oil advocators who are extremely pessimistic, I am an optimist. I have been pessimistic the first time I learned the Peak Oil concept. But the knowledge about the Malthus Theory actually turned me into an optimist. Humanity have faced many many crises before, each could have wiped out humanity from the surface of the earth, but we survived for millions of years nevertheless. So the looming resource crisis is no different and probably no worse from any of the previous crises humanity has faced.

Let me explain Malthusian in simple terms. A fish in the ocean, for example, can lay a few million eggs at a time. Each egg, given the proper opportunity, can grow into an adult fish and it can lay a few million eggs of its own. If you multiply a million by a million and keep multiplying, pretty soon you reach an astronomical number that total number of fish can easily fill the whole ocean, or fill up the whole galaxy. Of course that could never happen. Most eggs got eaten by other fish as food, before or after it is hatched. A pessimist would think that what if all one million eggs are eaten and not even one survives to grow up? Then the fish could go extinct pretty fast. That does not happen either. It just so happens that out of 1,000,000 eggs, 999,999 will not survive but in average exactly one will survive to lay eggs, no more and no less. The nature has a way of regulating fish population based on available natural resources like food and habitat. The Malthus Catastrophe happens on a daily basis for fish. But I do not see any fish being pessimistic. They have been living happily for millions of years and just keep laying as many eggs as they can. Life goes on. Shouldn't human society, with our collective intelligence, cope with our own Malthus Catastrophe better than fish?

The unfolding energy and natural resource crises, in my opinion, is a population crisis. The global population simply exceed what the earth's natural resources can support. If we have one billion people instead of six billion, then we still have plenty of oil and other natural resources left for every one to consume. There are ways to cope with it, peaceful ways, through conscious population control (like the family planning policy in China), and conscious reduction of consumption. We must abandon our American lifestyle of materialism. China, with a population five times that of the USA, and consumes only one third of the oil, and it manages a much robust economy than the American one. So America should be able to survive with much less oil consumption.

Skyrocketing oil price has already forced many American families to try to adopt and cope with over $4 a gallon gasoline prices. Abandoning driving altogether is impossible for most Americans. But abandoning SUVs and big pickup trucks in favor of smaller, more fuel efficient cars, is what people have been doing. The trend is very clear, sales of SUVs have stalled, but sales of cars are booming. The total auto sale in recent month have dropped some what, only because auto makers have not been able to respond to the demand change fast enough. My opinion is auto sales actually will see a few years of hyper boom, because people will retire SUVs and other inefficient vehicles, well before the useful lifespan of these vehicles. There will be a huge demand on new fuel efficient cars, to replace these SUVs on early retirement.

My advise to people is SELL your SUVs now, while you can still fetch a decent price for it and use the proceedings to buy a new fuel efficient car. You wait longer and more of these oil guzzlers will show up to flood the used car market, and dent the resale value. You should also buy a Prius, the most fuel efficient car you can buy today. I do not own stocks of Toyota Motors (TM) and I do not think they make a terrible amount of money on Prius. But I am getting 66.6 miles per gallon so I can afford a much higher gasoline price than most people do. Toyota could not produce a lot of Prius due to battery shortage. It costs a lot of nickel metal to produce the hybrid batteries. So buy a Prius while you can still lay your hands on one.

I can see there will be continued global nickel shortage due to auto makers rapidly ramp up hybrid vehicle production, but also due to ramped up effort to develop deep sea oil resources. You need gigantic oil platforms, called oil rigs, made of millions of tons of stainless steel, which needs nickel. There is a global shortage of oil rigs, so expect stainless steel and nickel demands ramp up just on this account. Check out the phenomenal raise of RIG and you know there is a severe rig shortage. Buy any producer of nickel while they are now cheap thanks to the recent nickel price correction, which now seems to have bottomed. That of course includes my favorite palladium stock, PAL, because nickel is the most important byproduct of PAL. I am also thinking about TGB, which I once owned in 2006. I still like it's low P/E ratio. Was its recent fall due to nickel? If then, it's good reason to buy on the dip, since I see nickel has bottomed in the current round of correction, especially in light of the big blow up in west Australia.

The solar sector has been hot in recent months but have cooled down some what. Do I consider any solar stocks a good buy here? I have longed and shorted TSL and LDK in the past but I considered them merely trade stocks and I no longer own them. My opinion is Solar PV is NOT the solution of our energy crisis, not silicon based ones, and definitely not the CdTe solar panels that First Solar (FSLR) produces. I suggest that you read an article called Order of Magnitude Morality. The point to make is production of solar PV products are extremely energy intensive. Although it looks like the energy consumed in producing these solar panels will eventually be paid back, due to their long lifespan, it does take up to ten (10) years to payback the energy consumed, fifteen (15) years if you count in everything, including transportation, sales, installation and maintenance. Massive ramp up of solar PV production will consum a great portion of our existing limited energy supply, make the energy shortage that much worse, before the energy contributed by these solar panels can start to make a difference.

Because of energy payback time as long as 15 years with everything counted, we could NEVER ramp up Solar PV fast enough to replace our energy supply. We don't have the time. For example, if we immediately dedicate 5% of today's global energy supply to solar PV manufacturing, which is a stretch because the world can hardly afford even 1% of spare energy supply now. But let's say 5% is available. By the end of the year, we will have produced enough solar panel to provide 5%/15 = 0.33% of the world's energy needs, reduce our reliance on fossil fuel to 99.67%. The next year we can dedicate 5%+0.33% = 5.33% of the energy to solar PV industry. And by the year end we have another 0.355% available. It would take 11 years for solar PV energy supply to reach 5% of the world's needs, and another 11 years to reach 15% of world's energy supply, and another 11 years to reach 35%. 33 years and we are still only at 35% of the world's energy needs.

I do not like any of the solar players in the market today. They all rely on government subsidies in order to prosper. I am a believer of free market and I am against all government intervention in the marketplace. Let the free market speak if it is something beneficial for the society. I am disturbed by the fact that why my tax dollars should help to pay for 60% of the cost of solar installation for my neighbor 100 houses down the street? He may think he got a good deal from the tax break. But he will continue to pay tax to help the No. 99 neighbor to install solar panels, and then No. 98, 97 etc. At the end of day whatever tax break he initially enjoyed, he pays back in future taxes. The tax money doesn't come from no where but from our own pockets.

One exception is ENER, which I meantioned before favorably, and still consider it a favorite long term play due to it's hybrid battery technology and other unique technologies. I consider inventor Standford Ovishinsky the Thomas Eddison of our time. The stock is very volatile so I would recommend buy it on the dips, not on the rallies.

The solar sector is hyped up by the Wall Street. If you have learned a lesson from the 2000 IT bubble, the lesson is don't follow the hypes! That reminds me of another sector wall street hyped up two years ago, the ethanol sector. The most notable stock in this sector is PEIX. I noticed it in early 2006 and I told folks don't buy it at $40. You will lose your money. Turning the food, corn, into the fuel ethanol, is never a very profitable idea. It is never a solution to the energy crisis. Don't listen to the hype, even if Bush himself hyped ethanol. Today, unfortunately PEIX trades at merely $3 a share. Ethanol price has gone up, but corn price has gone up even more, making PEIX barely profitable. All of a sudden every one now denounces the ethanol industry of consuming all the corn in the world, causing global food crisis and famine and all that.

I am a big believer of contrarian thinking. I did not buy JRCC and just watched it rally to $16 in early 2007 when there were all the drum beatings. But I rushed in and bought tons of it at $4 when no one wanted to touch it. Today JRCC is well above $46 and there are lots of drum beatings again. My advice to people is sell JRCC now. I am not saying it is the top. Don't try to catch the top, which no one can. There are much better opportunities else where than to squeeze the last few dollars out of JRCC.

I am tempting to apply some contrarian thinking in PEIX at below $3 now that no one touches it. I do not view it as the savor of the world. My investment goal is not to save the world. The ethanol industry is not the solution to the world's energy crisis. But it has its reason to exist as a legitimate business, satisfying some legitimate needs. When we truly run into oil shortage, and we can turn corn into ethanol to supplement the gasoline supply, I don't see why not! Burning food as fuel for transportation needs is nothing new. The First Emperor of China practiced exactly that 2222 years ago, i.e., burning food as bio fuel for transportation needs in order to bring supplies to his powerful army thousands of miles away. The transportation vehicles he used were driven by machines called horses, they consume food as biofuel in order to obtain the energy to drive the carts. 90% of the food transported is consumed by the humen and horses on the trip, and only 10% reached the destination to supply the army. If the trucks have no diesel fuel, no food can be delivered to your local stores. I would rather prefer to allow part of my food converted to bio fuel to allow the trucks to bring the rest of food to my grocery store. So maybe we should give it some thought if this is the right time to buy some PEIX or other ethanol players. Could PEIX develop alternative feedstock than corn?

I have a big dream that the success of Cold Fusion, now called low temperature nuclear reactions, may become a reality and we will have solved humanity's energy crisis for good, and saved civilization from catastrophic collapse. I know that from the fundamental point of view of quantum mechanics, which says that particles always have certain possibility to tunnel through energy barriers, cold fusion is NOT impossible. Think of all the hundreds of scientists who have resisted tremendous amount of peer pressures and continued the experimental research of cold fusion for 19 years of best of their times. Do you think they are all clueless crackpotists, or they are really up to something? Recent successful public demo by Yoshiaki Arata, a highly respected physicist in Japan, should bring people renewed hope that cold fusion could become a reality and could be the perfect solution for our energy crisis. Of course if that is the case, palladium price has got to go up a lot higher. Palladium is used to trigger cold fusion reactions. I recommend people to watch the video series War Against Cold Fusion to understand it. Instead of advocating for drilling the ANWR and depleting America's last bit of remaining oil as fast as possible, shouldn't America at least spend a few million dollars to check out the reality of cold fusion, when other countries like Russia, China, Japan, India and Isreal already beat us in the cold fusion research? Shame on the short-sighted politicians who only know ANWR!

Metals are my favorites. Base metals and precious metals. My all time favorite metal is tellurium, which I discovered when I studied the prospectus of FSLR. I talked about tellurium here and here. On a side note, I can not believe how stupid the street is, I talked about FSLR's RoHS risk back on Nov. 27, 2007. It's been so long since my article was published and no one paid any attention. And now they suddenly discovered the toxicity of cadmium, and speculate that CdTe solar panels could be banned in Europe. I think it is irresponsible market manipulation. Any competent analyst should have read FSLR's prospectus from day one and know about cadmium and RoHS. On this I want to come to FSLR's defence. They have documented the RoHS risk in the prospectus and in annual filings so they have not hidden anything. Recent news fuss made it sounds like FSLR just made an announcement and that a EU ban on CdTe solar panel is suddenly imminent. I think it remains just as speculative today as last year whether Europe will take actions to ban CdTe solar panel or not. I so far have heard nothing that indicates a move to ban is imminent, so it remains just a speculation of a possible event so far. Was it an attempt of the street to lure in some unsuspective fresh shorts, and then run another round of short squeeze? I remain skeptical because I know how this market could be rigged in either directions, with analysts often selectively distribute information they see fit.

The real risk of FSLR remains how it is going to resolve it's tellurium supply. I talked about it quite a lot and I tried to dig out information. But the FSLR management do insist that they have adequate tellurium supply. Since they have never revealed the actual data on their tellurium supply, we the outsiders can only speculate and discuss opinions, and the fact remains something only FSLR knows, until such time they are willing to come to the public and discuss it. Maybe they need more time for insiders to sell? One thing that I think I am sure is one day my stash of tellurium hoard might be worth its value in gold. I wish there is a tellurium mining stock to buy.

But really palladium and platinum are the next best thing. They are way much better than gold and silver. I could never bring myself to like gold. I did once buy gold stocks like NG and NXG. Now NG is less than half where I last sold it at $16+. I now frankly think gold is the worst of commodity investment, and gold mining could be worse. Of course as fiat currency depreciate, gold's nominal value in fiat money looks higher. But you still have nothing to gain. Go to Zimbabwe. You can exchange a gold coin for one trillion Zimbabwe Dollars. You feel good being a trillionaire but you are not getting rich.

Gold is money since ancient time and is still money today. I have a problem with that fact! Money, as an exchange media, must be something that people are willing to take in and equally willing to let go. If people want to hoard it but do not want to let it go, or people are rather happy to give it out and hate to take it in, then it can not be exchanged freely as a trade media. So by the virtue of gold being the money, it is something perceived to have near constant value in real term, people have a neutral sentiment in owning it or dishoarding it. and that is exactly the reality. There are more than 160,000 tons of gold being hoarded by different people and organizations. Any trade of gold, is largely between some hoarders of gold and some other hoarders of gold. The mine supply and jewelry industry demand, in this case, is relatively small in comparison, and does not have a material impact on gold's price. There could never any shortage nor any surplus of gold. I would rather buy silver than gold on the Friedman Theory. On silver have a look at SIL and CDE. Could be good bottom fishing target. While PAAS is now more expensive than silver itself. If you want leveraged gain on silver then buy some SLV. Similarly use USO and UNG to play on the oil and natural gas commodity prices.

I would like to look at things from the point of view of basic supply and demand relationship. If I want to invest in a commodity, I need to know that it's price must go up. I need to know that it is in demand and that there is a supply shortage. I also need to know how elastic or inelastic that the price change may affect the supply and demand, and bring back the balance. Something that is price elastic, that higher price could easily boost supply or cause people to reduce usage or seek alternatives, will have less room for price gain. On the other hand, if it is something price inelastic, that higher price will neither boost supply, nor persuade industry users to stop using it, or there is simply no alternative or replacement, then it is a commodity that has a lot more room for price to appreciate.

Palladium and platinum fits such description of commodity that is in short supply, that is in ever increasing demand that is rigid and non-negotiable. The supply is in shortage because the ongoing electricity crisis in South Africa, which greatly impacts production in this main PGM metal supplier of the world. The electricity crisis sees no solution until at least 2012, according to ESKOM and other reports from South Africa. The PGM production disruption is well documented for any one willing to dig out first hand information, instead of relying on second hand guesses. On page 9, table 3, you see the March, 2008 PGM production is down 28% from last March. SA supplies 85% of the world's platinum and 35% of palladium so that's a lot of global supply reduction.

Curiously, the trade of platinum and palladium so far has not followed the way the fundamentals of supply shortage dictates. Instead they follow gold and silver. Gold up and PGM up. Gold down and PGM down. What does PGM's own industry supply/demand has anything to do with gold or inflation hedge? I guess the metal traders are just slow in digging out useful information. If it takes the street almost two years to dig out something well documented in FSLR's IPO prospectus, it doesn't surprise me at all that the reality of South Africa's electricity crisis hasn't even sink in yet even in the minds of some of the most well known metals analysts, let alone the average investors. But soon the PGM fundamentals have to kick in. Industry users must buy for their consumption. The price movement will wake up investors.

I know one hedge fund manager, a physics graduate and very successful in his career, manages billion dollars of assets and claims to be a good friend of a briliant trader, Brian Hunter, whose one single mistake killed Amaranth Hedge Fund. I tried to talk to him about palladium and he told me right away he knew palladium, and there were lots of palladium mines in Canada, and he knew many funds who bought the physical metal. He totally believed he knew it but he really didn't. If a bright guy with such a good background could be so clueless, the average wall street investors must be in total darkness, and of course the computers they use to trade is even more clueless about fundamentals of the markets.

So be patient, spend your time do your own DD. Dig out first hand information and do your own analysis. If you have done so you have beaten the street already. If you further have the determination of sticking to fundamentals and not be swayed by the mindless computer trading of the big funds, then you will win big time at the end of the day. I am sticking to my investment in PAL and SWC since I have done my homework, and checked them many times and could not find any thing wrong with my analysis. And I will patiently wait for the market to wake up to the reality I have discovered long ago. Meanwhile I am taking pride in my legacy of the first individual tellurium investor in the whole world. I made the correct call at the lows of JRCC and ENER, so I know I have the sharp vision. I am not envy about the recent astonishing rally of JRCC and ENER, because I know in time, PAL and SWC will do much better.

P.S. The author is heavily invested in the stocks of PAL and SWC. I have hoarded physical to speculate on tellurium price appreciation.

5 comments:

Troy said...

GREAT post. Love it. You have certainly done your homework. I will link to your blog on mine.
wereallfullofbull.blogspot.com

I have a little story on pal as well.

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