Saturday, January 26, 2008

Investing In a Resource Constrained World Part Two

Three weeks ago I started the first part of a series of articles discussing the importance of making long term investment decisions based on the fact that we are living in a resource constrained world, due to rapid depletion of many none-renewable natural resources. If you look at what are the hot sectors in recent years, most of what have been "hot" are related to depleting natural resources one way or another. That includes oil, natural gas, coal, base metals, and precious metals. And of course, relating to the depletion of fossil fuels, the development of alternative energy is booming and the stocks are hot.

Palladium has been my most favorite metal. I have previously discussed the unusual characteristics of palladium. It is the only metal that defied the well established over-supply condition, with price rallied higher in the last 5 years, proving all metal analysts wrong in their bearish predictions. That surprising fact alone should catch people's attention to study what's unusual about this metal. I see booming demands of palladium from auto catalyst converters, jewelry, fuel cell, catalyst in biofuel synthesize and oil refinery, and misc. applications. Most astonishingly, palladium could be used in cold fusion and bring about a perfect solution to our current energy crisis. With even the authoritative American Physical Society (APS) now publicly endorses cold fusion as a real science, by sponsoring cold fusion conferences, who is to say cold fusion is not proven? A Russian scientist already promised to demo a 100KW working device by August, 2008. We will soon see if he keeps his promise. If cold fusion becomes a commercial reality, I predict palladium price could reach 100 to 1000 times more expensive than gold.

There are two recent shocking developments in the PGM (platinum group metals) market. One is widely publicized, the other is hardly noticed by any one. Both are extremely bullish for platinum and palladium, and therefore bullish for the only two primary palladium producers in the whole world, PAL and SWC.

First, the little noticed event. In recent years, Russia has been selling off its strategic palladium metal stockpile, accumulated from nickel mining during the Soviet Era, at a pace of roughly 2 million ounces per year. They traditionally ship the annual palladium stockpile sale to Switzerland, in the month of December. Read John Reade's alchemnist paper. Many people speculate that as of now, the Russian palladium stockpile should be largely depleted. So it's not surprising to me at all that indeed in the month of December, 2007, shipment of Russian palladium stockpile failed to show up in Switzerland. Even UBS's John Reade himself noticed this fact and commented recently as he continued to watch if any shipment could show up in early 2008, or maybe that's the END of Russian palladium stockpile sale.

The termination of Russian palladium stockpile sale is an earth shattering event! The 2 million ounces per year extra supply was the whole reason for the global palladium over-supply. With this extra supply now removed, there is actually a global shortage. See supply/demand data from Implats. Palladium rallied in the past 5 years under an over-supply condition. What happens now there is an industry shortage, with investment demand booming at the same time? Palladium price will have to go through the roof once people finds out the the global shortage.

There is recently also a tsunami type event in the global PGM market. South Africa's electricity power crisis had caught the attention of the whole world. Recently, shortage of electricity forced ALL South African's precious metal mines to shut down production. That's quite a shocking global headline news. It had been no secret that throughout 2007, mine production in South Africa has been impacted by various problems, including strikes, safety problems, shortage of electricity. But it only captured the whole world's attention on Jan 25, 2008, when people realized it's not just a few individual mines with problems. The whole country's mining industry shut down! This is not a temporary problem. The whole country's electricity supply infrastructure simply was neglected for too long, now it is unable to meet the rapidly increasing demand. It's a strategic mistake 10 years in the making, and will take till 2013 before we see the problem fixed.

South Africa supplies over 80% of the world's platinum and over 35% of the palladium. With no easy fix of the ongoing electricity crisis in sight, it is expected that PGM metal supply from South African will be greatly impacted in the next few years, causing severe shortage. Quick thinking investors immediately jumped on the news. Prices of platinum and palladium skyrocketed in recent days. I believe several things contribute to the rally:

  • The industry shortage causes the price rally.
  • Investors attracted by the metal rally. Their hoarding worsen the shortage.
  • Industry users, fearing a disruption of supply, will panic hoard at all cost.

I urge people to seize the opportunity and jump onboard to load up stocks of SWC and PAL. Especially PAL, it is an extremely valuable deal after the dramatic 14% drop on Feb 5th, 2008. It's a shame that evil forces are allowed to manipulate the market and distort stock prices absurdly away from their rightful values. PAL, a precious metal miner that supplies more than 5% of the world's need of palladium metal, is now hardly trading above its book value and hardly above the annual metal sales revenue.

How high should PAL and SWC share prices go? PAL, with 79M shares outstanding, produces 290K ounces of palladium and 25K ounces of platinum per year. That's 0.00367 oz Pd and 0.0003164 oz Pt per share. At a reasonable P/E ratio of 10, each $1 increase of Pd and Pt metal prices should translate to $0.0367 and $0.003164 gain of PAL share price. Since Jan. 23,08, platinum gained $288/oz ($1550/oz to $1838/oz); palladium gained $62/oz ($367/oz to $429/oz). Just based on this metal prices gain, PAL share price should have gained $2.28 from palladium rally, and $0.91 from platinum, for a total of $3.19 per share gain. But PAL only increased from $3.59 to $4.73. PAL should already be at $6.78 today!

I say people when you see such a dirt cheap deal, jump in to load as much as possible. Sadly most people would rather chase the high fliers with ridiculously high valuation ratio, than do their due diligence study and pick up gems tha no one wants. That's why the world has millions of fools but only a handful success investors like Warren Buffett.

One of such high fliers is the solar stock, FSLR, which I talked about in several previous Seeking Alpha articles. I pointed out that due to extremely limited global tellurium supply and booming demand from new applications, FSLR, which is exclusively based on cadmium telluride, has no growth potential. Not only it has no growth potential, I see that it shut business down in the matter of about two years. I also see an incredible opportunity in investing in physical tellurium metal, and have purchased a small stockpile as the result of my study. At the time of writting those tellurium articles I had a short position in FSLR. As of now, I have already close my FSLR short position so as to concentrate my investment resource in response to recent extremely bullish development of the fundamentals of PAL and SWC.

I stand by all my previous view points and I want to continue to discuss FSLR's tellurium problem, even though I no longer have a vested interest in the stock at this time. I feel I have an obligation to continue the discussion and warn people, especially as I made a shocking discovery recently from 5N Plus's recent quarterly release. The transcript of VNP's conference call provides more information and confirms my suspicion. That is, FSLR is probably getting only about half of the CdTe raw material it needs, from its dominant supplier 5N Plus Inc.. I do not know how they are going to continue the round the clock 24x7 production. More over, FSLR repeatedly assured investors that it has made proper arrangement to ensure raw material supply once the new Malaysia factories start up. But from 5N Plus, looks like FSLR hasn't yet talked with 5N Plus regarding the raw material supply of the Malaysia factory. If they haven't consulted with their most importat supplier, how can they be so sure their supply chain will be in proper order to support the new factories? I plan to short FSLR again right before the Q4,07 earnings' report.

I used to be a gold and silver fan, and have studied a number of silver mining stocks. My favorites are PAAS, CDE and SLW. I actually owned SLW for some time in 2006. It was claimed to be the puriest silver player. A bit too pure. SLW does not own any mine itself. If you are a resource investor, why do you invest in something that does not actually own the resources? SLW is essentially a holdings company, with its value derived from a few silver purchase contracts. I am just not sure whether you want to bet $3B worth of investments on nothing but a few contracts. Too much risk if those contracts are in jeopardy. I also looked at PAAS and believe it is probably one of the best silver mining company. But ultimately I decided that I would rather own silver rounds from PAAS, than its stocks.

In my last article I talked about IPSU, a sugar player, and JRCC, a coal player. I determined that IPSU may not be the best stock to leverage the sugar bull. IPSU does not produce sugar feedstock itself, so it's not clear how it can benefit from raising sugar price. As for JRCC, it rallied too fast for me to catch laterly, due to the rally of coal price. The strong coal rally in recent months took me by surprise. I do not see how the supply/demand equation of coal has changed. Coal is still abundant in the United States. I do not see dramatic increase of coal consumption in electricity generation. The rally of coal is probably speculation driven, motivated by recent strong demand on the international coal market. I am not sure how long the coal rally will continue, or whether it could turn south suddenly. Invest in JRCC is thus a bit risky at this price level. I would watch the coal movement a little bit to see if it lasts, and wait for JRCC share price to drop a bit before jumping onboard.

Agriculture is hot! The fertilizer sector seems to be pretty hot in recent months. That prompted me to pay attention to stocks like POT, MOS, CF, AGU, TNH, SEED, FEED, COIN. People know that Jim Rogers is favorable in agriculture. The few stock I cited here are mostly fertilizer producers, with stellar stock performance in the past 12 months, thanks to rapidly raising fertilizer prices. These fertilizer stocks see some set back recently. Should we buy here?

But after some study, I am skeptical about how much higher these fertilizer stocks can go. Fertilizers have only one usage: fertilizing agriculture and landscaping plantations. The surface area of the earth is not growing any bigger. Arable lands are actually shrinking. Food production of the world has been flat and do not see much growth potential. I do not see a big growth potential on the demand side of fertilizer. On the supply side, there is no limitation of the raw material feedstock of the fertilizer industry. Nitrogen is 80% of the earth's atmosphere. Potassium is one of the most abundant element on earth. As for phosphorite, it is less abundant but the known reserve still lasts a few hundred years. So fertilizers are not constrained by natural resources. The recent price boom of fertilizers are probably more due to rapidly raising energy cost, like natural gas, and less due to increased demand. I don't think fertilizer makers are the best place to bet your resource-oriented investments. However, maybe stocking up some physical fertilizers in your backyard could be a good idea.

Palladium, platinum, and tellurium are still my most favorite elements. I will talk about uranium and other metals in my next article.

P.S. Full disclosure: At the writting of this article the author is heavily invested in SWC and PAL and plan to add more position as fund becomes available. The author does not currently have a position in FSLR but intend to short it soon.

Thursday, January 10, 2008

Investing In a Resource Constrained World Part One

We are living in a resource constrained world, due to rapid depletion of many of the none-renewable natural resources, like oil, coal, and metal mineral resources. As the main stream media wake up to the Peak Oil reality, I believe it is important to keep the reality of a resource constrained world in our mind, when making investment decisions. In this article I want to talk about precious metals, including gold, silver, platinum and palladium, the rare metal tellurium and selenium, coal mines, agriculture, sugar, and fertilizers. Relate to these resources I will talk about the following stocks: PAAS, CDE, SLW, PAL, SWC, OMG, FSLR, JRCC, IPSU, POT, SEED, TNH, COIN, not necessarily in that order. This is the first part in a series. I will take about them in more detail in the future.

First on First Solar Inc.(FSLR) and tellurium, because I have some breaking news! I have previously written about FSLR and its critical reliance on tellurium supply, and about the fact that tellurium is increasingly being used on important new applications, which could force FSLR out of business. I also suggested buying physical tellurium as an investment.

The breaking news I discovered about FSLR, is from 5N Plus Inc. ( VNP recently went IPO and they have just made the first public release of quarterly operating results, for the quarter ending Nov. 30, 2007. Find it on I was shocked to discover that VNP saw virtually NO growth in sales revenue over several of past quarters. Here are the numbers of quarterly sales revenues:

Nov. 30, 07 $6.796M
Aug. 31, 07 $6.394M
May.31, 07 $6.400M (extrapolated from year total)
Feb.28, 07 $5.700M (extrapolated from year total)
Nov.30, 06 $4.890M
Aug.31, 06 $4.903M

We know that 55% of VNP's sales are CdTe sales to FSLR, so that's about $3.75M per quarter. We know during this time period, FSLR saw incredible production capacity expansion, going from one production line to three at the end of 2006, and then seven during Q3, 2007, due to the new Germany factory reached full capacity. The thoughput speed of the production lines also increased greatly.

Such a rapid growth would mean a lot more production consumption of the CdTe raw material, and a lot more purchases from 5N Plus. However the growth was NOT reflected in 5N Plus's quarterly sales revenue. The sales had been flat for 3 or 4 quarters. Why?

On page 26 of VNP's IPO prospectus, it explains that VNP currently has an annual production capacity of 100 metric tons of CdTe, and it is building a new factory in Germany to double the capacity to 200 metric tons, and then some further improvement to bring the capacity to 350 metric tons per year. They have also reserved empty land lots in Germany so that they can build another facility to further double the capacity. Such an aggressive expansion plan was the result of contract obligation to FSLR. The contract mandated that the Germany factory must reach full production by July 31, 2008.

That's a pretty aggressive expansion plan. Clearly both FSLR and VNP saw that the quantity of CdTe needed by FSLR warrants such an expansion. However, such a desperate need of more CdTe is NOT reflected in sales revenue growth of VNP, which almost stalled in recent quarters.

What's the road block? The roadblock is neither VNP's current production capacity, nor the lack of demand from FSLR. Judging from the number of $3.75M quarterly sales to FSLR, VNP's current production capacity is under-utilized. The only conclusion I can draw is they are not getting enough raw tellurium for the production!!!

My estimate is the cost of CdTe in whole sale price is probably $350 per kilogram or more. I saw 10 times higher retail price at, at $3500 for one kilogram CdTe of 99.999% purity. Assuming $350 per kilogram, the latest quarterly CdTe sale to FSLR was roughly 10 metric tons. FSLR's current capacity is 40 MW per production line per year, and 7 lines. So that's 70 MW per quarter. Each 1 MW of solar PV production costs about 250 kilograms of CdTe. So the need is about 17.5 metric tons of CdTe per quarter. They are getting far less than that!

First solar might end up having to shut down some production lines if it can not find more tellurium supply soon! Don't forget they have another 4 Malaysia factories being build, each as big as the Germany factory. Where are they going to get the tellurium supply? I think there is a looming catastrophy here in First Solar.

But there is an ongoing catastrophe in my favorite long stock PAL right now. The catastrophy is not with the company's business, but rather, with the company's stock price! I predicted a palladium super bull cycle and recommended buying PAL and SWC. The palladium price rallied to multi-year high recently, but the PAL stock price reached multi-year low. That rather defies the logic! In a previous article I analyzed why PAL stock was punished, and called a bottom on Dec. 13. Looking back, the bottom price of $3.40 a share was called correctly. But PAL has yet to rally above $4 credible.

I urge people to buy PAL below or near $4 a share promptly and do not wait too long. The reasons are not just the strong rally in precious metals recently, but more importantly, PAL's Q4 earnings will be released at the end of January or beginning of February. Since a considerable portion of the mine produced metal was not sold in Q3, but will be added to Q4 sales, it can be expected that the Q4 earnings result will be fantastic, boosting stock price.

More importantly, I sense that an explosive palladium rally is imminent now we have entered 2008. Traditionally, each year the Russians sell about 2 million ounces of extra palladium, from the government stockpile, flooding the global market and capping the metal price. They always shipped the government stockpile sale of palladium in one batch to Switzerland in the month of December. So far, year 2007 has ended, and there was no indication they shipped any palladium stockpile.

Palladium rallied in previous years despite of Russian stockpile sale. Now, when the fact that the Russians have finally depleted the stockpile becomes public knowledge, and people know that there is an industrial shortage without the Russian extra supply, you can expect the palladium price will explode into the stratosphere!!!

SWC is also a good buy here, but relatively, PAL has better value at this price. You get more palladium production per dollar of stocks. Read my detailed comparison between the two.

I am also poundering other potential stocks to buy, OMG looks like a fantastic titanium metal player, with unbelievably low P/E. I have not done enough DD to determine if the P/E is real, but I feel the stock may be a bit high to buy here, do your DD and wait for a dip to buy.

Among silver players, PAAS and CDE seems to be the best of breed, SLW is the purest of pure silver play. SLW seems to be an excellent trade vehicle if you like volatility. But I do not like it as a long term investment. Do not get me wrong. All these stock should go up long term. But if in comparison with silver they are less worth than silver as an investment, then you are better off buying physical silver than buying these stocks. PAAS's market capital current can buy more silver, than the worth of its underground mineral resources. The same could not be said abut CDE, however. So I think CDE is better than silver, and PAAS is worse than silver.

Besides precious metals, I also pay attention to other resource investments. I don't buy oil players. Too many people have thought about oil already. When too many people doing the same thing, it diminishes your investment return. However I like coal. JRCC is a coal player that I have been paying attention for a long time. It has a super low price/sales ratio. So if the coal price raises to the level that allows it to make a profit, the profit will be very remarkable. The problem with JRCC is it has too much debt, so during the ongoing credit crunch JRCC may suffer a bit in short term. I am going to watch for JRCC to come down a bit more before I will buy it. Another thing to keep in mind is coal is still abundant in this country.

Sugar is sweet! I noticed that sugar price recently has bottomed and is going up again. Fortunately I also noticed a sugar player, IPSU, which for some reason, is being naked shorted. I think IPSU below $18 a share looks like a very attractive buy. But will need to spend more time to study the sugar fundamentals.

Every one knows Jim Rogers is favorable in agriculture. In a TV interview, he said that he liked palladium better than gold and platinum! That I agree with him. He also said he liked agriculture better than palladium. That I totally disagree. I agree with him that agriculture is bullish. But agriculture is LESS bullish than palladium. The reason is very simple, palladium, the precious metal, is price inflexible in its industry applications. How inflexible? Just look at rhodium, it went from $300 an ounce, to now more than $7000 per ounce, and there seems to be no stopping. The demand can not go away, now can supply catch up. That's price inflexible.

Agriculture is quite price flexible, both on supply side and demand side. On the supply side, you just plant more and produce more. On the demand side, you have demand destruction. Demand destruction happens in the most vulnerable section of the human society: people who are poor and can not afford adequate food. So the demand destruction actually happens at pretty low price point, because poor people don't have much money. They either have to settle for less expensive, lower quality food, or in the worst case, just die off in famines. It's cruel to say that. I am not being insensitive, but it is a fact of life that this world see famines just too often whenever there is a food shortage crisis. The charities are always too little, too late.

Of course, the better hope is increased agriculture production. That is exactly what's happening. However, increased agriculture production poses increased fertilizer demand. That's why there is a sudden boom in the fertilizer sector. So it is worthwhile to check out why the fertilizer sector suddenly becomes so hot. I recommend have a look at POT, TNH, CF, MOS, AGU, COIN, SEED. All those are related to fertilizers and/or agriculture. I have not done a sufficent DD study on them to give a definite recommendation of buy or sell. I hope you do your DD and tell me what you think about these stocks. And I hope to discuss them in more details in the next article.

P.S. Full disclosure: I am heavily invested in PAL and also own some SWC positions. I am short in FSLR and plan to add more short positions. I am invested in physical tellurium and plan to buy more. I do not own any of the other stocks I meantioned here but do intend to buy some of them at appropriate time and price.