Blatant Manipulation in the Precious Metal Market

Recently the CME Group had been raising margin requirements on silver and other commodities almost on a daily basis. The relentless margin hacking up ultimately caused a plummet of silver price from near $50/oz, to around $35/oz, a roughly 30% drop, in less than one week. Such plummet in silver price was un-precedent. The plummet in silver price wiped out a lot of speculative silver investors.

A number of precious metal analysts call the CME margin increase blatant market manipulation. I agree. It's blatant market manipulation conducted by the CME exchange itself. It is unfair. The policy change is clearly tilted in favor of one group of market participants against another group. Whether such blatant market manipulation has broken any SEC regulation, or whether some one should go to jail for it, I will leave it to lawyers to decide. But one thing is clear: The actions of CME had caused disturbing disruption in the precious metal and commodity market.

The problem is not with the increased margin requirement. It is completely in an exchange's right and duty to set proper margin requirements and adjust it periodically to ensure orderly market trading activities. The problem is with the manner in which the CME raises margin requirement.

Instead of a gradual and smooth adjustment of the margin requirement over a long period of time, CME choose to leave the margin unchanged while the silver price was raising rapidly early in the year. And then, right before the "sell in may, go away" season, they suddenly begin to hack up silver future's margin aggressively on a daily basis. The consequence is predictable. Instead of stabolizing the market, they disrupted the market. Why they do not adjust the margin down accordingly, now that silver has lost 1/3 of its recent price high? Why are the margin adjustment asymmetic? One has to wonder whether the decision to successively jack up margin ratio was purposeful, with the goal of suppressing silver price in aim.

The margin requirement in its current forms are asymmetric, because the long side is being punished while the short side is rewarded. It is unfair because it requires CASH deposits on both the long and the short. This torelates and encourages illegal naked shorting of futures contracts.

Let me explain. A silver future's contract is a binding legal contract between the contract writer (the seller, or the short side), and the contract holder (the buyer, or the long side), that at a future time, the seller shall deliver an agreed amount of physical silver, for consideration of an agreed amount of cash tendered by the buyer. Alternatively, the buyer may choose to settle the contract in cash instead of take physical delivery. But that should be up to the buyer to choose, NOT up to the seller to decide whether the contract can be settled in cash or delivery be made. Failure to do either cash settlement or delivery by contract expiration date is a breach of the binding contract, and the side which causes the failure is the side at fault. Please note, if the contract buyer demands a physical delivery but the seller could not honor the request, it is a contract default even if the two sides could settle in cash.

Margin requirement is a requirement of maintaining minimum asset, imposed by the exchange to ensure that futures contracts will be fulfilled, and no default shall occur. It is reasonable to impose a cash margin requirement, so in the case the contract holder is unable or unwilling to tender the full cash amount for delivery, he/she is able to choose instead settle in cash and be able to pay the difference in cash.

But what about margin requirement on the contract seller side. The existing margin requirement on sellers is in CASH, just like the requirement on buyers. This ensures that the seller can pay the cash difference in the case the contracts are settled in cash. But what about the cases that the contract holder request physical delivery but the seller is unable to honor the request? Remember, it is up to the buyer, not the seller, to choose physical delivery.

What assurance does the exchange has that when the contract buyer demands physical delivery, that it will be honored, and there will be no failure of delivery? Nothing. There is simply no such guarantee. I think that is a big problem. Maybe the exchange reason in imposing a cash margin requirement on the short is that as long as the short has the cash, he she can always go to the spot market to acquire physical silver, and make good on the delivery request.

Such reasoning is frauded. The physical spot market is limited, while the volume of contracts that can be written and sold has no limit. It is impossible to deliver more silver that what's actually exist out of there. As a matter of fact, if all existing silver future's contracts are settled in physical delivery, the delivery requirement will be many times more than silver that is available.

I believe silver future contract writers must be required to pose a certain amount of physical silver, or demonstrate ability to delivery physical silver (like for mining companies), instead of pose cash, to meet the margin requirement.

Allowing silver future contract writers, most of them have no business in silver mining and have no possession of an ounce of silver, to meet their margin requirement in cash instead of silver bullions, not only is unfair and frauded, but probably is ILLEGAL, too.

Knowingly enter into a business contract with knowledge that he/she can not and will not fulfill, is not just a SCAM, but a CRIME punisheable under contract laws and criminal laws.

If one trader naked short 2 million shares of a company's stock, knowing there's only one million shares outstanding and that he/she could not possibly borrow two million shares, is ILLEGAL under SEC regulations. You can go to jail for doing that.

If you write up a contract to sell a bridge in Brooklyn, New York, and actually collected an idiot's money from it, knowing full well that you do not own that bridge, is a crime. You go to jail for it. I am not sure though, about some one who sells real estate property on the moon, as some obviously is doing. But at least the guy claims he owns the moon, and the buyers do not insist on delivery.

Shouldn't there be some legal repercussions for the nake shorters of silver, especially the biggest naked shorters of silver who happen to be big banks? They write and sell a huge volume of silver future contracts to knock price down within a very short period of time, rip profits doing so, knowing full well those futures contracts are invalid, because they could NOT be honored if physical delivery is requested. There were far more silver future's contracts sold and outstanding, than physical silver that is available.

I hereby request that CME and other commodity exchanges consider imposing margin requirements in physical commodity, rather than in cash, on future contract writers. And I want to see if the authority is up to its task to investigate whether there has been illegal naked shorting in the precious metal and commodity future's market, activities that certain parties write future contracts that they know full well can not be honored. But I do not hold out hope on that happening any time soon.

To precious metal investors, I say you either take physical delivery, or do not even participate in the market. What is the point of buying a contract but do not take delivery? Future's trading is a zero sum paper game. As I explained in the past, if you want to profit from the commodity bull market, take possession of physical goods is the only way. If you don't hold it, you don't have it.

Full Disclosure: The author is heavily invested in physical palladium metal, and have very large positions in palladium mining stocks SWC and PAL. The author also owns a number of silver mining stocks but does not own any share of GLD, the gold ETF, or of SLV, the silver ETF.

Richest Billionaires Must Also Be Biggest Losers

It sounds ironic. People who worked their lifetime to become some of the richest billionaires must have some good quality in their characters to ensure their success. But some how once the richest billonaires reach their pinnacles, their fortunes inevitably begin to decline, despite of their best efforts and intentions to keep growing their stakes to something even bigger.

But it is also absolutely true! The richest billionaires are also the biggest losers.

I am not just talking about the financial crisis of 2008, in which probably most people lose money anyway. I am talking about it as a generally true fact, like in the last ten years. In 1999, Bill Gates was the richest person in the world, with a net worth of $90B. Remember that was in terms of 1998 US dollars, when gold was $288 an ounce by the year end. So Bill Gates was worth 313 million ounces of gold then. Warren Buffet's $36B would have been worth 125 million ounces of gold at the time.

By 2005, Bill Gates was worth $46.5B, Warren Buffet was worth $44B, and Carlos Slim of Mexico was worth $23.8B. In terms of gold, which was $437/oz (end of 2004), Gates was worth 106.4M ounces, Buffet was worth 100.7M ounces, and Slim was 54.5M ounces. Gates was only 1/3 as rich as he was in 1999. Mr. Bill Gates probably wished that he had sold his company in 1999 and staked away his fortune in gold bars at a secret location.

By today, after the market plummet in 2008 and then an incredible recovery in 2009 and 2010, let's check the score again. Carlos Slim is worth $74B, Gates is worth $53B, and Buffet is worth $47B. Gold was $1422/oz at the end of 2010. So in terms of gold, these three richest billionaires are worth 52M ounces, 39.4M ounces and 35.2M ounces, respectively. The combined fortune of all three is only worth 40% of what Bill Gates alone was worth in 1999.

These two charts track the top billionaire's networth in US$ and in gold ounces, in last 10 years:

It's really surprising. Warren Buffet is known to be the world's most successful value based investor, with all the good characters of investment success: patient, determined, diligent. He had the track record of consistently gaining about 40% each year, in his investment career spanning over 4 decades. But in the last 10 years, his fortune barely gained anything even in terms of the depreciation US dollars.

In terms of gold ounces, or real purchasing power term, Warren Buffet lost more than HALF of his fortune in the last ten years. He lost that much fortune despite of all his personal DD efforts working 12 hours a day, and a team of hundreds of the world's best financial geniuses working with him. All these time and energy spent trying to make the best investment decisions for the world's most respected investment firm Berkshire Hathaway, and they still lose money?

Warren Buffet is famously know for his despise of gold, which he doesn't understand:

Gold gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.

That famous gold quotation sounds reasonable with me and I actually agree with him. An ounce of gold is forever just an ounce of gold. It doesn't grow. Gold is only worth what it costs to extract an ounce of gold from the ground. That certainly is worth a lot of money but it is not growing. Gold is merely a storage of value, not a growth of value. So gold is really not an investment.

But Warren Buffet could well have digged a hole 10 years ago and buried all his fortune in gold bars. His stake would not have grown had he done that, but his fortune at least would not have shrunken like it happened. In the last ten years Warren Buffet diligently managed his investment firm, trying to find valuable companies to buy, selling any asset that seems to cost him money, his giant investment kindom accumulates huge amount of profits and dividends, allowing him to buy up more assets. But despite of all these, his net fortune is barely flatline in US dollar terms, and shrunk to barely 1/4 where he once was, in terms of gold ounces.

Why top billionaires must necessarily once day become top losers? It's not because these rich people have grown too old to think rationally, but simply because they have become too big to grow. Young Warren Buffet could buy a six-pack soda for 25 cents and then sold each can separately, and make an instant 20% gain in an afternoon. Senior Warren Buffet, with his net fortune worth $47B, would now have to buy 18 billion of six-pack sodas for $2.50 each, and find a giant beach with 108 billion thirsty people to vendor individual cans of soda to them for 50 cents each, to grow his fortune 20%.

The world does not have a beach that big. The world is a small place. The universe has a finite size. Persistent growth is not possible in a finite world. When you hit a certain size, you simply can not grow any more. Rapid growth is only possible when you are small. Warren Buffet once purchased a lot of silver bullions, about 1/3 of what the whole world had to offer. It costed only 2% of his fortune. But he could not keep even just 2% of his fortune in physical silver. He was forced to sell his silver.

To the average Joe investors, it's pleasant to know that you can beat the billionaires easily. You can easily make more money than billionaires do, in making the kind of investment decisions that billionaires could not make: Warren Buffet could not buy silver, but an average Joe can walk into a coin store and purchase a couple hundred ounces any time. Had you bought physical silver a mere two and a half years ago, your fortune has more than quadrupled from your initial investment, an investment gain that few of the world's billionaires could achieved.

I pitched physical tellurium investment a few years ago when tellurium was $40 a pound, today it's nearly $500 per kilogram, with the price surged 50% in just the last two months, marching with certainty towards gold price as I predicted. Had I pitched tellurium investment to Mr. Warren Buffet, he would have brushed me away as if I told him to vendor soda packs on the beaches. Folks like him are too big to be concerned in such narrow markets, but an average Joe Six-Pack could have bought six buckets of tellurium for less than 10 grands, and make himself a millionaire in a few short years.

It's great to be a small investor since you have many great opportunities to easily grow much bigger. Those opportunities are not available to billionaires. I notice that Mr. Jim Rogers, my most respected commodity investment guru, pitched silver and my favorite palladium to his audiences since early 2009. The annual global production of silver is only 600M ounces. After industry demand is meet, there is no more than 100M available to investors, or $1B in early 2009 silver price. Palladium's annual global production is slightly over 6M ounces. There is no palladium left for investors after industry demand is meet. But even if there are some palladium ounces available, there are probably no more than 500K ounces per year available to investors. At early 2009 prices, the market liquidity of silver and palladium was $1.1B and $0.1B respectively. If you bought either metal at the lows, your money would have quadrupled by now. But I don't think Jim Roger's fortune had quadrupled during the same time. Mr. Jim Rogers himself is probably too rich for those two narrow precious metal market. Both silver and palladium and excellent investment opportunities for the average Joes, and un-available to billionaires. Jim Rogers could not buy the metals himself that he urged people to buy.

So, do NOT listen to the world's top billionaires. You should be inspired by the stories how they accumulated their fortune, and their general philosophy of the society and of life in the world. But do NOT listen to top billionaires as far as investment decision goes. They have now become irrelevant losers while you are the winners. You need to listen to the small guys like me and other Seeking Alpha authors, and then do your own thinking. Warren Buffet would not tell you to buy gold, silver, palladium and he probably doesn't know what is tellurium. I will tell you to buy tellurium, buy palladium, and other investment opportunities meant for the small guys. At the end of days the billionaires are proven wrong, and small people like me are proven right.

Full Disclosure: I am heavily invested in physical palladium and silver, and related mining companies, but otherwise have no specific positions related to the discussion of this article.

Hot Money, Hot Commodities and the US Dollar Carry Trade Part 3

In part one of the article, I argued why the collapse of the US dollar is inevitable and commodities are the only safe haven in the event of currency collapse; In part two of the article I begin to demystify some mis-conceptions about commodities investment. Some times even Jim Rogers could be wrong. I specifically cited the example of the UNG natural gas fund.

In this part three, I will elaborate more on what are the correct approaches for commodities investment, and what is the best commodity to invest in. I am going to discuss the things that Jim Rogers was wrong about.

I can not emphasize this enough: When you invest in something, you should always ask the question WHO PAYS FOR YOUR PROFIT. You can't create money out of thin air. Some one has to pay you for you to make a profit. If you can not figure out who pays for your profit, then your investment thesis has a problem.

In the market, the majority of people must be the losers so as to allow a few people in the minority to make obscene amount of profits. That's how the world works. Always think for yourself, do not let other people do your thinking for you. I have high respect for Jim Cramer who I think is a smart guy. Unfortunately too big a crowd gathered around him, so that the biggest crowd must necessarily be the biggest crowd of fools and losers, by definition. That's not Jim Cramer's fault, but his success, as an entertainer.

Warren Buffet is the buy-and-hold-forever type of investor. Who pays Warren Buffet if he nevr sells? The companies he own keep operating profitable businesses to genenate fortune for him.

Who pays the day traders who buy and sell equities in short periods? It's got to be fellow day traders. So day trading is nothing but gambling, a zero sum game with 50/50 winning and losing odds. In recorded history no one becomes a billionaire through day trading.

Who pays you when you invest in something for long term? The rest of the investor community, Mr. market pays you. All long term profitable investments requres two things:

1. You need to have the wisdom to recognize the long term value of your investment.
2. The rest of the world must disagree with you, so you can buy your investment cheap.

I must particularly emphasize the second point. For your investment thesis to be correct, people must disagree with you. They will ridicule you, curse you, calling you all sorts of names. If people laughed at you, don't be discouraged and don't get angry. Instead take their laugh as a compliment and take comfort in the fact that most people disagree with you, so you are in the minority, so you are probably right.

But you still need to make sure you are right in the first place. This requires hard work doing your due diligence research. This also requires that there need to be some people, who, after spending time doing their own due diligence, no longer laugh at you and start to agree with you. That is important. If every one in the world laughs at you, then you are an idiot. If 99% of people laugh at you but 1% do take you seriously, then it says you are a genius and the world is a fool.

All the successful investors receive more than enough of their fair share of being laughed at, in the early stages of their investment careers, including Warren Buffet and Jim Rogers. But no one laughs at Warren Buffet any more. Every one takes him seriously now. That's his problem. Anything he wants to buy, it leaks out before he could buy enough so he ended up paying more. Any time he wants to sell, people beat him before he could sell much. When you have a big crowd around you, it makes a billionaire very hard to make his next move.

Jim Rogers also have a big fan group, so even though he deserves high respect from me, I will take him with a few grains of salt. His pitch on agriculture commodities, his best favor, for example, I think is flawed. Let me discuss why. hope some one can pass this note to Jim Rogers himself, so he knows why he is wrong, or argues with me why he is still right.

Jim noted that every one needs to eat, and there is limited land resource to produce all the food people need to eat. That is a fact. But that is a fact known by every one already, and it is a true fact for millions of years already. The best invest ideas always come from facts that are recent news, and that few people know, not from something every one already know for a long time. So this immediately rings an alarming bell on Jim's agriculture commodity thesis.

Jim failed to notice that the threshold for demand destruction is low for food, and hence it caps the value appreciation potential of food. Poor peoplein poor countries already dedicate 75% to 90% of their disposable income on food. How are they going to pay more? There is not much room to go from spending 90% of income to spending 100%. People will just have to eat less and eat what their income can afford them. So this reduces demand and caps the price appreciation. In fiat currency term, the price can still go up a lot. But in purchase power term, there is virtually no room for growth.

Consider that no one can spend more than 100% of disposable income, and that food expenses are already the biggest percentage of people's spending, I would say that in terms of purchase power, agriculture products are probably the WORST of commodity investments, not the best.

Applying the same thinking, I think Jim's another pitch is a great one: Water. Water is more important than food to sustain human lifes. How much an average family spends on water, in terms of percentage of disposable income? I am paying roughly $1.50 for one unit, about 97 gallons. That's only 1.5 cents a gallon. So there is a lot of appreciation potential. If there is water shortage, when water bills hit 25% of a family's spendings, people will start to use less while each gallon will become more expensive. Pushing the theoretical limit, you can probably survive reasonably well on just two gallons of water per day and the water will costs a family of four about $1000 per month. That's roughly $4 per gallon water. So that's a lot of appreciation potential going from 1.5 cents to $4 per gallon of water. That price target is actually realistic, as people in some Arab country are already paying more per gallon for water, than for gasoline!!!

Water is just an example to stimulate thinking. Investing in water is tough. How do you store water at low cost for long time without spoil it, besides there is no shortage of water on earth. There is only a shortage of water purification treatments and transportation. Maybe investing $1000 or so for a secured drinking water supply, is a wise investment for your family.

I consider precious metals as commodities in a broad sense. Many gold bugs consider gold as a sacret cow, different from other commodities. I disagree. Gold or any precious metal is simply a metal that is precious. Nothing more and nothing less. Sacret cow only exists in religions.

What's the best commodity to invest in? As I discussed in my last article, the only sensible to invest in a commodity is to either hoard the physical stuff, or invest in the companies that produce the stuff. So an ideal commodity to invest in should be easy to store, and has the largest price appreciation potential:

1. It should be compact and easy to store, and remain safe and stable for long term. This immediately rules out any thing gaseous or liquid, because they are hard to store.


2. It should be price inelastic on the demand side. That means price can be driven up to very high level, and the industry consumers can still afford it. This immediately rules out food products and base metals that are used in bulk quantities, like steel, copper and aluminum.


3. It should also be price inelastic on the supply side, that means it should probably be a by-product. Most producers will not bother to increase the production of their main product just to produce more by-product and marginally increase their by-product profits.

Once you apply these rules, there are not many commodities that can qualify as the best commodities investment. Three metals meet all the requirements: Palladium, silver and tellurium. No. 46, 47 and 52 on the periodic table.

Silver is almost as widely known as gold, and more widely used as money than gold, throughout human history. People in China and other Asian countries love silver better than gold. Recent news from China indicate that silver investment is red hot, while the gold market is flat. Jim Rogers himself encourages the Chinese to buy silver and palladium, rather than gold.

Over 70% of global silver supply is produced as a base metal by-product, only 30% is produced from primary silver mines. So silver can be classified as a by-product metal. On the demand side, silver is price inelastic. Silver is widely used in the electronics industry, but so little silver is used in individual components, that the cost is never a concern. On the jewelry side, material cost ofsilver is a very small percentage of total cost of most silver jewelries, so at current price level, silver jewelries are price inelastic as well.

I like silver as a storage of wealth. But I like palladium much better, as an investment. For decades, there is a large structural deficit in global palladium supply. The global palladium deficit was only filled in by the annual Russian Government paladium stockpile sale, which is about 1 to 2 million ounces a year. Global mine production is about 6.5 million ounces per year while consumption well exceed 8 million ounces per year. Read Platinum 2009 Interim Review to get an idea of platinum/palladium supply/demand numbers.

Russia has the world's largest nickel mine, Norilsk Nickel (Nilsy.PK), which is also the world's largest palladium producer, since they produce palladium as a by-product. The Russian government accumulated the excess palladium production during the Soviet Era in their strategic metals stockpile. You must read the 2003 report by Alan Williamson to understand the Russian palladium stockpile and how its size could be estimated. A false rumor regarding the Russian palladium stockpile trigger the palladium price spike of 2000/2001.

Many metals analysts have been speculating that this Russian palladium stockpile is near depletion. If that is the case, it will be a paradigm shift event which could send the metal price sky high, far exceeding the 2000/2001 price peak of palladium price.

Two recent news items confirms that the Russian palladium stockpile has indeed depleted. One is on August 31, 09, another is on October 15, 09. So far, this news has not caused much attention and has not resulted in explosive palladium rally yet. My favorite palladium mines, SWC and PAL, have moved up in share price. But they are still far from the heights where I expect to see them to reach.

But looking at the performance of palladium price in the past year, how could any one still complain? As fellow SA contributor John Lounsbury also noticed, Palladium already did far better than platinum, silver and gold in the past 12 months. I just wish more people learn the story of the depleting Russian palladium stockpile.

Many years ago, Warren Buffett correctly pointed out that Mr. Market is a fool. My own experience tells me that I could never underestimate the foolishness of Mr. Market, or the stupidness of the world. You only need to look at the global warming hysteric fiasco.

The foolishness of the general investor community can be best reflected in the tellurium story. Two years ago I advocated for hoarding physical tellurium and predicted that the business of First Solar (FSLR) is not going any where, as they could be suffocated by a global tellurium shortage brought about due to the emerging new applications of tellurium based electronic devices, like phase-change memory. How many people listened and believed me? More people in the world understand Einstein's Relativity Theory, then people who understand tellurium supply and demand! Now Numonrx was able to make multi-layer phase-change-memory chips. This is a paradigm shift in the electronics industry. As advanced as the modern microelectronics industry is, they were never able to produce a multi-layer computer chip. It's going to be huge for tellurium and a gigantic jackpot for the tellurium investors.

But for now, people still fight hand over fist to buy FSLR stocks, believing that First Solar can grow its business unlimited. Some investors actually believed that tellurium can be extracted from sewages, because I told them most tellurium is extracted from the slime mud produced during copper electrolysis production. Yeah right! Just don't do it at home and don't dig out the sewage pipe in your toilet. I assure you there is no tellurium to be found.

Full Disclosure: The author hoards physical tellurium, physical palladium, and has large long positions in SWC and PAL, as well as silver mining stocks SSRI, PAAS and CDE. The author no longer holds position in UNG and has no short or long position in FSLR. The author holds other positions unrelated to the discussion in this article.

Last Chance to Save the United States of America From Collapse

Congratulations to our President-elect, Mr. Obama. It's fitting that an African American shall take up America's top job to salvage this country from an imminent political, social and economic collapse. Closer ties with Africa, a land blessed with rich natural resources, might provide the best opportunity we desperately need to save America and continue our prosperity!

Circuit City (CC) bankrupted. General Motors (GM) could be next and Ford (F) is not much better. Mean while we are bailing out AIG (AIG) for the second time (or maybe the third time) in just a few months as it seems to be just another growing black hole. And who will bail out the Federal Reserve Bank or the US Government itself?

If you read my past articles, you know my favorite precious metals are palladium and platinum. PGM metals used in catalytic converters in vehicles account for half of global demand. Am I concerned about these two precious metal's future prospect?

I am not concerned at all, not only because PGM metals are precious metals and hence are safe haven investments just like gold and silver, not only because PGM metals have strong demand in emerging new applications especially in alternative energy sectors like fuel cell, hydrogen economy, bio-fuel, and coal-to-liquid, but even within the auto sector, the global demand continue to remain strong fundamentally.

Enron collapsed a few years ago. Did we stop using electricity at the time? No. Do you stop buying auto insurance if AIG goes out of business? No. More than ten years ago, the last American owned TV manufacturer went out of business or was acquired by a foreign entity. It did NOT stop Americans from watching too much TV today, either.

The downfall of the US auto industry is a completely separate story from global auto demand, just like a sunset of US based TV manufacturers did not mean a sunset of consumer demand of TVs and other electronics. It simply means that the US auto industry is no longer competitive in the market place against foreign auto makers like Toyota (TM) and Honda (HMC). Businesses go bankrupt even during good economic times, if they can not compete. But I truly feel sad about the current status of the auto industry and other manufacturing infrastructure of this nation.

From a fundamental point of view, the global auto demand is expanding even as the world enters a period of severe economic recession. IEA recently revised the projection of global oil demand in 2008 and 2009. The lowered projection is 86.5M barrels per day for 2008, which is still 0.5% higher than 2007, and the projection for 2009 is 87.2M barrels a day, yet higher than 2008. Higher oil consumption must mean higher vehicle demand.

Let's do some simple calculation. One barrel of oil produces roughly 19.5 gallons of gasoline and 9.2 gallons of diesel, totalling about 28 gallons of road vehicle fuel. If global oil demand is 86M barrels a day, that's 880 billion gallons of fuel consumed per year. An average vehicle drives 150,000 miles during its lifespan and consumes fuel at a rate of roughly 20 MPG, so lifetime consumption of fuel is 7500 gallons. So 880 billion gallons per year means the world is wearing off vehicles at a rate of 117 million per year. That is the expectation of global new vehicle demand in the next few years, versus current 70M auto sales per year.

China just announced a 4 trillion yuan ($586B) stimulus plan to transition her economy to one based on domestic consumption demand rather than on exportation. Chinese demand on commodities, goods and services will be insatiable even as her growth slows down, because China's population is just huge and the per capital consumption is still at a very low level comparing with global average, leaving plenty of room for growth.

October auto sales in China increased 8.37% over last year. For the first ten months, auto sales were 5.67 million, which is 6.8M annually. There are only 40M passenger cars in China. These numbers are incredibly low considering China's 1.3 billion population. Global average ownership of cars is roughly one car per 6 persons. China has one car per 33 persons. China today consumes 8M barrels of oil a day, still less than half of global average. Using the rough numbers above that correlates to 11 million vehicles wear off per year in China. So China needs 11M new vehicles a year just for replacements, not to mention new ownerships. I will not be surprised if auto sales in China double or triple in the next 5 years.

The global commodity bull cycle will continue if you understand the impact of China's demand growth. Global consumption of many raw materials can easily exceed available supply by a large margin, even if China's per capital consumption only reach where global averages are!

No wonder we see ever increasing Chinese influence in Africa. Africa is blessed with some of the world's richest mineral resources, especially South Africa, owning over 90% of the world's PGM metal reserves and virtually every spieces of mineral resources, missing just a few. China is also blessed with mineral riches. China is rich in more than half of all known mineral spieces, especially in rare earth metals and tungsten, antimony, indium, etc. But China doesn't have much base metal reserves. China has zero reserve in PGM metals and very little in cobalt, metals of critical strategic importance. What China doesn't have, Africa has plenty. And what about USA? We are the world's capital of helium. We have plenty of coal. That's about it. America desperately needs to develope good relationships with Africa and South America, if we want to be prosperious in the 21st century.

Upon his inauguration, President Obama needs to first pay visit to China, second to Africa, and third to Russia. America, now the world's top debt nation, needs to be bailed out by the world's emerging economic power houses. We can not afford to be a superpower any more as we are not self sufficient and can not survive on our own any more. We need a peaceful and co-operative world to help us. President Obama must prevent an Iranian War or World War Three from breaking out, during his term(s). Prosperity comes from peace, not from aggression.

Now coming back to the US auto industry. Is there still hope in the Big Three, GM, Ford and Chrysler? I think the fundamental demand of autos from US consumers is still there. The current credit crunch means a consumer may not be able to get an auto loan. But it does NOT destroy the auto demand, merely postpones it. If I see a vehicle break down on the roadside, or a vehicle crashed on the highway, I am pretty sure that within less than 24 hours, a certain auto repair shop or a new car dealer will see a new customer come to their doors for business, regardless of how many credit cards the customer may have. The mobility needs can not be eliminated. The question is will the customer come to a Toyota (TM) dealer or a GM one.

There might still be some hope if GM can adapt itself to meet customer's demand, but I don't think it can do it alone. It needs a government bail out. I am against using tax payer money to bail out private enterprises. But it is in our vital national interest to bail out the US auto industry to preserve jobs and our manufacturing basis. The current GM shareholders must be wiped out. GM must go bankrupt, then the government must immediately come in to help the bankruptcy re-organization and give the auto maker a second life.

Full Disclosure: The Author is heavily invested in SWC and PAL, two palladium mining companies, as well as in OMG, a cobalt chemical company. The author does not have a position in GM or Ford, and does not intend to buy or short either.

Concentrated Short Getting Desperate!

I preciously discussed extremely narrow floats of SWC, and a possible TRAPPED big short player here. Latest data show that institutions loaded up even more long positions. And this trapped big short is becoming desperate in trying to unwind its short positions BEFORE the good earnings SWC will announce in a few days.

How desperate the concentrated short has become? SWC dropped 25% in just last four days, and that's on top of a 25% correction from recent high of $16.47, a correct which was triggered by an insignificant one cent quarterly loss in the first place. There is absolutely nothing that justifies such rapid and furious drop of a stock that has very bullish fundamentals. The only reason is this big short is hammering SWC by heavy shorting, hoping to trigger a panic sell from the long side, so that this big short can unwind its huge short position, which is as high as 6M shares.

But institutions are loading. Based on observation of the NASDAQ statistics. Total institution holdership see dramatic increase in recent days. They increase a net 1.4M long positions in just the past 16 days:
July 10,07: 36,354,783 shares
July 15,07: 37,144,283 shares
July 21,07: 37,429,043 shares
July 26,07: 37,736,888 shares

So who is buying and who is selling? The big institutions are massively buying cheap shares, and while some retail longs panic sold, more retail longs get an excellent entry point and they jumped in in recent days. So really the only big seller is the big concentrated short. Not only they could not unwind their positions, the accumulated even more short positions.

This short position MUST be unwind at some point. And it must be unwind before the big news of the earnings report. The big short must be pretty close to a panic, judging from how desperate they have become in hammering down SWC today.

Folks! Do your own DD. But I presented all the facts I know here. This is a rare opportunity to make some big money in a short period of time. Jump both feet on board tomorrow. But make sure you finish doing your own DD today!!!

As of this writting SWC closed the day at $9.29. I believe this is pretty much the bottom here. Big institutions, while they enjoy loading cheap shares here, would not allow it to drop too much and cause a panic within the long camp. Big boys have a short squeeze to do, remember! When big boys accumulate enough long positions, and the trapped short digged itself deep enough in a pile of short positions, big boys will launch the short squeeze. Besides many retail longs begin to jump in. Big boys do not want too many retail longs to spoil the fun, because retail traders tend to sell for profits too soon, diminish the effect of short squeeze.

So load it up before some one else does!

SWC Q2 Earning Estimated is 26.5 Cents Per Share!

Today both the SWC production numbers and metal prices for Q2 are known. One can crunch some numbers and get a pretty good estimate of SWC Q2 earnings.

Reduced mine production in Q2 versus Q1 hurts a bit, but the dramatic increase of metal recycling will absolutely move things up and lead to a very profitable quarter. Let's use the Q1 data as starting point and do the calculations.

In Q1, 305000 tons of mines were milled. Q2's metal production is 133.1K ounces versus Q1's 144K. So proportionally, 23100 less tons of mines were milled. At cash cost of $136 per ton, that is a cost reduction of $3.142M on the up side.

Palladium production in Q2 is 102.5K versus 111K ounces in Q1, a reduction of 8.5K oz, using Q1 production price $377/oz, revenue reduced by $3.2M on the down side. But each ounce of production is expected to be sold for $384 based on the hedge, a $7/ounce improvement. So that's an extra revenue of $0.72M on the up side. Combined, there is a down side of $2.48M.

Platinum production is 30.6K versus 33K in Q1, a reduction of 2.4K ounces, at Q1 price $915 per ounce, that's a revenue loss of $2.196M. However each ounce of platinum production is expected to sell for $950, a $35/ounce improvement, for a total of $1.071M. Combined, there is a $1.125M down side.

So far, reduction of production combined with improved metal price contributes a $0.463M on the down side.

Now the big good news is on recycling. In Q1, SWC recycled 27K platinum, 37K palladium and 6K rhodium, totalling 70K, for a total cost of $66.175M. This Q2, SWC recycled 46.3K platinum, 39.2K palladium and 7.6K rhodium, totalling 93.1K, proportionally, there is an extra cost of $21.84M on the down side.

Using the Q1 recycling metal price, $336 palladium, $1149 platinum and $5052 rhodium, the extra metals recycled mean an extra revenue of $0.7392M + $22.1757M + $8.0832M = $30.998M on the up side. Now you see recycling is BIG!

But the recycled metals are sold at improved market prices and not hedged. The market price for Q2 are $368 palladium, $1300 platinum and $6150 rhodium. So the extra revenue due to price improvements are: $1.2544M + $6.9913M + $8.3448M = $16.5905M.

So far everything tallied up, the net upside is $25.2855M. In Q1 SWC lost $1M. In Q2, the net change is $25.2855M up side improvement, so gross profit will be $24.2855M, or roughly $24M, at 91.585M shares, that is 26.5 cents per share gross profit. Since SWC enjoy loss carry over from previous years, no tax needs to be paid. So that gives us 26.5 cents per share net profit for Q2.

Of course this has NOT take into consideration that SWC might pay a bit higher per kilogram of recycling scrap metal, or that the metal may sell at slightly less than market price. But however you put it, I expect to see at least 20 cents per share net profit!

I think we are going to see SWC EXPLODE to the up side once the earnings is announced in early August, and it beats the street consensus of 3 cents by a huge margin!

SWC and PCU Compared: Both 20 Baggers!

The copper mining stock PCU closed on Mar 31,2003 at $14.60, which is dividend and split adjusted $5.14. Four years later PCU closed today at $109. That's a 20 bagger in 4 years.

I compare SWC of today with PCU of 4 years ago, and find there are lots of similarities.

On Mar. 31, 03, the market cap of PCU was $14.60 * 80M shares = $1.168B. Today, SWC has a market cap of $1.11B. Similar size.

In Q1, 2003 PCU sold 198.7M pounds of copper, sold at $0.76 per pound, total copper sales revenue was $151M. The stock price/sales ratio was 1.93. Less than 2.0. In Q1, 07, SWC sales revenue was $146M. The stock price/sales ratio is 1.90. Both stock has similar sales revenue, similarly low price/sales ratio of less than 2.0.

In Q1, 2003 PCU made a slim profit of $18M, which is a very small fraction of the sames revenue. So the profit margin of PCU was very thin, same is true for SWC, which hardly makes any money from its huge sales revenue.

But if the underline commodity is bullish, you could never judge the value by the low profit margin. Once the metal price goes up, the profit margin immediately goes up. Copper went from $0.76 to recent $3.60 a pound, slightly more than quadrupled. So when the commodity quadrupled, the PCU stock price gained 20 folds.

SWC today stands where PCU stood 4 years ago. SWC could well be the next PCU and gain 20 folds in the next four years. All it takes is for palladium price to quadruple, just like copper price quadruple. I think I have made a very solid case why palladium price outlook is super bullish. see my previous blog entries, and here, and here. Pallalunar

Note: David posted a good question, as copper went from $0.76 to $3.60, palladium also went from $142 to near $400. Why PCU boomed and SWC did not? Simple answer is before copper reach $0.76, copper mining was not profitable so PCU was flat before 2003, once copper reached that profitable threshold of $0.76 it really start to take off! For SWC, the profitability threshold is not at palladium $142, but at palladium price being $339. Last quarter SWC had a slight loss of one cent per share. So SWC should start to take off here because this is the threshold where SWC starts to make money. In the past when palladium was much lower, SWC was protected by palladium hedge sales contracts which guaranteed a floor price of $339-ish for more than 80% of the production. Those hedge put a palladium ceiling price at $1000 and limits 20% of the SWC production. We are far from hitting that ceiling yet and even when we do only 20% of the production will be hurt. See Q1,2006 quarterly report, page 12 and 13 for details of those hedges.

Golden Proportion Rules. SWC Bottom Soon!

I am going to discuss some technical analysis of SWC chart, although I am not a big technical guy.



First graph. Let me circle out all four bottoms, the one in 2003, the one in 2005, and the one in 2006, and the current one. We see that all four point line on a perfect straight line!!!

More over, if you see the distance between the four bottom points, it looks like a Divine Golden Proportion. Could it really be Golden Proportion rule? I looked up the historic data on SWC. Sure enough it was a Golden Proportion Rule!

First bottom was on Mar. 20, 2003, the little peak between the double bottom. It traded as high as $3.18, Let's count it as $3.15.

Second bottom was on May 16, 2005. Price went as low as $6.05. From First to second bottom is 788 days. Golden Proportion says times 0.618034, which gives 487 days.

Third bottom was on Sep 15, 2006, the little peak between the double bottom. Stock closed at $8.39 that day. That was 489 days after the first bottom.

It looks like we are pretty close to the fourth bottom, but can not say the bottom has already occured. Based on Golden Rule, we take 487 days and further multiply by 0.618034, the result is 301 days. 301 days after Sep. 15, 2006 is July 13, 2007, which is next Friday!

A more amazing feature is the third bottom close price at $8.39, when divided by first bottom price of $3.15, the result is very close to the base of natural logarithm, 2.718. Actually if you use $8.56 to divide, the result is exactly 2.718!!!

Extrapolate the result, the fourth bottom price would be at $10.84. The ratio is $10.84/$3.15 = exp(0.618034)^2. Another Golden Proportion Rule!!!



Thus I predict a bottom on July 13th at $10.84, based on the Devine Golden Proportion Rule.

A nice set of palladium coins I recently received. You know what they are? There are no more than 100 whole sets like this the whole world around!

The Extreme Narrow Float of SWC

I have emphasised that SWC float shares available to retail investors are extremely narrow, and outstanding short shares too high, and cited it as one of the bullish reasons for SWC. Let's do a very careful analysis of the numbers.

According to SWC Q1,07 quarterly report, bottom of page 7, Total outstanding shares are 91,514,668 as of Mar.31, 2007. (Email from SWC says on May 1st, 91,686,297 shares)

Most of the SWC shares are owned by Norilsk after the Norilsk palladium transcation in 2003. How many shares? From SWC 2003 Annual Report page 5 we know Norilsk initially acquired 45.5M newly issued shares, paid with $100M cash and 877,169 ounces of palladium. Then Norilsk made a tender offer and acquired from open market an additional 4.35M shares at average cost of $7.50 per share. So Norilsk should own a total of 49.85M shares of SWC. (Email from SWC says 49,813,222 shares)

Other insiders are the managements: My tally is the management personels own a total of 1,180,337 shares as the latest known at the time of writting. Once subtracted Norilsk and insider owned share, the remaining float of SWC is 40,484,331 shares. That's the float available to institution and retail investors. (Accurate number is 40,692,738. Bloomberg says 40.204M)

The latest known institution ownership is 37,348,005 shares. (July 10,07: now 36,354,783) (July 15: 37,144,283)(July 21: 37,429,043)(July 26: Now 37,736,888).

So, after subtracting institution ownership, the float left owned by retail investors is 3,136,326 shares. Barely over 3 million shares. (2.775M if you use Bloomberg float and NASDAQ institution holdership number.)

The outstanding short shares, as of June 15,07, is 5,284,169 shares (July 13: now 6.0125M). That's even much higher than retail long positions. That mean even if ALL retail investors sell their long positions, there are not enough shares available to allow shorts to buy and cover.

A fierce short squeeze will happen, it is only a matter of time. During the short squeeze some retail longs might be eager to sell to lock in profit, but it will be far from enough to allow shorts to cover. This looks very bullish for SWC.

SWC is next Apple, 20 Folds in 4 years!

I now put more than half of my portfolio in SWC, stillwater mining company. Incredible bullish fundamentals here, but few people know, because few people have any idea what is Palladium and Platinum, the main products of SWC. They do not know why palladium is bullish. At first look people are scared away by the seeming high P/E ratio of SWC, currently stands at 165. That makes SWC extremely cheap to buy here. Let me explain below.

SWC is the ONLY United States mining company that produces the precious metal palladium and platinum. The only other places that produce these two metal in significant amount are Norilsk in Russia, South Africa, and PAL in Canada.

If you bought stocks of Apple Computer, AAPL, on April 17, 2003, four years later now, you would have made 19 folds profit from your original investment. But SWC will be the next AAPL, meaning the stock price will increase 20 fold from current $12 a share, to $240 a share, in the next four (4) years.

How come? The current price/sales ratio of SWC, i.e., the ratio of stock price, divided by annual sales revenue per share, is very low. It currently stands at 1.71. A low price/sales of 1.71 and a high price/earning of 165.0, means only a tiny fraction of the sales revenue goes into the earnings. You divide the two ratios and get earnings/sales = 1.04%. So only one percent of the sales revenue goes into the earnings.

The beauty of bullish commodities like precious metal is that as metal price increases, the company does NOT need to increase production. It simply produces the same amount of metal, at the same cost, but any increase of sales revenue due to metal price increase directly goes into gross profit.

The current earnings/sales = 1% that means the price is barely high enough to pay for the cost. If the price just doubles, then sales revenue will double, but the cost remains the same. That means earnings/sales will improve to 50%. That is a huge improvement, 50 fold improvement, from 1%. Not only earnings/sales improves 50 fold, but the denominator itself, sales revenue, doubles. So it would actually be a 100 folds increase of earnings.

Think about it, it merely takes the metal price to double, to improve SWC's current P/E ratio by 100 fold, from 165.0 down to 1.65!!!

If the metal price further doubles, then sales revenue has quadrupled, with earnings/sales now stands at 75%. So that would be an improvement of 75% * 4 / 1% = 300 folds, of the net earnings. That means the P/E ratio will be pushed down to 165.0 / 300 = 0.55. Extremely low.

Of course the stock price of SWC would have to increase dramatically to bring P/E ratio to a number that makes more sense. How about the stock price increase 20 folds. That will then bring P/E to 0.55 * 20 = 11.00. That is a P/E number that looks more reasonable. But really that is still way too conservative. A stock that grows so rapidly really deserves a P/E several times higher than 10-ish. So SWC might actually increase more than 20 folds in 4 years!!!

Of course, that assumes that palladium price really does go up quadruple in 4 years, from current $375 an ounce to $1500 per ounce. Whether SWC can go up 20 folds in 4 years depends on this, and this alone, that palladium price MUST quadruple in 4 years. If palladium price does not move, then SWC is not going any where.

For palladium price to quadruple in 4 years, the price of the metal will have to increase 40% annually, or increase by 9% per quarter. Will this be possible? Palladium price has already doubled in the past two years! It only needs to keep this pace for four more years.

I will discuss why palladium price will keep increasing at rapid pace in the next article. But in short, it is a supply/demand thing. The supply is limited. The whole world produces no more than 7 million troy ounces of palladium per year. One troy ounce is 31.1 grams. What about the demand side?

1. The auto industry, which is the largest consumer of palladium, is increasingly switching away from platinum, which is now almost four times as expensive as palladium, and back to use palladium in their auto catalyst application.

2. The demand in the jewelry industry. Palladium jewelries are rapidly becoming ever more popular, especially in China. And it is picking up in the United States recently. I suspect that China is only a rehearsal and the real fun would be in the US and Europe market. The physics property makes palladium a suitable metal for jewelries. The lighter weight and affordability makes palladium the only plausible choice in many jewelry applications.

3. The dental application. Traditional dental filing material is a silver-mercury alloy based material. Mercury is extremely toxic. Modern technology found that a palladium based solution is much better and none-toxic. Japan has mandated that all dental fillings MUST be done using palladium. Other countries may follow suit and pass similar laws. Any one in the know will reject mercury and prefer palladium in dental care. There is not enough palladium even if a good fraction of the world's population demand palladium for their dental cares.

4. Investment demand. Palladium is one of the four precious metals. As US dollar and all the world's paper fiat currency loses their value over time rapidly. There are growing interest of investing in precious metals. Palladium market is extremely narrow. Even the smallest investment demand will cause significant market price rally, which in term will attract more interest demand. Recently Novartis Pension Fund in Switzerland announce that they will invest 1% of their portfolio in buying physical palladium. That would buy about 4.5% of the world's whole year output of palladium. This one fund purchase may be just the tip of iceberg. Investment demand like this will corner the market and cause palladium price to go sky high!!! Remember the Hunt Brothers and Silver Thursday?

I believe right now SWC is the best buy after its stock price has corrected and bottomed due to a recent insignificant earnings miss, after an incredible rally in the previous two months. The fall from $16.50+ to $11.20 is way oversold, on such a bullish stock.

This chart of palladium future clearly shows dramatically growing investment interest in palladium starting from the second half of 2003.

Read this web site to understand the important applications of palladium.
http://www.palladiumcoins.com/uses.html

USGS data on PGM metals.