The True Rationale of Commodities Supply and Demand

The price of rhodium staged an impressive rally in recent weeks. At the bottom of recent commodities sell off at the end of October, 08, rhodium dropped to $750 per ounce, from the high of $10,000 just a few months ago. Since the October bottom, rhodium price has raised to $1650 per ounce, a surge of up 120%, while gold is up only 25%, silver up 36%, platinum is up 58% and palladium is up 38%. Clearly rhodium has been the best performing precious metal.

But if you ask the metals analysts, they will tell a bearish story. Rhodium has no investment demand, as the metal is extremely hard to buy and sell, and there is no futures trading on rhodium. Rhodium's demand is purely industrial, with auto sector accounts for over 90% of the total. The auto sales are weak, so the rhodium demand should be weak and the price must drop.

Analysts get one thing wrong. For an easily hoarded metal like rhodium, the true industry demand does NOT equal to the immediate consumption need. The true demand is how much industry users are willing to buy, at current price, NOT how much their current needs are. Analysts have confused purchase demand, the force that drives price, with consumption demand, which doesn't affect price.

Like wise, the true supply of the metal is NOT how much the mining companies have produced, but rather, how much they are willing to sell, at current price. I suspect some South African PGM mines may hold back some of their rhodium to wait for a better price in the future.

As the metal is dirt cheap now, industry users will want to buy more, much more than they would need for the next 3 months, 6 months or even 10 years. The cost is minimal to store rhodium for long term. It makes perfect economic sense to buy extra at $1600/oz, so you can buy less when the price runs up to $10,000 again. It's common sense people should buy more when things are cheap, and buy less when they are expensive.

Such rationales, as well as the fact that PGM prices rallied strongly off their recent lows, are proofs that the bearish calls on the PGM metals, such as bearish calls made by the Fortis Group, do not reflect the reality and are completely unfounded. Investors would do better looking at the complete picture and do not let the analysts do the thinking for you.

The same rationale can be applied to other easily hoarded commodities, like industrial base metals: copper, zinc, nickel, cobalt, aluminum. That might be the reason why most commodities bottomed at roughly the same time, and then all rallied up since. People in the industry understand they can not expect prices to stay low forever. If prices are lower than marginal production cost, producers will have to cut back and prices must go up to reflect the real cost. So it is prudent for industry users to buy more, hoard more for their future needs, if they can, while the prices are low.

One exception is coal, as coal is cheap and bulky. It is costly to store large quantity of coal if it is not used soon. That's why coal price hasn't recovered yet like other commodities do. I would caution about buying coal stocks now, like BTU, ACI, CNX, MEE and JRCC.

The Chinese government understands the economic principles of commodities pricing. There are reports that China has been aggressively spending out its US dollar reserves to buy and stockpile all sorts of industrial materials. Some speculate that China's purchases could be the reason behind recent surge of copper price. Copper is unique as its price never significantly fall below production cost, and few producers actually cut copper production as they are still making profits. For example, Southern Copper Corp. (PCU) could still break even in Q4, 08. Read "copper standard" on recent China speculations in copper.

If China and other countries are stockpiling industry raw materials, then it's a good bet that dry bulk shipping stocks will continue to be bullish, as you need ships to transport bulk materials around the world. All shipping stocks are still dirt cheap to buy, like EXM, EGLE, DRYS, TBSI, GNK, NM, DSX, OCNF, SBLK. My favorite shippers are EXM, EGLE, TBSI, due to their high ratio of shipping capacity versus current market capital, and DRYS due to its asset of ultra deep water drilling rigs. Watch Transocean (RIG) to get an idea on deep water oil drilling.

The biggest metal story is about my favorite metal palladium. On sunday April 19, CBS 60 Minutes carried a special TV program about the science that will shape our energy future: Cold Fusion! You can watch it or read it. Read my previous comment on the breaking news.

The 60 Minutes program, titled "Cold Fusion is Hot Again", is a powerful endorsement on the science of LENR, Low Energy Nuclear Reactions, previously known as Cold Fusion, an important physics discovery previously discredited, but picked up research interests again as new evidences have convinced many former cold fusion skeptics.

It's an impressive CBS report to watch or read. CBS contacted American Physical Society, who sent Dr. Robert Duncan to help to make a determination. Dr. Duncan was a cold fusion skeptic. They flew him to the Israel lab to spend several days there. Let him scrutinize every detail and ask tough questions. At the end, Dr. Duncan was totally impressed and convinced by the compelling cold fusion experimental evidences. The fact that CBS brought alone a skeptical physicist to visit the cold fusion researchers and convinced him that the experiments were legitimate is pretty impressive. On the other side, Dr. Richard Garwin's claim in the TV program that the researchers measured the input energy wrong for 20 years (?!), was decidedly unimpressive. Watch the program and judge by yourself.

Cold fusion relies on the precious metal palladium. Successful commercialization of cold fusion will mean humanity will have a cheap and virtually inexhaustible new energy source, and hence we can put the threat of Peak Oil Crisis behind us. If you are concerned about our energy future, if you care about our children's future, you need to contact politicians and urge them for support of cold fusion research. This science was suppressed for 20 years. We can not allow it to be suppressed any more, for our children, as Peak Oil has already become the reality.

Cold fusion will take some time to be developed into a commercial reality. But when it does, palladium price could go up to unimaginably high level. Such a great investment is worth buying and holding patiently for long term. So now is time to buy any physical palladium you can lay your hands on. It is also a good time to buy stocks of Stillwater Mining (SWC) and North American Palladium (PAL). They are the only PGM producers in North America. As I explained, when things are priced ridiculously low, it is a good time to buy.

Full disclosure: The author is heavily invested in palladium mining stocks SWC and PAL and own AAUK. I also hold large stakes in shipping stocks EXM, EGLE, DRYS, TBSI, GNK, and ETF shares of USO, UNG and SLV.

Safe Haven Investments: Imminent Danger and Opportunities!

When people see danger in the market, their animal instinct response is to liquidate everything and go fully in cash to ride out the storms. The conventional wisdom is "Cash is King". But conventional wisdom doesn't work anymore, as this is unconventional time. If you are fully loaded in cash or US Treasury Bonds, this news first noted by Karl Denninger should completely shock you out of your shell:

$2.29 Trillion Dollars US Treasury Bonds Failed To Deliver!

Note it is $2.29 TRILLION, with a T for Trillion! I never heard one can short US Treasury Bonds, let alone naked shorting US T-Bonds! The T-Bonds are considered some of the safest investments, with the full faith and credit of the US government guaranteeing the principal, and you get an interest payment. So shorting US T-Bonds is virtually guaranteed to lose money. You will have to payback the principal plus the interest. You do NOT short the US T-Bonds, let alone naked shorting, let alone as much as $2.29 Trillion.

That is UNLESS you are a really BIG player and you clearly see imminent danger of the collapse of the US T-Bonds, and of the US dollar itself. I wrote before that Warren Buffet saw extreme danger in the US Treasury Bonds and he was completely out of the bonds and fully into the equities market now. Of course people should respect and follow this guy's wisdom. But small potatoes like Warren Buffet could not have naked shorted $2.3 Trillion US T-Bonds. Some one much bigger and knows better did it. I will not speculate. Please read Karl Benninger's comment.

Money created out of thin air is NOT King! The Kings now are precious metals. Never mind the fact that the dollar staged a shocking rally and precious metals plummeted. The dollar rally is nothing but a bubble, while current precious metal prices, especially platinum and palladium, is nothing but absurdity. Physical commodities MUST be priced above their production cost, or the supply will simply dry out, as no one can continue produce metals at a loss. So if I am sitting on my precious metals, I pretty much have the guarantee that they will soon appreciate in real purchase power term. On the other hand, if you are sitting on trillion of dollars of the fiat currency, and the currency falls, the only guarantee you will have is they will continue to fall further down, until eventually they reach zero.

The general market always manages to fool most people most of time, and causes more people to lose more money in unexpected way, and rewards only the selected few who has the wisdom and who has the determination to stick to their wisdom. The current global crisis necessarily means an astronomical amount of fortune must be totally wiped out. What could be a better, cleaner and quicker way of wiping out trillions of dollars of fortune instantly, than to first herd the sheeples into holding nothing but cash, and then the currency suddenly collapses? Of course the US dollar rallies big time if every one is herded into buying dollars. A bubble is something pumped up to a valuation much higher than where it should be.

Fiat money is completely at odd with the economy basics of supply and demand. For anything physical, equilibrium can be reached as the price impact positively on supply and negatively on demand. Higher price encourages more production while low price suppresses the supply. When the price falls below cost, supply dries up as no one can continue to produce and sell something at loss. On the demand side, the price has exactly the opposite effect. High price suppresses demand while low price encourages consumption.

Fiat money acts in exactly the opposite way. The less valuable a currency becomes, the more is being produced out of thin air. The cheaper the currency becomes, the less people desire to own and keep them, and the faster people want to get rid of them. When people want to get rid of their paper money as fast as possible, it speed up the velocity of money, and cause the value of the currency to plummet even more, forcing the government to print more money. The vicious cycle continues until the currency is totally destroyed. Throughout civilized history of mankind, every single experiment of fiat currency has failed. No exceptions.

In Chinese the word CRISIS contains two characters, DANGER and OPPORTUNITY. We are in extreme danger but also with extremely good investment opportunities. The opportunities are made even better because every one runs away from them and run towards a gigantic death trap with a sign "Cash Is King". Remember one thing, safe havens must be small, with narrow spaces that accomodate only a few refugees.

It reminds me of the Bible story of Noah's Ark. People ridiculed Noah as he was building his ark, thought it had never rained a single drop for a year, how could the flood come? The flood did come as Noah expected. Had these people listened to Noah and seek refuge in his Ark, would it make a difference? No! The Noah's Ark was still only big enough to contain just one pair of each kind of animals. It wouldn't be a Noah's Ark if it was made any bigger. Likewise, today's financial safe haven wouldn't be a safe haven, but a death trap if it was big enough to allow every one in!

Although we do not see a drop of rain yet, trillion dollars of wealth will soon be flushed away by the coming financial flood of hyperinflation. Have you built your Noah's Ark yet? There is definitely NOT enough material to build a big enough Noah's Ark to save every one.

I can't understand it! There are tons of investment opportunities in commodities right now. You can buy a few metric tons of nickel or copper or cobalt or a number of other things. You know they are priced far below their production cost right now. So it is absolutely a guarantee they must appreciate to at least the fair price of their cost. Can you find any better investment, with such absolute certainty of making double, triple and quadruple the money in the next few months, regardless of the demand? How could people be so blind and not seeing the opportunities? They all rush to cash and T-Bonds waiting to be slaughtered, and they actually thought it was safe to be with the biggest group of mobs?

Nickel is now less than 1/6 its price of May, 2007? Hello?!

ENOUGH IS ENOUGH! When enough is enough, the eruption is fierce!

On Monday, third largest nickel producer in Russia, Ufaleynickel, responsible for slightly less than 1% of global supply, announced that they are shutting down production, as the nickel price is simply too low. They need to see at least $26,000 per metric ton to break even.

Instantly nickel shot up to touch $5.00 a pound, from Friday's $4.00. That's a one day rally of 25%. It's probably the biggest one day rally of any commodity in history. Removing 1% of global supply doesn't really change supply/demand that much. But the price was suppressed too much so the bounce had to be fierce. Had you bought nickel at $4, you have made 25% profit in just a day. And yet people rush away to buy US T-Bonds to earn 3% annual interest while waiting to be slaughtered in the looming implosion of the bonds market?

Want to make a 10 fold return in two months, and maybe two weeks? Go buy some palladium metal. Any palladium metal you can find. Palladium price can go from $170 per ounce to $1700 per ounce in no time, once the Russian Checkmate plays out.

The Russian Checkmate event will be Norilsk Nickel (NILSY.PK) shut down production. They are the No. 1 nickel producer in Russia. No. 3 has shut down already. Would No. 1 be far away? Norilsk shut down, and 45% of global palladium supply is gone. I can't even start to predict where palladium price could go up to, with 45% of supply removed instantly. In 2000/2001, one false rumor from Russia was enough to send palladium up to $1100. It would be fun to watch the effect of 45% of palladium supply removed.

Of course, you can get better leveraged gain investing in the palladium stock Stillwater Mining (SWC) and North American Palladium (PAL).

Will Norilsk shut down? They are facing a severe liquidity squeeze. In first half of 2008, Norilsk group reported a profit of $2.682B, at 32% profit margin. If you look up metal prices as of Oct. 24, 08, and re-run the numbers, they would have to write down -$4.594B of sales revenue for the whole group, or $3.634B for the main Norilsk Mine, resulting in heavy losses. The cash drain will be nearly $2B per half year.

Norilsk group had $4.8B cash as of end of June, 08. The main Norilsk mine probably had $4B in cash. They spent $2B in a recent stock buyback, a senseless decision which Mr. Mikhail Prokhorov denounced as "capable of putting the company on the verge of bankruptcy". Operation loss since June probably costs them another $1B. They have a debt payment of $400M due in November. Do they have any cash left? Can they continue to operate the mine at heavy loss? Why would they continue to operate with heavy loss until bankruptcy?

The bullish case for palladium can not be disputed if you understand how bad a shape Norilsk Nickel is in today.

Yesterday's news of Ufaleynickel shut down mentioned OM Group (OMG) and reminded me that OMG is the best cobalt play, because it dominates the chemical sector involving cobalt. I consider cobalt as a better metal to buy than silver, with the potential of 10 fold appreciation in a short period of time. Check out news on Minor Metals. If the speculation of Katanga Mining shut down plays out, cobalt price should fly soon. You can buy cobalt from BHP Billiton (BHP).

There are so many beaten down silver and gold mining shares now. All are very good buys: PAAS, SSRI, SIL, HL, NEM, AUY, NAK, IVN, NG. There are so many to name. Even Southern Copper (PCU), my very first commodity play, is now back below where I first bought in late 2005. Anything in mining is good nowadays. I would not touch Silver Wheaton (SLW)though, because of counter party risks. Also forget about any coal player now. I continue to call for selling JRCC, ACI, ANR, BTU, CNX, at any rally. The US coal market is a local market and is now bearish. Again watch Dry Ships (DRYS) share movement as it is an important indicator of the health of the global economy. I might even consider buying some DRYS as the valuation has become so attractive. But I first need to get a conformation that cross ocean shipping activity is recovering.

I will keep a portion of my portfolio in iShares Silver Trust (SLV). I will not buy gold or SPDR Gold Shares (GLD). I believe gold is adequately priced at current level. The money spent on gold is better spent on something else. Even buying a ton of nickel or copper is better than gold.

But the best of all is still palladium, and the only two pure palladium plays, SWC and PAL. We are witnessing a singularity event unfolding in the palladium market as Norilsk Nickel will inevitably shut down, to protect its own best interest. What is singularity? A singularity is the kind of extremes like what you get when you try to divide a number by zero!

Full Disclosures: The author is heavily invested in SWC, PAL, has considerable stake in OMG and SLV, and will continue to buy some select silver shares including SSRI, HL, PAAS and SIL. I am also looking for opportunity to buy DRYS soon.

The Best Investment Opportunities Are Hard to Hold On!

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Investing In a Resource Constrained World Part Three

Wow! What a turbulent marketplace lately! I took some hits lately in my holdings of PAL and SWC, my favorite precious metal palladium mining stocks. But nothing compares with the shocking collapse of BSC, which falls from $60+ to only $2 a share bought by JPM, in just two days. I have sympathy in people who lost big money in BSC. Maybe LEH is next victim? Maybe WM? CitiBank? Maybe even the invincible MER and GS could also fall. There is so much panic and chaos in the financial market.

Recently, Gene Epstein published a cover story on Barrons declaring a commodity bubble is bursting. Has commodity topped? Do we see a commodity bubble bursting? I must point out that Mr. Epstein is completely wrong! I am NOT disputing any of the numbers or facts he cited, but he completely mis-interpreted the facts, and even reversed some causual relationships.

Prices of commodity is determined by the supply/demand balance. If supply exceeds demand, price goes down, but if demand exceeds supply, price goes up. When there is a shortage, the price will keep moving up until eventually the supply/demand reaches equilibrium again, often times due to higher price stimulates increased supply and supresses demand. But there could also be cases where higher price actually stimulate demand and supresses supply!!! I will talk about that later. Depending on how price elastic or inelastic the supply and demand is, equilibrium price could be achieved quickly, or the price could be pushed to an extremely high levels, like rhodium. Price appreciation alone does NOT tell you whether something is over-priced or under-priced, supply and demand data does. Please repeat the previous sentence one more time.

Unfortunately, in his long article, Mr. Epstein meantioned not a single word, and cited not a single number regarding the supply/demand relationship. What audacity allowed him to claim there is a bubble, when he can't even tell us how many barrels of oil the world produces a day and how many barrels it needs! All he ever did was showing us some price data. Now repeat my previous highlighted sentence one more time.

Mr. Epstein talked about speculative hot money chasing a relatively narrow commodity market, and he believed that's the reason we currently have a commodity bubble and it is bursting. He got the causual relationship completely reversed! The commodity bull market is NOT caused by investments by speculators. It's the opposite, the commodity bull is the reason that attracts investors to put their money in it. Anything that is bullish or hot of course naturally attracts investor money and speculators. If that alone makes it a bubble, then a lot of things are bubble: You buy bonds and the bond market must be a bubble, you deposit your money in a bank and it must be a bubble. You go to Wal-Mart shopping and Wal-Mart must be a bubble, too. Actually Wal-Mart must be the largest economical bubble to be popped imminently, judged by how every one visits Wal-Mart daily and spend their money there. How ridiculous!

Can there be a commodity bubble? Of course. Can speculative investments cause a commodity bubble? Of course. A bubble is formed when the price is high enough to correct the natural demand/supply imbalance, but artificial demand by speculative bidders keep pushing price much higher from the level supply/demand already balanced. We are far from even reach the supply/demand equilibrium yet for any of the commodities, let alone form a bubble yet.

But Mr. Epstein did get one thing right, that is, even though only a very small number of funds are chasing the commodity market, the amount of money involved is already a huge amount comparing with the size of the commodity market. That is absolutely right. But it is NOT the reason we have a commodity bubble here. Instead it is the reason for the extreme volatility we see in the market place. We see silver price jumps up and down 2 dollars a day, an un-precedent volatility. That's exactly because too much speculative money is chasing too narrow a physical silver market. Try to squeeze 100 people into a 25 square feet room. They MUST fight fiercely. When a huge amount of money is concentrated in a narrow market, exceptional volatility must be the result, but it doesn't change the fundamentals, volatility will wash out some of the speculators, which is one way the system achieves some sort of balance.

So what does the supply and demand fundamentals say about current commodity market? Two things decide that commodity shortage will be a long term phenomena. First, governments of the world are printing exponentially increasing amount of fiat currency to flood the market. Fiat money is one thing that is definitely NOT in short supply. Their purchasing power are dropping rapidly nowaday. When purchasing power of fiat money drops, instead of supressing demand on commodities, it actually stimulates stronger demand. For money discussions I urge you to visit Gold Is Money and JSMINESET.

Here is an example. I learned last week the price of rice is going up rapidly in international market. Does the higher price make me pause to think about how I should eat less rice? No! I rushed to the nearest COSTCO and picked up TEN bags of the 50 pounds rice, at a price which is still cheap, I used up all the cash in my wallet, or I would have bought more. I am concerned that when the news of rice shortage spreads, there will be panic buying and the shelves will be empty in no time. I do not intend to cause a panic, and I am not speculating on rice to make profit. I am just hoarding some for my own consumption. But here is a good example raising price actually stimulates my purchase demand. Not only higher price stimulates demand, it also supresses supply. Vietnam, India, Cambodia all decided to cut back or totally shut down their rice export, reducing supply to the international market. Is this a bubble? No, there is a real global shortage.

China has too much of US dollars in its foreign exchange reserve, but not enough of anything else. It doesn't have a significant strategic oil reserve. It doesn't have any strategic base and precious metal reserve of any significant size. If the import oil is interrupted, China could be crippled in less than 15 days. If there is a major conflict in the future, China could not last more than a few months if its outside source of metals, and other critical commodities were cut off. China desperately needs to spend out its huge reserve of dollars before it becomes worthless, and stock up some strategic reserves of any thing and every thing that it could buy. And who is to say Japan, Korea, India, Brazil is not on the same boat? Facing an uncertainty future of a crisis looming world, every nation on earth desperately needs to hoard up something and everything to secure its own future. And individual persons are doing the same hoarding and preparation, too. This factor alone will mean we will have a very very long commodity bull cycle.

The second thing that decides that we will have a long commodity bull cycle is the fact we live in a resource constrained world. The earth has a limited size, with limited natural resource on its accessible surface. Have you heard about Peak Oil? King Bubbert's Curve? It's a flawless mathematical derivative that says when a limited, non-renewable natural resource is being produced, the annual production rate reaches a peak when about half of the resource is depleted, production enters a permanent declining phase once we go past the half depletion peak, regardless any technology progress or improved efforts to produce more.

I believe the current commodity boom cycle is different from all previous ones. Previous commodity bull cycles are just a part of economic natural cycles of boom and burst. But for the first time in history, the current commodity boom cycle is closely related to the peaking and depletion of many critical natural resources we have become addicted to. That includes oil, natural gas, coal, precious metals and base metals. We have only 9 years worth of proven reserve of natural gas, the global oil production has just peaked, global silver production has long peaked and only have 13 years worth of production left. Copper has probably peaked already and there is 27 years left. (Check out these natural resource stocks: NGAS, CHK, SWN, JRCC, PCU, FCX, TGB, PAAS, CDE, SSRI, MGN, just to name a few)

Once a none-renewable natural resource has peaked, the annual production enters a permanent ever declining phase, despite of best effort of technology to boost production. So supply will be limited and will be ever declining. Higher price will have virtually no effect in boosting supply. Therefore there is only one way left to bring equilibrium back: supression of demand, otherwise known as demand destruction.

Has commodity cycle peaked? The answer is in whether the supply/demand has be brought back into equilibrium? The answer to the later question is has demand destruction occured? I do not see demand destruction occured in any thing yet at all.

Demand destruction in food items would be massive occurance of famine and mal-nutrition globally; Demand destruction in oil would be that people give up their SUVs and ride a bike 20 miles to go to work every day; Demand destruction in copper, zinc and steel would be we see the Fed issuing plastic pennies, and auto makers promote plastic light body vehicles; Demand destruction in platinum and palladium would be that people get married with a plain silver engagement rings, with no diamond; Demand destruction in tellurium would be FSLR shut business down. I do not see any of the demand destruction happen yet. People complain about higher prices but they just pay more to get the same thing.

On engagement rings, I believe true love does NOT take a compromise. Read this story:

For some people, however, no compromise is acceptable. Take Noah Cuttler, 29, of the District. He met his true love, ... about a year and a half ago ... and Cuttler decided two months ago he was ready to pop the question. ...

He knew platinum was the metal of choice, ... Finally, he pulled out his credit card and charged $1,000 for a platinum band from his dealer and several thousand dollars more for a 1.3-carat diamond. He plans to propose after she reads this article.

". . . it's supposed to be for a lifetime," he said.

Mr. Cuttler must have proposed to his love by now and I wish the best outcome for this couple. He is surely not the only one who falls in love. Across the ocean, millions of young Chinese couples have planned to get married in China's Wedding Year 2008, a year with special significance to the Chinese, not only because the number 2008 starts with a 2, meaning "The couple" or "both of us" and ends with a lucky number 8, signifying "fortune", and the year 2008 is the Gold Ox year in Chinese zodiac, but also because it's the year of Olympics in China, which is scheduled to start on 8/8/2008, triple fortune, I guess. Estimates in China are that 2 or 3 times more people will get married in 2008 than an average year. My estimate is there will be 35 million or more weddings held, about 5% of the population or more.

Getting married is a commitment of lifetime and the Chinese do NOT take any compromise. A platinum diamond ring is a must have in a wedding preparation nowadays, among other things. People with less affordability may settle for a palladium diamond ring, but will not compromise for anything less. A typical Chinese couple would pour resources from parents and friends, on top of their lifetime savings, just to make a lavish wedding happen, because they are judged by people on how lavish a wedding they could afford to carry out. A compromise on a platinum or palladium diamond ring is just unthinkable due to the social peer pressure.

If only half of the 35 million newly wed Chinese couples buy a platinum or paladium diamond wedding band, each containing half ounce of the metals, that would be a demand of 9 million ounces just in the Chinese jewelry sector. The whole world produces only 7 million ounces of each of the two PGM metals a year from mines. The prices of PGM metals have got to shot through the roof.

Thus I encourage people to take advantage of recent price dip, and buy stocks of the only two primary palladium mining companies in the world, PAL and SWC. I have explained the two earth shattering events in the PGM metals market. The fundamentals have not changed a bit at all. South Africa is now on mandatory electric power rolling blackouts and it is entering the winter season, which makes matter worse. The Russia stockpile sale still has not shown up in the Custom of Switzerland. The recent downfall of the PGM metals, which coincidented with the knock down of gold and silver, is nothing but inherit volatility when too many speculators jumped on board. Once the excessive is shaken out, which I think is about finished by now, the PGM metals should continue the rally up in no time.

P.S. The author owns stocks of PAL and SWC, and hoards physical tellurium, gold and silver.

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.