The Brightest Stars in the Commodity Boom Part One

Thursday sees the market's knee jerk reaction of oil dropping of $4 a barrel, in response to China's announcement of gasoline and diesel price boost of 16%. Most traders perceived higher price will supress Chinese demand on oil. They know nothing about what's going on in China. After the price boost, gasoline still costs only US$3 a gallon, far cheaper than prices in the US and Europe. It will not supress demand at all, consider that only wealthest 3% of households in China own a vehicle. The Chinese transportation fuel market is in severe short supply. Refineries are unwilling to increase production because the crude prices are high, while the refinery product must be sold at government controled low prices, well below cost. The government hopes the price boost will encourage refineries to INCREASE fuel supply to ease the shortage. It actually will boost oil demand. Consider buying USO for a quick rebounce once the market realize they got it totally wrong!

Commodity guru Jim Rogers is my hero not only because he correctly predicted the commodity boom as early as 1999, but because the way he does market research and due diligence study is very inspiring to me. His millenium adventure around the world, which I recommend every one to read in his bestseller books, was not a safari, but a real adventure with real danger to his life. I do not think I can be as brave. I wish I knew him and read his books earlier. Commodity investments provided some of the most spectacular returns in recent years. You look at the spectacular chart below. Don't you wish you have bought some rhodium in early 2004? Me? I wish I had studied about CD-RW and bought tellurium in earth 2004 for $10. I want to talk about rhodium in more details in a later article since this is a very interesting case study on how to find commodity super stars, before they shine.


Jim said the commodity boom is far from over, which I agree. Although the current commodity bull cycle started in 2000, many of the raw materials did not start the earnest rally until pretty recently. Copper did not take off until late 2003/2004. Food grains and fertilizers did not take off until early 2007. As for coal, it doesn't make much movement until early 2008 when it all of a sudden rallied spectacularly, running from $45 a ton to well over $160 per ton in a few short months, surprising every one including me. I had the vision to load up heavily the coal mining stock JRCC at $4 last year, but did not have the foresight to see that it could reach almost $60 today, in just a few short months.

JRCC gained 15 fold in 10 months, or more than 12.5 fold in exactly 7 months. How often do you see such an incredible rally. How you wish you have grabbed that opportunity. I did catch it at the start but did not hold it through the whole course. I remember on Nov. 19, 2007 I was watching JRCC and I really wanted to buy it back but I had no dry powder. I knew I was giving up an opportunity but never knew how big an opportunity I had gave up. I wish had paid closer attention to the coal market and discovered this article last year.

Of course, JRCC is not the only coal stock that see spectacular rallies lately. There are a dozen others, PCX, BTU, ACI, CNX, FCL, FDG, MEE, ANR all gained tremendously.

How do you discover such bullish commodity players, before they take off, and how can you hold on to them for the whole course? And even more importantly, how do you decide your exit strategy? One word, due diligence research. If you know the market fundamentals and supply/demand trends, you can spot a bullish commodity player before it takes off, and you will have the conviction to hold through the highs and lows to rip full profit potential, and you will also know when it becomes over-valued and it is time to move on.

Coal's recent rally far exceeded my original expectation. I believed coal was bullish but I thought it's a long term play, at least 2 or 3 years out in the future. It is worth going back and re-example my original assessment of the coal market, and see if I missed anything.

As I discussed before, for any commodity play you need to exam the supply/demand relationship to see how bullish it is. You concentrate on several things:

• Is the natural source of the raw material scarce or abundant?
• What's the supply/demand numbers. How bad is the shortage?
• How price elastic is the supply. How high does the price need to go to boost supply, and how soon will it happen?
• How price elastic is the demand. Can demand be reduced or replaced if the cost is too high. How high the price need to go to cause that to happen?

I looked at all four criterias for coal and could not find a very solid bullish case. Global coal reserve is still abundant, worth a few hundred years of production. The global coal supply and demand figures in 2007 were 3135.6MT and 3177.5MT respectively. The shortage was 41.9MT, about 1.3% of annual demand. A very small percentage of shortage worth about 5 days of global consumption. Coal is mostly used as fuel in power stations, which often stock up to 3 or 4 weeks worth of coal. That should be plenty of buffering to absorb 1% or 2% of shortage in any given year. From the price elasticity point of view, the high coal price can not last long. China's coal production in 2007 was up 7% year-over-year. Recent news indicate that due to higher prices, the largest coal producer in China is boosting coal production at an annual pace of 13.3% or more. The global coal shortage may end soon right when every one is talking about higher coal prices.

So why did coal price double or triple in just a few months? I guess several reasons.

1. Global coal market is huge. But most coal supplies are already tied up in multi-year long term supply contracts netween producers and power stations. So the amount of coal available on the spot market is pretty limited and so is very sensitive to any temporary supply disruptions.
2. Mid to long term, both the coal supply and demand is quite price elastic. But in very short term, both supply and demand could be completely price inelastic. If a power station is running low on coal reserve and face the danger of shutting down electricity, they pay any price to ensure uninterrupted electricity supply. Mean while disruption at Australia's Newcastle Port forces many dry bulk ships, up to 30 at a time, waiting for weeks to be loaded with export coal. Can't load faster no matter what price you pay.
3. A few global events caused short term supply shortage. Those include the disruption in Australia's NewCastle Port, a major coal export port. By the end of last year, the Chinese government launched a crackdown which shut down a whole batch of small scale private coal mines operated under unsafe conditions, removing a significant portion of the production. As the coal shortage becomes evident, the government is now urging those small coal mines to resume production as soon as possible, when safety has improved.
4. It can not be ruled out that international hedge funds may be speculating on the coal market and bid up the price on the futures market.

Currently most coal mining stocks are prices so high that their prices are justified on the basis that coal price will continue to climb, and will stay high for the foreseeable future. If you look at the history of coal prices there have been periods of quick booms and bursts. JRCC itself emerged from a bankruptcy just a few years ago, and it is still heavily in debt today. So my advice to all the folks holding coal stocks is to sell now and move to something else. I am not calling a top, few people can recognize a top right when it occurs. I am definitely not calling for shorting coals. In all likelihood, the coal fever may well continue for some time and make new highs, but the big crowd has arrived. When big crowds arrive it is often time to move on to something else. There is always a bigger opportunity some where else where the big crowds have not gathered yet.

The biggest crowds in commodity investment probably concentrate on oil, coal, alternative energy, and gold. The gold crowd is too crowded. Today you can not visit an investment site or even tune to a radio or TV station, without hearing some one pitching gold. The most famous gold bug operate a free web site which I read daily. I appreciate the education on fiat currency, the credit crisis and the need of individuals to protect themselves from inflation. But why should gold be pitched as the only good hedge against inflation, and no mentioning of other precious metals, like platinum, palladium, even rhodium? I don't buy gold! You have nothing to gain in gold, in real term, comparing with other physical commodity investments. The only way you can make profit from gold is when you sell it to another gold investor, who just like you, hopes to be able to sell gold for yet higher price to the next gold investor in the line. Pretty much sounds like the bigger fool theory? The world has accumulated 320,000 tons of gold. There is never shortage of gold.

Relatively, the palladium investment crowd is far smaller and far quiet. Lots of gold bugs and silver bugs on the internet. But I have yet to find a palladium bug. Even the respected metals analysts don't understand the palladium market. Year after year they made bearish predictions based on the notion that Russian stockpile palladium flooded the market, each year they were proven wrong as palladium moved up and they scratch their heads wondring why they were wrong. Does it really stretch the mind to understand that Russian stockpile HAS to run out one day, and that will result in an industrial shortage, sending the metal price flying? Look at the sudden boom of investmenet interest since late 2003. Some one must had a Eureka Moment at that time and had been quietly loading up on this unprecedent investment opportunity ever since, driving the price up.

And now, on Nov 11th, 2008 the Russians themselves admitted they are running out of palladium stockpile. Is there any wonder that palladium price surged 12% in one week time since then? People are getting it and jumping on the wagen but unfortunately even a highly respected and award winning metals analyst, Rhona O'Donnell, didn't get it at all! She believed there was still some palladium stockpile some where "available to the market".

Hello! Whoever hoarded palladium since 2003 do NOT do it for a global charity. It's for making money! If the price is not right, it is NOT "available" to any one at all. On such notion of "large stockpile available", then shouldn't some one argue then that gold price should fall just because there are huge stockpiles in the world? No one ever made such a ridiculous argument. Whoever hoarded palladium waited exactly for such a Russian checkmate moment, and now the Checkmate Time in palladium is coming rapidly. The data contained in the Rhona O'Donnell article confirms that without Russian stockpile palladium, the market is in a pretty big gap of supply shortage. Do you notice that the palladium lease market may be halted?

Could palladium be the next rhodium? It could be possible. At least it's a way much better physical metal investment than gold. So you can never go wrong buying some palladium coins or metal bars. Of course, buying the stocks of the only two primary palladium producers in the world, SWC and PAL, may provide higher leveraged investment gains.

PGM metals are unique. Unlike gold, whose largest demand is investment demand, which is unpredictable and can not be counted on. PGM metals are critical to many important industrial applications whose demand can not be supressed even at very high price levels. But at the same time, the physical metals can also be hoarded away by investors, increasing the physical demand and adding to the shortage, driving up price. The global PGM market is so narrow and so tight that minimal investment demand can send the price to very high levels.

That is quite different from other commodity investments. I buy SWC and PAL stocks but I also buy physical palladium metal bars. All your folks who buy coal or oil stocks, do you also stack up a ton of black coal or a couple hundred barrels of crude oil in your backyard. If I visit Goldman Sachs office, do I expect to find a truckload of coal just delivered? No, there can never be any real physical demand from speculative investors, not even in the futures market. All trades are done on paper and when the contracts is about to expire they roll it to the next month. No delivery is ever taken so there is no physical investment demand in coal, oil, food grain etc.

I think I would rather invest in something that can be physically hold in my hands. But maybe I will just buy enough USO to hedge the gasoline price I pay at the pump, UNG to hedge my monthly natural gas bill. Finally read an interesting speech by Kevin Crisp which explains why PGM metals are critically important to the industries.

P.S. The author is heavily invested in SWC and PAL.

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.

The Tellurium Supernova Has Erupted

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

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


The Tellurium Supernova has erupted!


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

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

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

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


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


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


4. VNP noted rapidly expanding industry demand on tellurium. They meantioned 300 metric tons start metals per year for thermoelectrics applications (page 21). That number really strikes me. According to USGS, global tellurium supply can not be much more than 200 metric tons per year. Thermoelectrics usage of tellurium wasn't even meantioned a few years ago. Now that market alone consumes 143.4 metric tons of tellurium alone (48% of the Bi2Te3 thermoelectrics material is tellurium)

So we can pretty accurately estimate FSLR's raw material supply by looking at how much CdTe that VNP is selling to FSLR. VNP refused to provide numbers in kilograms, but they gave a price range of $300 to $500 per kilogram during the Q2 conference call, and suggested in Q3 conference call that the price may exceed the top of the range now. So using $500 per kilogram one can get some reasonable numbers. VNP also revealed that 60% of sales was to FSLR, and 65% to 70% in latest quarter.

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

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

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

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

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

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

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

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

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

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

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

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.