Extreme Opportunities to Make or Lose Money

Today's market is full of opportunities to make money or rather to lose them. Just remember: The market always makes the biggest group of people lose the largest amount of money to allow a few to get obscenely rich at the same time.

For your own good, you should always avoid the biggest crowd, and go to quiet secret places few noticed, it's true for making money and for life in general. Imagine you are at a place with hundreds of thousands of people. There is imminent danger and there are only two bridges leading to safety. One is narrow and in terrible shape. Another is big and in solid shape. Which one would you rush to? I would rather foolishly run to the dangerous one, knowing that all the smart folks will rush to the safer bridge, and collapse the safer bridge due to the sheer weight of the big crowd. That's the philosophy of life.

Read my previous analogy using Noah's Ark. Safe havens, by definition, must be narrow and can not accommodate too many people. If a perceived safe place can accommodate every one, then it is a death trap! The biggest presumed safe haven today, and hence a death trap, is the US Treasury Bonds market. There is an imminent danger in the TB market. People invested in treasuries have already lost big time, without realizing it. The bridge is perfectly safe, until one last person step onto it, and then it collapses suddenly under the collective weight.

Like the bridge, the TB market could collapse merely because there are too many investors in TBs for the perceived safety. The problem is when these people want to unwind their positions, who is going to buy? Whoever want to buy TBs have already done so! In 10 years you will be paid back the principal amount, but maybe not the purchase power. I suspect that government of China or Japan may have utilized recent US Treasury Bonds frenzy to quietly unload their overly too large US Treasury Bonds holdings which are otherwise impossible to unload. It's purely just my speculation with no evidence that I know.

Always avoid the big crowds! Last year when I suspected the big crowd had arrived, I called for folks in coal stocks like JRCC, ACI, ANR, BTU, CNX, MEE, to take profit. The timing was perfect as JRCC peaked just one day later after my article was published on Seeking Alpha.

Recently I was alerted that the dry bulk shipping stock DRYS was too crowded with too high a daily volume. My initial entry into the shipping sector was perfectly timed near the bottom, and I picked the best one to buy at that time, DRYS. But when I became cautious as the sentiment in DRYS was too high. So I switched from DRYS to EXM, another dry bulk shipper, as I believe EXM presented a much better valuation now. Read also David White's take on EXM.

Then, on Jan. 22, 09, DRYS dropped $4.01 on some "bad" news, even as the BDI surged up 5% that day. The news was out before the market open, but it turned into a total panic only in the last hour of trading. I think DRYS was overly punished by the news which isn't so bad after all. DRYS is over sold here. But EXM is still a better buy, from the valuation point of view. Unfortunately Mr. George Economou, the CEO of DRYS, will continue to disturb investors' perception of the company, regardless whether any of his private dealings are appropriate or not. I would rather stick with a company clean of such doubts.

In a previous article, I recommended shorting three stocks which are related to discretional consumer spending, and hence vulnerable during hard times: Coca Cola (KO), Pepsi (PEP) and Colgate (CL). All three are down from when I recommended the shorts. These stocks are not very volatile, and do not have too much short interests. So they are nice long term shorts if you hate volatility.

Along the thinking of discretional spending, I would now recommend shorting Apple (AAPL), and a recent high flier PALM. The current valuation of AAPL is just ridiculous. It is based on the hope of continued fast growth of AAPL's earnings, which is unrealistic. How many more iPhones can AAPL sell, before the market is saturated? The recent hype of PALM is a joke. They have a nice product which may be better than iPhone, but so what? I would rather buy a proven and established product, than something un-proven and non-established. Google (GOOG) is probably a good short, too. GOOG's income mostly comes from web advertisements. When companies are struggling to cut cost, they do not have much appetite spending money on advertisements. These three might not be immediate shorts amid recent earnings announcements. But watch closely for good short entries.

Stillwater Mining (SWC) continues to be my most favorite stock to hold. I firmly believe there is an undisputable bullish case for the precious metal palladium, and hence for SWC. I have yet to analyze North American Palladium (PAL)'s recent announcement for a comment. But SWC is a better value with much higher ore grade and a much bigger mineral reserve. Read about the palladium bullish case.

In short term, the dry bulk shipping sector is the best to be in. The global trade has not and can not come to a complete halt. The shipping industry is capable of adjusting to lowered demand quickly. But think about it: Trillion dollars of government spending is going to be a much bigger demand on physical goods and commodities, than your $200 weekly grocery shopping. There is a chance shipping can even reach new highs.

The unique nature of shipping supply and demand is that when demand is high, it's hard for supply to catch up, because you can not build new ships fast enough, or make the ship sail fast enough to meet the demand. On the other hand, when the demand is weaker, the industry CAN respond promptly to reduce capacity to meet lower demand, by canceling new ship orders, speed up scrapping of old ships, lay up ships for longer period of maintenance, or simply sail slower to save fuel cost and make fewer port calls. All those adjustments are happening right now so in short term, dry bulk shipping is very bullish. All of these shipping stocks are good buys: EXM, DRYS, EGLE, NM, TBSI, GNK and OCNF.

Full Disclosure: The author is heavily invested in SWC and shipping stocks EXM, EGLE, TBSI, as well as hold PAL and cobalt stock OMG. I have no positions on other stocks mentioned in the article.

The Real Supply and Demand of Oil and Other Commodities

The market irrationality has reached a new record. Spot price of the crude oil free falls to $31.41 a barrel (WTI Cushing Spot) two days after OPEC cut production by 2.2MB per day and made clear that they wanted to see $75 oil and will continue to cut if necessary. As OPEC vowed to keep cutting until they see $75 oil, oil should go up, but it actually went down. What gives?

In search for an answer, people blame it on "the oil demand has collapsed". Global oil demand did NOT suddenly collapse in the two days after the OPEC announcement. Look in a mirror for the answer. Yes that says you! Every one bet on raising oil after OPEC cut. The market ALWAYS fools most of the people most of the time, logical or not. Fundamentals work in long terms, not in short term moves. If you bet on short term moves, try to bet against most people, instead of bet on fundamentals.

Has the global oil demand collapsed? US oil import in October actually surged. Read the EIA provided weekly US oil import data. In the week ending Dec. 19, total US oil imports were 12.780M/day, versus 12.907M/day in the same week a year ago. That's only a 1.0% drop. Consider the surging oil demand in China, Russia, India, the global oil demand probably sees a slight increase or at least remain flat.

Do not forget Peak Oil. The world's top ten oil fields are all in steep production declines. Mexico's Cantarell Oil Field is declining more than 33% a year! According to Matt Simmons, Mexico, our 2nd largest oil supplier, will CEASE to export oil by the end of 2009.

The free fall of oil completely defied logic. I did purchase some USO a bit too early after the OPEC decision. Judging from what happened to other commodities, oil price may continue to drop to such low level that most oil producers can no longer make a profit. At that point people may finally be convinced that oil producers will cut production for real, instead of cheating on the OPEC production quota.

The fundamentals of commodities supply and demand can not change in just a few months. As I discussed before, the global credit crunch resulted in forced liquidation of global supply chains, as every one liquidate their inventory to raise cash in order to survive. The inventory sales flood the market to create a false over-supply situation while supply destruction is playing out at break-neck pace as unprofitable mines are shut down.

Due to the credit crisis, global commercial activities are brought to a grinding halt due to lack of credit. The global shipping industry is hit hardest. Read my analysis on what happened in the shipping industry and why I bought shipping stocks like DryShips (DRYS) near the low. If you followed my past articles, you know I have followed DRYS for a long time but never bought before. I believe DRYS could be like the coal stock JRCC I picked up around $4 last year, gaining some 15+ fold from the low in a matter of a few months!

BTW I continue to call for people to sell JRCC and other coal stocks (ACI, ANR, BTU, CNX, FCL and FDG) at any good rally. The US coal market is now a bear market. Coal is long term bullish but short term bearish. Obama's Global Warming team doesn't help coal either. I knew Steve Chu when I attended his seminar on his laser atom trapping research, two years before he was awarded the Nobel Prize in Physics. I am sad a brilliant physicist was tricked by the Global Warming Hoax. He was too occupied to spend 10 minutes scrutinizing the global warming claims using his basic physics training. But in any case, the coal sector is not going to be a happy sector for a while. Mr. Secretary Steve Chu, please spare a few dimes to the Cold Fusion research scientists, you know, as an experimental physicist, no one could continue to do the same experiments for 19 years, unless there really IS something in it. Cold fusion is real science and humanity's best hope of overcoming the energy crisis due to fossil fuel depletion.

We need to make a distinction between the aberration caused by the credit freeze up, and the real fundamentals of supply and demand. The credit freeze up only has a temporary effect in halting global goods movements and suppressing or delaying demand. It can not last long. Governments around the worlds are printing fiat money like crazy and injecting huge liquidities to get the credit moving again. There are clear signs it's starting to work. Banks are NOT in the business to hoard cash. They are in the business of taking in deposits and then loan money out to earn the spread of interest rates. If banks do not resume regular business soon, the whole banking industry will disappear from our society. That is not going to happen.

The real supply and demand is no where near a catastrophe. World Bank predicted a 2% drop in international trade next year. MasterCard reported a 3% y-o-y drop in US gasoline purchases. US Census Bureau reports a 4.4% increase of goods exports and 3.9% increase of goods imports in October, compare with last year. The scariest number is Japanese government reported a 26% drop in export to the USA in a recent month. Well dah?! Japanese count numbers in Japanese Yen, the same US$ amount is now 23% lower in Yen compared with a year ago. So Japanese export in US$ terms probably dropped a mere 3%. Every one is shouting "demand destruction" but how many actually dig into the data and scrutinized the facts?

As I discussed, the modernization of China, India etc. is the fundamental driving force behind the global commodities bull cycle. This transition has been going on for some 30 years and can go on for decades more, as the per capital consumption of many raw materials and goods in China is still far below even the global averages. Read "China Eats the World". China's current highway mileage is worth about ONE INCH of highway per person. There is a gigantic demand of steel and cement if China provides its citizens at least one finger or one foot of highway.

The basic demands come from basic human needs. During bad economy times, people cut spending on luxuries but continue to demand on things that are essential. So let's exam what is luxury and what is necessity in the people's lives. First let's not confuse luxury with expensive items. Something expensive doesn't necessarily make it a luxury, and something cheap doesn't mean it is a necessity. This is important to keep in mind.

Drinking Coca-Cola is a luxury; driving a car to work is NOT; Brushing your teeth with tooth paste, rinse your mouth using mouth rinse liquid, or using shaving creams while shaving, is a luxury; but visiting a dentist for dental cleaning or a dental crowning, is a necessity. Watching big screen TV is a luxury, but owning a computer to surf the internet, is essential. Living in a 5-star hotel is a luxury, but living in a place with roof over your head, is absolutely essential.

Companies that produce "luxury" items should be considered good short target now, particularly those big blue chips stocks few thought about shorting. In early August, 08 I called for shorting soft drink companies like Coca Cola (KO) and Pepsi (PEP) as I believe soft drinks will become non-essential luxury items. These two stocks have moved down a bit but they are still good long term shorts.

Now come to think about it, do people really need to use an ever growing amount of toothpaste, mouth rinse liquid or shaving creams? Even Albert Einstein did not use shaving cream. He just used warm water. I am thinking about shorting related stocks like Colgate-Palmolive Co. (CL). With a saturated market and shrinking profit margin, it's ridiculous that CL is priced at more than twice its annual sales and 15 times its book value. The short ratio seems to be low so CL may be a good long term short. On similar consideration maybe one should also consider Procter & Gamble Co. (PG) as a possible short. The difference is PG's is at a more reasonable 2.83 times book value, and it is well diversified into a lot of different products. So I will be cautious and want to do more DD before shorting PG.

Three things in life are absolutely essential: eating, living and moving. Eating is of course the most important. However there is a lot of room in cutting eating cost, without cutting nutrition. People will cut on non-essential and unhealthy processed food, and rely more on cheaper fresh food. One example is potato chips and pop corns. Why would any one eat these junk food? Frito Lay came to mind but it's part of Pepsi Co (PEP). Any one can recommend a good snack food producer to short?

There is much less to be compromised in living. For 99.99% of Americans not living under a roof is unthinkable. You either own a home or rent a home, one way or another. Surprisingly, the majority of the home builders, like DHI, CTX, LEN, RYL, are still around today. People either own a home, or have to rent one. So if people are not buying houses, then there must be a booming rental market and a booming business building rental units. Is it time to buy home builders as many of them seem to have gone up from their lows? I am skeptical. We need to see at least half of home builders go out of business to remove enough excessive capacity, before the remaining ones can return to profitability. There are so many good things to buy now. It's not time to go into home builders yet.

I see even less room to be compromised on moving. The mobility is an essential human needs more important than eating and living. In the Great Depression movie "The Grapes of Wrath", the family lost everything and they had little to eat. But they kept their family truck, which allowed them to move to California, find a job and find a place to live. Without a four wheels car you are reduced to just two legs. Without two legs and you are reduced to two wheels. That's how important mobility is.

Car ownership is an essential part of American lifestyle. You need a car to go to work or go shopping. Even if you do not have a job, you still need a car to move around looking for jobs, or go get some help, or to move to a better place. Has the global auto demand collapsed? Not by a long stretch! Just look at the global oil consumption. The Big Three US auto makers, particularly GM, are at the mercy of government help now. But it is a problem of the Big Three unable to compete with foreign auto makers, not a problem in fundamentals of the global auto industry.

The current credit crisis forced many people to delay buying new cars, but it also means a strong pent-up demand to come back soon. Historically, due to the skyrocketing oil prices and inflation, auto demand collapsed in early 1980s and GM stock hit a low in mid 1982. But just a little over a year later, in 1983, US auto sales reached a new record high as consumers who delayed car purchases found they still need a new car when the old car breaks down.

I believe it is in America's best national interest, as well as in the interest of the consumers, to keep the Big Three alive and keep the competition alive, and the vehicle prices low. But I do NOT advocate buying GM stocks as an investment. There is no reason to believe they can pay off the huge mountain of debt and pension obligation, and start to make profit any time soon. So there is no reason to invest. Both the longs and shorts in GM stocks right now are just gambling against each other, trying to pick a few dollars from each other's pocket.

We should invest in companies that have been indiscriminately hit hardest, but are financially strong and have good future prospect of profitability. The best sectors to be in right now are mining companies and bulk shipping companies. The shipping sector should rebound sooner and stronger than anything else, due to the pent-up shopping demand from the goods stockpiled on harbors waiting for credit letters. That is why I started massively purchasing shipping stocks like DRYS and EXM. There are others, like DSX, EGLE and GNK.

But my best favorites remain the by-product rare metals, palladium, and cobalt. Both metals are critical both during peace times and during war times. Stillwater mining (SWC), America's only palladium mine, remains my biggest holdings, although DRYS now catch up to be my No. 2. Another palladium mining company to own is North American Palladium (PAL). I also own a significant stake in OM Group (OMG), the world's dominant cobalt chemical company.

You've got to like palladium and cobalt because both metals are mostly by-product metals, and supply of both could be interrupted by a single-point-of-failure, which is very real. I talked about a possible Russian Checkmate. Norilsk Nickel (NILSY.PK) could suspend unprofitable production due to low nickel price, hence cut off 45% of the world's palladium supply.

Now it seems things at Norilsk are playing out in better favor of palladium than I thought! Norilsk resumed the US$2B stock buyback. That leaves them $2B less in cash and closer to a liquidity squeeze that will force them to shut down the unprofitable mine soon. Norilsk also announced production cut. Nickel production in 2008 cut to 298K tons from planned 300K tons, and reduces to 290K to 305K tons next year. The cut in palladium is much more dramatic, from a planned 3.05M ounces to actually 2.764M ounces in 2008, and 2.61M to 2.62M ounces production next year. Why the production cut in palladium is much bigger than nickel?

Norilsk explained there are two reasons for lower palladium production:

Reason 1: they will reduce local mineral ore production and purchase third party intermediates (metal concentrates) to supplement nickel production. Nickel concentrates purchased from third party will contain no palladium, only nickel.

Reason 2: much lower PGM content in the ores. Norilsk's mineral reserve statement shows that the nickel rich part of ores actually contain less palladium (2.91% Ni and 7.41g/t Pd) while the nickel poor ores contain more palladium (1.19% Ni and 11.92g/t Pd) . If they seek to reduce capital expenditures, they will produce the ores rich in nickel and poor in palladium. Using the content ratio of the richest nickel ore, if Norilsk's polar region nickel production is 225K tons, then the palladium production will only be 1.922M ounces, versus the normal 3.05M ounce.

It's end of December now and the annual Russian government stockpile palladium shipment has NOT showed up in Switzerland. Maybe the Russian palladium stockpile sale has finally ended for good. It's in Russian's strategic defense stockpile. There is no reason to sell at current low palladium price. The Russian Government has taken effective control of Norilsk Nickel, and will support the mining company by buying up its metal products.

What better support can the Russian Government extend, than to simply buy up Norilsk's palladium production and re-stock the nation's defense stockpile? In doing so they can bid up the global price of palladium to over $2000 an ounce, which means a cool extra $6B per year for Norilsk, a money they desperately need right now.

These numbers and facts continue to convince me that Stillwater Mining (SWC) is the best mining stock I can own for the next 5 years. That is the reason I continue to hold a dominant position in this mining stock, America's ONLY producer of the strategic PGM metals.

Full Disclosure: The author is heavily invested in SWC, DRYS, OMG and PAL. I currently have no position in GM, KO, PEP or CL.

True Safe Haven Investments: Inflation or Deflation?

Is it deflation, stagflation, or hyperinflation, in the current global economic crisis? That's the quadrillion dollar question investors must get right. This article will answer that big question but it is also meant to be a sequel to part one and part two of the serial articles talking about valuations of physical and non-physical assets as well as currencies. Please read the first two parts of the articles if you have not. It's critical to understand valuation of commodities and currencies first, before the big question of inflation versus deflation.

Recently, as the credit crisis unfolds, we saw the worst commodity price plummet in history, while the US dollar index rallied amid the unfolding financial crisis. Many people wonder that the commodity bull market has ended as the global economy enters a recession. Their reasoning is that due to credit squeeze, people cut back on spending as they could not borrow any more.

Such notion is wrong. While people looked at the weaker demand side, they failed to notice the destruction on the supply side! On the consumer spending side, people are NOT cutting back in TOTAL spending. Actually people are squeezed to spend every dollar from their monthly income, just to keep heads above water. More and more people are living from paycheck to paycheck, meaning they have to spend every dollar of they take in, and have nothing to save. They might be forced to cut spending on some specific items and spending more money on other things. The total spending in dollar terms is up.

Recent commodity price plummet is NOT a fundamental change in the supply/demand relationship. Fundamentals do not change abruptly in just three months.

The real reason is that the global credit crunch squeezes out inventories in the supply chains, causing a temporary and false supply surge, depressing the price. Such price depressing effect is only momentarily. It will be corrected violently to the bullish side once the false surge of supply is exhausted and the effect of supply destruction becomes evident.

In any commodity market, besides the supply side and the demand side, there is a long supply chain connecting the supply and the demand. In different parts of the supply chain, there are sizeable stockpiles of the materials. Under normal supply, the stockpiles at different parts of the supply chain will buffer out supply disruptions and ease out price shocks. That's why when a commodity is in adequate and abundant supply, the price will be flat.

However, stockpiling materials requires operational capitals. Often time money tied up in inventories is credit provided by banks, in the form of so called commercial papers. Things work fine if the credit market is healthy and adequately funded.

Unfortunately in a credit crunch, borrowing money is expensive or virtually impossible even for good businesses. Faced with a liquidity squeeze, businesses must raise cash for operational needs or to merely service debts. That means selling off inventories and cut spending in purchase of raw materials and equipments. When producers cut spending in productive activities, the supply destruction is in the pipelines!

Not only corporations are selling, hedge funds invested in commodities are also selling like there is no tomorrow. Every one is liquidating everything to raise cash and stuck the money in safes. That is absolutely foolish! While governments around the world are printing astronomical amount of money out of thing air, people are hoarding the funny papers in their pillows? We are in the making of a Weimar Republic on a planetary scale, and you hoard the fiat money?

When businesses at all levels suddenly sell off the inventories and at the same time halted purchase of new feedstock materials, prices are depressed prompting more sell offs. This leads to the false illusion of supply surplus, while hiding the fact that production of further supply is being suffocated. It's an extremely dangerous situation, as it could lead to a sudden onset of supply disruptions just as every one cheer at cheaper prices, without realizing that the supply chains have been squeezed empty.

My wife told me the best sell always happen right before a store goes out of business! When you go shopping this weekend and enjoy the lowest prices you haven't seen in a long while, you'd better ask the manager when will the next delivery truck arrive, or will it arrive at all! It's economic 101, all businesses are for profit. No one can operate at loss sustainable.

What do you expect when the supply chain stockpiles are depleted? There is no longer a buffer to absorb supply disruption and price shock. The market will suddenly discover that the supply has dried up. So the price will rally violently, in an extreme volatile way. That is what I predict will happen in all commodities in the coming weeks, including oil, food grains, and metals.

The market of platinum and palladium metal (PGM) is probably a good case study. About half of these metals are used in making the catalytic converters on vehicles. To reduce the risk of price volatility and supply disruptions, auto makers normally maintain a stockpile of PGM metals worth about 6 months to one year's consumption. Jack Lifton from Resource Investors described a very interesting case when one man's attempt to modify that inventory level caused dramatic reaction in the tightly traded rhodium and platinum market.

I am a big fan of palladium and platinum investment due to these metals bullish prospects. After the headline news of South African electricity crisis in early January caused the platinum and palladium prices to shot up, they stayed at the relative high level till the end of June. And then, at the onset of global financial crisis, they plummeted in a free fall fashion, all the while South Africa's PGM production continue to suffer from tight electricity supply. What gives? Who is selling? Every metals analyst is puzzled by the mind boggling fall of platinum and palladium.

The Big Three US auto makers, General Motors (GM), Ford (F) and Chrysler are facing a severe liquidity squeeze. They have been aggressively reducing inventory levels for months. When you are in a liquidity crisis, you sell whatever asset you can sell quickly to raise cash. The most liquid asset, of course, is the platinum and palladium precious metal stockpile.

In the narrow platinum and palladium spot market, when inventories from auto makers were sold out, it creates a lot of downward pressure. If industry users are selling, speculative hedge funds will be selling as well. The only buyers therefore must be the value-based long term investors. A recent Resource Investor article by Nathan Becker also provided explanation that hedge funds have to sell their precious metal hoardings due to liquidity squeeze.

I agree with Nathan Becker mostly but I must point out that he only considered the demand side and failed to recognize the damage that low metal prices may inflict on the supply side. No one can produce metals at heavy loss sustainable. Businesses must scale back production or shut down, if they can not make a profit. Anglo Platinum (AAUK) is currently producing at an average cost of US$1250 per ounce basket PGM metal (60% of Pt, 33% of Pd and 7% Rh) while the current market price of the PGM basket is only US$778 per ounce. It's only a matter of time before South African producers must start to reduce production if the prices do not improve to profitable level soon.

Last week's market plummet creates one of the rarest buying opportunities in our times for savvy investors with cash at hands ready to buy. How often do you get to go to an out of business sale and pick up things at prices far below their cost? Nickel is on out of business sale, copper is on out of business sale, grains like wheat, corn and rice are all suddenly on nose bleeding out of business sales. Grab them while you can. It may not be there tomorrow.

Do you think mining companies and farmers can continue to sell you nickel at $5.00 a pound, wheat at $5.53 per bushel, corn at $3.84 per bushel, and expect to continue the business at all selling things well below cost? It's the same out of business sale like what your wife told you!

The absolute best out of business sale is the palladium, metal of the 21st century, currently at $185/ounce bid. Gold mines are every where, silver is mined everywhere. But only four places in the world produce significant amount of platinum and palladium: Norilsk Nickel (NILSY.PK) in Russia; the Bushweld Complex in South Africa; Stillwater Mining (SWC) in USA; and North American Palladium (PAL) in Canada.

None of the four palladium producers are operating at a profit at current prices of nickel, platinum and palladium. They must each or together decide to slash production to boost metal prices, or face eventual bankruptcy. Any of these four have enough leverage power to boost metal prices on their own, and I believe there will be strong will to do that, as no business wishes to operate at a loss if they have a choice.

That is reason enough for investors to purchase physical palladium at current price, as there is a virtual guarantee the price must go up to reflect real cost, regardless of industry demand. 1980 was a good historic example when auto industrial demand of PGM metals collapsed, but investment demand still pushed the metals to all time high, together with gold and silver.

Out of the four, Norilsk is in bad shape and is most likely to slash production, due to low nickel price, now stands at $4.93 per pound versus the high of $25 per pound last year. There are also huge political pressures to shut the mine down to clean up the environmental catastrophe.

But South Africa is in a much worse shape as Rand dropped nearly 20% in one day versus US dollar. When a country's currency can drops 20% in a day, it's pretty much a broken and bankrupt country. The light of South African will go out, so will the light for that country's PGM mining industry. I previously pointed out that ESKOM, SA's electricity company, has to keep borrowing money and burn lowest quality trash to keep operation going. Now the global credit crunch means they have lost the ability to borrow. It's soon before it all blows up.

South Africa blowing up, as hinted imminent by the Rand's 20% one day drop, means removal of 85% of world's platinum and 35% of palladium supply! You can not have a more bullish story than that, on any other commodities. Stillwater Mining (SWC), with their palladium sale protected by a hedge floor price well above current market, is the best to weather out current market and best to leverage the coming bull market in palladium and platinum.

The only other metal that is even close to the bullishness of palladium/platinum, is the metal cobalt. There are strong and rapidly increasing industrial demands due to alternative energy applications, and due to the need of more drilling equipments in the oil/gas industry, and due to the metal's strategic importance in military applications. I wish to dedicate one article just to talk about cobalt. But suffice to say for now I consider cobalt a better physical metal to buy than silver and it should appreciate at least 10 fold relative to silver. Like PGM metals, 90% of the world's cobalt supply is concentrated in one country, Congo, which has been in years of civil wars and the conflict looks like flaring up again. So the supply is vulnerable while the demand is strong and growing. That's a perfect making of a bull market.

The best cobalt play I found is a stock called OM Group (OMG) (Oh-My-God). It is current a very decent buy at ridiculous low valuation. If you know any other cobalt play, or know places other than BHP Billiton (BHP)'s Cobalt Open Sale that I can buy physical cobalt, tell me!

Now, back to the US dollar. We are creating trillions of dollars out of vacuum and throw them into a blackhole. Make no mistake; it is inherently hyper-inflational. It's a big dilemma the whole planet is facing today. Short term it is about liquidity preservation or die. A little bit longer term it is about valuation preservation or die. Hoarding fiat currency while new money is created out of thin air preserves liquidity but loses value. Hoarding physical assets preserves value but reduces your liquidity.

I think we will see a very sudden and abrupt switch from a false US dollar rally caused by every one hoarding the cash, to a hyper inflation scenario where every one wants to spend out the cash as fast as possible. In physics it's like a high pressure and high temperature phase transition. The credit will go straight from solid ice to rapidly expanding vapor, skipping the liquid phase altogether, blowing everything out. The phase change will come imminently and suddenly, so be prepared for it!

A few side notes: I called for shorting Coca Cola (KO) and Pepsi (PEP), now it looks like I was right. I called for selling coal stocks like ACI, ANR, BTU, CNX, FCL, FDG, JRCC repeatedly since June 20th and I continue to make such call as I see the US coal market is now bearish. I can see JRCC drops to near $10 or even below. Continue to watch DRYS as it is a good indicator of the global economy.

Full Disclosure: The Author is fully invested in SWC and PAL, and is also heavily loading OMG recently. I am also buying SLV, GLD, SSRI, PAAS, SIL.

Principles of Wealth Preservation Through Physical Assets

Yesterday, barely one week after the fall of Fannie Mae (FNM) and Freddie Mac (FRE), we saw the fall of the third and fourth largest financial institution at the same time. Lehman Brothers (LEH) filed for bankruptcy. Merrill Lynch (MER) sold to Bank of America (BAC) in a hurry. Dow plummeted more than 500 points. We are looking at an un-precedent financial tsunami and it is at times like now that people MUST preserve their wealthy through safe haven investments, or risk losing everything.

When it comes to safe haven investment, people immediate think about physical assets like gold, silver, oil, land, real estate. There is a reason for it. Physical things have intrinsic values. Value of a paper fiat currency, or a stock, can fall to zero. But value of any physical assets can not fall to zero. The intrinsic values of physical assets are the reasons why they preserve wealth during times of financial and economic crises.

It is important to understand why physical assets like commodities have intrinsic values and how are they determined. Without this knowledge you might end up over-paying for something and losing your wealth. Those folks buying gold at the $800+ high in 1980 ended up losing big time and they may never be able to recoup their losses, because they chased the gold maniac and over-paid well above the intrinsic value of gold. Knowing how to measure the intrinsic values is more important as the value of the US dollar is changing dramatically, so the dollar price no longer provides an objective comparison.

To understand how intrinsic values of commodities like gold are determined, a few common misunderstandings must be demystified. Those common misunderstandings include:

A commodity's value is determined by its usefulness, or how much people are willing to pay.

A commodity's value is determined by supply and demand, the more scarce the more valuable it is. The more abundant the cheaper it should be.

Both notions are considered common sense by most people. But both notions are actually wrong if you think them through. Why are both notions wrong? Let me use one example to illustrate why these two notions are wrong. Let's talk about water, potable, drinkable water.

Water, of course is extremely useful and important. Water is needed to sustain life. But yet water is cheaply available. So something useful doesn't necessarily make it expensive.

Water is also abundant. Coca Cola (KO) can produce as much soft-drink as people of the whole earth needs to drink, and much more, there is even competition from Pepsi (PEP) and others. The Saudis can buy as much water as they need. Some one can filter the sea water to produce any amount of fresh water as long as the Saudis pay the right price. But the abundant water is not exactly cheap as dirt. Vise versa, something scarce doesn't necessarily make it expensive, either. Remember I mentioned KO and PEP for a potential short? I believe both companies will survive a severe economic recession or depression. But profits are going to plummet as consumers cut back on discretional spending on soft drinks.

The case of water provides a good example of the intrinsic value of a commodity. A one-gallon bottled water is sold roughly at about the cost to produce and ship it, plus a bit of marginal profit. The reason is very simple: If price of bottled water is too low to be profitable, then no one is willing to produce bottled water and so supply immediately falls, bringing the price back up. But if price is a bit too high, then driven by good profit, competitions will bring in extra production, which brings price down again. This leads to the important principle I want to talk about:

A Commodity's Intrinsic Value Is the Cost of Replacement

In my past articles, I have emphasized the basic economic principle that

Supply and Demand Drives the Price

And now I am talking about that commodities should be valued at the cost of producing them. Have I changed my mind? Am I contradicting myself? No! There is no contradiction. Both principles are valid and they are consistent with each other. The reason these two principles are compatible between them is that the replacement cost, the cost of producing the commodity, is NOT a constant. The production cost itself is driven by supply and demand.

That's because when the demand weakens and the price fall, businesses that produce at higher cost will fail, reducing the supply and leaving only the lower cost suppliers in play, hence the replacement cost is reduced until things reach equilibrium.

Likewise, when demand exceeds the supply, price must go up, and new source of supply where it previous was too costly to produce can now come into play profitably. So this is the case where strong demand drives up price as well as the production cost.

Let's use natural gas as one example. Some predicted that natural gas price should fall and they point out recent US production increase. What they failed to mention is that due to international market competition, LNG (Liquefied Natural Gas) import into USA has collapsed so the increased domestic production can barely make up for the drop of importation. The weekly NG storage number is significantly lower than the level last year, meaning the market has consumed more than the available supply for the past year. Further, almost 100% of the domestic production increase comes from the so called shale gas, a resource impossible to produce in the past and is still prohibitively expensive to produce today. The horizontal wells are very hard to drill and production from each well is very slow. Some estimate that shale gas is unprofitable to produce unless the natural gas price remains at $10 or more per MM BTU. Current spot price is at $7.39.

More over, from an energy equivalence point of view, one MM BTU natural gas is equivalent to 6.5 barrels of petroleum. So current price of natural gas is equivalent to only $48 per barrel oil, even though it is a cleaner fuel. Comparing with petroleum, natural gas is now in an extremely oversold condition. Using the principle that commodities should be priced at the production cost, which is at least $10, I am seeing United States Natural Gas Fund (UNG), is an excellent buy here and I see it less affected by turbulence in the general market. I bought UNG at around $33 myself. I also call for buying NGAS as it is an unconventional natural gas play, with a nice ticker name others are jealous for.

Let me come back to the topic of safe haven investments. The most important feature of a safe haven investment is not to make money, although that will be nice, but the main goal is to protect and safeguard your wealth. It must be something physical, with intrinsic value that does not fall, and is under your control and disposal. Safe haven assets are something you accumulate and you are not supposed to sell at any price, until time is getting real bad. And then these hard assets you own will protect you and your family. It's like buying a gun for your self-defense, do you buy it one day and then sell the gun next week, thinking that as you were not in danger that you do not need it any more? No! You buy and just own a gun indefinitely if you want protection. It's the same principle for safe haven assets.

Trading paper futures contracts, buying one day and selling another day and gambling on daily charts, like hedge funds are doing, is NOT safe haven investment. Safe haven assets are physical asset you just acquire while they are still cheap, and hold on for rainy days, as such, suitable physical assets to acquire must not only preserve and grow in value, but they must be easy to store, transport and safeguard as well. This leaves very few suitable options. You can not store coal, oil, natural gas or even helium in your backyard. The only practical things to consider are gold, silver, platinum and palladium. Even silver is considered too bulky in comparison with other precious metals. But for average Joes who do not have a lot of net worth, silver is perfect as a safe haven asset.

In near term, I am bullish in precious metal producers; I am bullish in natural gas and in crude oil. But I am now bearish in coal. I called for the coal producer, JRCC, at $4, and then called for taking profit in JRCC at $60+. My calls were perfect. I called for JRCC to reach low $20-ish and it is here today. The bullish sentiment in the coal sector is still too strong. But the fundamentals of the US economy does not support a bullish US coal market. If a large amount of US coal is shipped to Europe we might continue to see a coal bull market. But the dry bulk shipping rate is collapsing, as reflected in the stock price of DryShips (DRYS). The falling dry bulk shipping rate show there really isn't a lot of coal being shipping around the world. If investors are hoarding coal in their backyard, it might provide additional demand. I have not heard any one hoarding coal at home, though.

I am seeing JRCC to continue to fall to low double digits, in the $10 to $12 range. If you are in JRCC, or in other US coal players like ACI, ANR, BTU, CNX, FCL, ICO, MEE, PCX, dump them on the next rally up. It's no longer time for a coal bull market. There are better bullish investments some where else.

The best commodity bull plays right now, are precious metal producers. This is especially true as many precious metal players are now at ridiculously low prices. It's a basic supply and demand thing. A big part of the demand now comes from investment demand. If you look at the big picture, that investors large or small must now purchase physical precious metals as safe haven assets to protect themselves. The argument of investment demand now supercede any argument regarding the industry demand, because the investment demand can be orders of magnitude larger than industry demand.

Once again, physical commodities provide protection of value because their intrinsic value is the replacement cost. They can not fall below that replacement cost for extended period of time, because when it happens, it quickly kills off the supply, and then the price is brought back up. The intrinsic value also goes up as production cost goes up due to inflation and high material cost.

So which precious metals provides the best value protection as well as the best potential for gain, depends on its current price relative to its replacement cost. Gold I think is the worst. Gold's current price allows most of gold producers to be comfortably profitable. The huge above ground gold stockpile means there is no lack of gold even if many producers go out of business. So gold does not provide very good bottom price protection here. On the up size, there is currently enough incentive for new gold project to be developed, bringing extra supply to the market. So that limits the up side potential as well.

Silver is better than gold because current silver price is unprofitable for many primary silver producers. Current silver price just does not provide incentive for new silver supply to come online. Further, according to USGS, the world's remaining silver resource will be depleted in about 13 years at current production rate. So silver has very limited down side here and much greater up side than gold. I have recently purchased silver players like PAAS, HL, and SIL.

But I think PGM metals, platinum and palladium, provide best of all worlds. PGM source is pretty much limited to South Africa, Russia and two North American producers, Stillwater Mining (SWC) and North American Palladium (PAL). South Africa, by far the dominant supplier, producing 85% of the world's platinum and 35% of palladium, saw PGM production collapsed due to the country's electricity supply crisis, which is a long term problem with no solution in sight. In August alone, their PGM production falls by 32.8% from a year ago, while the 2007 production was also down significantly from 2006 level.

The investment community has completely ignored South Africa's electricity woe and production fall, while totally exaggerated the demand set back in the auto catalytic converter sector, and in the jewelry sector. In my last article, I point out that diamond demand is actually booming. That alone point to a higher jewelry demand of platinum and palladium. A loose diamond can not be worn. It must be set in a precious metal setting, platinum and palladium.

Investors also forget that their own purchasing of the physical PGM metal constitute a physical demand, on top of any industry demand. At current prices of $1120 per ounce platinum and $230 per ounce palladium, this is pretty much a bottom price which is already below the replacement cost. None of the South African PGM mines can make a profit producing platinum at $1120 per ounce. Do you know it takes 20 tons of hard rock ores and 5 months of total processing time to produce just one ounce of platinum?

Regardless of the precise industry demand figure, if the market does not begin to pay a better price, South African PGM producers will have to cut back production so the price will boost. That alone is a strong argument for investors to purchase platinum at current price. I wonder why the South African PGM industry would not shut half of their mines down to help alleviate the country's electricity crisis, and make much greater profit from half of the production. It seems they are not worried about weak demand or over-supply at all as they see the purchases are strong. They would rather worry about potential demand destruction if they do not strive to produce as much as possible to supply the market. Nothing can be more bullish when the main suppliers tell you that they worry about not having enough supply, instead of not having enough demand, when the platinum price is already so low.

Platinum's sister metal, palladium, should be a better buy than platinum because it is currently only 1/5 of the price of platinum. Historically the prices of the two were close to each other, as these two metals are inter-changeable in many applications. Industry users tend to use more of the less expensive metal, reducing the price gap over time. Palladium, being mostly a byproduct metal, except for that only SWC and PAL produce the metal as main product, is way much less price elastic in the supply, hence it has more explosive price rally potential. Palladium coins are now rare and hard to find. You should buy any palladium coin you can find with a decent premium. Of course the better buy would be the producers themselves, stocks of SWC and PAL.

How do you decide on the valuation of these two palladium producers, SWC and PAL? Look at historical price figure. The performance of the two tracks each other at roughly a 3:2 ratio, with SWC being about 1.5 times the price of PAL. The price of PAL collapsed in November, 2007 after a catastrophic secondary offer diluting the shares and provided an excellent short target to the naked shorter. Same story as what happened to Hecla Mining (HL) recently.

Consider that SWC still has lots of proven and probably mineral reserves, 23 million ounces worth of PGM metals, and they have hardly touched the tip of the iceberg of the gigantic stillwater igneous complex, and that there is opportunity to expand into the bullish chromium sector, while PAL's current mine is near depleted and they have yet to develop the rich Offset High Grade Zone. I think I would put a fair price ration between SWC and PAL at roughly 5:2.

Nevertheless, both companies are strong buy on the palladium play. Both stocks have been heavily shorted and heavily manipulated. The high outstanding short interests can not be safely unwounded, even at current low prices. Both companies have a very strong and patient majority or near majority stake holder behind them.

Behind PAL is billionaire investor George Kaiser, who own nearly 50% stake for many years, presumably because he believe palladium has an extremely bullish future. If Mr. George Kaiser wants, he can easily lift up global palladium price single handedly.

Behind SWC is an even stronger player, a 54% stake holder, Russia's Norilsk Nickel (NILSY.PK), the largest palladium producer in the world. They took all the trouble to acquired SWC to control over 50% of the world's palladium supply in the first place. Their strategic aim is clear: dominance of the global palladium supply, not for charity to the humanity, but for maximum profit. The Russia can name the palladium price any way they see fit if they want to. They have not taken any action to boost palladium price so far. But I guess a Russian checkmate is just a matter of time. They do not acquire SWC just to supply the world with dirt cheap palladium at a price far below cost.

I really can not see a market more bullish than that! And I really can not comprehend why so few investors can see what the Russians are up to. Time to buy some SWC and PAL. This will be an investment of a lifetime. Mr. George Kaiser has been waiting patiently for nearly 10 years so I think I can wait for a few more months. I am hoping that SWC or PAL suspend palladium sale at the spot market because it makes no sense for any company to sell products at a heavy loss. They could even buy back palladium at spot price! Even Gold Corp (GG) has suspended an unprofitable mine due to current gold price. If either SWC or PAL suspend sales or buy back palladium from the spot market, a lot of fun could happen fast. The global palladium market is so narrow that any one might squeeze the supply and pump up price.

P.S. The author is heavily invested in SWC and PAL, and hold long positions in HL, UNG, NGAS, PAAS and SIL.