Blatant Manipulation in the Precious Metal Market

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Richest Billionaires Must Also Be Biggest Losers

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Grave Warnings to Precious Metal Investors - Buyer Beware!

I am a palladium bug, not a silver bug or gold bug. Although I do like silver and gold and I like all precious metal investments. My favorite remains palladium. But regardless what precious metal you like best, I urge all precious metal investors to own ONLY physical metals and stocks of their favorite precious metal mining companies.

I strongly discourage owning any Exchange Traded Funds, ETFs that invest only on future contracts or other paper instruments. I cited UNG and USO as perfect bad examples. At a point of time UNG was once the second largest long position in my portfolio, right after SWC. I still can not help but pad myself on my back for promptly realizing the fundamental problem with a paper based "commodity" ETF such as UNG, and sold without hesitation. Had I held UNG till this day I would have been much poorer. Unfortunately such ETF funds continue to make many unsuspect investors poorer by the day. So I urge every investor to carefully read why paper based ETFs do not work.

I do expect that 99% of the people will attack my view point that paper ETFs will not work. I don't mind as I know 99% of the people simply could not grasp the concept until they have lost all their money. I will be very happy if 1% of people feel that I have helped them to avoid costly mistakes and to make smart investment decisions.

Like advocators Jim Sinclair and Ted Butler, I always encourage people to directly own physical precious metals. I do not trust the physical gold ETF, GLD, and the physical silver ETF, SLV. Like some other folks I expressed skeptism whether these funds actually hold the physical precious metals as they claimed. These ETF funds were hosted by entities known to be hostile to precious metal investors and known to have large short positions in silver so why should people trust them? At one point I went so far as scrutinizing the almost 10,000 pages long silver bars list posted by iShares Silver Trust (SLV), and discovered plenty of red flags.

But what I just discovered may shock the raw core out of every SLV investors' shells. If you read the following and you still feel comfortable investing in SLV, and do not feel a need to scrutinize the fund a little bit more yourself, then maybe you are too numb to even invest money in the dangerous marketplace of today, and it is probably a good thing you lose money, if indeed this is exposed to be one of the biggest scam of our time.

This is a nuclear bomb I am dropping, so before I continue let me make a few things clear for my own legal protection. I am a US Citizen with constitutional right to free speech, and conscious forces me to speak out. I do not have a short position in SLV and stands for no monetary gain out of this disclosure. I am a supporter of precious metal investments and want to see higher silver price. I have no vested interest against any entity involved, other than that I insist seeing honesty and integrity of all involved parties.

That said, I have noticed that iShare recently hired an independent auditor to inspect the silver bars in their vault, and issue audit certificates such as this most recent one. I urge you to follow the link to immediately download a copy of the inspection certificate and save it on your computer, lest it disappear soon! The auditor, Inspectorate International Limited, is a very reputable commodity inspector for 150 years in the business. Very good! I welcome iShare's move to hire a reputable auditor to look at their silver bars and disclose it to the public. If you trust Inspectorate, and they visited iShare vaults and come back to tell us they see all the silver bars stored in the vaults, then it should put all skeptism at rest and people should feel safe to invest in SLV shares, right?

Not so fast! Not so dandy fast and easy, I say folks! Look at this Audit Certificate once again. It's only two pages. Print it out, friend. But Inspectorate is a big company and it just so happens that the same Mr. Paul Alston, a nice and respectable English gentlemen, was also hired to do audit for GoldMoney.com, and issued audit reports like this, this, this, this and most recently this.

Do you see anything unusual, folks, when you compare the two pages SLV audit report and the 14+ pages GoldMoney audit reports, alleged done by the same Mr. Paul Alston?

1. SLV has a two page lousy report that says almost nothing, while GoldMoney has much more elaborate reports detailing every aspect of the inspection process, including such seemingly unimportant information like the brand of the sale used for weighing, even though SLV has way much more silver to be inspected.

2.Inspectorate issued a paper audit certificate to GoldMoney and they have to use an awkward optical scanner to scan the image of the paper certificate and post on the web. More awkwardly, the brits use a paper size narrower than standard American letter size, thus the scanning exposes the ugly paper edge, telling the size of the margin to the edge of the paper. Wouldn't it be nice to do like what iShare did, create a nice and clean electronic PDF document, leaving no trace of the paper, and just digitally embed the Inspectorate logo, and an image of Mr. Paul Alston's signature? Except that anybody with a computer can do it. It's not hard to find a sample image of Mr. Paul Alston's signature off the web, right? (Don't try it at home, kids!)

3.Unfortunately Bank of New York Mellon is in America and speaks a different kind of English than the one spoken by Mr. Paul Alston, a nice British gentleman. And the vaults are supposed to be in England. They forgot such unimportant details and let a lousy American created that Inspectorate Report. Congradulations on getting the paper size to be the correct A4 size, but they need to work on small details, for example Inspectorate would not begin the sentence with "The Bank of New York" as the sentence subject and would not use the ® mark when referring to third party names, and the British would refer a date as 7^th of July, 2010, not in the lousy American style July 7, 2010. I encourage them to really spend some time studying how Inspectorate issue their audit certificates. They should have done that before they post it.

I will stop here and let people draw their own conclusions. But I do NOT for a single bit believe that Mr. Paul Alston himself personally counted and inspected 308,542 pieces of silver bars, and sampled and measured each one bar out of each pallet of 30 bars all by himself and his gangs, and issued that SLV audit certificate and signed his name on it. Not a bit at all.

Full Disclosure: The author is fully invested in mining stock SWC, PAL and precious metal palladium. The author also holds physical silver and silver mining stocks like SSRI, CDE and HL, but has no position in ETF funds GLD, SLV, UNG and USO.

Peak Oil, Alternative Energy and Platinum Group Metals

The world's attention is increasingly turning towards alternative energy as the reality of Peak Oil is sinking in, even though the public discussion of Peak Oil is still only just wispering, with majority of investors unware of the looming global crisis.

Fossil fuels are cheap and convenient: they are easily produced, and the fuels themselves serve two purposes at the same time: They are both energy source, and energy storage. When you fill up your car with 15 gallons of gasoline, you acquires both the energy needed to drive your car a few hundred miles, as well as ways to store the energy: the energy is stored in the gasoline until it is burned in the internal combustion engine.

Any alternative energy development must address these two issues as well: energy source, and energy storage. Alternative energy sources we talk about, like solar, wind, ocean wave, nuclear, addresses only the problem of energy source, but not the energy storage.

While scientists are making some progress in developing high energy density batteries, the basic physics is that energy density in any battery could never come even close to the chemical energy density in either hydrogen, or carbohydrate fuels. The best energy storage solution we can find is to synthesize carbohydrate fuels using energy derived from solar, wind, nuclear or coal fired power plants. Such synthesized carbohydrate fuel can then be transported using the existing infrastructure before they can be utilized. Finally, fuel cell batteries can extract energy from the carbohydrates and turn it into electricity energy, at an efficiency much higher than simply burning them in a combustion engine.

So this is the alternative energy recipe scientists have given us:

1. First electricity is generated from alternative energy sources like solar, wind, ocean wave, nuclear, hydropower, etc.


2. Second electricity is used to synthesize carbohydrate fuels, allowing the stored energy to be easily transported and utilized.


3. Third fuel cells are used to generate electricity from carbohydrate fuels to provide end energy usage, like driving a vehicle or other electricity driven machines.

Do you realize that for steps 2 and 3 to be possible, a category of rare and expensive precious metals are need. You need the so called PGMs (Platinum Group Metals), namely platinum and palladium. These two metals serve as catalysts in synthesizing cabohydrate fuels. They also serve as catalysts in fuel cell batteries.

Among the two PGM metals, palladium is probably even more important. Palladium is very unique in its extreme affinity to hydrogen: one volume of palladium is capable of absorbing 900 times the volume of hydrogen. Such extreme affinity to hydrogen makes palladium an ideal catalyst in any chemical process that involves hydrogen, including, of course, the chemical process to synthesize carbohydrate fuels, or the chemical process to turn carbohydrate fuel into water, carbon dioxide and electricity, as it happens in fuel cells. There is no shortage of efforts by scientists to look for alternatives to the expensive platinum and palladium, in the last one hundred years. Unfortunately no practical substitute could be found so far.

No wonder when President Bush advocated hydrogen economy in a State of the Union address in 2003, some one reminded us that you can NOT have a hydrogen economy without palladium, and that the USA is lucky to have one of the world's only two primary palladium mines: the Stillwater Mine (SWC) in Montana. The other palladium mine is North American Palladium (PAL). Read "The Russians Are Coming" by Mother Jones.

Recently there is an investor mania in the sector of rare earth metals, just like the one in solar energy a few years ago, due to recent news that China is limiting production and export of rare earth metals. The rare earth metals mania is not without a good reason. The alternative energy development is a huge investment theme due to Peak Oil. In the alternative energy development, you need efficient electric motors to turn mechanical energy (like wind power or hydropower) into electricity and turn electricity into mechanical power (like in a hybrid car), and you need high energy density batteries to store the electricity energy. The high density batteries need rare earth metals. To make the strong magnets needed to build electric motors, you need rare earth metals. Not to mention the advanced electronics technology need rare earth metal as well. No wonder the whole world panicked when China begin to cut back rare earth metals expert quotas, and there is an investor mania to rush into potential rare earth mining plays like MCP, REE, AVARF.PK and UURAF.PK these days.

But let me be clear: rare earth metals are not rare at all. China could not cut the world off on rare earth metals even if she wants to. There are plenty of rare earth resources else where in the world that can be developed. They just won't be cheap.

But here are these two other metals that are truely rare, and that all alternative energy technology more critically depend on, and which China has zero domestic sources. China runs the danger of being cut off by the world on these two critical metals if there is a resource war.

Those two metals, as I just mentioned, are palladium and platinum. Supply of these two metals concentrate in just a few spots in the world: Russia's Norilsk Nickel (NILSY.PK) mine, South Africa PGM mines, and these two palladium mines in North America: SWC and PAL. Price of platinum but even more so that of palladium, have been surging up relentlessly due to strong supply/demand fundamentals. China, Japan and other nations without their domestic sources of these two metals, better begin to think about accumulate their strategic reserved of these two critical strategic industry and war time metals.

Likewise, investors would do much better hoarding physical palladium metal bullions, than hoarding a basket of 2 dozen different rare earth metals and not knowing which one will do best in the near future.

In the next two articles I will talking about how effects of resource peaking in two countries will impact global supply of platinum and palladium catastrophically, causing market panick in the near future, sending prices of these two metals surging to unimaginable high levels:

Peak Coal in South African and the Global PGM Supply

-How South Africa is running out of coal. How booming India coal demand will deplete South Africa's coal supply. And how these will impact South Africa's electricity supply and therefore constraint that country's platinum and palladium supply.

Peak Nickel in Russia and the Russian Checkmate on Palladium

-The Russian checkmate on global palladium supply are in two aspects: First the end of Russia strategic palladium stockpile sale, due to the stockpile depletion. Second, palladium production of Russia's Norilk Nickel (NILSY.PK) mine declines dramatically, as ore grade deteriorates. Third, More shockingly, Norilsk Nickel is now considering the more cost effective Activox Process technology, which it acquired by spending US$6.5B to acquire LionOres a few years ago. The Activox Process will dramatically cut sulphur dioxide pollution. But the new technology will only extract base metals nickel and copper, leaving platinum and palladium in the residue un-extracted, unless the price is high enough to provide the economic incentives to extract the precious metals using alternative approaches. This change would be a catastrophic loss of global palladium supply and will be sure to cause market panic.

Full Disclosure: The author has large long positions in palladium mining stocks SWC and PAL, in addition to silver mining stocks like SSRI, CDE, HL, and coal mining stocks PCX and ACI. The author has no position in rare earth metal plays REE and MCP.

The Pitfalls of Almost Every ETF Investments

I am telling you something every investor should know, but no one has told you! Even the most successful investors like Warren Buffet or Jim Rogers has failed to tell you this important investment rule that you are about to hear from me. I believe Jim Rogers does not intend to withholding his investment knowhow from you, but he truely does NOT actually get it himself. It took me a while to get it as well.

When Jim Rogers pitched agriculture commodities and urged people to buy future contracts of those commodities, he did NOT know what he was talking about! I hope that some one close to Mr. Jim Rogers can bring my words to him and explain why he was wrong. I have high respect to Mr. Jim Rogers and I hope he gets what I am about to tell below. This is an investment mistake 99% of people make, including Jim Rogers himself.

If you believe something is bullish and want to invest in it, then you MUST own it outright.

Allowing some one else to own your investments for you, simply won't cut it. Owning something "indirectly", for example, by purchasing futures contracts, won't cut it, either. If you don't hold something outright, physically, under your own control, then you really don't own it. If you don't own something outright, then all you have is merely a piece of promise, written on a piece of paper. You are owning merely paper assets, not the physical assets. You should reject all assets that rely on a promise printed on a piece of paper, because a promise can be created out of thin air, and can just as easily vanish into thin air, with little or no repercussion to the one who breaks the promises, but tremendous loss to you who wrongly trusted that promise. Let me explain.

But first let me clarify that owning equities, i.e., owning shares of stocks of publicly traded companies, is NOT owning paper asset. The company, like the Stillwater Mining Company whose stock I own, is a real physical business entity, if I push a computer button to buy shares of SWC through TD AmeriTrade, I do own a small piece of that company. My ownership is recognized as legitimate. If I have any doubt I can request physical stock certificate. If there is still any doubt regarding the ownership, then the stock should not be bought. So let's make it clear, equities, as long as the ownership is not in question, are physical assets, not paper assets.

But all indirect ownership of physical assets, or ownership of derivatives of physical assets, are paper assets because they rely on a promise made by some body, written on a piece of paper. Take for example the physical gold ETF, the GLD, and physical silver ETF, the SLV. The respective investment prospectus claims these funds are backed by physical gold and silver, and hence owning shares of these two ETFs are equivalent to owning actual physical precious metal.

Maybe these ETFs are really backed by physical metals, maybe not. We don't know. All I know is by owning shares of either GLD and SLV, you are NOT owning physical gold or silver. Not at all. You are owning something which is based on a mere promise, a promise that some how some where in a secret location in the world there are a pile of gold or silver bars and those bars really do belong to you, but you have no way of knowing and you have no access to it. Those physical precious metal bars might as well be put on the moon and you can point to the moon and tell your grandsons that you really do own something on the moon, and that some one promised it to you, you just don't have control or access to it.

Make no mistake about it: You are owning a piece of promise, not a piece of metal, by owning GLD or SLV. It's up to you to decide how much you can trust that promise and how much you value it. But to me, I don't even trust my best friend to hold a few palladion coins for me, why should I trust some guys that I don't even know personally to hold my precious metal in a fund called GLD and SLV? In the past I scrutinized the metal bars list of SLV and raised plenty of red flags. I determined that regardless whether those red flags have legitimate explanations, it is not worth risking my own investments to count on some Santa Clause keep a good promise.

Another categories of ETF funds are even worse. The GLD and SLV fund at least claims to be backed up by physical assets. But there are ETF funds which are backed up by nothing but paper. Most notably are the USO fund for crude oil, and UNG fund for natural gas. The USO fund does not own a single drop of oil and the UNG fund does not own a single cubic of natural gas. They own future contracts, i.e., promises made by some one, not physical commodities digged out of ground. Why do people buy these two funds and then expect to make profits when prices of the underlining comodity goes up, if there is not an ounce of the actual stuff involved? They don't. I recognized that fundamental fact on Oct. 29, 2009. I advise you to read that article again. It was a very important lesson I learned.

Lucky for me, once I recognize why the investment based on paper will not work, I quickly unwinded my entire investment in UNG, which was once the second largest position I held, without suffering any loss, and I never touched it again. In hind sight I have chills in my spine thinking what could happen had I not timely realized what's wrong with UNG, and other similar paper based ETF funds. Unlucky for many investors who still buy such paper ETFs thinking they are investing on the right thesis of bullish commodities, or bearish US dollar. These investors suffered great losses and will continue to suffer losses in the future, until they realize the problem with owning paper, or untill they lose all their money, whichever comes first.

Notice what the prices of crude oil and natural gas were doing, since the low of March, 2009, and what were the share prices of USO and UNG doing, during the same period? Do I need to bring your attention to what FAZ and FAS has been doing over the long term? They are supposed to be a pair of opposite financial ETFs and they are supposed to run in the opposite directions, but over the long term, both run down. Same story with UUP and UDN, the dollar up and dollar down funds. In short term they indeed run opposite to each other, but in longer term, both runs in the same dorection: downward. All those are paper instruments based on nothing but mere promises made by counter parties. So why should any one expect to make money out these papers? Why do you think those counterparties are nice Santa Clauses ready to deliver profits to you happily? They don't. These paper instruments are gamblings, not investments.

There have been recent criticisms on UNG, on GLD and on SLV, and even on USO. I share some of the criticisms on these ETF funds. But no one on Seeking Alpha has really touched the more fundamental reasons why paper-based, or promise-based ETFs, are fundamentally wrong as investment vehicles, regardless of the bullish fundamentals of the underlining commodities.

When it comes to investments, if you don't hold it, you don't own it. Please pause and think about it. Hopefully you learn something. Hopefully next time Mr. Jim Rogers tells you to buy agriculture commodity future's contracts, you can help me to explain to him why he was wrong; why people should not buy this index or that index, or this or that ETF, or buy future contracts or other derivatives. Hoarding the physical stuff is the only correct way to invest in a commodity.

I still remember when I first pitched physical tellurium investment, many analysts, some well known, immediately asked me where they can buy tellurium futures contracts. I should have told them that I am quite happy to write up and sell them some tellurium futures contracts, at good prices, but they are not going to make money out of me. If you want to make money from tellurium, you have to purchase and hoard physical tellurium, just like I did. It is true for all commodities. It is true for all investments. If you don't hold it, you don't own it.

Therefore I reject virtually all ETF investments as legitimate long term investment vehicles. If you want to invest in precious metals, you have to own the real metals, or own stocks of the related mining companies. I am happy to see that I am now vindicated and will continue to do well in my insistence that palladium will be the best precious metal to invest in, and my insistence on the only known primary palladium producers, SWC and PAL. It was not a love affair. It was a firm conclusion from my own objective investment analysis. I just wish that if investors are bullish on palladium, they should go out of their ways and purchase any ounce of physical palladium they can find, instead of counting on buying palladium future contracts.

Full Disclosures: The author owns SWC as the largest position on his investment portfolio, and is invested in physical palladium metal. The author does not have position in USO, UNG, GLD, SLV, FAS, FAZ, TBT, UUP, UDN, and does not intend to enter any position either. Although the author hoards physical tellurium and is skeptical of FSLR, he holds no position in FSLR.

Unwinding of Currency Swap = Looming US Dollar Crisis!

The Daily Gold blogger Harvey Organ reports that ECB and other Central Banks are terminating the currency swap with the US Federal Reserve Bank as of Feb. 1, 2010. How they are going to unwind the currency swap is something very interesting to watch. It could finally trigger the long expected US dollar crisis: Collapse of the US treasury market and the US dollar itself.

In a currency swap, two central banks print their own currency out of thin air and swap them in a zero interest loan according to the exchange rate. Then after a period of time, they return the loaned currency to each other. For example the FED will loan US dollars to Bank of England (BOE) while BOE loans British Pounds to the FED. Upon the end of currency swap agreement, they unwind the trade by the BOE returning the US dollar, and the FED returning the British Pounds.

The question is how they are going to be able to unwind? The total swap is believed to be as high as US$500B. Some say as high as US$2T. If the central banks merely locked up the cash in a vault, they could easily return the money. But that would defeat the whole purpose of currency swap. Instead of being locked up in a vault, the swapped currency must have been SPENT in some way. Then the question is how do they get the money back if it is already spent, sold out or otherwise given away?

For example I long suspected where did the British get the money to buy US treasuries over recent times? According to latest official data, UK's holdings of US treasuries was up $145.1B in 12 months, while China's holdings went up only $76.4B.

Where did the UK get the money to buy US treasuries? Unlike China which earns US dollar from its trade surplus against the USA, The UK has a huge trade deficit against the USA. It spend US$2 buying US goods for each US$1 it earns selling products to the USA. Where did they get the US dollars to purchase US treasuries? If it was not from trade balance, it must be from the give out by the FED, in the name of currency swap. It cost UK nothing to print British pounds and then exchange for the dollar, just like it costs the FED nothing to print the dollars.

In a sense, FED is secretly buying our own debts through foreign hands, via the currency swap agreements!!!! Now, how is the currency swap going to be unwinded? What magic are they going to pull this time, asn the BOE has already SPEND out the US dollar in buying US treasuries. It does NOT have the money to return to the FED.

Likewise, probably the FED does not have the money to return to BOE either. They must have spent out the British Pounds as well as other foreign currencies, in repeated attempts to sell foreign currency and buy US dollars, to support the dollar, in recent times.

It's going to be fun to watch how the unwinding can be done. If my speculation is right, BOE must sell its holding of US treasuries to raise US dollar to unwind the loan, and the FED must also need to sell dollar and buy British Pounds to unwind its loan as well. Both would be fatal blow to the value of US treasury and US dollar.

Time to run to precious metals as your financial safe haven. Don't run to euro, as the eurozone is crumbling down. Don't run to Japanese yen. Japan has an even worse debt problem. When Japan collases under its debt it must sell US treasuries to salvage its own currency, which will trigger a domino effect leading to the fall of the dollar. The only thing safe are precious metals and commodities.

But unlike most other precious metal bugs I will not tell you to run to gold, or silver. Every one talks about gold as if it is the only safe haven. When every one talks about one thing, be careful. The world is not in shortage of gold. The world has plenty of gold that could easily lasts a couple thousand years if we do not produce gold any more. Warren Buffet famously critized gold by saying that you dig out the metal from the ground, and then dig another hole to hold up, and have to pay armed guards to watch it, what for?

I am also questioning the wisdom of silver investment. Silver bugs have been calling for silver shortage for years. But I never see any solid data to back up the claim of shortage. If there is no shortage, if a precious metal's price is only supported by investment demand, then there is a problem because anything that is purely supported by investment demand, is by definition a bubble, the investment demand could easily turn into investment supply in an instance.

The only good precious metal investment, must be one which is based on REAL industrial shortage, not by the hypothetical investment demand. If there is an industrial shortage, the price MUST go up regardless what investors believe. And price movement due to real shortage, on the other hand, can create solid and reliable investment demand. Such precious metals will provide the best performance way much better than gold.

The only two precious metals I see solid data to support a supply shortage case, are platinum and palladium. Of course my favorite is PALLADIUM. My most favorite mining stocks are Stllwater Mining (SWC) and North American Palladium (PAL), the only primary palladium producers. Russia's Norilsk Nickel (NILSY.PK) is world's largest palladium but they are mainly a nickel producer. South Africa's Anglo Platinum (AGPPY.PK) and Impala Platinum (IMPUY.PK) produces by-product palladium. Watching Platinum Today on related PGM metals news, and KITCO for price movements.


The parabolic price rally of palladium in the past one year, a performance that is far better than gold, silver and platinum, has vindicated my conviction on a palladium bull case.

Why palladium? FOUR things make palladium extremely bullish:

1. Termination of Russian government palladium stockpile sale, due to stockpile depletion.

2. Looming South African electricity crisis could strike again any time, just like two years ago.

3. Launch of ETF Securities physical palladium fund (PALL) in the US market.

4. Long term potential of palladium used in Cold Fusion, make it a must have strategic metal.

I have discussed these points in many of my past articles which I will not repeat. I merely needs to point out that Impala Platinum's PGM Supply Demand data confirms dramatic reduction in Russian palladium supply, as the stockpile sale has ended. There is now a big strictural deficit. Read more detailed discussions on GIM forums.

I do not have to cover the recent launch of ETFS platinum and palladium funds, either.You can see the powerful price surge of palladium recently, and read what fellow SA contributors have to say:

Why Gold ETFs Should Be Afraid of Platinum Cousins
Platinum and Palladium ETFs: Dare They Outshine Gold?
Platinum, Palladium ETFs Are a Home Run
Pent-Up Demand Is Behind Platinum Fund's Success
New ETFs Off to Roaring Start
Don’t Blame Platinum, Palladium ETFs

Sadly, even though people have caught attention to platinum and palladium. There has been absolutely NO mentioning of the end of the Russian palladium stockpile sale, and how palladium rallied from $300 to $1100 in 2000 merely because of a FALSE rumor related to the stockpile sale. Nobody mentioned the South African electricity crisis either, even it triggered quite a rally in PGM prices in early 2008, and another South African electricity crisis is looming again in the near future. Please read the background discussions.

And yet most people don't even know about platinum and palladium. All they know is gold gold gold, silver silver silver.

Let them have gold. I want to have palladium. And I can not own enough stocks of SWC and PAL. I have been predicting and advocating for a super bullish palladium rally for almost two years. No one paid attention until it really happens.

But this is just the start! The real fun will begin when auto makers realize what's going on in Russia and South Africa, and start to panic hoard. If it were not for the foolishness of major industrial user like TOYOTA(TM), GM and FORD (F), rhodium would never see gigantic price swings from $300 to $11000. Shouldn't industrial users acquire and keep a plentifully large stockpile when rhodium was at $300, so they do not need to pay $11000 an ounce a few years later? They never learn.


Full Disclosure: The author is heavily invested in palladium mining stocks SWC and PAL, and own PALL. The author owns silver mining stocks like CDE, SSRI, PAAS but have no interest in ETF funds GLD and SLV, as I do not trust their gold and silver holdings.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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


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


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

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

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

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

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

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

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

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

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

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

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

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

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

Hot Money, Hot Commodities and the US Dollar Carry Trade Part 2

In the last part of the article I discussed the reason why the collapse of the US dollar is all but inevitable, but the US economy itself will be strong enough to survive. Let me say it again, collapse of the US dollar does not equal to collapse of the US economy. If the dollar becomes worthless, Microsoft (MSFT) or Intel can sell their hardware or software products for gold or coins. They can still manage to make a profit, because the world still want their products.

How do investors protect themselves during a currency collapse?

First, the majority of investors and the majority of average American people will be wiped out financially. That is a FACT of mathematical statistics when a country's currency collapses. Majority of people will be wiped out, but a selective few in the minority will be able to rip huge profit from the crisis. If you want to protect yourself, you can not be with the majority. You must be with the minority group of people. Do NOT let other people do the thinking for you.

So are you listening to the most popular economic analyst or the most popular financial TV host? If you do, you are in danger because you are together with the biggest group of fools! You find safety when you are forced to jump from a big boat to a small boat, not the other way around. Just ask Titanic survivors how they survived. They jumped onto very small boats instead of wait for something bigger than Titanic to come to their resque. Safe havens must necessarily be small and can not accomodate too many people.

Commodities are the only safe haven. As Jim Rogers said, commodities are the only asset class with fundamentals impaired, but improved. But there are lots of myths in the commodity investments. Even Jim Rogers himself had also spreaded some incorrect myths regarding commodities investment. Most people do not know how to invest in commodities because they have not even once laid their fingers on any physical commodity. The only thing they have ever touches is a computer keyboard and mouse. A computer and a brokage account is all you need to invest in commodities, right? Wrong!

The door for commodities investment is extremely narrow. Let me tell you a small story. I am a big fan of tellurium investment and hoard actual physical tellurium. The price low of tellurium a few years ago was about $10 per pound, recent high was about $140 per pound. I predicted tellurium price could go to multiples of gold price once phase change memory goes into wide application. Almost every one laughed at me. Some, a few, did take me up seriously but they ask me NOT where to buy the physical tellurium, but rather, where to buy paper future contracts of tellurium, or what mining stock they can buy. When they hear that these two investment instruments do not exist for palladium, they left with disappointment. Most market traders do not know what to do with physical asset. They would rather prefer the convenience of pushing a computer button to instantly buy and sell something. Till this day, I think there are far fewer tellurium investors than people who understand Einstein's Relativity.

I believe that pure computer trading is the wrong way to invest in commodities. To invest in commodities you HAVE to get your hands dirty and lay your hands on the physical things. Let me explain using the example of the United States Natural Gas (UNG) fund.

Recent dismay performance of UNG gave me pause to think about how to invest in commodities. Natural gas spot price recovered from the low of about $1.84 to now nearly $5, almost a triple, but the share price of UNG still struggles around $10. Why is UNG not tracking the price of the natural gas itself? The simple answer is it's killed by contango. But there is a deeper reason.

UNG does not hold the physical natural gas. Instead they hold futures contracts. In theory, when natural gas price goes up, the asset value of these futures contract also go up. But in reality such methodology is flawed. You are holding future contracts that you never intend to take delivery. So near the expiration of the future contracts, you are forced to sell them, at any low price. Mean while you must buy the next month's future contracts, at whatever high price they are offered. As a result, in each round of the roll-over, UNG loses positions and loses money.

More over, the more investors are interested in UNG, the worse a situation UNG finds itself in. (Remember, the bigger crowd is always the loser!!!) During each roll-over, UNG could be purchasing more future contracts than producers have products available to write those contracts, hence it bids up price on the buying end. Then it turn around to sell the future contracts to industry consumers, it has more to sell than the industry consumers can buy, hence it pushes the price down on the selling end. How could you not lose money? It's like two mechants compete with each other. They bid the price up purchasing produces from the same farm, and then cut each other's throat to sell to customers at super low prices. Both lose.

Since UNG purchases future contracts that it never intend to take delivery, conceiveably on the other end of trade could be some one who write future contracts that he never intended to deliver, as he does not have the product to deliver. As no delivery is ever demanded, such paper future contracts can be created out of thing air in unlimited quantity to "meet" investment demand. Basically one side provides empty promises of supply, the other side provides false demand that never materializes. This is nothing but a zero sum game. One party's loss is exactly the other party's gain.

Therefore it is flawed to believe that trading future contracts is investing in cmmodities. It is NOT. Future contracts are derivatives with which the two sides gamble against each other. The commodity may be bullish, but you have a 50/50 chance to beat your counter party to win.

If you are interested in commodity investment, do NOT buy paper derivatives, whose supply is unlimited. Buy the physical thing, which is limited, and take delivery.

Now from a fundamental point of view, every investor needs to ask: If I invest in something and I gain, WHO pays for my profit? You are not the FED so you can't create money out of thin air. If you make a profit, then some one or something must be paying you that profit. If you buy a stock and make money, it's because the business of the company generates revenue and income, or because another investor pays you more than your original cost. I invested in physical tellurium because I know some years down the line, First Solar (FSLR) or Intel (INTC) will pay me gold price to buy my tellurium hoard.

But who pays for your profit when you invest in a commodity? Do your fellow investors pay you? If so it sounds like a Ponzi scheme. It has to be industry users of the commodity that pays you the profit. The only way for you to get paid by industry users, is for you to participate in the supply and demand of the commodity, for you to become a physical demand and then a physical supply. That means the only sensible way of investing in commodities, is for you to take physical delivery, hold for long term, until the price is higher, then you sell to the industry users.

Once again, The door for commodities investment is extremely narrow. Most of supply and demand have been directly negotiated between industry suppliers and industry users, leaving you no opportunity to participate in the market. Natural gas is a good example. The opportunity to store natural gas is virtually non-existant for outsider investors. Any gain or loss is likely directly settles between industry suppliers and users, and that leaves investors out of the natural gas business and unable to rip profit from the price appreciation.

So if you think investing in commodities is as easy as pushing a computer button, and you do not have to deal with the huzzle of buying/selling, transporting and storing the actual physical stuff. Please pause and think again. WHO PAYS YOUR PROFIT if you are not taking all the huzzles?

For this reason I am inheritly suspicious about all sorts of commodity ETFs, like GLD and SLV. Particularly SLV. Read my previous Instablog regarding some red flags in the SLV fund. What troubles me is that these nice folks help you to take care of all the sweating and laboring to handle the physical stuff, and allow you comfortably making profit sitting in front of a computer. It just sounds too good to be true.

(to be continued...)

Full Disclosure: The author is long precious metal palladium and silver, hold big positions in palladium mines SWC and PAL, as well as SSRI and CDE. I hold shipping stocks like EXM, EGLE, TBSI, DRYS, and small positions in natural gas fund UNG. I short the US dollar by holding some long positions in margin brokage account.

The Inflation/Deflation Debate and China's Commodity Carry Trade

The inflation vs. deflation debate is heated up again. The debate looks far from being settled, even among professional investors. The average Joes are probably more clueless. This may be the single most important debate in the investment world.

Jim Rogers, Peter Schiff, James Sinclair, Gerald Celente, Marc Faber and Congressman Ron Paul are on the inflation camp. The argument is simple: As the US government racks up trillion dollars of deficit spending, the money can come from neither raising tax, nor borrowing. So the only way out is print money out of thin air. In history, any time a government chooses to solve its fiscal problem through massive money printing, it always leads to hyper-inflation at the end. So that is going to happen. It might be postponed a bit but can not be avoided.

But I will not immediately dismiss the arguments from the deflation camp, either. Well known people on the deflation camp includes Mike Shedlock (MISH), Nouriel Roubini, and market ticker Karl Denninger. They present three strong arguments for deflation:

1. Credits are destroyed in the ongoing de-leveraging process. Credits are circulated as money so the destruction of credit means less liquidity in the system.


2. Although the government is massively printing money, most of the newly printed money is just hoarded away in the vaults of banks and do not enter circulation.


3. Where is the inflation today? It's no where to be found!

Debunking the second argument is simple. Banks keep a high reserve because they are highly leveraged and they fear a bank run. If banks hoard cash instead of extend consumer credits, people will have to withdraw cash so they have the money to spend. Such a bank de-leveraging process could escalade into a bank run, resulting in the destruction of the banks and massive release of cash into the general circulation.

De-leveraging of the financial derivatives bubble does not cause deflation. Look at the history of Dutch Tulip Mania and the subsequent collapse. Did it lead to price inflation and deflation of things unrelated to tulips? Of course it didn't. The Dutch grocery stores never took a flower as a payment for milk and bread. Can I use a credit default swap to pay for milk and bread today? I can't. Inflation is a currency phenomenon. It has nothing to do with leverage.

De-leveraging is the process that people abandon paper assets due to counter party risks, and turn towards physical assets with no such risk. Physical assets have intrinsic values: the marginal costs to replace them and maintain an adequate supply. So in the de-leveraging process, paper assets will lose value, and physical assets will gain value. The US dollar is a paper asset. The dollar is leveraged on the full faith and credit of the US government on its ability to pay off its huge amount of debts, which frankly does not look good at all.

The world knows the US dollar is going down. Chinese students laughed loudly when Tim Geithner told them China's US dollar assets are "very safe". Many very rich and successful Americans know the dollar is going down. People like Jim Rogers are moving their assets out of the US dollars and into China and other places. No wonder the US government is cracking down on Swiss Accounts owned by Americans.

So here is your answer where is the inflation. Blame it on guys like Jim Rogers are selling their US assets! Jim Rogers is a billionaire. He sold his house in New York, therefore New York real estate collapsed. He sold his furniture, sofas and tables and chairs, so that brings the furniture prices down. He sold his US stocks so the US equity market is down. He sold his stuff for US dollars, and bring his dollars away from the US soil, and into China. Jim Rogers drains liquidity from the US market, thus prices of everything drop :-) Speaking seriously: This is an ongoing BANKRUPTCY LIQUIDATION SALE, not a deflation. The low prices will not last.

I told you that is exactly what happened, in my last article. Liquidity is drained from the US market because smart capitals are escaping from US soil to look for opportunities in places like China. This is a huge liquidity drain from the US. But it also causes headache for the Chinese. They need to deal with all the "hot money", the US dollars flooded into China to be exchanged into Chinese Yuan, as speculators are betting on Yuan appreciation over the dollar.

In other words, currency speculators are EXPORTING our inflation to China by draining the liquidity from the US and bringing hot money to China.

How China handles the massive inflow of hot money? China simply print their own money to soak up all the inflowing US dollars. It costs them nothing to print the Yuan to buy the dollars, and they can spend all the dollars to purchase physical assets and raw materials around the world. This is the Commodity Carry Trade they are playing, very successfully.

Few people in the west recognize China's real strategy. They thought it is impossible for China to sell the dollar and exchange it into euro or yen. Why would China sell one paper just to exchange for another paper? They thought China's recent commodities buying spree is to merely boost price to help domestic producers, or to stockpile for strategic safety. But China's buying of aluminum, a material that China has plenty, signals that it goes far beyond strategic hoarding. Commodities ARE China's new foreign exchange reserves. China is not selling the dollars, China is SPENDING the dollars.

With continued inflow of US dollars, and with China's own money printers running at high speed, China has plenty of money to spend and continue the buying spree. With Yuan tightly pegged to the dollar, this game can continue indefinitely until currency speculators stop sending the dollars to China. Then the US will go from being the largest exporter to the largest importer of inflation, over night! All the dollars will fight their way back home at once. Goods and raw materials will flow out of the USA, until this land is ripped barren! I predict many people will be voting with their feet, before the nightmare scenery occurs.

The currency speculators did the wrong thing selling dollars buy the Yuan. The dollar is going down, but so will the Chinese Yuan. Investors should go to physical commodities, not Yuan or any foreign fiat paper money.

Some Chinese already realize that the Yuan is losing purchase power. In recent months, there was a SUDDEN turn up in real estate markets in major cities in China. The housing slump turned into red hot housing boom, literally over-night, caught many people in a big surprise.

Unless you read news in Chinese, you might think I was telling a fairy tale. But it is absolutely true. There is a sudden housing boom; an auto sales boom; a boom in bank loans. Mean while China could NOT sell its own treasury bonds. What does that tell you? China could not borrow a mere Y28 billion Yuan (US$7B) from its own people. Why would China be able or willing to extend another trillion dollars of credit to the US government?

Jim Rogers is absolutely right that commodity is the only asset class whose fundamentals have not been impaired, but improved. One of the best sectors to play the Chinese commodity buying spree is dry bulk shipping, as China's global buying spree is far from over.

Stocks in dry bulk shipping include the follow names:
EXM, EGLE, TBSI, DRYS, GNK, DSX, NM, OCNF and SBLK.

There is a shipping ETF called SEA. Do your own due diligence on specific positions.

Raw materials that China does not produce, but are critically important to China's economy, are the best commodities to buy. This includes platinum group metals, platinum and palladium; aviation metal titanium; battery technology metal cobalt. My best favorite is the palladium metal, and palladium mining plays: Stillwater Mining (SWC) and North American Palladium (PAL). Recently Andrew Snyder published an article pitching palladium as a critical metal for China, and SWC with a potential of 1,389% gain, without naming the names! I am not sure any one knows what China's next big purchase is. But it is a fact that palladium is one of the critical strategic metals that any modern country must stockpile. Look at TIE as a titanium play, and OMG as for cobalt play. I also recommend buying physical cobalt.

If you are interested in rare and strategically important metals, then follow Jack Lifton, a regular writer for Resource Investor. Jack's article on tellurium got me first interested in the metal. I actually bought some tellurium. Read a recent article on First Solar (FSLR) and tellurium: Hard to Find, Easy to Smell. It's amazing that FSLR still holds up well today and there is still no rush to buy tellurium. But as I predicted, Samsung bets big on tellurium based Phase Change Memory. The chip is already in commercial production. I recommend shorting FSLR if it raises near $200 a share. If you hold long or short position in FSLR, you have a fidelity to your money to demand the truth from FSLR on their tellurium supply.

I have high respect for Jim Rogers. But I have a huge disagreement with him on his love of agriculture commodities. I know his agriculture love is very influential and a lot of people agree with him. But I must point out that he is completely wrong on agriculture. In terms of dollar or any fiat currency, all commodities are bullish. But in terms of growth potential in real purchase power term, agriculture products will perform near the bottom, only better than gold.

I don't like gold (GLD) at current price at all. As the world is facing so many resource crisis, I can not understand why the world as a whole still dedicate a lot of efforts digging a metal that is least useful, and least in shortage. Sell gold to buy silver, physical silver, not SLV. After I carefully scrutinized the silver bars list I do NOT believe SLV has the actual silver bars.

On agriculture: granted that the world sees a food crisis looming; granted that every fact Jim Rogers cited is correct: Farmers can't get loans to buy fertilizer; Asian countries eat more meat; And that food is the single most important human need. Despite all these facts, Jim Rogers is still wrong on being overly too optimistic on growth potential of agriculture products.

Jim Rogers doesn't know how the poorest people in the world are struggling to feed their families. There is demand destruction. The poorest people in the world are already spending 80%, 90% or more of their income on food. Farmers could barely make any profit raising their cattle. If food price doubles, do you think the poor people will have more than 100% of their income to spend? Or a farmer can spend more to feed their cattle? No! Poor people will have to buy less and eat less, and farmers will have to slaughter their cattle.

Such demand destruction can quickly reduce food demand, and hence it tightly caps the price growth potential of agriculture products. This is why agriculture products will never be the most bullish of all commodity plays. Agriculture is still bullish, not bearish, but the growth potential is simply unattractive. A number of rare metal plays can easily beat any agriculture hands down.

My last article called to buy United States Natural Gas (UNG) fund. I was a bit premature. But at current price level, UNG has no more down side and plenty of explosive upside potential. A recent EIA report noted an important trend: At current low natural gas price, it could become economically incentive for power plants to switch to burning natural gas instead of coal to generate electricity! Please read that document carefully. If power stations switch from coal to natural gas, the huge demand boost will put a rock solid bottom at current natural gas price. In comparison, I will caution about adding position on US Oil Fund (USO).

Full Disclosure: The Author is heavily invested in palladium mining stocks SWC and PAL. I also hold significant positions on shipping stocks EXM, EGLE, TBSI, DRYS, GNK, as well as positions in UNG. I hoard physical tellurium metal but have no position in FSLR.