China and the World Drives the Commodities Boom

The Baltic Dry Index (BDI), a shipping index considered as one of the most reliable global economic indicator, has been surging up for 17 consecutive days as of Feb. 11, 09. It's not often that something just keeps going up for 17 days. The strong rally of BDI has caught a lot of attentions. However, dry bulk shipping stocks like DRYS, EXM, EGLE, GNK, TBSI and NM plummeted instead of moving with BDI. What's going on? Let me digress a bit on the big pictures before talking about specifics of shipping fundamentals.

Most people remain skeptical about the outlook of the BDI, despite of 17 days rally. Trader Mark asked "What's Really Going On". Most believe the BDI rally will be short lived. So when BDI finally dropped for two days, Bespoke Group declared "BDI rally is DEAD"!

The skeptics are wrong because they only read the news headlines but failed to study the real reasons of the BDI plummet in 2008 and strong surge back recently. They do not know the fundamental forces behind the global commodities boom and China's emergence as a major economy. The skeptics failed to predict a rebound in BDI so soon and so powerful. I correctly called the bottom and called for an imminent and powerful rebound of the BDI as well. So I am comfortable to call the skeptics wrong and predict continued surge of BDI.

Skeptics are wrong because they know what's going on in the USA, but paid little attention to the rest of the world. Chinese knew even less about the world 30 years ago. There was no TV, no telephone and you were NOT allowed to listen to foreign radio stations. Today, China has more internet surfers and cell phone users than the USA has population. Chinese teenagers are bigger fans of America's Hip Hop than American teenagers. One rich Chinese farmer bragged to live in an exact replication of the White House, down to small details. The Chinese are eager to learn everything in America and Europe, and try to imitate everything.

The internet brought easy access to information and profoundly changed China and the world. INFORMATION, not idealism, is the fundamental driving force behind the global commodities boom. China is not alone. Changes are also happening in India, Brazil, Russia, and even in the African continent. An isolated African village could remain in a primitive lifestyle indefinitely. But once they have a TV or a computer or just an outside visitor, they will learn about the outside world. They will want a better life and they will be eager to learn to acquire knowledge and work skills. They will produce something to exchange for useful products from the rest of the world. The chain reaction will leads to more developments and more demands of the world's raw materials. As I discussed before, it all started with one Chinese's visit to Texas and a cowboy hat, and now it becomes a global trend no one can stop.

INFORMATION drives the global commodities boom. The current global financial crisis, severe as it is, will NOT last as long as the Great Depression. Easy access of information allows capitals (smart money) to quickly discover and relocate to new investment opportunities.

Many Americans believe the collapse of the US economy is the end of the global economy. But we are not the whole world. The rest of the world can live on without America. The danger America faces is that the rest of the global economy can continue to boom without us, as capitals flow away from American soil to find opportunities overseas. The Obama administration's new stimulus package WILL boost demand for sure, for a while. But will it bring home capitals to generate jobs, or rather drive capitals and jobs to overseas?

President Obama: I challenged you to bring home Jim Rogers, America's best known billionaire refugee. If he comes home with his money, we have hope. If he stays in Singapore, I might as well leave, too. Please abolish FASB#157, "Mark to Market" rule immediately! There is simply no fair market value in an unhealthy, distressed and distorted market. There have been heated debate of M-to-M rule on the Bank of America (BAC) message board on Yahoo (YHOO) Finance. Abolishing "Mark to Market" is the only way to save banks.

The outlook of global shipping is bullish as China's 4 trillion yuan stimulus program is already taking effect. China's bank loans in January more than double the record set a year earlier. Steel price surged 41% from the low, indicating a booming demand again. More demand on steel means more demand on iron ore and more demand on shipping.

In recent years China's economic growth rely on growth of export to the US and Europe. But China's export remains a small percentage of its GDP. China can sustain its growth without exporting goods to the USA in exchange of US dollars. The 1.3 billion population can and will generate huge domestic consumption demand. China is pushing people to consume more.

China sells goods to the USA and then uses the dollars to buying US treasury bonds. China is basically lending money to America so we can continue to buy Chinese products. This is unsustainable and will not be sustained. Instead China should lend the money to African countries so that Africa can purchase Chinese goods and export their natural resources to China for a payback. I have been reading XinhuaNet (ChinaView) daily. This is exactly what is being discussed in China and what China is doing in Africa. Unlike the debt-laden and tapped-out US market, the African market is completely un-tapped. Africa can afford to borrow more money from China, put more money in their infrastructure building and consume more goods and services. Eventually a developed Africa can afford to pay back the debts.

The information age is narrowing the gap between people and between nations. The world doesn't even have enough commodities to satisfy the development of one China. So does the world have enough to satisfy an Africa and a South America in addition to China? The developing world is developing rapidly and looking up to a much better life standard. Does the world have enough ships to ship raw materials from Africa to China, and goods from China to Africa?

I am bearish on US dollar and US treasury bonds. I am bullish on commodities, on global shipping, and on precious metals, especially palladium. Please read my last article on palladium's fundamentals. I am heavily invested in Stillwater Mining (SWC) and North American Palladium (PAL), the only two primary palladium producers in the world. People do need to be cautious about precious metal ETFs: GLD and SLV. James Sinclair publicly questioned where GLD gets all the gold bullion. He should ask where did SLV get all the silver bars with low serial numbers (like 1,2,3). Buy physical metals, not ETFs!

Trader Mark quoted from a Lloyd's List article, which expressed skepticism that the freight rate surge could be short lived. These concerns raised must be carefully addressed:

1. Recent freight rate surge resulted from China restocking the import iron ore inventory. It will slow down as there is no evidence of increased steel demand.

Well, surely there is already strong evidences China's economy and demand on raw materials is recovering rapidly. Pay more attention to news from China!

2. Despite of a remarkable raise in percentage, the BDI at current 2000, is still far below the all time high last August at 12000.

Come on! No one expect the BDI to return to high level overnight. Nothing goes straight up or down. BDI did not fall from 12000 to 666 overnight. No one expects it to return to 12000 tomorrow. The surge from 666 to 2000 in just a few weeks is a more remarkable recovery than any one can expect. In geometric scale, the recovery is at 38% already. From 666 to 2000 is a triple. Another triple will bring it to 6000, just a leap short of 12000.

3. Huge back log of new ship orders. New ships entering service in 2009 and 2010 could expand the global dry bulk fleet by 40%, causing capacity oversupply. Refer to this article on details.

That's a good argument. But we should not take data out of context. New ships are entering service but old ships are being scrapped at the same time. During recent years of shipping boom, scrapping was almost none, as ship owners extended the services of old ships to profit from high shipping rate. Now the shipping rate has fallen, there is a sudden rush to send all the old ships to scrap yards, to bring in cash liquidity and enhance the balance sheets. In just two month, 4 million DWT tons worth of ships were sent to demolition, more than the last few years combined. Scrapping old ships is surely faster than building new ships!

Numbers from the UNCTAD review need to be taken in context. As of end of 2007, there were 10053 new ships and 495M DMT tons on the order books, including 222M DWT tons of dry bulk carriers. That was 72 times higher than it was in 2002. 72 times!!!

Global dry bulk fleet is about 600M DWT tons in size, so assuming a new ship takes 2 years to build, 222M worth of new ships will be build in two years, not counting scrapping, the increase of global fleet will be 222M/600M = 37%. That's how some analysts figured the 40% increase.

But the number is wrong! Average ship lifespan is about 20 years. So normal scrapping due to aging would remove 10% of the fleet in 2 years. The speed up scrapping of over-aged ships could remove up to 20% of the fleet in 2 years. Subtracting 20% scrapping, the increase of the global fleet is only 17% in two years even if all new orders are built.

But don't expect 222M worth of new ships in the next two years. Due to low shipping rate and lack of financing, more than 1/3 of ship orders have already been canceled. More are being canceled or delayed. Read Hellenic Shipping News, ship yards around the world are in very bad shapes. Many could go bankrupt without help.

Question: If shipyards had normal business in 2002. Now their order book is 72 times bigger than the 2002 level. That looks like an incredible booming business by any standard. Why are shipyards in bad shapes now? Even if 30%, 50% or even 90% of orders were canceled, the remaining orders would still be many times bigger than the 2002 level, not to mention the profit from cancellation fees. There are not a lot of ship builders in the world. The list easily fits on one sheet of paper. Global ship building capacity could not have increased too much from 2002 level, surely not 72 times! There is not enough space, materials, building capacity or financial backing to build 10053 ships at the same time, and deliver them within two years.

Some one must get the numbers terribly wrong. In any case, you can be rest assured that if ship builders are on the brink of bankruptcy, then we will NOT see any rush of new ships joining the global fleet in the next two years. More likely the global fleet will shrink instead.

Thus I encourage people to take advantage of recent shipping stock plummet. Buy shipping stocks like EXM, EGLE, DRYS, NM, DSX, GNK, TBSI, OCNF, SB and PRGN. I have not looked at all of them in details. But based on my study, my personal favorites are EXM, EGLE, DRYS and NM. Please do your own due diligence research.

Disclosures: The author is heavily invested in palladium producers SWC and PAL. I also hold big positions in shipping stocks EXM, EGLE, DRYS. I do not own other stocks mentioned.

Recent Developments in Precious Metals and Shipping

Gold rush 2009 is on! Gold is the front runner in precious metals so far. Gold is now only 10% away from its early 2008 high; silver is 39% off; platinum is still 57% off the high; palladium is still 67% off the 2008 high. Gold is the front runner and palladium is the laggard.

Don't buy the front runner, buy the laggard! Chasing the front runner and big crowds is the fastest way of losing money. Just look at recent bloodshed in DryShips (DRYS), a front runner in shipping stocks. I switched from DRYS to EXM and cautioned about DRYS in mid January, 09. So I was lucky to have avoided the massacre in DRYS. There are inherit problems in DRYS that are now exposed, but big crowd sentiments added to the severity of plummet.

Gold is currently the front runner of precious metal because most people intuitively know what is gold. But few people have heard about palladium. Recent stories from Russia and South Africa indicate that palladium and platinum has the most bullish fundamentals among precious metals, while gold has the weakest fundamentals.

First, palladium. Norilsk Nickel, producer of 45% of the world's palladium, just released the Q4 and full year 2008 production. The palladium production dropped to 2.702M ounces, much lower than the 3.05M ounces in 2007, even though the nickel production is in line with 2007. Norilsk expects another drop of 7% in palladium production in 2009 to bring it down to about 2.5M ounces. The reason cited is lower grade of PGM content in the ores. I explained before that Norilsk has two types of minerals: the one high in nickel and low in palladium content, and the one low in nickel and high in palladium. Due to current low nickel price, they must opt to mine the high nickel ores, hence produce less palladium.

Base on my calculation of their mineral ores grades, if they produce the highest nickel grade while maintaining the nickel production level, the 2009 palladium production could drop to only 2.0M ounces, from 3.05M ounces in 2007. More likely, Norilsk will be forced to cut nickel production to meet weaker global demand. In that case, palladium production could fall significantly below 2.0M ounces.

Adding to the bullish case is news from South Africa of a looming mining worker strike to protest against the job cuts. I think the mining companies there, hurt by low PGM prices, would LOVE to see the strike proceed so as to drive up the metal prices.

The bullish case of palladium can not be better. Look at the supply/demand picture starting with data from Impala Platinum (IMPUY.PK); we will be talking about global demand of roughly 8.215M ounces. On the supply side, South Africa can provide roughly 2.2M ounces if current production cuts are implemented. Russian will provide 2.0M ounces, North America will provide about 0.33M from Stillwater Mining (SWC), other sources count for about 0.3M, and there will be little recycling as low palladium price discourages recycling.

Summing it up; we are looking at about 4.83M in palladium supply, versus 8.215M in industrial demand, not counting any investment demand on the physical metal. The deficit will be 3.385M ounces, or 41% of industrial demand. No other metal has such a large margin of deficit!

Remember, a less than 4% deficit in rhodium was all it took to drive the metal from $300 to $10000 per ounces!!! What would a 41% deficit in palladium do, to the price? What would investors do, when they jump on the palladium shortage wagon and help drive up the price?

Remember, the Russian Government is trying to help Norilsk Nickel with its financial difficulties due to current low metal prices. There have been talks that the government will purchase some of the precious metals from Norilsk Nickel and re-stock the government's depleted strategic stockpile. The Russians can easily drive palladium price up to $2000, $3000 or even $5000 per ounce, if they so choose. I don't see why not! The Polar Bears are not Santa Clause! They want to make money just like every one does.

In 2000/2001, upon one false rumor that Russian government was terminating the annual palladium stockpile sale, the panic buying drove palladium price up from $300 to $1100 per ounce. There was only one investment fund noticed the palladium rally, and profited from it. At the time gold was at the low and there was no interest in precious metals as safe haven assets.

Today, it is a material fact that Russian government stockpile sale ended, and Norilsk's palladium production is down, and Russian government may be buying the metals to help Norilsk as well as replenish its strategic stockpile. And today there is plenty of interest in all precious metals as safe haven assets as the financial crisis unfolds. Rest assured there will be a lot more investment interest in palladium than last time.

It's not too late to buy physical palladium. And time to buy stocks of the world's only primary palladium producers, Stillwater Mining Company (SWC) and North American Palladium (PAL).

I am openly calling these two companies to consider how they can help the average investors to acquire the physical metal easily, and hence be able to participate in and gain from the coming palladium boom. I believe that the precious natural PGM resources are NOT the private properties of mining companies, but belong to the people. These two companies, blessed with the privilege to produce the natural resources, have the social responsibility that they must maximize the value of the metals they produce so as to pay back the community.

Likewise, the Governments of the USA and Canada have the responsibility to ensure any minerals produced from their soil must maximize the values and must not be sold below cost. If the metals are priced below cost, then the governments should purchase and stockpile these precious strategic metals. The Chinese government is already stockpiling strategic metals to protect its domestic mining industry and take advantage of recent low commodity prices. The US and Canadian governments must do the same for their respective national interests.

Now let's talk about gold. Current price of gold is about $900 per ounce. I believe gold is fairly priced as most gold mining companies are making comfortable profits. I believe there is now no good reason for average Joe to buy gold at this price. Joe makes $40K per year, or $28K after tax. He makes $112 per work day after tax. So to buy a one ounce gold coin, he needs to work at least 8 full work days to earn enough money for it.

Joe might as well take 8 days off to go prospecting for gold. Some gold prospecting web sites claim you can collect up to two ounces of gold a day. Sounds like a better deal than earning a salary to buy gold. Maybe California the golden state should have zero unemployment? Lost your job? Go prospecting for gold and you get yourself a job making tax-free real money.

The economic incentive to prospect for gold rather than to buy gold puts a reasonable natural cap on gold price, in terms of purchase power. But silver, platinum and palladium are different as you can NOT prospect for these other precious metals. So these other precious metals should have bigger room for gain. My only advice is stay away from ETFs like GLD and SLV. Instead buy physical metals and precious metal mining shares. I am suspicious of these two ETFs after I browsed through their physical metal bars serial number lists. I will not elaborate here. Spend your time scrutinizing the lists to see if you can find some red flags.

What about shipping and the recent bloodshed in DRYS? The Baltic Dry Index has been going up strongly for TEN consecutive trade days in a row, reaching 1099. The low was 666 on Dec. 4, 08. How often do you see something going up 10 days in a row? That says the shipping is recovering strongly. The plummet of shipping rate last year was largely due to credit crunch freezing up trading activities, NOT due to supply and demand. As the credit now eases up, there will be pent-up demand to clean up the goods previously piled up on harbors.

The short term outlook of dry bulk shipping is bullish, the long term prospect is even better, as governments around the world, particularly China, are ramping up gigantic economic stimulation programs. Governments can print money out of thin air. They print paper money not to hoard their own money, but to spend the money.

When governments spend money, every dollar spent is a demand on physical goods and services, just like average Joe's grocery spending. So it is really a moot point talking about consumers spending less and saving 3% of their incomes, when the governments are racking up deficit spending in the tune of multiple trillion dollars.

China is one big driving force behind growing global demand on commodities, as well as growing demand on global shipping, and will continue to be, for many years to come. It's not just a matter of economic development; it is a matter of China's very survival. That's because China is rich in cheap labor forces, but poor in critical natural resources.

As Jim Rogers correctly pointed out, China's very survival hangs in one thing: WATER. China's biggest engineering projects are all water related. The most famous one is the Three Gorges Dam, the world's largest hydro-electric dam. At its peak of construction, this one project alone consumes 1/4 of the world's cement and steel production.

But Three Gorges Dam is nothing comparing with another mammoth project that's already well underway in China, but little talked about in the western world, China's South to North Water Diversion Project, which is at least TEN TIMES as big as the Three Gorges project. It's been talked about for half a century but was only recently rushed through the approval by the People's Parliament in a hurry without much debate: There is simply not much to debate about: Beijing, with its 14 million populations, is depleted of water resources and desperately needs the water to quench the thirsty! It's a non-negotiable, survival issue!

The South-to-North Water Transfer Project was supposed to take at least half a century to finish due to its gigantic scale, but will be rushed probably in a decade, due to the urgency of the water crisis in Northern China. Just think about how much concrete, steel, construction machineries and materials this one project will demands from the world! The infrastructure projects in China will ensure a global commodity and shipping boom for many years to come.

What do I think about DRYS's recent plummet? The panic was caused by DRYS's disclosure that two banks notified it that it was in breach of the loan covenants, as the fair market value of its ships has fallen below a certain percentage of the debts, and that DRYS was trying to raise $500M cash by selling shares in the open market, hence dilute the share value.

I do NOT think the loan covenant thing is too much a deal. How do you define a ship's fair value? I think any physical property's fair value is its replacement cost. But the convention is use recent market transactions of similar properties to determine the "fair market value". I think such terminology is ironic! The market is never a fair place to begin with so the word "fair" and "market" don't come together. Why would it be a "fair price" when a ship owner is coerced to sell its ship far below inherit value, under financial stress? Such unfair price is then used as "fair price" to undercut the assets of every one else and force many more defaults and stress sells, further escalating the crisis. This unfair "mark to market" rule results in distorted values of physical assets. It is one of the culprits of current crisis in real estates and other sectors. It must be abolished and replaced by a "mark to cost" rule.

In light of the continuous surging BDI index, the value of ships goes up with BDI. Banks know this and they don't want to bring an unnecessary crisis on themselves. They will work with shippers to find acceptable solutions to the loan covenants. It's in their best interest to do so.

My biggest worry about DRYS is the ongoing sell of shares to raise $500M. This will greatly dilute the value of DRYS shares. How much dilution? No one knows. So even though DRYS has become much cheaper, I would advice wait a little bit till the dust settles, just to see how much the share dilution factor is. Mean while I believe other shipping stocks like EXM, EGLE, GNK, DSX, TBSI and NM are better buys than DRYS, until we know more about DRYS's share dilutions. For the same reason, avoid OCNF for now.

Full Disclosure: The author is heavily invested in SWC, EXM and EGLE. I also own shares of PAL, OMG, TBSI, DRYS and USO. I do not own other stocks mentioned but positions may change at any time.

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.

Precious Metal Fundamentals - Recent Developments

We live at a time where information, as well as ENTROPY, spreads at light speed. We must be able to use our own intelligence to discriminate and filter out the noise from the internet, otherwise the internet is nothing but a giant trash can. In this world with little trust left in the system, we can no longer trust the authority of any information source. Mr. Bernard Madoff has proven that higher authorities CAN tell much bigger lies for much longer time. Everything we hear must be scrutinized using facts, logic and reasoning. I spotted an internet fraud and developments so far proved me completely right.

Recently Mazda repeated its claim of their single-nano catalyst technology which cuts usage of PGM metals in vehicle catalytic converters by up to 70%. Their technology uses smaller PGM particles and a proprietary agglomeration prohibition material. As a PGM metal investor I always pay close attention to such news that may bring change to the PGM supply/demand fundamentals. So how much can we believe in Mazda's claim and how soon do we expect an impact on the PGM metals demand?

History is the best teacher! In 2002, Daihatsu, announced that they invented a perovskite based Self-Regenerating "Intelligent Catalyst", which dramatically cut PGM metal usage while making the catalytic converters more durable. The idea was pretty good. Frankly the 2002 Daihatsu claim was much more credible than today's Mazda claim. There were independent researches on the perovskite based self-regenerating catalyst at the time. Now six years later, where is Daihatsu's "smart catalyst" today? Has it leads to any reduction in autocatalyst consumption of PGM metal? Not a zilch! If Mazda's idea of reducing metal particle size could work, it would have been tried long ago. My physics background allows me to conclude confidently that the so called single-nano technology CAN NOT work reliably and durably. I do not believe it until they get an EPA approval.

I am not saying that Daihatsu or Mazda made false claims. But scientific researches and commercial applications are two different worlds. In reality, 99% of research advances never make it into commercial products. Those few that do make it into the commercial world, take a long time to get there, and could still be ultimately rejected by the market, for non-technical reasons. Inventor Thomas Edison got cold water poured over himself when he tried to patent one of his first inventions, a voting machine that can precisely tally up voting results. Why we struggled with hanging chads in 2000? Politicians would rather prefer Diebold.

Why recent PGM thrifting news only came from small Japanese auto makers like Daihatsu and Mazda, but never from bigger names like Toyota Motor (TM), or Johnson Matthey, who is responsible for 1/3 of the world's autocatalytic converters? Mazda is NOT setting its priorities right. Each catalytic converter contains about 4 to 5 grams of palladium, worth about $24 at today's price. How can they cut corners and sell vehicles with sub-quality parts to customers? There were so many complaints about defective catalytic converters that even EPA had paid attention. You think consumers will let you get away with it?

Auto makers should boost the palladium content in catalytic converters and make them reliable and durable. Green cars with reliable emission control should then be exempted from the costly ($60+) annual SMOG tests in California and other states. Consumers will welcome the saving of money and hassle as it is worth far more than the extra cost of PGM metals.

I am convinced that the bullish fundamentals of palladium are even better in 2009. Recently Impala Platinum (IMPUY.PK) updated their estimate of platinum and palladium supply/demand data for 2008. Notice the significant drop of Russian supply? The annual sale of Russian Strategic stockpile palladium, about 1.5M to 2M ounces a year, finally ENDED! Back on June 11, 08, the palladium market knee-jerked when Norilsk Nickel (NILSY.PK) merely suggested the termination of the stockpile palladium sale. Now it really ENDS, how will people react when it becomes widely known? Russia maintains a Defense Strategic Stockpile for its own war time needs, not for selling PGM metals below cost to the world.

In Impala's estimates, recycling accounts for 1.1M ounces of palladium supply in 2008. CPM Group estimated the recycling as high as 1.6M ounces a year. The good news is this supply will also be removed in 2009. A new catalytic converter contains about 4 grams of palladium. An old one has about 2 grams left. Recycling recovers about 75%, or 1.5 grams each, worth about $9 in palladium at today's price. The PGM recycling is a long complicated and costly process. At today's low price there is simply no incentive for recycling. Stillwater Mining (SWC) is better off dropping the PGM recycling business now and concentrate on mining. This can boost the metal's market price as well as unlock large working capital that was locked up in the recycling materials inventory, and hence enhance the company's balance sheet.

On recycling, more than 1M ounces of palladium supply are removed. Mining production also dropped significantly. Norilsk Nickel estimated the 2009 palladium production to drop to 2.6M ounces from 3.0M as they now mine the nickel rich and palladium poor minerals to reduce cost, as well as process third party nickel concentrates which contain no palladium. North America Palladium (PAL) shut the mine down earlier, removing another 0.280M ounces supply. South Africa also saw about 10% drop of palladium production, or 0.25M ounces. Stillwater Mining (SWC) also expects reduced production in 2009.

When you add up all the supply disruptions and halt of Russian stockpile sale, despite of a 5.3% drop in auto catalyst demand, we are looking at an unprecedented palladium deficit in 2009, far bigger than in any other precious metals. And we haven't added in potential investor demands! Who wouldn't want to buy some palladium if you know what's going on!

The collapse of PGM prices in recent months was NOT due to fundamentals; rather it was due to investment funds as well as big auto makers were forced to liquidate their precious metals holdings to raise cash. Especially General Motors (GM). Auto makers normally keep 6 months of PGM metals supply to weather any supply shocks. When GM struggled for its survival, it had to sell its PGM inventory at cheap prices. Now that GM says it can expect to survive without more government money. It's time for GM to rebuild the inventory in light of the looming shortage.

Palladium has by far the strongest fundamentals and the best potential for an explosive rally, among all precious metals. I still believe that due to the huge above ground inventory of gold, and the current price above the intrinsic value of production cost, the yellow metal has little room to gain in real value. Gold is a liquid and stable currency, but has no investment value if you are looking for gains.

I like silver better than gold. Silver is mostly a by-product metal so the supply is price-inelastic. As a safe haven investment, silver is more appealing to Joe-Six-Packs as it is more affordable, while gold is more appealing to rich people due to its high density of value. Most people on the GoldIsMoney forum believe silver is more bullish.

But none of the silver bugs even presented specific and quantitative data on silver supply and demand so I want to have a closer look. Photography usage of silver, which traditionally accounts for 1/3 of the demand, is now diminished as digital cameras replace analog ones. Sterling silverwares like spoons and goblets are also going into history. Industrial demand saw some increase in recent year but is uncertain as the global economy goes into recession.

The biggest uncertainty factor is silver jewelry. Silver jewelries are low end cheap jewelries. They are those cheap bling-blings you pick up in a mall or a grocery store when you happen to have a few extra dollars and you just like what you see. So in a sense silver jewelries are discretional spending items and are vulnerable in a slowing economy.

The high end jewelries made of gold, especially platinum and palladium are different from silver. They are rarer, and are more likely purchased as some special gift rather than casual spending. No one would buy a silver earring or necklace as an engagement gift, for example. Your fiance(e) will expect a diamond ring made of platinum, palladium or white gold. People will not tender their platinum wedding bands to pawn shops for cash, but they are perfectly happy to toss out old silver jewelry pieces.

Unlike PGM recycling, which is complicated and costly, recycling from scrap silver jewelries is simple and inexpensive as the materials contain high concentration of silver. Silver recycling remained at near constant high level over the past years, regardless of silver price. The PGM metals are different as low PGM prices discourage recycling and reduce the supply.

I believe silver remains bullish due to investment demand. But due to uncertainties in industry demand, I recently reduced my silver mining stock holdings in SSRI, PAAS and HL, and concentrated more on palladium mining stocks, SWC and PAL. The continued strong rally in Baltic Dry Shipping Index (BDI) shows I made the right call on the shipping sector. So I continue to hold large positions in shipping stocks, like EXM, EGLE, GNK, OCNF and DRYS.

Full Disclosure: The Author is heavily invested in palladium mining stock SWC and shipping stocks EXM, EGLE, GNK, OCNF and DRYS. I also hold positions in PAL, USO and OMG.

Opportunities in an Irrational Market Place

We saw another irrational knee-jerk market reaction on Jan. 7, 09. Oil price dropped more than 12% in a day in response to EIA's weekly inventory report, which shows an increase of 6.68M barrels. The un-warranted knee-jerk reaction shows the market interpreted the data completely wrong. If you scrutinize the data, oil price should jump up, not down.

Simply, if oil is being hoarded, of course the inventory will jump up. The data shows US oil imports of last week increased dramatically over the same week a year ago: 13.698M barrels a day versus 12.904M. So for the week an extra 5.558M barrels of oil was imported. If the USA is buying more crude oil, of course inventory will raise. When Americans are buying more, shouldn't the oil price be driven up in the international market? Inventory was up NOT because Americans are consuming less, but because we imported much more.

EIA report says oil products supplied was 20.1M barrels a day, down 2.9% from a year ago. Gasoline demand was down 2.2% from a year ago. Those are very small percentages. Early last year, due to high gasoline prices, many people switched to more fuel efficient vehicles. So it's not surprising that Americans may well be driving slightly more mileages but actually consume a bit less gasoline, simply because of better vehicle fuel efficiency.

I discussed in my last article that the fundamental demand on oil and automobiles have NOT weaken as mobility is a basic human needs, more important than even food. I cited the Great Depression story "The Grapes of Wrath" where a family lost everything but they kept the family truck as it was vital to the family's survival. The current weak auto car sales are merely postponement of demands, not disappearance of demands.

I did not sell my US Oil Fund ETF (USO) holdings during the panic on Wednesday. Shipping stocks like DRYS, EXM, EGLE, GNK, OCNF and NM all dropped heavily with oil, despite of the BDI index going up for the day. I used the opportunity to load up a lot more shipping stocks. My favorite now is EXM, because it is even more under-valued than DRYS. Hellenic Shipping News recently has a nice story about EXM. My initial entry into the shipping sector was on DRYS, but then I find that DRYS is a better known name in shipping. I would rather pick something a bit less popular. Why pay the extra premium just for a popular name?

How do you deal with an extremely irrational and volatile market, with stocks routinely move 10% up or down in a day? Just do NOT run with the mobs! Do things contrary to the group mentality. Buy on the dips, and NEVER set a stop loss sell order or panic sell. Why lose your positions to a computer, and then have to pay higher price to buy back the same shares? When people are selling in panic, it's good to buy. When people are complacent, then you should sell.

Not wanting to follow the majority is one reason why I was never interested in SPDR Gold Shares (GLD) and I recently get out of iShares Silver Trust (SLV) totally. I am always skeptical about the physical precious metal ETFs like GLD and SLV. The metals might actually be there as claimed. But they are not in your physical control. Someone else that you don't know, let alone trust, controls th0se metals. There is also counter party risks in these ETFs. I never understand why the banking Santa Clauses took all the trouble setting up precious metals ETFs and hire guards to watch the metals for you and help YOU make money without lifting a finger. Theoretically there can be one trillion shares of SLV held long and another trillion shares shorted. But the world does not have a trillion ounces of silver. You either buy and own physical precious metals and bury them in your backyard, or you merely own promises on paper.

Opportunities knock on the doors when you least expect it. Today I noticed something that shocked me. The trade volume of the E-TRACS UBS Long Platinum ETN (PTM) suddenly surged to more than 10 times the average daily volume, starting on Jan. 6, 2009, while platinum staged a remarkable multi-day rally. Some one must be buying the PGM metal massively.

I do not know what's behind the sudden surge of PTM trade volume. But I have done plenty of research in the PGM metals sector and I firmly believe the fundamentals of these metals are very bullish, despite of temporary set backs. I continue to hold a large position in Stillwater Mining (SWC), one of the world's only two mining companies who produce palladium as the main product. The other one is North American Palladium (PAL).

The sudden surge of PTM trade volume and recent strong rally of platinum and palladium prices are good news to shareholders of SWC and PAL. There have been some extreme daily movements of these two stocks lately, especially SWC's extreme price movement on Jan. 6, 09, which is also the first day PTM saw unusually high trade volume. I can only speculate that the price manipulation in SWC and the sudden surge of PTM trade volume could be connected.

I continue to monitor the coal sector even though I do not currently hold any coal mining stock. I believed that globally, the coal supply and demand was largely balanced, with a shortage of no more than 1% or 2%. The current economic downturn could well turn coal into a surplus, particular in the US coal market. I suggested that if you hold coal stocks like ACI, ANR, BTU, CNX, JRCC, etc., you should sell them in the next rally as the US coal market might be bearish in short term, although I believe coal has long term potential.

Surprisingly, international coal prices stabilized at not much below $100 per ton, and they are quietly trending up again, despite of oil price drop to recent lows. What gives? Maybe Europe figured that they need to rely more on coal as their oil and natural gas supplies become vulnerable. This is painfully clear after recent dispute between Russia and Ukraine shut down natural gas supply to a big part of Europe, causing panic. Predictably, Europe will need more coal and will need to import them from overseas. So the US coal market may not be bearish after all, if Europe starts to turn towards the USA to purchase coal.

But in such case, it's better to buy the shipping stocks at deep discount from their recent highs, rather than the coal mining stocks. The coal has to be transported by ships, right?

Full Disclosure: The author currently holds positions in SWC, EXM, EGLE, DRYS, PAL, OMG and USO. I do not own other stocks mentioned here.

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.