Friday, January 27, 2012

Coal's Weak, So Buy Peabody: ACI, ANR, BTU, CLD, PVR, WLT

Yes, that title seems counter-intuitive. Why buy a major U.S.-based producer of coal at a time when thermal coal prices are weak and the outlook for metallurgical coal is uncertain? Well, the reality is that it's only when coal markets look terrible, that Peabody Energy (NYSE:BTU) ever looks relatively cheap. While this leading energy company has more work to do in Australia than expected, today's prices represent a relatively good long-term entry point for patient and risk-tolerant investors.

Blame it on the Wombats
Peabody's fourth quarter was not especially strong, and it's mostly the fault of the acquired operations of Ma carthur Coal in Australia. Honestly, few analysts or institutional investors really care about the revenue of a coal company like Peabody, but it was up 26% from last year, with an 8% increase in tons sold and better than 11% growth from the U.S.

What analysts do care about are metrics like EBITDA, shipment volumes and per-ton profits. Shipments were up about 8% as reported and a bit more than 6% on an "organic" basis. Although shipments from the West region were better than expected and Midwest shipments were OK, shipments in Australia were a fair bit weaker than expected.

At the same time, operating costs were problematic. The West was again pretty good this quarter, but costs were higher than expected in the Midwest and the operating costs in Australia were higher because of significant cost overruns at Macarthur, which were about twice the operating cost per ton of Australia as a whole. This took a real toll on operating EBTIDA, and although the reported growth was good, it was more than 10% shy of expectations.

2012 Will Be a Year of Retrenching
Peabody acknowledged its problems with Macarthur on the call, and at least some of the problems seem attributable to former management not really running operations at peak efficiency. That's not altogether surprising, given that Australian coal companies have been under a lot of pressure to increase production, with costs being a secondary concern, to meet surging Asian demand.

The problems in Australia are fixable; they'll just take some time and money to do so. Consequently, profit expectations in Australia need to be a little lower for 2012, but these adjustments will pay off with better profitability down the line.

A Chill in Thermal Coal
Peabody supplies about 10% of the coal burned by U.S. utilities and the state of the thermal coal market is a significant issue for coal stocks these days. Natural gas prices have fallen so low that they're actually starting to crimp demand for Powder River Basin coal; this is definitely a bad thing for a PRB pure-play like Cloud Peak (NYSE:CLD). How bad are things? Prices are getting close to the cash cost of production and that doesn't happen very often.

Unfortunately, it's hard to say that things will get rapidly better. At current prices, PRB coal is still about one-quarter more expensive than natural gas and coal from Appalachia is about 70% more expensive. Although it's true that there's a limit to how much utilities can substitute gas for coal, Peabody management thinks upwards of 80 million tons could be in play in 2012, depending upon prices. For companies with more exposure to thermal coal, names like Cloud Peak, Arch Coal (NYSE:ACI) and Penn Virginia (NYSE:PVR), that's definitely a concern heading into the year.

The Bottom Line
Peabody does have a metallurgical coal "kicker," but the uncertain economic outlook in Europe and China may keep a lid on met coal pricing and take some steam out of Peabody, Walter (NYSE:WLT) and Alpha Natural (NYSE:ANR). Still, the longer-term outlook is fairly positive.

Based on past EV/EBITDA experience, Peabody shares ought to be trading somewhere in the mid-to-high $40s. That suggests 25% or so undervaluation; maybe not the greatest discount out there among commodities, but more than investors often get with a company of Peabody's quality. By all means, consider other commodity plays like copper and steel, but also consider buying Peabody at these levels, as a play on eventual price recoveries.

Why is Platinum Cheaper Than Gold?

In recent months there has been a near paradigm shift in the precious metals market that goes against basic market analysis of supply and demand. I'm referring to the recent change in which gold became higher than platinum. This shift occurred during last October and since then has proceeded with no clear end in sight.

Currently, gold is near $1,728, and platinum is at $1,608 per ounce, i.e. gold is nearly 7.5% more expansive than platinum.

During July/August the linear correlation changed direction and sharply fell to -0.5, i.e. a strong negative correlation between gold and platinum. This change came during the sharp rally of precious metals, when the uncertainty vis-à-vis the U.S. economy soared; this was stem, in part, due to the debate over raising the debt ceiling, and the announcement of S&P to downgrade U.S.'s credit rating. During that time when gold soared, platinum didn't react to this news in the same way and only slightly increased.

Will this change in which gold is more expansive than platinum will continue? For the time being, it seems that the answer is yes, but once the gold bubble will burst (probably in 2013), we should see a reverse in this direction and gold will become cheaper than platinum as it once was.

Funny Pic

Yellow Gold Looks Strong Again…

The stock markets had a very solid session. Most charts shot higher after Apple beat estimates Tuesday night surging over 10%. This set the tone for stocks Wednesday. Also the FOMC said they would keep interest rates low until mid 2014 and projected a 2% inflation rate which took the market by surprise. Looking at the 10 minute intraday charts of gold, silver, oil, and the SP500 you would think it was the 4rth of July with everything shooting higher.

My gut feeling before the FOMC meeting was that there would be no QE3 announced. This I figured would trigger the dollar to rise which in turn would put pressure on stocks and commodities. But the low interest rates until mid 2014 was the wild card trumping that scenario.

Trading around FOMC meetings always brings a heightened level of uncertainty to traders and investors. The news is unpredictable making that much more of beast to try and out smart. I personally do not trade on any news because of the added risk involved.

Let’s take a quick look at gold and silver…

The Weekly Gold Chart:

Gold has started to break out of its down trend and if it can hold up into Friday’s close then it will be a very positive sign for the shiny metal. It is still mid week and a lot can happen, so let’s see how it holds up and go from there.

The Weekly Silver Chart:

Silver has some work to do before it’s back in an uptrend on the weekly chart. I would not be surprised to see it catch up with gold and run toward the $35 resistance level in the next couple days.

Mid-Week Trend Conclusion:

In short, gold is on the move and in the next few weeks I figure we will be getting involved. Silver I think will unfold a little different from a chart pattern point of view, but I do feel there will be a buying opportunity soon also.

Looking more broad based we are seeing the stock market continue to make new highs with solid volume behind it while Crude oil continues to tread water.

Still Crashing: 2011 Was Worst Year Ever for Real Estate Sales

While the National Association of Realtors says the real estate trend for 2012 will be one of “continued slow growth” as we saw in 2011, the reality is that there is no growth.

It’s so bad, in fact, that 2011 was the worst year on record for home sales. You read that right. The worst year since records have been kept – a trend we warned of back in 2009 when green shoots were reportedly popping up all over the country.

Fewer people bought new homes in December, making 2011 the worst sales year on record.

The Commerce Department said Thursday new-home sales fell last month to a seasonally adjusted annual pace of 307,000. The pace is less than half the 700,000 that economists say must be sold in a healthy economy.

About 302,000 homes were sold last year. That’s less than the 323,000 sold in 2010, making 2011 the worst year on records dating back to 1963.

The median sales prices for new homes dropped in December to $210,300. Builders continued to slash price to stay competitive.

Still, sales of new homes rose in the final quarter of 2011, supporting other signs of a slow turnaround afoot in the depressed housing market.

Source: San Francisco Chronicle

Millions of homes remain in the shadow inventory, prices continue to drop even with interest rates at historic lows, and jobs – the real driver behind the ability to purchase a home – don’t seem to be coming back, despite an unemployment rate that is officially on the decline.

No matter how bad it gets, however, the corporate media’s cheerleaders will continue to try and convince us otherwise.

Homebuilders are slightly more hopeful because more people are saying they might consider buying this year. And home construction picked up in the final quarter of last year.

Although this decline was unexpected, it does not change the story that housing has likely bottomed,” said Jennifer H. Lee, senior economist at BMO Capital Markets.

Ian Shepherdson, chief economist at High Frequency Economics, said easier lending requirements, historically low mortgage rates and improved hiring all point to consistent, albeit slow, rises in sales in the coming months.

“A sustained rise in new home sales is imminent,” he said. “Homebuilders say so too, and they should know.”

People may be saying they might consider buying this year, but there is a difference between someone wanting to buy a home and having the ability to do so.

Housing, as we have vehemently maintained since the onset of this real estate crisis, is not going to bottom any time soon. We are looking at a decade’s long, perhaps longer, collapse of the U.S. real estate market.

Variable mortgage rates are going to continue to adjust upwards for those buyers who took them on in the midst of the boom, which means they will be paying more in monthly payments at the end of this year than they are today, putting even more strain on consumers who are quickly running out of savings and losing purchasing power for essential goods to monetary inflation.

On top of that, there are literally millions of homes in shadow inventories – homes that have been foreclosed on that, for all intents and purposes, aren’t even counted as being in existence.

Home builders are, naturally, going to say that a sustained rise in home sales is imminent. Does anyone really expect them to come out and say, “Hey, we’ve got a great house for you, but it may lose 20% in the next 18 months.” They will say whatever they have to say to make a sale.

Since the initial meltdown in sub-prime real estate the financial pundits, economists and industry insiders have been telling us things would get better, that we’re just about to turn the corner. These are the same people who argued that the sub-prime fiasco was isolated to just that sector of the market.

We now know that the problems were much, much bigger than that, yet the most influential media outlets, like the Wall Street Journal who last year penned Why 2011 May Be the End of the Housing Crash, continue to ignore (probably by design) what’s really going on.

Going forward, we may seem some positive real estate numbers, because prices don’t drop in a straight line. The long-term trend, however, is very negative for home values.

To get an idea of how bad it can get, just look to Japan. From peak to trough, their real estate bubble saw a collapse of 75% over the ten years following the burst in 1990. They have still not fully recovered.

We’re not immune to such a collapse. Expect the worst, because there is a strong chance this is exactly what’s coming.

Author: Mac Slavo
Date: January 26th, 2012

Gold To Hit $2,000/Oz By Third Quarter, Then Retreat – Barclays

Precious metals, paced by gold breaking $2,000 an ounce by the third quarter, should lead the commodity sector in 2012 with 20% gains by the end of the second quarter and up 21% for the entire year, Barclays Capital said Thursday.

In a research note, Barclays said after rising to $2,000 by the third quarter, gold likely will back off slightly.

Gold will still end higher year-over-year, Barclays said. Silver should have a similar trajectory, up in the first and second quarter, peaking in the third quarter. However, they see silver ending 2012 below levels recording in the fourth quarter of 2011. “Gold’s larger share in the S&PGSCI weighting means the double-digit growth expected for this year is a larger driver of overall returns,” they said.

Commodities have rallied stoutly in January, but they might be vulnerable to a setback near-term. As a whole, however, the main commodity indexes should rise in 2012 about 10% as China is able bring its economy down to a soft landing, the U.S. will continue to grow and worries over European sovereign debt will ease, they said.

In addition to precious metals, base metals should be the next-strongest price leader of the group. Base metals are forecast to show returns of 13.5% in the first half of 2012 and 14.4% in all of 2012. All base metals but nickel should rise, with several peaking in the third quarter before pulling back by the end of the year.

Energy prices are forecast to rise, with gains of 2.9% in the first half of the year, rising to 8.8% by the year’s end.

Agriculture markets, outside of cocoa, could see weakness in 2012, particularly in the second half of 2012. The agriculture markets might be the only sector to see negative returns in 2012, they said.

Commodity investment flows should also rebound this year, Barclays said. In 2011, investment flows were the weakest since 2002, with just $15 billion investment, down from $67 billion in 2010. In December alone, there were $7.7 billion in net withdrawals from commodity funds. The year ended with $399 billion total assets under management, which was up just $19 billion over the year prior.

“We believe commodity investment flows will rebound in 2012, but will not go back to the very high levels reached in 2009-10. An easing in the unusual factors which capped flows last year, ie, the European debt situation, along with what we expect to be an economic stabilization, should provide upside potential to commodity investments,” they said.

Barclays also expect correlations between commodities and other asset classes to ease this year. “Last year saw a pick-up in the correlations on the back of macro concerns and heightened volatility leading to a number of sell-off episodes across different markets,” they said.

“Negative roll yields” – or the drag on returns when investors have to sell a less-expensive nearby commodity contract and buy a more expensive deferred commodity contract to retain a position – should ease, they said.

This happens when commodity markets are in contango, or carry, meaning prices for the commodity rise as time goes on to reflect costs for insurance and storage. Backwardation happens when the nearby prices are more expensive than longer-dated priced. When that happens it signals strong immediate demand and usually tight current supplies.

“Negative roll yields are likely to become less of a drag on overall returns this year as tightness returns to several commodity markets, as supply struggles to keep up with demand. As a result, this should make commodities more attractive for first-time investors. The easing in negative roll yields is in line with a trend already observed through 2011. For instance, the negative roll yield on the S&PGSCI shrank from -11.8% in 2010, to -3.3% in 2011 and -0.2% YTD in 2012,” they said.

Peter Schiff’s Latest Gold Price Prediction

Speaking with GoldSeek Radio host Chris Waltzek this week, Euro Pacific Capital CEO Peter Schiff expects the re-inflation trade to dominate in an unprecedented way in 2012, as money mangers send oil, gold and other dollar-sensitive assets much higher in price, or at record prices, in their effort to flee the dollar.

In particular, the former U.S. senatorial candidate from Connecticut expects gold to reach its inflation-adjusted high of approximately $2,300 this year, citing the Fed’s reaffirmation on Wednesday that it intends to further suppress rising interest rates for another three years.

Schiff contends that the dollar will suffer greatly as a result, “fizzling” out of investor portfolios as the market realizes that the alleged dollar strength last year has been nothing but an illusion brought about by the euro’s relative weakness against the Greenback.

“In fact, it [U.S. dollar] is already fizzling,” Schiff told GoldSeek Radio. “In fact, it’s fizzling quite a bit today after Ben Bernanke basically said zero percent interest rates will be here until the end of 2014, so we got an extra year or so of zero percent interest rates. Although I think it [dollar collapse] is going to hit the fan before 2014, but, that’s got gold up $40 today [Wednesday].”

According to Schiff, professional traders will view the Fed’s most recent language as a signal that more debt monetization by the Fed is planned for 2012, with a lower dollar as the price paid for a Fed monetary policy of affecting artificially low interest rates in the U.S. Treasury and corporate debt markets. But Schiff doesn’t see how the Fed getting a free lunch from its actions.

Within 24 hours of the Fed’s statement of Wednesday, the USDX has already broken below its 40-month MA support of 79.72 and has accelerated downward on Thursday to 79.21 in early afternoon trading.

“They [Fed] have to create massive inflation to keep interest rates that low, especially as prices are rising, they will continue to rise,” Schiff added. “I think we could see record high oil prices this year. It’s clearly the consequences of all this money printing the Fed has to do to keep buying up the bonds to keep interest rates low.”

Schiff continued, “It’s reasons to buy more gold, buy more silver,” as a weaker dollar elicits more central bank buying of gold as a hedge against heavily-weighted dollar bank reserves.

While the euro was weak against the dollar throughout the second quarter of 2011, central banks began aggressively accumulating the yellow metal as its price, in dollar terms, dropped.

However, also during the second half of 2011, U.S. money supply has again stalled, according to economist John Williams of That stall remains as the telltale signal to central bankers that the Fed, indeed, needs to step up purchases of future Treasury issuances, on top of maturing U.S. debt and illiquid mortgage-backed securities, if Bernanke has any chance of achieving his objective of negative real interest rates.

On Jan. 23, India-based The Economic Times stated, “The WGC, an industry-backed group, said in November it expected central banks to add some 450 tonnes of gold to their existing reserves in 2011, driven mainly by purchases from emerging economies that are seeking alternative investments to the U.S. dollar.”

Many gold analysts expect central banks to accelerate purchases of gold, led by China’s central bank, whose gold reserves continue to rise along with imports of gold from its principal supplier, Hong Kong.

Though Beijing reports its gold reserves at a considerable lag to its central bank’s activity in the marketplace, gold consultancy firm GoldCore reported earlier this month that China imported a record 102 metric tons of gold in November, as the that latest print shocked the gold community into reassessing their price targets for 2012.

GoldCore continues, “Informed speculation” suggests that some of Hong Kong’s gold exports to China include the People’s Bank of China, with one analyst telling Bloomberg following the news, “there is always the possibility that some purchases were made by the central bank.”

Gold’s $200 move off its bottom in December and breakout above the $1,700 point to a resumption of the gold rally. The gold pundits are wrong, according to Schiff.

Without naming any analyst in particular, Schiff suggested that talk of the end of the gold market bull, as heralded by economist Nouriel Roubini and Kitco’s Jon Nadler during the December plunge, is pure nonsense.

Data show that American investors own so little gold, which indicates to Schiff and gold expert Peter Grandich (in an interview with GoldSeek this week) that the gold price has further room to run much higher before the manic stage ends at a top.

“We’re a long way from a blow-off top that you would get at the end of a bubble,” Schiff said. “We might eventually get there, but we’re years away and thousands of dollars an ounce away.”

Chart of the Day - Regeneron Pharmaceuticals (REGN)

The "Chart of the Day" is Regeneron Pharmaceuticals (REGN), which showed up on Wednesday's Barchart "All Time High" list. Regeneron on Wednesday posted a new all-time high of $83.14 and closed up 4.39%. TrendSpotter has been Long since Jan 5 at $60.94. In recent news on the stock, Roth Capital downgraded Regeneron to Neutral from Buy with a target of $78 on valuation concerns. Regeneron on Jan 10 rallied 14.9% after Eylea sales beat expectations. RW Baird on Jan 10 upgraded Regeneron to Outperform from Neutral and raised its target to $81 from $56. Regeneron Pharmaceuticals, with a market cap of $7.2 billion, is a biopharmaceutical company that discovers, develops, and commercializes therapeutic drugs for the treatment of serious medical conditions.


The Impact of Low Rates Through 2014

Bloomberg details the latest from the Fed:

Chairman Ben S. Bernanke said the Federal Reserve is considering additional asset purchases to boost growth after extending its pledge to keep interest rates low through at least late 2014.

Policy makers are “prepared to provide further monetary accommodation if employment is not making sufficient progress towards our assessment of its maximum level, or if inflation shows signs of moving further below its mandate-consistent rate.”

The immediate market reaction was a risk asset rally, a huge rally in gold (per Calculated Risk: Bernanke made it clear that even if inflation moved above the target – and unemployment was still very high – the Fed would only slowly pursue policies to reduce the inflation rate), and a rally at the belly of the yield curve (the yield curve flattened out to five years… shorter rates couldn’t fall as they are already at or near zero). Why? The “late 2014″ date is much later than the June 2013 date previously projected by Bernanke last summer.
The impact of this announcement (and the previous projected rates) can be seen in the chart below that shows the Fed Funds rate curve (implied by EuroDollar futures) for March 2013 through December 2014, as of various dates over the past year.

What do we see? We see an initial drop between March and June of last year as Bernanke indicated low yields for the foreseeable future, then a huge drop (mid-summer) after Bernanke stated rates would remain zero through June 2013. Today’s announcement really did nothing through June 2013 (that was already projected), but was felt further out along the curve.
The key question is what is the Fed trying to accomplish?
In “normal” times, low yields = cheap financing = increased consumption (it creates an incentive for individuals to borrow and banks to lend), but in today’s zero-bound world the impact is minimal. Increased consumption is limited as individuals are trying to rebuild their own balance sheets and those that might benefit most from borrowing, don’t necessarily have the credit to qualify for a loan. In terms of impact on unemployment, GYSC (of Economic Disconnect fame) states:

Unemployment is a structural problem, not a cyclical one, but the FED is still stuck in the past.

In addition, there are some theories that consumption may actually be negatively impacted by zero bound rates. As I outlined over the summer, I think it is possible that negative real interest rates may actually cause individuals to save more, while Kid Dynamite outlined yesterday that low rates forecasted may cause individuals to hold off from making a loan fueled purchase:

Let me explain: right now, one appealing factor of home buying/selling decisions is that interest rates are very low – you can afford to buy more house. If I think that interest rates are going to remain low for a long period of time, I will be in no hurry to lock in this low rate on the debt I’m borrowing – I will be in no hurry to go out and buy a house.

So what is it then? Corporations!
There is one sector that I think will be positively impacted by the latest announcement…. corporations. Don’t let their record profits as a percent of GDP (while personal income is at record lows) fool you into thinking they don’t need help at the populations expense. Seriously though… my initial reaction upon hearing that rates would be held down near zero through 2014… buy credit… WITH duration out to around ten years (the secondary impact is positive for equities, as explained below).
While Treasury yields are at all-time lows, corporate spreads remain at elevated levels (when yields fell during the summer when we had to deal with the US downgrade and Europe, spreads widened significantly).

In “normal” times, when markets calm these spreads would be expected to narrow, which I still believe is the case. One would also “normally” expect Treasury yields to rise as investors shift out of Treasuries, causing the hard interest rate component of corporate yields (rate + spread = yield) to rise, but this risk has been removed for the foreseeable future out to around ten years. The result is that corporate bonds seem like a very safe investment. This decreased risk should mean even cheaper financing for longer dated maturity corporate bond issuance.
So will this finally set off a round of corporate fueled expansion? If they don’t see aggregate demand improving, then I don’t see how this will impact the underlying economy. But, with the cost of equity high (i.e. what I perceive as fair to cheap equity valuations) and cost of debt low (i.e. these lower yielding corporate bonds), we may see significant change in capital structures (perhaps via private equity).
Source: Barclays Capital