Oil and Gold Portfolio Comments -- Lots of ’Em

March 19, 2009

Oil and Gold Portfolio Comments -- Lots of ’Em

Dear Outstanding Investments Reader:

Do you remember that old expression about how “a rising tide lifts all boats”? Whatever is causing the current rise in the economic tide of Wall Street is lifting a lot of the boats in the portfolio from post-crash lows.

Oil Moving Up

It didn’t hurt that in the past three weeks, the price of oil has moved from the high $30s to a solid position in the upper $40s per barrel (and over $50 as I write). I expect this price to hold steady for a while and then move up more. Sure, there will be ups and downs. But the trend is up.

As I said in previous updates, OPEC output cuts are starting to hit home. Back near the beginning of 2009, some OPEC players began to choke back the valves. So tankers didn’t load. And now, two-three months later, those tankers that didn’t fill up with OPEC oil are not docking at Western terminals. Oil that does not unload doesn’t get refined. And oil that doesn’t get refined does not become gasoline at a filling station near you. At any rate, oil supplies are tighter and prices are higher. One of my old admirals used to say, “When all else fails, count the other guy’s ships.”

So in the past couple of weeks, McDermott Intl. (MDR: NYSE) moved from the $10 range to near $14. Baker Hughes (BHI: NYSE) went from under $27 to near $31. Halliburton (HAL: NYSE) went from under $15 to almost $17.50. Superior Energy Services (SPN: NYSE) went from $11.50 to well over $14.

Apache Oil (APA: NYSE) climbed from $52 to over $64. BP (BP: NYSE) went from $34 to over $39, and management stated that the dividend will remain unchanged for the rest of this year. It’s always nice to get an 8.7% yield and have management tell you that it’s a safe expectation.

Refiners in the Doldrums

No news seems to help the beaten-down refiners, however. They’re still in the doldrums. Tesoro (TSO: NYSE) has barely budged from the $13 range. And Valero (VLO: NYSE) has been trading in the $16-17 range.

There are a couple of problems for the refiners, especially pure plays like Tesoro and Valero. (I say they’re pure plays because they don’t produce crude oil. They just buy and refine it.)

The refiners are victims of a stealth “gas war” at the pumps. That is, last year, the dramatic increase in gasoline prices turned the political spotlight on fuel prices and oil company profits. A lot of people, politicians and media pundits just plain hated oil companies for making record profits. Nobody ever complains when IBM makes a profit. But Exxon? It’s like those greed-heads robbed the collection box down at Mother Teresa’s chapel for blind, orphaned lepers or something.

So a lot of the majors like Exxon, Chevron, Shell, etc. simply lowered their prices for fuel and are running near break-even or at a loss. The numbers for “downstream” operations at most oil companies look pretty bad.

I guess the thinking is that if the executives get hauled in front of Congress (again), they can truthfully claim that they’re not making money from charging consumers at the pump. Instead, they make their money at the upstream end of exploration and production. Is this the right way to run a business? No, it’s not something that John D. Rockefeller would have recognized back in the 19th Century. But we live in the 21st Century. Today the alternative is getting ripped to shreds by a spiteful and energy-ignorant political class that’s pandering to raw populist resentment.

The problem for refining companies like Tesoro and Valero is that they don’t have upstream operations. They can’t cross-subsidize their refining losses with production profits. So Tesoro and Valero are getting squeezed at the refinery.

One good note is that Tesoro and Valero both refine a lot of heavy oil, which tends to be cheaper than the light, sweet stuff. So the heavy oil generates what’s called a “crack spread.” That’s the difference between the lower price for heavy oil and the higher price for light, sweet crude. It’s how Tesoro and Valero made money in the past, and it’s what lets them keep the doors open even now.

Meanwhile, several new refineries are in the end stages of construction, particularly on a 580,000 barrel-per-day (bpd) behemoth on the west coast of India owned by India’s Reliance Petroleum Ltd. It may seem strange that a far-off Indian refinery is disturbing the refined fuels market in North America, but it’s true.

When this new Indian colossus is up and running sometime in 2010, there will be an instant glut of refined product on world markets. Just the bow wave of this new capacity has, apparently, hurt the prospects for North American refineries. Still, it may be a reverse case of people “selling the rumor,” instead of waiting for the actual refined products to hit the markets and establish their own channels of commerce. The North American refiners may very well be oversold.

For now, I think that the holdings in Tesoro and Valero are quiet money. Of course, they own refineries. And who’s going to build a new refinery in the U.S. these days? You have to go to India to find new refineries. Still, there are no fundamental supply-demand issues that will cause a return to the good old days of eye-popping earnings. So I don’t expect any Lazarus-like resurrection. But if the U.S. economy begins to improve and shows some strength, both of these guys could surprise us with earnings increases and make nice moves.

And one other thing. Valero is quietly buying up a lot of ethanol plants at totally distressed prices. Many of the ethanol high-flyers of a couple years ago are now in bankruptcy court. No, I’m not a fan of ethanol. But Congress mandated that a lot of ethanol be blended into gasoline. So Valero is ahead of that curve. Management is thinking ahead.

Nuclear Moves

With the nuclear power plays, nuclear component maker Curtiss-Wright (CW: NYSE)Cameco (CCJ: NYSE) got up off the mat, to move from $13 to $16.50. Denison Mining (DML: TSX) is languishing with many other Toronto stocks, trading in the $1.30 range. moved about 10%, from the $23 range to $25. Uranium miner

It’s as if everyone is waiting for some signal from the new Obama administration on the policy toward nuclear power. What are the new guys going to do? They aren’t saying. Not yet, except for canceling the nuclear waste storage site at Yucca Mountain, Nev., after 20 years of work and $10 billion in investment. Well OK. That says a lot. Maybe too much, considering the silence emanating from elsewhere.

The Obama camp has made no secret of its antipathy toward fossil fuels and enthusiasm for a zero-carbon future. Now it has to make policy. I hope it’s not exactly a news flash that we could quadruple the power supply of renewable energy systems in the U.S. and still not be able to match the daily baseload of power from nuclear plants.

Really, take the current power supply from wind, solar and geothermal. Double it with a lot of new investment. Thousands of new windmills. Tens of thousands of new solar cells. Hundreds of new geothermal wells. Now double that again. And do it in the current environment of frozen credit markets. It’s not as easy as it sounds, right?

OK, it’s not easy. But suppose you could quadruple the renewable power output in, say, four years. And suppose you could wire it all up to a dramatically expanded power grid, with wires running to the deep hinterlands. It’d still be less than the current megawatts the country is getting from nuclear. So do you see the problem?

Like it or not, the Obama administration had better get its act together on nuclear and make a commitment. Either that or it had better start drafting the press releases to explain the rolling brownouts and blackouts that are already cooked into the pie.

Precious Metals

The stock market rise has put some selling pressure on gold and silver. Gold prices have retreated from $1,000. But we are still in the early innings on these precious metal investments.

The Outstanding Investments gold and silver portfolio is focused on the long-term decline in the value of the dollar. So any decline in the price of gold and silver is another opportunity to build your stash of physical metals (5-10% of your portfolio in REAL GOLD and SILVER) as well as great mining company shares.

Remember, you won’t get much warning when the dollar decides to fall off a cliff. Take yesterday for example, the dollar took a major hit after the Fed announced that it will be buying more gov’t bonds and mortgage backed securities – that’s another 1.2 trillion in ”new” currency hitting the money supply. The announcement created a frenzy in the gold market. The price of gold shot up $50 per ounce less than 2 hours after the feds meeting.

Precious metals are like fire insurance. You don’t wait until you smell smoke to call your agent and buy coverage.

Shares in South African miner AngloGold Ashanti Ltd. (AU: NYSE) have moved up over $36, for a nice gain in less than a month. But there’s much more to go with this great and growing miner.

Canadian stalwart Agnico-Eagle Mines (AEM: NYSE) is still hovering in the $50 range. I’m not worried. It has the reserves in the ground and the skills to dig them out.

Kinross Gold Corp. (KGC: NYSE) is doing fine, despite the share price pullback to the $16 range. The company operates in a wide range of jurisdictions, from South America to Alaska to Russia. There will always be some news about a dispute with the local authorities. And there’s just something about gold mines that makes the mouths of politicians everywhere salivate like Pavlov’s dogs. I believe that Kinross management has its issues under control. One way or another, Kinross will still mine gold from its growing list of properties and strong reserve base.

In fact just yesterday I learned that Ecuador invited Kinross to resume operations in that country. All operating suspensions have been lifted. Kinross Gold can resume activities on its Fruta del Norte gold-silver project in south-eastern Ecuador, which it acquired when it bought Aurelian Resources on September 30, 2008. The deposit is believed to contain 13.7 million ounces of gold and 22.4 million ounces of silver. First production could begin as early as 2012. This is great news.

Shares in Yamana Gold (AUY: NYSE) dropped to the $4 range last fall and have clawed their way back up to $8 in recent weeks. Yamana’s most recent operating statements make the case that management continues to steer the ship toward a solid recovery in the current price environment. And things could improve quite a bit, very fast, if gold prices continue to rise. Yamana earned $179.4 million in the fourth quarter of 2008, despite a $74 million hit from price adjustments for copper. This last item was directly related to the epic collapse of copper prices during the period. It looks as if copper prices have stabilized (consumption is rising in China!), so the bad news is contained for Yamana.

No news seems to be good enough to lift up the shares in NovaGold Resources (NG: AMEX), hovering in the $2-3 range. Its Donlin Creek project in Alaska recently received the prestigious Thayer Lindsley Award from a major Canadian mining organization. The award honors the NovaGold team for defining the Donlin Creek site, and classifying it as one of the most significant new ore discoveries in the world. Right now, NovaGold is beginning the permitting process so that it can eventually turn the 30 million-plus ounce discovery into a mining operation.

Meanwhile, word came that investment guru Marc Faber holds a significant number of NovaGold shares. And Faber has a nose for great investments. Still, NovaGold has delivered too much bad news to the markets in the past year. It’ll take a while for NovaGold to recover. Then again, some cashed-up larger mining firm could always swoop in and just take the company over. Stranger things have happened.

That’s all for now. (Except, remember to buy some gold!)

Thanks for reading. Best wishes…

Byron W. King