Thursday, April 7, 2011
Yesterday 'the boyz' had a video session with a man much more famous in Canadian financial markets, than American - Eric Sprott. [Dec 30, 2009: Eric Sprott Wonders if US Debt Scheme is Simply the Biggest Ponzi Scheme Ever] Keep in mind, like most managers, Sprott is talking his book as he has a multitude of commodity based products under his wing... but he reaffirmed an extremely positive view on silver. Indeed despite the 22% gain in Q1 2011 alone, he sees it doubling again to $80.
With all the major currencies headed by central bankers happy to devalue it, the case against precious metals is difficult to make. One can assume when the next recession happens (cyclically it should be here within 3 years), the only game plan in town nowadays is another global round of quantitative easing and fiscal spending to the moon. Rinse. Wash. Repeat.
(lost in the Fed speak the past few weeks, I read yesterday the Bank of Japan has put in $275 BILLION USD worth of yen into the system since the earthquake - relative to their economy size, that would be akin to the Fed doing $1 TRILLION - in a few weeks!)
In the nearer term, as the Fed works on creating the 3rd bubble in 12 years, it looks like commodities are going to be the "winners" this time around. As we saw with NASDAQ stocks and U.S. real estate, the last stages of the bubble will be parabolic moves upward - and then the crash. But until then, speculators will want to play the Fed's mandate to create bubbles. And unlike the appreciation in housing and stocks during the last 2 Fed bubbles, the move UPWARD in commodities is causing all sort of pain for citizens globally. Got corn?
6 minute video
- Sprott, the chief investment officer and CEO of Sprott Asset Management, doesn't see a bubble in gold, calling it wildly under-owned when viewed in historical terms. But if you want to get the genial Sprott really worked up, ask him about silver. Even at three-decade highs near $40 an ounce, Sprott says silver will more than double from here.
- What would change his mind? Global stability and rational central bank behavior.Nothing, in other words.
- When pushed, Sprott says $2,000 gold and $50 silver are possible in 2011. But he's got the kind of macro bullishness that leads to buying any and all dips, as he believes higher levels for precious metals are inevitable.
- "I've owned gold for 11 years, and I've never sold any of it," Sprott says with conviction. And gold is only his second favorite metal. As befitting a hedge fund manager, Sprott is betting on other assets declining in price as his precious metals soar. He's bearish on base metals -- those used in production -- and he's shorting financial and consumer-related companies.
Claude Resources (CGR)
Great Basin Gold (GBC)
Midway Gold (MDW)
Kimber Resources (KBX)
Minco Gold (MGH)
Cardero Resource (CDY)
There are good reasons to expect stock prices will continue to move higher. Stocks really aren't that expensive, when compared to earnings. The S&P 500 is trading at 15.5 times reported earnings, compared to average bull market peak valuations of 19.7. Earnings will almost surely continue to grow rapidly. Bloomberg reports consensus estimates of Wall Street analysts showing average earnings growth of 17% in the next 12 months. Stocks are also cheap relative to interest rates. The earnings yield of the S&P 500 (6.4%) is still substantially above the yield of benchmark (10-year) U.S. Treasury bonds (3.5%).
This all sounds like good news, doesn't it? But here's one fact you probably won't see reported anywhere else: The entire rise in U.S. corporate profits came from the financial sector. That is, the earnings growth driving our current bull market in stocks is coming exclusively from the financial sector. The nonfinancial sector of our economy actually saw profits fall in last year's fourth quarter. Today, financial sector profits make up more than 30% of total domestic corporate profits. That's the same level we saw in 2006 and 2007… just before the financial crisis.
What's behind the surge in financial sector profits? You already know, dear subscriber…
You already know the Federal Reserve has been shoveling out as much money as the banks want and charging nothing for it… You already know the Fed has lowered interest rates for member banks to almost nothing. But how does this impact the real world of finance? Let's look at Annaly Capital Management (NLY) to find out.
We like to use Annaly as our window into the secret world of the big banks, because we're familiar with the company (having watched closely for the last decade) and its business model is Banking 101: Annaly borrows money at a privileged rate and lends it safely via the government-guaranteed mortgage market. At both ends of every deal, Annaly enjoys the warm, loving embrace of our sovereign nation. It takes advantage of the Fed's interest-rate manipulation at the short end of the curve (where it borrows) and the Treasury's backing of Fannie and Freddie at the long end of the curve (where it invests). Playing the government's game is unbelievably profitable…
At the end of 2010 (the most recently reported quarter), Annaly paid only 1.8% to borrow money – and it could have as much as it wanted. It turned around and "lent" those same dollars out at an average rate of 3.65% via investment in Fannie- and Freddie-backed mortgage securities (which are guaranteed against any credit loss). In this way, Annaly earned a "risk-free" profit of 1.85% on each dollar it touched. Annaly's total portfolio grew to $75 billion – meaning its net interest income was almost $400 million in the fourth quarter alone.
Now, let me ask you a few simple questions about all this… Does it seem reasonable that a banking institution with only 114 employees and no branches should earn a risk-free $400 million in one quarter? That implies annual profits of much more than $1 billion. What did it do to earn these profits? Nothing more than pose as a buyer. I say "pose" because Annaly borrowed nearly all the money it used in these purchases and never assumed any risk whatsoever on the things it "owned." Does this make sense? Does it make sense that we, as a society, should trade $1 billion or more for this "service"?
I admire the men who built Annaly and run it today. They found a simple – and wildly lucrative – way to take advantage of the absurdity of our banking system. Annaly's roughly $400 million in profits make up a tiny fraction of the $400 billion-plus profit generated by the financial sector last quarter. But they represent perfectly how these dollars were "earned." In almost every case, the money wasn't earned at all – it was simply manufactured by a charade just complex enough to fool the press and the average debtor.
But what about the parts of the economy where profits can't simply be manufactured with fiat money? How's that part of the economy growing? It's not. Whoops.
Given these facts, I would suggest investors pay close attention to the government's ability to maintain its paper charade. The prices of gold, silver, oil, and most other major commodities would seem to indicate this process of printing money and paying bankers $400 billion a quarter to move it around isn't productive. Instead of producing wealth, we're only producing debt… which is getting much harder to afford, thanks to inflation… which is a terrible side effect of using monopoly money and allowing the government to play the game's "banker."
Here's another interesting fact… Stephen Moore in the Wall Street Journal today writes:
More Americans work for the government than work in construction, farming, fishing, forestry, manufacturing, mining and utilities combined. We have moved decisively from a nation of makers to a nation of takers. Nearly half of the $2.2 trillion cost of state and local governments is the $1 trillion-a-year tab for pay and benefits of state and local employees.
Forgive me for being cynical… but it seems the only sector of our economy that's growing is the banking sector, which manufactures profits via a paper currency regime that's stoking a massive inflation and remains threatened by a growing banking crisis in every developed country. Meanwhile, the banking system is being held together by our government, an institution that's bankrupt on any conceivable scale – to the point that the world's largest bond investor (PIMCO's Bill Gross) has sold every single U.S. Treasury bond and is publicly calling Congress a house full of "skunks." The government has also become the largest employer, the largest source of union members, and the single largest customer of almost every company in the United States.
If you haven't noticed, coal stocks are heating up in 2011 in a big, big way. The Masters favorite picks? James River Coal(NASDAQ:JRCC), (NYSE:ICO), and for broad exposure to coal, Coal ETF (NYSE:KOL).
The Market Vectors Coal ETF is up more than 13% since the Japan Tsunami on March 11th. The fear of meltdowns at nuclear reactors in Japan has caused many investors (and governments) to think twice about the viability of nuclear power as an alternate to oil.
But that's not the whole story. Massive flooding in Australia has hit Australia’s coal industry so hard that it was estimated to cost the country $8.3 billion - loss of is estimated to be between 20 million and 30 million tons. The resulting supply disruptions are another reason why Coal prices are on the rise.
James River Coal (JRCC):
Over the past 12 months James River Coal Co (JRCC) shares have traded between $14.44 and its 52-week high of $27.06. James River Coal Co shares are now trading with a P/E Ratio of 8.8 and EPS of 2.82.
International Coal (ICO):
Market Vectors Coal ETF (KOL)
Over the past 12 months Market Vectors Coal ETF (KOL) shares have traded between $28.35 and its 52-week high of $51.87.
It’s no secret that the silver market is red hot. As I write, silver American Eagles and Canadian Maple Leafs are sold out at their respective mints. Buying in India has gone through the roof, especially noteworthy among a people with a strong historical preference for gold. Demand in China continues unabated. Silver stocks have screamed upward.
So, as an investor looking to maximize my profit, I have a natural question: is the silver trade getting too crowded, meaning we’re near the top? Have the masses finally joined the party such that we should consider exiting? After all, it’s not a profit until you take it, and you definitely want to sell near the top.
There are several ways to measure how crowded the silver market might be. I prefer to look strictly at the big picture and not get caught up in the weeds. This means I’m looking for signs of market exhaustion or the masses rushing in. Nothing says “peak” more than an investment everyone is buying.
So how crowded are silver investments right now? Let’s first look at the ETFs.
At $35 silver, all exchange-traded funds backed by the metal amount to $20.7 billion. You can see how this compares to some popular stocks. All silver ETFs combined are less than a quarter of the market cap of McDonald’s. They’re about 10% of GE, a company that still hasn’t recovered from the ’08 meltdown. Exxon Mobil is more than 20 times bigger. And this isn’t even apples-to-apples, as I’m comparing the entire silver ETF market to a few individual stocks.
This is even more interesting when you consider that it’s the ETFs where most of the public – especially those that are new to the market – first invest in silver. So while the metal has doubled in the past seven months, total investment in the funds is still far beneath many popular blue-chip stocks.
Okay, maybe all this money is instead going into silver mining stocks. How does the market cap of the silver industry compare to other industries?
While you fetch your magnifying glass, I’ll tell you thatthe market cap of the silver industry is $73.1 billion. It barely registers when compared to a number of other industries I picked mostly at random. The dying newspaper industry is over 26 times bigger. Drug manufacturers are 213 times larger. Heck, even the gold market is 19 times greater. And here’s the fun one: the market cap of the entire silver market, with all its record-setting prices and stock-screaming highs, represents just one-third of one percent of the oil and gas industry.
To be fair, there are a number of sectors that are smaller than silver. Radio broadcasters ($43.2B), video stores ($10.9B), and sporting goods stores ($2.5B) have puny market caps, too. But then again, who’s buying DVDs or baseball mitts to protect their wealth from a coming inflation?
Silver hardly resembles the picture of an investment that is too crowded.
I’m not saying one should rush to buy silver right now. After all, it has doubled in seven months. Unless this is the beginning of the mania, prudence would certainly be called for at this juncture. The price will always ebb and flow in a bull market, and an ebb is overdue.
The question, of course, is from what price level it occurs. What if a correction doesn’t ensue until, say, a month from now, and the price falls back to… where it is now? I remember some articles in January that insisted silver would fall to as low as $22, and, well, they’re still waiting and have in the meantime missed out on some huge gains. For silver to fall back to $22 now would require a 40% drop; not impossible, but I wouldn’t hold my breath.
Fixating on market timing takes your focus off the ultimate goal. In my opinion, instead of worrying about what will happen next week or even next month, focus on how many ounces you have, and then buy at regular intervals until you reach your desired allocation. This has the added benefit of smoothing out your cost basis. And don’t forget to buy more as your assets and income increase.
This is a market where you’ll want to be well ahead of the pack. Someday in the not-too-distant future, average investors will be tripping over themselves to join in. That will make the market caps of our silver investments look more like some of the others in the charts above. And that will do wonderful things to our portfolio.
If current trends persist I assume when the S&P hits 2500, there will be 100 shares trading a day?
[click to enlarge]
- The CHART OF THE DAY compares the Standard & Poor’s 500 Index with daily share trading in exchange-listed companies, as compiled by Bloomberg, during the past two years. The latter is represented by a 200-day moving average, which smoothes out day- to-day swings in buying and selling.