Whenever the market gets too quiet, I naturally think, “What’s next?” While I could ponder about the next euro crisis, runaway inflation in emerging markets, and a collapse in China, I can’t exactly time any of these events. However, interest rates will be important in the next three months regardless of what happens.
Are they stabilizing, rising, or possibly falling? Since QEII can’t easily push rates downward anymore, we likely won’t see lower rates without turbulence in the general market. As a result, I’m internally debating stable versus rising rates. Companies are making large bond issuances at current market rates, and the market is eating them up. Furthermore, QEII has been fully priced in, and the market doesn’t expect a change until June. The stable rates crowd does have an argument.
However, inflation expectations could push rates higher. Currently, a debate rages over the cause for higher rates. Is it inflation or economic recovery? It’s too soon to declare a winner. But as more data comes in, the picture will become clearer and rates could start rising faster. Even if no black swans appear in the next three months, the developments in the Treasury market will be more than enough to keep the market busy. Of course, Casey Research has been betting on higher interest rates for some time. But this month, we’re more bullish on the trade than usual. To find out the best ways to play rising rates, check out the current edition of The Casey Report.
In this issue, we’ll start with a report from the energy team on the Australian floods and their effect on the coal market. Then Alex Daley will give us a piece on Facebook’s valuation and how Goldman Sachs will profit from the deal. In case you read Chris Wood’s take on this last week, Alex’s article is still worth reading it as it takes a different angle. Then, at the end, I’ll share a few thoughts on gold.
By the Casey Research Energy Team
The most important metallurgical coal basin in the world is underwater. Open pits have become lakes, stockpiles are soaked, and rail lines are submerged and in places destroyed. Damage is estimated at $5 to $6 billion.
Australia accounts for almost two-thirds of global coking coal production. Much of it comes from Queensland, where an area the size of France and Germany combined is underwater. That includes the Bowen Basin coal region, which produces almost a third of the world’s coking coal. The Bowen Basin was hit with 350 mm of rain in December, against an average of 102 mm.
Floods are now receding from the Bowen, giving some miners an opportunity to ship from existing stockpiles. Other mines are still inaccessible, and several rail lines are still submerged or damaged. And since open pits are still flooded and will take weeks to drain, shipping from stockpiles only postpones the inevitable: a reduction in met coal supply. Analysts think a recovery to pre-flood coal production levels will take at least three months.
At least six major global coal miners have declared force majeure, which means they can miss contractual shipments because of circumstances out of their control. The list includes Anglo American, Aquila Resources, BHP Billiton, Macarthur Coal, Rio Tinto, Vale, and Xstrata. Mines responsible for between 100 and 140 million tons of annual coking coal production are now under force majeure, representing as much as 40% of global supply.
And it’s probably not over yet. Australia’s Bureau of Meteorology predicts both eastern New South Wales and southeastern Queensland have a 60% to 70% chance of receiving higher-than-average rainfalls between January and March 2011.
What does it mean for coal prices and coal equities?
First, coal is not traded daily, like copper or gold. Coking coal prices are set in quarterly negotiations between steelmakers and coal miners; contracts for the first quarter of 2011 were mostly settled before the floods, at an average of $225 per ton (already the second highest level ever). So prices have not changed yet, but there is lots of talk about where they will go next. Analyst predictions for the second quarter range from $250 to $350 per ton.
Coking coal producers not affected by the floods are already reflecting the increase, and that will likely continue. Teck Resources, for example, climbed from below $59 to almost $63 in the last days of December, before slipping with the markets. Western Coal and Grande Cache Coal also made gains. The longer-term impact will of course depend on how long it takes for Australia’s mines to return to normal operations, but in general the situation supports Casey’s bullish stance on coking coal: there is not a lot of supply, and demand is constant, if not rising, so prices can only trend up.
Casey’s support for coking coal has already generated big returns on at least one recommendation. Some ten months ago, Chief Energy Strategist Marin Katusa was on Business News Network (BNN) talking about met coal, and he recommended Cline Mining at just over $1. Those who traded on that advice are now looking at a 300%+ gain, as Cline is currently trading at more than $4, in less than four months. And Casey’s Energy Report recently added a new metallurgical near-term coal producer to its portfolio.
As for thermal coal, prices seem poised to edge up slightly because of the floods but, unlike metallurgical coal, there is plenty of thermal coal to go around. The situation has disrupted just 8% of global thermal supply. So while the floods may be causing a pop in thermal coal equities, the increase is unsustainable. There are thermal coal deposits all over the world, and many countries produce enough to meet most of their energy needs. China’s thermal coal stockpiles remain very healthy, for example, and it is the second-largest importer of thermal coal in the world. The top importer is Japan, but even it only imports some 113 million tonnes annually and relies on coal for less than 30% of its electricity needs.
As such, the pop in thermal coal equities is not going to last. Hence, investors should use the lift as an opportunity to reduce their positions.
The floods are also a reminder of the extremes of Australian weather – a prolonged drought in Queensland ended just two weeks before the torrential rains began. And while the rains pound Queensland and New South Wales, which cover the eastern third of the country, searing temperatures have residents of neighboring South Australia and Victoria on alert for bushfires. That is simply a reminder that Australia’s weather can often impact the country’s all-important met coal mines.
[No one is more knowledgeable in the volatile energy market than Marin Katusa and his team. That’s how subscribers could rake in an exceptional 818% gain on Uranium Energy (UEC) in only 24 months. Find out about the “next big thing” in energy, and how you can profit, here.]
By Alex Daley, Casey's Extraordinary Technology
The past few weeks have seen a flurry of news in technology with the mega-sized Consumer Electronics show in Las Vegas ushering in the first new platform for Microsoft Windows in over a decade, the announcement of at least 40 forthcoming mobile phones to be the first class labeled with the “4G” moniker, and a rush of new tablets from vendors trying to follow Apple’s iPod into a lucrative new space.
But few announcements have generated more buzz than the widely reported investment by Goldman Sachs in the hot privately held social media goliath Facebook at a staggering $50 billion dollar valuation.
The problem: it’s just not true.
Yes, Goldman will invest $500 million dollars in Facebook in exchange for a 1% slice of the company, according to the little public information available on the private deal. But Goldman expects a quick return on that investment outside the equity value itself, so the valuation implications are far from cut and dry.
In addition to its own stake, the deal also reportedly entitles Goldman to create a $1.5 billion special-purpose vehicle for its investor clients to get their own (minimum $2 million investment, except for Goldman partners) chunk of the closely held startup.
When those clients invest, Goldman takes a 4% placement fee and will also take 5% of any profits generated. This means millions of almost guaranteed dollars in Goldman’s pockets – can you imagine them not being able to raise that money? With a full subscription, they will receive $60 million in fees, with totals rising as high as $125 million if Facebook’s valuation approaches $100 billion on IPO or other private events.
Not only will Goldman see a good chunk of its investment dollars returned to it in the near term through fees paid by its investor clients and solidly contracted business with Facebook itself, Goldman also stands to make far more from the eventual IPO of Facebook. Now a shoo-in for leading the eventual IPO of the firm, Goldman stands to make the standard 6% offering fee.
If Facebook can really attract a $50 billion valuation at market and lets loose just 20% of its equity for a $10 billion offering, that would mean $600 million in fees to Goldman. A lot of factors will determine the value of that commission, but add into it all the fixed fees and commission from debt raises, other private funding events, and general advisory fees, and it is easy to see Goldman rounding out more than $1 billion dollars in revenue from their relationship with Facebook over the next two or three years.
With all of the potential fees now coming their way, Goldman’s own investment says very little about the valuation of Facebook. It’s not a market-based price, and many additional promises may exist to affect the true valuation. Until there is a fair market pricing event, drawing valuation conclusions is a dubious science at best. But that fair market may be just over the horizon, thanks to this private deal.
Facebook has effectively put a clock on its IPO. Any private company in the U.S. with $10 million in assets and more than 500 shareholders must disclose its finances publicly within 120 days of the fiscal year it reaches that threshold. And Facebook is warning new prospective investors that the company is likely to hit that investor limit this year with the new vehicle just created. That means Facebook will probably have to disclose its finances publicly by April 2012.
When technology giant Google reached the same threshold in 2004, it prompted a full IPO of the company shortly thereafter. So, many analysts are now calling for a summer of 2012 offering.
While founder Mark Zuckerberg, who owns about 25% of his company, has long resisted an IPO, the winds appear to be changing. In addition to the 500 investor limit, employees of the company are heavily invested. But employees’ special class of shares does not really become available until an IPO or sale of the company.
The latter is less and less likely as valuations sore. Plus, early private investors are probably itching for more liquidity, especially as demand for the shares appears to be reaching a fever pitch, with multiple private stock sale websites brokering share sales off the markets at extreme valuations these days.
According to insiders who claim to have access to the deal, Facebook posted more than $1.2 billion in revenue in the first 9 months of 2010, with net income of $355 million, or a 30% margin. If revenue holds up in Q4, that will mean a greater than 100% gain over the $777 million in revenue the company is stating it saw in 2009.
As investors in Casey’s Extraordinary Technology have seen, a long-term understanding of cash flow potential can give an investor an edge in the market and produce great gains. In this deal, the insiders are the only ones with access to that information. Goldman Sachs is not about to jump into Facebook without some strong due diligence and a good understanding of its return.
Making valuation judgments with less than full information is always a mistake – this time it is the media that are jumping to erroneous conclusions, not investors. That is, until Goldman opens its new investment vehicle to its pension fund and insurance company clients at the same valuation Goldman took, only without any fees flowing to offset their costs.
[Every month, Alex Daley, Editor of Casey’s Extraordinary Technology, analyzes the ins and outs of the tech market, finding undervalued companies with groundbreaking technologies for subscribers to invest in. Recent returns averaged 30-40% with just a few months or even weeks. More here.
After yesterday’s article that touched on gold manipulation, I got to thinking more about the subject. It seems that the thesis no longer makes sense. Supposedly, the major banks want to keep gold down to hide inflation and the bad state of the economy. Second, they want to make money by manipulating the market.
It would seem that only the second reason could possibly hold up now. The main reason being that the cat is out of the bag. There’s nothing left to hide about the state of the world economy. Gold and silver continue to push higher, and then there are other commodities such as platinum and palladium. Are the big players manipulating them also? But let’s not stop here; Bernanke’s printing press has inflated numerous agricultural commodities as well. To top it off, interest rates are rising.
Furthermore, no one is oblivious to the dangers around the corner. Europe still remains in poor shape. Portugal seems to be the center of the next crisis, and Belgium may soon be joining the ranks of the PIIGS. The U.S. economy continues to drag, despite a few small positive signs.
So what would the banks achieve by manipulating gold prices? Everyone already recognizes the economy’s weak standing. Even on good market days, we’re celebrating too close to the cliff’s edge. If the banks wanted to hide important factors in the economy, they would have to engage in a grand conspiracy way beyond the gold market. The major players can’t rig every market on Earth. Even the Federal Reserve has trouble controlling rates lately.
The rule of thumb to follow on these matters is this: short-term manipulations can make a risky profit; long-term manipulations make cautionary tales. Whether it’s the Federal Reserve keeping rates artificially low or the Barings Bank disaster, these things usually don’t turn out well.
CNBC had an article and video yesterday with some amusing quotes from a technical analyst:
I think not owning gold is a form of insanity, it may even show unhealthy masochistic tendencies, which might need medical attention.
And, here’s another one:
The downward trend in the dollar is awesomely powerful. It's vital to get yourself out of the dollar long-term on any significant rally. Continuing to own a currency that is going to be printed virtually into oblivion … is crazy.
Aside from our own stance on gold, his statements are not an exaggeration. Previously, investors were concerned that a slightly stronger dollar or market would send gold tumbling. Of course remembering the early ‘80s is important. However, in 2010 the dollar rallied against the euro and gold stayed strong. Furthermore, the market made a small comeback, and gold remained intact – in fact, it went up as well.
In light of this recent performance, even the bulls should hold a little gold in their portfolios. If the market starts really picking up, gold won’t immediately fall out of the sky. And if the market doesn’t do so well, gold will act as a good hedge.
The question isn’t “Should I own gold?” The real question is, “How much?” At Casey Research, we recommend dividing your investments into one-third gold/silver, one-third cash, and one-third other investments. Clearly, the market bulls should hold less gold, but still their portfolios would be lacking without at least some.
That’s it for today. Speaking of the yellow stuff, gold is at $1,373.90 at the moment, and oil has just topped the $90 mark again at $90.51. One more thing, the Uruguay Casey Phyle meeting is taking place this Saturday the 15th, between 1 and 3 PM. The speaker will be Peter MacFarlane, a consultant to high net worth individuals since the early nineties. He is a company lawyer, writer, and speaker on international finance, offshore banking, investment and citizenship.
But that won’t be the only Phyle meeting this Saturday; the Panama Phyle group will be having its first meeting ever on January 15th as well.
Both of these events sound like a good time. I wish that I could make it down. Any interested parties for either event can contact email@example.com for more information.
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Casey's Daily Dispatch Editor