On the Importance of Infrastructure

Dear Reader,

With 70,000 people protesting in the streets of Athens last Sunday, I’m again reminded of an  American advantage: real political and economic debate. I don’t mean this in an idealized sort of way. Personally, I’ve always found phrases such as “political debate makes a democracy strong” silly and logically problematic. There is nothing intrinsically holy or sacred about debate. In fact, sometimes the best solution to a problem is everyone agreeing to do the right thing without a debate at all.

So, what do I mean? In the United States, politics centers on the real issue, that of big government versus small government. It’s a philosophical struggle between two views on how to run the country and economy. Now, I’m not saying that our political system actually operates this way. The reality is big-government Democrats versus big-government Republicans. However, the public debate does focus on the size of government. If one starts a political conversation with the average American, it’s not surprising to find some understanding of big government versus small government, free markets, etc.

This isn’t the case in places such as Greece. Several articles on the Greek riots pointed out that the protestors blame “corruption” for their problems. In my recent article on Croatia, I pointed out the same mentality there. The locals always blame a generalized “thievery and corruption.” But looking at Greece, the problem is clearly not corruption. Greece’s problem is the same story around the world – a crisis of too much government and too much spending.

The protests themselves show a high level of confusion among the population. What do these 70,000 protestors want the government to do? There’s no money left! Taxes have already been raised, and the country will soon receive a second bailout. Austerity isn’t an option. The Greeks can kick and scream all they want, but there’s no way to sustain their previous level of expenditure. If the Greek population doesn’t even understand the problem, then there’s almost no chance of finding and enacting a solution.

I’m not saying that the United States will solve its debt problems. In fact, I’m very pessimistic about our debt burden. However, our population generally “gets it.” Many citizens may be huge hypocrites on Medicare, Social Security, and their own pet programs, but they understand that spending will become unsustainable. Very few Americans blame our poor economic recovery on abstract ideas such as “thievery and corruption.”

Furthermore, consider this: The U.S. is not in a state of default, but nonetheless, our national debt and spending are constantly in the news. In many European countries, no one even mentions the national debt until a crisis is already in progress.

The first step to solving any issue is properly identifying the problem. In the U.S., this puts us one step ahead of most countries. Unfortunately, the United States has just as much trouble taking the next step as anyone else. While Americans discuss the real problems, never does the U.S. government actually enact difficult changes; and ultimately both parties support larger government.

Let’s get to the rest of the issue. The Casey Research energy team will discuss the importance of good infrastructure for mining and some major infrastructure projects around the world. Then, Alena Mikhan and Andrey Dashkov discuss supply and demand for gold in Q1 2011. Last, I’ll touch on one reason for a rising euro alongside a failing Greece.


The Essential Nature of Infrastructure

By the Casey Research Energy Team

The need for infrastructure is one of the biggest challenges in moving a project toward development. If you’ve discovered a new gas field, you need a pipeline to take that gas to market. If you’ve developed a way to tap into the tidal currents at a narrow pass, you need a transmission line to connect your power to the grid. And if you’ve discovered a mineral deposit, you need a road and an electrical connection to power the massive crushers, grinders, and pumps involved in extracting the mineral from rock.

Of course, resources often turn up not where it’s convenient but in the middle of nowhere. And the need to build a power line or pipeline can easily tip the cost-reward balance into the red, leaving development plans to gather dust on the drawing board.

To tip these projects back into the black, companies have to work with each other and with governments on permitting and building infrastructure. For example, in North America, where the glut of natural gas from shale deposits is keeping prices very low, one consortium is looking to build a liquefied natural gas facility to enable producers to sell gas to buyers an ocean away. In Europe, a pipeline to bring natural gas from Russia to the EU through the Baltic Sea (thereby bypassing Ukraine) is nearing completion, while another Russia-EU pipeline planned along a more southerly route was just dealt a new setback. And in Canada, two recent announcements have set the stage for a resurgence of resource exploration and development in remote areas.

With so many major developments in the works, it’s time to pay heed to the importance of infrastructure.

Those Canadian announcements came from British Columbia (BC) and Quebec – two provinces with swaths of northern lands replete with resources but so bereft of infrastructure that resource development has been very limited. In northern BC, the main stumbling block for new projects has been the lack of a power line. The provincial power grid extends roughly two-thirds of the way up the province, then stops. And that line carries only 138 kV, which means it has little spare capacity. A higher-voltage (287 kV) line reaches only halfway up the province.

Northern communities and projects have to rely on dirty, expensive diesel generators. The mining industry in particular has been lobbying the government for years to build a power line into the north, as there are at least eight major discoveries in the northwest region of the province that stand a chance of becoming mines only if they can tap into the provincial hydropower grid. That lobbying has finally paid off: On May 9, the federal government gave the environmental green-light to the Northwest Transmission Line, as it is known. Construction is set to begin shortly on the C$404 million project, which will extend the 287-kV line another 335 kilometers north.

Several thousand kilometers to the east, the Quebec government is drafting even bigger northern infrastructure plans. The provincial government just announced an ambitious $2 billion plan to build roads and airports within an area of 1.2 million square kilometers, all aimed at supporting development of energy and mineral resources. The Quebec plan foresees 11 new mining projects that could crop up over the first few years of the plan. Access to the north is also expected to prompt development of several hydroelectric projects that will generate 3,000 MW of power.

All told, the government estimates that the projects borne out of this C$2 billion investment will receive $80 billion in public and private investment over the next 25 years. That’s a pretty impressive return.

Then there’s the Nord Stream gas pipeline. This 1,224-km long double pipeline will provide a direct connection between Russia and the European Union by running under the Baltic Sea. It allows Russia to bypass Ukraine, a former satellite state with which Russia has repeatedly clashed over prices and siphoning. Since the EU relies on Russia for over 40% of its gas, the conflicts have threatened its supply.

The first of the pipelines is expected to start transporting gas before the end of the year and the second in 2012. When both are done, the pipelines will be able to move 55 billion cubic meters (bcm) per year. The entire project was financed and developed privately at a cost of €7.4 billion.

While €7.4 billion is certainly a hefty price tag, it comes in below the latest cost estimates for one of the biggest competitors to Nord Stream: the Nabucco pipeline. Nabucco is supposed to run from the Middle East and Caspian region through Bulgaria, Romania, and Hungary to a hub just outside Vienna. The consortium behind Nabucco includes some of the biggest players in European gas, such as RWE of Germany, OMV of Austria, and MOL of Hungary. But the consortium has hit one setback after another over the last five years. Now the project's price tag has risen from €8 billion to €12-14 billion, and the construction start date has been pushed back to 2013.

Building infrastructure is a complicated, expensive task. Permitting alone can take years, especially when a project crosses borders. After that, financing can provide another major challenge. During those years, the cost of supplies and labor often change dramatically – in the case of Nabucco, consider that the price of iron ore – the main component in steel pipes – has risen 50% over the last year. Yet these projects are essential, and their presence or absence impacts commodity prices in multiple countries.

So what does all this have to do with your investments? Add an item to your due-diligence checklist: the presence of infrastructure, even at early-stage exploration. Whatever commodity a company seeks, hand in hand with discovery comes the question: How can we get it out of here?

If researching infrastructure isn’t really your cup of tea, you can fall back on the first item on your checklist: good management. Knowledgeable and experienced people at the top are always planning for success, so the projects they consider will either already have access to the necessary infrastructure or it will be technically and economically feasible to build.

So if a story seems too good to be true – perhaps a company is telling you about an untapped, highly prospective gas field or a massive copper-gold deposit – check into the local infrastructure. There likely isn’t any, which means there won’t be a gas development or a mine anytime soon.

[While “infrastructure” isn't one of Doug Casey's renowned 8 Ps of resource stock evaluation, it is a component that Marin Katusa and his team check out before making an energy investment recommendation. You can put their expertise to work for you – risk- free for three months – with a subscription to Casey Energy Report. Details here.]


Soros Sells Gold – Time to Be Contrarian

by Alena Mikhan and Andrey Dashkov

The current gold bull market has lasted a decade – the same length of time that the great 1970s bull market for precious metals lasted. Many industry old-timers seem to have interpreted gold’s race to almost $1600 and silver’s rise to almost $50 as signs of a grand finale. Our perception is that traders and industry insiders who thought $1000 gold was high have been cashing in.

This may be the thinking behind the recent gold selling done by George Soros. Soros’ selling of holdings in two leading gold-backed ETFs put some wind in the sails of the “end of the gold bull” side of the debate. Not just that April 2011 was a top, but that it was the top. With SEC filings showing that other funds cut their ETF holdings as well last quarter, some folks sure seem to think so.

The question is: Are they right? This seems like a good time to update readers on gold’s fundamentals, in the context of Q1 2011.

The recent selling influenced the figures in the latest report from the World Gold Council (WGC). According to the WGC, ETFs and similar vehicles experienced total net outflows of 56 metric tons (about 1.8 million ounces) in the first quarter of 2011. Total amount of gold held by global ETFs by the end of the quarter was 2,100 metric tons (67.5 million ounces).

The outflows, however, didn’t spell an end to the quarter’s gold run, but coincided with (and perhaps helped to shape) short-term weakness. Those who didn’t see a tidal shift toward a gold bear market took advantage of the selling and added to their positions. WGC reports a 26% annual increase in investment demand – 310.5 metric tons (10 million ounces) in Q1 2011 compared to 245.6 metric tons (7.9 million ounces) in Q1 2010. Noteworthy is that a huge part of this growth was attributed to bar and coin purchases: Physical bar demand alone was responsible for 280.4 metric tons (9 million ounces), which is 62% more than during the same period in 2010. That’s actually rather bullish, as it’s the retail precious metals investor we expect to spark the Mania Phase of this gold bull market.

The balance of supply and demand in the gold market also remains bullish. Demand grew in Q1 2011, but total supply was down 4%. Central banks and official sector institutions acquired 129 metric tons of gold (4.1 million ounces), which is more than their combined purchases during first three quarters of 2010.

The factors that have worked so well for gold so far – the weakening dollar and an uncertainty about the U.S. economy; Europe’s problems with sovereign debts in PIIGS; and political turmoil in Africa and the Middle East – are still in force. Gold remains a safe haven in the eyes of investors. And that includes Soros, by the way, who turned his ETF holdings into shares of Goldcorp (T.G) and Freeport-McMoRan Copper and Gold Inc. (NYSE:FCX), adding the leveraged upside exposure to gold that gold stocks offer.

One of the best ways to learn about how to play the leverage offered by the best gold stocks and profit all along the learning curve is to subscribe to the Casey Research metal publications International Speculator and BIG GOLD.


Why Do More Bailouts Mean a Stronger Euro?

By Vedran Vuk

Some of you have probably been thinking, “What the hell is going on with the euro?” The headlines continue to report the worst from Greece and the rest of Europe, yet the euro continues to get stronger and stronger. Has the world gone completely mad? Common sense suggests that bailouts would be a bad sign for the euro.

Here’s another way to look at it. Yes, the bailouts are bad for Europe in the long run, but for the prospects of higher interest rates in the short term, they could be very useful. When the ECB raises rates, it must consider Greece’s fiscal situation. An interest-rate hike for the eurozone means a higher cost of debt for Greece as well. This is a very sticky situation as the ECB wants to avoid inflation, but it also can’t let Greece fail.

Sure, the ECB could take the rate hikes slowly, but this could be dangerous. Hence, there’s the bailout option. With extra money from a bailout, Greece will be able to more easily weather rate hikes. Hence, the second Greek bailout makes it easier for the ECB to raise rates for the eurozone as a whole without worrying about Greece. And higher rates mean a stronger euro. As a result, currency traders are likely expecting higher interest rates sooner, and hence the currency is rising.


Casey Phyle Announcements

If you’re interested in getting together with other like-minded Casey Research readers, two new Casey phyles are starting up – in Ottawa and in Montreal, Canada.

Interested parties in Montreal should contact Nick at Nickdabramo@aol.com. For the Ottawa group, please contact Greg at greg_utas@rogers.com.


Additional Links and Reads

Found: $775bn of Missing Muni Bonds (Financial Times)

Whoops! The Federal Reserve “accidentally” didn’t count municipal debt held by some households when estimating the size of the municipal debt market. The real figure should be $3.7 trillion – 23% higher than the estimate of $3 trillion. This is hardly a rounding error.

Cyber Cops Stymied by Anonymous Hackers (Bloomberg)

In the Daily Dispatch, we’ve written about the evolving threats to consumers and businesses on the Internet. This article does a good job of explaining the law enforcement problems associated with cybersecurity, and it also covers a list of the most recent corporate breaches.

Bank of America Gets Pad Locked After Homeowner Forecloses on It (WFMY News)

Perhaps it’s a bit early for the Friday Funnies, but this is a great story. Essentially, Bank of America owed a couple reimbursement for legal fees. After five months of not receiving payment, the couple’s attorney filed to have the bank’s assets seized and moved to foreclose on a local Bank of America branch.

Well, that’s it for today. Thank you for reading and subscribing to Casey Daily Dispatch.

Vedran Vuk
Casey's Daily Dispatch Editor

Jun 07, 2011