Washington State Opts for Wage-Price Spiral

I recently wrote about how government minimum wage laws can be a conduit for a wage-price spiral that would trigger hyperinflation.  The state of Washington is about to make this a self-fulfilling prophecy by raising its minimum wage to $9/hour.  Other states are automatically following suit.  Here we go!  Expect Washington to lose small businesses as entrepreneurs decamp for lower-cost states.

Minimum wage mandates can get silly.  I find it odd that California has a different monthly minimum wage just for sheepherders.  Their annual California minimum salary of $17,070.24 is higher than the minimum wage of $16K a worker would get for 50 weeks of 40-hour labor.  What's up with that?  Sheepherders probably work just as hard as janitors and restaurant servers and can get free meals and lodging too.  Why not special wages for cattle herders, rabbit pen monitors, and hog farmhands?  I don't get it.

What I do get is that public outcries for action on workers' stagnant buying power will prompt more minimum wage increases, more price hikes by employers, and yet more erosion in spending power.  This stagflationary spiral can erupt into hyperinflation any time foreign central banks or sovereign wealth funds turn away from our Treasury bond auctions.  China and Japan have already established a non-dollar financial conduit.  The U.S. dollar is already on a slippery slope thanks to decades of federal indebtedness and a Fed that no more room to lower interest rates.  The hyperinflationary fire awaits its first spark.  

The Haiku of Finance for 12/30/11

No blue light specials
Sears closing stores in some states
Many vacant malls

Flat 2011 Market Presages Flattening Of Many Portfolios In 2012

The U.S. stock market has gone pretty much nowhere in 2011.  In fact, it's gone pretty much nowhere for at least a decade.  Investors who started picking up bargains in tech stocks after the dot-com crash have little to show for their bottom-picking.  Blue chips with decent dividend yields have done better, especially for those who reinvested their dividends, and especially for those who stayed diversified with fixed income investments.  The bond market continues to rally with the Federal Reserve holding its interest rate target at zero.

The industrialized world has entered a fantasy land where credit can magically be paid off with the creation of more credit.  This is not as unique as it seems.  Previous credit explosions have always ended in tears when governments could not stop the monetary printing presses they started.  Paying your enormous debts with hyperinflated currency feels great until your paycheck starts to deteriorate even more rapidly.

In 2012 I will continue to find ways to defy conventional asset allocation.  Allocating capital to bonds makes little sense in the face of hyperinflationary credit creation.  The only bond exposure I will consider in 2012 (once my remaining California munis mature) is through TIPS and related instruments.  Allocating capital to stocks makes little sense with broad market valuations in excess of their historic P/E ratio of 14.  I will consider more stock investments in the aftermath of a major market decline but not before one occurs.  Even so, I remain a deep value fundamental investor.  Residential real estate in rent controlled locales would be disastrous purchases for new investors if high inflation becomes a reality.  Hard assets like precious metals are okay for my own portfolio as diversification tools, but I am mindful that gold's price is far above its historical average.  Rare earth metals are industrial inputs that will be hurt badly if exports of manufactured goods from China to Europe and the U.S. decline in 2012, as I suspect they probably will.

The eye of the hurricane is passing.  Europe cannot bail itself out.  The Fed's dollar swap lines can keep a drowning Europe afloat but cannot pump water (i.e., too much sovereign debt) out of its lungs.  U.S. government-owned financial assets await new buyers.  Some kind of storm can hit without warning in 2012 and blow a lot of portfolios away.

Nota bene:  Long GDX and FXI with covered calls.  Long some California state munis maturing in 2012.  Sitting on plenty of cash.  

The Haiku of Finance for 12/29/11

China penny stocks
Will they ever make money?
Hardly any chance

First China Pharmaceutical Group (FCPG) Won't Reorganize

Trinity Investment Research did it again.  They pumped another penny stock in a mailer last year and it went nowhere but down.  First China Pharmaceutical Group (FCPG) is a drug distributor in China that used to be called E-Dispatch.  Why the name change?  Beats me.  Maybe they just wanted to differentiate themselves from all of the links I found when I did a web search for "E-Dispatch."

They sure don't differentiate themselves with financial results.  They turned a profit in the last two quarters of 2010 but are now losing money.  Their negative retained earnings are getting farther in the hole.  Free cash flow has been negative for three years.

The company has problems that are forcing it to abandon a proposed corporate reorganization it had planned to execute.  The details don't interest me.  A foreign penny stock that can't get a simple administrative reorganization right isn't going to get serious attention from me.  Investors who bought FCPG when this mailer came out would have lost around 90% of their money if they had held on until now.  I don't like those kinds of returns.

Full disclosure:  No position in FCPG, ever.

The Haiku of Finance for 12/28/11

Another down day
Market barely moved this year
Only lucky gains

Eagleford Energy (EFRDF) Shouldn't Waste My Time

Hey, here's another so-called winner from one of Tim Fields' old Untapped Wealth mailers.  This one was about Eagleford Energy (EFRDF), an exploration company looking for oil in - you guessed it - Texas' Eagle Ford shale region.

Can you guess by now what their financial results have been like since 2009?  If you guessed anything other than negative net income, retained earnings, and free cash flow, you haven't been reading my critiques long enough.  I'm looking in SEC's EDGAR . . . was there even a 10-K published in 2010?!    Oh, wait, I found something that looks like a financial statement on a page about their annual meeting.  Check out the table on page 8 for the most important thing you need to know:  Net losses increased as revenue increased.  That means they can't control their variable operating costs.  The more they drill, the worse they'll perform.  I can't believe there's an analyst somewhere giving this a Buy rating but maybe some sell-siders really are desperate for attention.

The management team reads like a grab bag of dudes thrown together from some miscellaneous acquisitions.  I could probably find a couple of homeless people in San Francisco who could fill out any empty slots they have.  Eagleford can't afford my finder's fee.

The company touts its projects for being adjacent to the producing properties of larger competitors.  Folks, I've lived in San Francisco adjacent to multimillionaire neighborhoods for over seven years but that doesn't make me one.  Read phrases like "working to develop a number of potentially high volume oil targets" as really meaning "we haven't produced very much oil yet."  Wait, I take that back, they did hit something in June of this year but it's not clear how much.  That was their last press release for 2011.

I shouldn't even bother writing any more about this one.  Investors who bought the stock in late 2010 when I got this mailer paid well over a dollar for something now trading at twenty cents.  In a just world, Trinity Investment Research would have to explain its touts to investors after the fact.

Full disclosure:  No position in EFRDF, ever.

The Haiku of Finance for 12/27/11

Four main shopper types
All have one thing in common
They all pinch pennies

Quiznos And Sears In Trouble

I never would have guessed that Quiznos was on the verge of bankruptcy since I don't follow the fast food sector all that closely.  It has reached agreement with its major debtholders to execute a debt for equity swap, but that just buys time.  The fast food sector is really crowded and Quiznos has to compete against low-priced alternatives like Subway in addition to burger and pizza chains.  I've always thought of Quiznos as a premium alternative to Subway with its focus on grilled sandwiches with lots of meat - a high-cost way to serve the costliest part of a sandwich.  Maybe consumers are tightening belts in more way than one.  If they concede the low-price market to Subway then IMHO they can win in more upscale urban areas.  That means closing store locations in low-income areas.

Speaking of store closings, Sears has had problems for years.  Merging its blue-collar brand with an even more downscale brand like Kmart was always an uncomfortable mix.  The genius behind the idea was a hedge fund guy, not a retailer.  Now shareholders reap the harvest sown by his knowledge gap as Sears is forced to close the bottom 3% of its stores.  Sears needs to come to terms with the dominance of Wal-Mart and Target at the extreme low-price end of the retail spectrum and refocus its branding on the middle market where it belongs.  The demise of Montgomery Ward last decade should have been a golden opportunity for Sears to cherry-pick some better store locations.

Two retail brands that used to mean something are now in trouble for wandering outside their core demographics.  Growing without thinking first can do that to you.  How many Quiznos outlets are located in shopping malls with a Sears as the anchor?  In an ideal world, there would have been many.

Full disclosure:  No positions in any of the companies mentioned above.

China And Japan Getting Away From Dollars

The run on the dollar that could sink its value and bring surprise hyperinflation to the U.S. has just become a lot more likely.  China and Japan are moving to trade each other's currencies directly rather than use the U.S. dollar as an intermediary.  This won't lead to an immediate shift away from the dollar.  After all, the greenback has constituted around 60% or so of central banks' foreign currency holdings since at least 1995, according to the IMF's COFER report.

The change does signal to other nations that America's main trading partners will favor the illiquidity risk of less-traded currencies over the valuation risk of holding dollars tied to unsustainable spending.  China and Japan do have debt problems of their own, but they may be wagering that two drunks trying to stand each other up over the Sea of Japan is less tiresome than levitating a much larger drunk off of his back from across the Pacific Ocean.  They may even print some more of their own currencies just to have the liquidity to buy each others' bonds.  The Fed isn't the only player around that can do quantitative easing.

The U.S. financial elite should take a breather from its construction of swap lines for the eurozone to pay attention to this news.  America's deficit spending since 9/11 constituted a transfer of wealth from Asian central banks and sovereign wealth funds to shareholders in U.S. defense contractors and Medicare vendors.  Trade partners who opt out of petrodollar recycling will make it harder for the U.S. to peddle dollar-denominated debt outside the U.S., because there will be fewer nations willing to keep an inventory of dollars to buy it.

In any case, China and Japan have just quietly removed a source of demand for dollars.  This deal is another sign of higher U.S. interest rates to come, hyperinflation or not.

Full disclosure:  Long FXI with covered calls.

DOE Reached Same Conclusion On Wind Rare Earths As Alfidi Capital

Some of my fine readers may have noticed my recent interview in The Gold Report where I named dysprosium as the rare earth metal most likely to remain strongly in demand.  I mentioned it in the context of continued strong demand for wind turbines that also used neodymium in their magnets.  Well, lo and behold, the U.S. Department of Energy reached a similar conclusion in its 2011 Critical Materials Strategy.  It specifically named dysprosium and neodymium as two of five metals that may pose supply challenges for the clean energy sector.  The Gold Report has a good article pointing out implications for the rare earth mining sector.

The DOE report also has some great details on alternative technologies that may ameliorate the rare earth supply crunch when they are fully mature.  This is another subject I mentioned in my interview.  Listen up, Wall Street!  Keep reading this blog if you want to hear about emerging industry issues.  

MabCure (MBCI) Still A Work In Progress

Tim Field's Trinity Investment Research once sent me a mailer about another so-called winner.  Let's check out MabCure (MBCI) and see if they performed as the teaser flyer from the Untapped Wealth newsletter predicted.  Here we go again with three years of negative net income, retained earnings, and free cash flow.  Just once I'd like to see some financial health from one of these publicly-traded companies that pumpers like to tout.

MabCure aims to research novel cancer diagnostics and treatments by identifying markers and antigens specific to tumors.  I do not possess the medical expertise to ascertain whether this is a valid approach.  I can only wonder how a traditional laboratory approach like this will fare when faced with massively distributed competition from small-scale biohacking labs.  There is probably enough  information in the public domain for a networked collaborative of garage biolabs to assemble bio-widgets that can identify markers.

I'd rather participate in a local biospace than invest in a biotech company doing marker identification the old-fashioned way.

Full disclosure: No position in MBCI at this time.  

The Haiku of Finance for 12/26/11

"Mega Monday" hope
Spenders had chance to buy sales
Redeem those gift cards

Athabasca Uranium (ATURF) Digging Brand New Sites

The eventual end of the program that extracts fissionable material from decommissioned Soviet-era nuclear warheads will require nuclear plant operators to find new uranium supplies.  Uranium producers can expect no shortage of capital to chase new deposits.  Athabasca Uranium (ATURF) is going after uranium in Canada.

I have concerns about the relevance of the management team's expertise.  There is little room for doubt about their collective talent, although I'm having difficulty looking up the operating histories of some of their previous companies (specifically Kinetex Resources and Choice Resources Corp.).  The thing about uranium is its uniqueness among energy sources.  Its radioactivity requires special handling far above and beyond normal mining safety protocols.  Its potential use in the most lethal weaponry possible make it subject to stringent controls on reporting and transportation.  I truly believe there only a small number of mining people on the planet with expertise that is germane specifically to uranium and other radioactive resources.  It's kind of nice that one ATURF director has nine years of experience with uranium explorer Northern Continental Resources (merged with uranium explorer Hathor in 2009).  Another director has a long background in nuclear energy.  I still wish the company had more nuclear bench strength in its management rather than its board.

All of the company's projects are still in the early surveying and drilling phases, so evaluating any of them is impossible for now.  At least they're digging in an area known to be productive.  I wish they had more capital because $4M doesn't sound like much for the number of sites they need to drill.  ATURF needs some 43-101 reports in 2012 on what they find.  Stay tuned.

Full disclosure:  No position in ATURF at this time.

Riverside Resources (RVSDF) With Multiple Mexico Properties

Most exploration-stage mining companies will stick to a handful of properties, like no more than three.  They do this to stay focused, contain costs, and keep operations predictable.  Portfolio approaches are typically for major miners that can deploy capital and talent globally, or incubation companies that can spin off projects as separate companies.  Riverside Resources (RVSDF) is an exploration-stage mining company with a business model that defies this conventional wisdom.  They are exploring multiple properties in North America with a focus on Mexico.

The good news is that they have plenty of cash and short-term investments, and are profitable as of June 30, 2011 (a big change from the net loss in the same quarter in 2010).  The quality of management probably has a lot to do with that result.  The CEO and members of the team responsible for drilling have strong backgrounds in mining.  Riverside seems to have done a lot of things right according to its unaudited financial statements, with timely capital raises and a sufficient number of wholly-owned properties.  Their key to turning a financial corner appears to be the revenue they've collected from larger partners who held options to explore various properties.  Majors who elect not to extend these options allow properties to revert to 100% ownership of the original explorer.

The risk for Riverside is that too many of its properties could be abandoned by larger partners.  Having 100% ownership is not a selling point if the owned properties have been abandoned by prospective joint venture partners.  Riverside would then be under pressure to prove its remaining properties are viable.  A quick scan of several of their press releases reveals a lot of drill intercepts at less than 1.0 g/t Au.  This past quarter's profitability gives Riverside some breathing room it can use for more exploration.

Full disclosure:  No position in RVSDF at this time.  

Argentex Mining Corp. (AGXMF) Bringing Pinguino Property To Maturity

There's more to Argentina than gauchos and Peronists.  There's metal down there and Argentex Mining Corporation (AGXMF) says it found some.  Argentex is drilling at a number of prospective properties in Santa Cruz Province, Argentina.  The company's property at Pinguino looks particularly intriguing.  The ore grades appear decent, with a 43-101 report estimating fairly low grades of gold but decent grades of silver and indium.

The Pinguino property is smack dab in the middle of an active mining sector but that does not guarantee it can become a viable mine.  The nearest road leading to Pico Truncado and a port for export appears to be about 50 km away, based on eyeballing the company's map.

The IFC's equity investment in October 2010 is a huge vote of confidence in the company but the warrants attached to their equity, if ever exercised, will dilute existing shareholders by about 14%.  The consolation for investors is that the share price will have to rise by 245% in five years before that C$1.14 exercise price is triggered.  Getting the price to the level requires management's commitment to make Pinguino a viable producer.  I do not know at this time whether Pinguino has the logistics trifecta - water, power, roads - to make this possible.

Argentex's burn rate of approximately $602K/month means its cash of $1.9M (as of April 30) would have lasted until the end of August 2011.  The problem is that they still had liabilities of $1.87M; netting that against the short term investments of $3.2M would have left them them with a reserve of $1.4M.  At their present burn rate they were perilously close to running out of cash at the end of last summer.  They're obviously still operating as of the present date thanks to a recent bought deal that netted them C$10M in cash at a valuation far higher than what the IFC obtained.  That is a very encouraging sign for a junior resource company; if the company was having operating problems or sitting on poor properties, subsequent investors would demand lower prices for investments.

Argentex lives to fight another day.  If they use that C$10M wisely, it will last 16 months and they will have the opportunity to show later investors that they can commit capex to logistics infrastructure at Pinguino.

Full disclosure: No position in AGXMF at this time.  

The Limerick of Finance for 12/25/11

A Santa Claus rally this year
Would make many bears shed a tear
With shorts they must cover
If stocks more than hover
A short squeeze would quickly appear

Euromax Resources (EOXFF) Strategizes In The Balkans

Gold explorers usually stick to areas in the Western U.S., Canada, and other areas with well-known geology.  Most people don't think of looking for gold in southern Europe; then again, those ancient European empires had to get their gold from somewhere.  Euromax Resources (EOXFF) is exploring the Balkans for metals.

The company's technical advisers have quite strong backgrounds, but there is no indication they are onsite in the Balkans.  The executive team is somewhat strong, with the CEO and Executive Chairman both having managerial backgrounds in the resource sector (although they are not trained geologists).  Euromax has heretofore been an exploration company.  Changing their strategy to that of a production company is hard and will require focus.

Comparing their properties invites questions about their intended strategy.  The company plans to develop its Trun property in Bulgaria first because they own it 100% with no concessions to outsiders.  This may be a classic case of a sunk cost instead.  The company has spent millions exploring Trun and still does not have enough drill holes to definitively establish a development plan; that's why they're planning more drilling at the Logo site.  Recent drilling results at Trun indicating 1.23g/t at the longest intercept are not encouraging.  The potential bonanza hole at 7.13g/t has an extremely short length.

IMHO the company's most valuable project is the Ilovitza, Croatia property and recent metallurgical results reveal that an amazingly concentrated 16.6g/t of gold can be culled from an 0.25g/t ore body.  Sometimes simple drill results can underestimate the amount of recoverable ore.  The Ilovitza property appears to have roads on site and water sources less than 200m from the drill holes, which will greatly facilitate mining.  All they need is a dedicated power source and the logistics trifecta will be complete.  Once the back-in rights from another mining company expire on January 23, 2012, Euromax will be able to develop Ilovitza free and clear if they have sufficient financing.

Here's a brief note on financing.  Euromax had over C$4M in cash on hand at the end of September and has an apparent burn rate of about C$300K/month, based on their most recent unaudited quarterly statement.  They can survive for about a year, but if they expect to start production at any of their sites they will need a lot more cash very soon.  Alternatively, they can continue to option out interests in their properties so larger miners can do the heavy lifting.

Euromax deserves a chance to succeed if it gets its strategy right.  It is still a high risk stock due to its changing strategy, unaudited financial statements, and curious focus on a 100% owned unknown property (Trun) over a more encouraging property with a defined metallurgical process (Ilovitza).

Full disclosure:  No position in EOXFF at this time.  

The Haiku of Finance for 12/24/11

Hard times at Kodak
Digital killed film demand
Times are a-changin' 

Strategic American Oil (SGCA) All In The Family

I've been sitting on a teaser mailer from one Bob Flaherty that I got around October 2010.  It touted a Flaherty-related investment site called OnShoreOilProfits.com that is no longer active.  It also touted a stock called Strategic American Oil (SGCA) that is slightly more active than that defunct website, but not by much.

The financials resemble so many other penny stocks I've checked off here at Alfidi Capital.  Three years of negative free cash flow, net income, and retained earnings, all of which have progressively become even worse as time has passed.  Okay, the negative free cash flow for 2011 was slightly better than 2010 but not by much.

The company likes to keep its business in the family.  The 10-Q filed on June 20, 2011 reports that the company sold 15% of its working interests in its Galveston Bay fields to a company controlled by the father-in-law of Strategic American Oil's own CEO!  The other company in question, SPE Navigation 1 LLC, was later purchased by Strategic American Oil.  This set of transactions makes absolutely no sense.  Why sell a working interest in property to a company you later acquire outright?  Let's see . . . SPE's corporate cash went to SGCA . . . and cash later went to SPE's owners upon acquisition.  It sounds like a Rube Goldberg method for extracting cash from a company with no change in the value of physical assets transferred.  Press releases in later months make absolutely no mention of the prior deal to sell a working interest to SPE, so claims of increased reserves from "acquisitions" must be taken with a grain of salt given these shell games.

The 10-K filed on Nov. 15, 2011 shows us exactly where these kinds of roundabout transactions will take a company.  Check out just their oil data.  With only five "net" wells they can produce about 6000 bbls/year, and with slightly over 97,000 bbls as proven reserves their fields should be productive for about 16 years with no further discoveries, acquisitions, or engineering improvements.  Productive is not the same thing as profitable.  This company loses money and will only be profitable if it dramatically lowers its costs.  Engaging in sweetheart deals with extended family members does not lower costs.  The section of the 10-K on risk factors mentions the company's limited operating history, but it has "operated" as an exploration company since 2005.  They were originally looking for gold.  Another big risk factor is the auditor's opinion that doubts the company's ability to continue as a going concern.  Folks, you really have to read the 10-K on these kinds of companies.

So where's Bob Flaherty, the guy responsible for sending me the mailer on this stock?  Hey, he's over here at Flaherty Financial News.  He's got his son working for him.  The Flahertys have something in common with Strategic American Oil.  They all keep business in the family.

Weikang Bio-Technology Group (WKBT) In The Inscrutable Orient

Sometimes there comes a stock that sounds too good to be true.  Weikang Bio-Technology Group (WKBT) markets traditional Chinese medicinal treatments.  I first noticed it in a typical pumper mailer from Jim Trippon in October 2010, who used to name his service as variously "Conservative Investor Alert" and MyChinaProfits.com, neither of which I can locate on the Internet today.  Now he publishes China Stock Digest which links to a bunch of other links detailing his various business outreach efforts.  I don't have time to review all of those links.

Weikang Bio-Technology looks good, on paper anyway.  It reported extremely healthy financial results in 2009 and 2010 but those results have not at all been reflected in its share price.  This makes me wonder what the market knows about this thinly-traded stock's prospects.  I do not understand why a stock that reported $24M in net income in 2010 trades as a penny stock.  A private placement earlier in 2010 raised cash even though the company seemed to have plenty of cash on hand.  I'm more than curious to know why they needed to raise a private round given that their reported statement of cash flows shows more than enough free cash flow to fund growth internally.  This makes no sense.

I'm also curious about some key news the company has announced this year.  Weikang dismissed its auditing firm of Goldman Kurland and Mohidin LLP on May 9, 2011.  RedChip terminated its investor relations agreement with Weikang on May 12, 2011 because Weikang's management did not make themselves available to RedChip analysts.  This termination came only four months after Weikang initiated its relationship with RedChip.  Weikang announced on Nov. 15, 2011 that it will be unable to meet the SEC's filing deadline for its next 10-Q.  These news items, taken in sequence, have progressively negative connotations.  Their new auditor did give them a positive report in June.  I prefer not to invest in companies whose news releases make me wonder what's really going on inside a company.

Full disclosure:  No position in WKBT at this time.  

The Haiku of Finance for 12/22/11

Truck tonnage slow rise
All that slow steaming caught up
Looser supply chains

South Boulder Mines (SBMSY) And Eritrean Exploration For Potash

South Boulder Mines trades as STB in Australia, and SBMSY here in U.S. markets.  The company does have other mining projects in Australia but one newer project is worth a discussion.  They think they've found a bunch of potash in Eritrea and want to try their luck bringing it into production.  How hard can it be?

The good news is that potash deposits have fairly uniform geology, unlike metal deposits that form in veins and require more precise estimations of grade and depth.  That makes for a straightforward estimate of the mine's layout and required capex.  They have considered requirements for new roads and port facilities in advance and have budgeted to build them from scratch.  The potash site is below sea level, so pumping water to the site from the coast is feasible in energy terms.  I am curious as to whether the seawater would have to be desalinated or otherwise treated prior to use in a potash mine; there is precedence for using treated waste water.  Saltwater from oil drilling is apparently also useful in the hunt for potash, so maybe seawater isn't a worry at all.

The bad news is all about Eritrea.  The U.S. State Department has a good summary of Eritrea's political situation.  Eritrea's willingness to defray the company's capex costs is nice but the government's requirements for free carry, an option to buy a 30% stake after the bankable feasibility study, a 3.5% royalty, and a corporate tax rate of 38% all add up to a serious bite before the common shareholder will see a penny of net earnings.  The government completely controls the economy, prohibits civil liberties, and has not held free elections.  That should give foreign investors pause in considering how safe their investments will be.  Transparency International rated Eritrea as 2.5 in its Corruption Perceptions Index in 2011 (that's pretty bad).  The Heritage Foundations' Index of Economic Freedom ranks Eritrea's economy in 2011 as one of the least free in the world.  The U.S. government is also sufficiently concerned about Eritrea's support for Al Shabaab, an Al Qaeda-inspired radical Islamist terrorist group, that it advocated international sanctions against Eritrea earlier this year.  The UN enacted those sanctions and recently made them stronger.

Read that State Department political summary again for an interesting fact.  Eritrea's GDP was only $1.87B in 2009.  South Boulder Mines estimates revenue from this project of $6B over 17 years, or roughly $353M/yr.  That's almost 19% of Eritrea's total GDP, from a single project.  A country as corrupt and poor as Eritrea would be sorely tempted to nationalize a lucrative mining project.  I have no idea whether the Eritreans would actually do such a thing, but they don't seem to have much respect for the law or international norms of behavior.

The company owns a legacy nickel property and plans to spin it off. Why not sell it to raise the money they'll need for capex at the potash site?  That would make the rest of the raise easier.  It would also be easier to raise capital with working interests rather than share issuance, as the Eritrean government's potential equity stake could massively dilute shareholders.  Working interests, if creatively structured, can let revenue flow to strategic investors before the Eritrean government collects its onerous taxes.

In any Western country, a potash play this large and shallow would be a more straightforward financial decision.  Its location in a country with a questionable political structure should make investors think carefully.

Full disclosure:  No position in STB / SBMSY at this time.

House GOP Prepares To Cave On Measly Payroll Tax Cut

This just in - fiscal irresponsibility remains alive and well in our nation's capital.  Republicans in the House of Representatives have agreed to extend the payroll tax cut.  We can do some simple math to see just how little this will matter as an aggregate economic stimulus.

If the tax cut is worth $40 per payroll employee, and 160M Americans benefit from its extension, then the whole thing is worth $6.4B in forgone federal revenue.  Americans, being what they are, may buy another $40 worth of pizza and beer for a month.  Poor working stiffs on payroll do have a higher marginal propensity to consume.  They will not put that $40 toward their IRA contribution in 2012.  They will not pool it with their neighbors to start a small business or resilient community.  They will choose the fun today with no regard for the hangover tomorrow.

The tax cut is politically popular and financially suicidal.  The inability of the federal government to come to grips with the mismatch between its revenue and spending cannot be solved with these kinds of cynical games.  Credit rating agencies are once again threatening to downgrade the U.S. government's sovereign debt rating.  Sooner or later, some instance like this tax cut standoff will be the straw that breaks the camel's back.

Our leaders reflect our desires.  They are mirrors of what our public character as Americans has become and that's why we return them to office.  Our elected officials are incapable of making hard choices necessary for austerity because we can be counted on to vocally endorse profligacy.  This is our fault.  The bond market is the only adult in the room.  It will force us to pay the piper.  

Jobs Recovery Not Turning Any Corners In Dec. 2011

Mainstream financial reporting still makes me laugh.  Popular analysis of headline numbers is designed to brighten our moods and keep consumers spending during Christmas shopping sprees.  CNBC wants us to think jobless claims are dropping unexpectedly.  The "dropping" and "unexpectedly" memes are two different but related phenomena.  Claims probably dropped because seasonal hires in retail and logistics can no longer file claims for jobless benefits.  This is only unexpected to observers who've never worked in retail or logistics during the Christmas holidays.

Working as an extra sales clerk in a department store or pallet mover in a warehouse is a low-skill, low-pay opportunity that rarely leads to permanent improvement.  I once worked as an assistant school custodian over Christmas break in 1989 during my junior year in high school.  It was easy money for moving school desks and raking leaves at a local elementary school.  The job does not belong on my resume and I had no ambition to move up the ladder to be a janitor.  My holiday sojourn may or may not have been counted in the nation's employment statistics for 1989 but it wouldn't have mattered either way.

The end of the holiday shopping season will probably see jobless claims return to pre-November levels, once the numbers are reported around March 2012.  Meanwhile, real unemployment as measured on Shadow Government Statistics remains around 22%.  I'm eyeballing John Williams' charts because I don't have a subscription.  His headline numbers are superior reflections of economic reality.  Don't expect permanent improvement in this jobless non-recovery; Europe's banking system has yet to fully implode and take us all down once again.  

Gold American Mining (SILA) Has Mined . . . What Exactly?

Someday I will reach the bottom of the stack of pumper mailers I've collected for some months.  Until then, I must continue to summarize the results of their urgent admonitions to "buy now" as if my life depended on a penny stock.

Gold American Mining (SILA) was the subject of a mailer from The Myers' Letter.  The mailer claimed that SILA was a shoe-in for takeover by Goldcorp (GG).  Nothing of the kind ever took place.  Sparking a takeover rumor is a classic stock pumper's gambit.  No takeover is ever likely due to this company's lack of any revenue at all.  I'm not even sure if SILA is still operating, as the website is currently offline.

Gold American Mining has negligible assets.  Reading the 10-K from November 2011 is a hoot.  The company began as a plan to market golf "services" at private clubs to people unqualified for membership.  The ownership of the property in Zacatecas State, Mexico, they had optioned to explore for gold is under a legal cloud.  The company has exactly one employee.  The "risk factors" section includes doubts about the company's ability to continue as a going concern.

Why would anyone buy this stock?  All of the information needed to make a common sense decision is right there in the financial statements available at the click of a button.  The mailer is useful for filling my neighborhood's paper recycling bin.

Full disclosure:  No position in SILA or GG at this time.

Getting More Bearish On YRCW Is Now Impossible

That headline is not an attempt at reverse psychology.  Today I decided to find out whether I could either short shares of YRC Worldwide or buy puts to bet on further price declines.  Borrowing shares to short through my brokerage proved impossible; I would probably need some kind of special connection directly to a market-making specialist firm to make it happen.  My brokerage's order system wouldn't let me buy puts, not even ones out to the farthest expiration date.  I found that odd as those puts have clearly visible ask prices.

It is now technically impossible for those bearish on YRCW's prospects to get any more bearish using widely available financial instruments.  Check out the existing short interest on the stock.  There are 59M short shares against an outstanding share count of 6.8M.  The overwhelming short interest has maxed out the market's ability to accommodate investor interest.  That should be unsurprising for a company with an EPS of -$720.  That is a remarkably negative achievement.  Think about how far in the hole a company would have to be with results so poor, and so obvious.

I should have shorted this stock in early 2010.  Sometimes waiting for easy money makes me wait too long.

Full disclosure:  No position in YRCW/YRCWD at this time.  

Hints On Due Diligence In Rare Earth Mining

My genius readers have the chance to read my interview today with The Gold Report, which I've noted has also been picked up by other online media outlets.  I mentioned the logistics trifecta - water, power, roads - as something absolutely critical to a productive mine.  I also need to elaborate on the subject of production costs.

Investment banks and resource industry sources regularly publish information on the cost production curves for specific mining sectors.  Professional investors and analysts prefer to invest in projects whose cash costs of production are in the bottom quartile of their peer group.  I'm not sure how 25% became the threshold or whether it's been academically validated as a useful cutoff, but it's become an industry truism.  This business rule holds true for minerals, oil, natural gas, coal, potash, and any other resource that must be extracted from the earth's crust.  That's why junior miners whose executives have good business sense will tell you whether their cash costs place them in the cheapest 25% of their peer group. 

The problem with rare earths and other critical metals is that there are too few operating mines worldwide to construct statistically valid cost curves.  The rare earth sector is currently dominated by Chinese mines whose financial reporting may not be transparent.  The important point to remember is that investors must use factors besides the cost of production to evaluate new resource projects, especially those in the exploratory stage.  I'll recap some of those factors below.

Management experienced in the sector.  I get impatient whenever I sit through investment conferences and roadshow presentations and listen to a mining company CEO whose background was in investment banking, management consulting, financial brokerage, or something else unrelated to mining.  That tells me the insiders and founders are just looking to dress up a bad property and quickly flip it to the next round of suckers and bagholders.  Yes, folks, there really is some of that from time to time in resource investing.  Effective mining CEOs need to be operating geologists, without exception.  They should ideally have a career history encompassing an entire project lifecycle, from exploration to shut-down.  It's also nice to see other geologists and mining engineers on a junior resource company's management team. 

National Instrument 43-101 compliant report.  The SEC's rules for companies disclosing resource reserves are much more restrictive than Canadian securities rules.  The SEC requires disclosure of a company's resources that can be economically extracted.  Canada, with a more liberal bent to encourage development of its resource sector, requires companies preparing for production to publish what's commonly known as a 43-101 report.  The importance of the report for investors is its disclosure of a company's proven and probable reserves, aka "2P reserves."  This reserve category is the most useful estimate of what a company can economically extract, and does not include inferred or implied resources that may later be added to the 2P category after production begins.  The 2P number can be plugged into a valuation model to determine the company's worth. 

Burn rate.  This is the amount of money a junior company is spending monthly to operate.  Divide its annual net losses by twelve, then divide that monthly loss into its cash on the balance sheet.  I also like to subtract shot-term liabilities from the cash on hand just to see if the company will survive for a year.  Companies that run out of cash before their exploratory results are complete will need to return to investors hat in hand.  Raising more capital will dilute shareholders immediately (through common stock issuance) or eventually (through warrants and PIPEs). 

Logistics trifecta.  I've said it before and I'll say it again.  Water is for heap leaching a mineral deposit, which will also require plans for treatment and disposal of tailings (either in a pond or dry-stacked after baking) that retain traces of toxicity.  Electric power is for the equipment and base camp; the company must either be a mile or two away from a transmission line and have planned capex for a step-down transformer, or must have large volume diesel tanks on site.  Roads to the project site can be of the gravel and unimproved variety but they must at some point lead to a metals refinery by linking to other hardball roads or a port. 

There you have it, critical elements investors.  Please do your own homework while researching investment opportunities.  I can't do investors' homework for them because nobody pays me anything to do so. 

The Haiku of Finance for 12/19/11

Ma Bell walks away
Won't buy T-Mobile at all
Costly breakup fee

Valdor Technology (VTIFF) Shoots For Fiber Optic Niche

Fiber optic aficionados like the folks at Valdor Technology (VTIFF) are fond of well-crafted engineering solutions.  I don't doubt the quality of their product.  I admit skepticism about this company's ability to sell premium products in a heavily commoditized niche industry like fiber optic connectors.  I am concerned that the most recently available financial report on Valdor's website dates to Q1 2009 and it is unaudited.  The income statement shows progressively larger losses from 2008 to 2009 and there is a similarly widening "shareholder deficiency" on the balance sheet. 

Typical fiber optic connectivity involves cheap solutions like epoxies and gels.  The fiber optic market is dominated by big companies like Corning and 3M.  That seems to be good enough for the $2B annual market for cable and connections.  Valdor's premium product is aimed at a niche in high-performing systems operating in extreme environments.  There's nothing wrong with carving out a niche, provided it's sufficiently lucrative. 

Let's do a quick back-of-the-envelope example.  Lockheed Martin's F-35 Lightning II may be a prime candidate to have its fiber optic cables linked by the kind of clamped connectors offered by Valdor.  It needs cable for its control systems and must operate at high speeds in extreme conditions.  The problem lies in the size of the market.  The total planned production for the F-35 is probably no more than 3000 right now, including planned buys from non-U.S. partners.  I have no idea how many of these connectors would be needed on each aircraft, so I'll just assume ten per airframe.  The upper end of the market price range for one of Valdor's connectors is $35, so that's revenue of $350 per aircraft.  Multiply that by 3000 for a total market size of $1,050,000.  Note that the figure is not annualized, but represents the total lifetime product cycle revenue possible for that particular niche.  These are my uneducated guesses, of course, but that total is still a fairly small number compared to the total market for connection.  Perhaps each aircraft requires more connections for cable.  Perhaps Valdor can raise its price per installation.  Perhaps oil and gas wellheads, another potential target market, require much more numerous connections. 

It won't be difficult for the leading gel/epoxy manufacturers to tweak their formulas periodically to get just a little more adhesive capability.  A slightly improved mass solution at a lowball price is probably suitable for most applications anyway.  Products like Valdor's would be better candidates for on-site manufacture by high-tech customers themselves if Valdor is willing to license the technology for small batch use.  That's why I like engineers - they're adaptable.  I like Valdor's product, but I believe small-batch tech producers should change their business models from making products to making designs amenable to additive manufacturing. 

Full disclosure:  No positions in any companies mentioned. 

Alpha-D Updates For 12/19/11

I made very simple changes to my portfolio today.  My covered calls on GDX and FXI expired unexercised.  I renewed them with monthly expirations.  The underlying equity positions have fallen from the last price I paid for them, so the possibility that these calls may be exercised raises the further risk that I will either realize a tax loss or repurchase them at a disadvantageous price.  Such is the nature of equity investing with covered call writing.  I'm fine with that.

I also remain the proud owner of some California muni bonds that will mature in 2012.  They are useful as a deflationary hedge.  I bought them at a premium to their face value because their coupons were higher than going rates on Treasuries.  The premium nets out against other capital gains; the cash flow from interest is tax free.  It is difficult to justify further purchases of fixed income products in a macroeconomic environment where central banks worldwide seem determined to devalue fiat currency.  Bonds and cash do poorly when such conditions persist.

I continue to be intrigued by the relative performance of FRO and SFL, two shipping twins I've been watching for years.  I missed my chance to buy SFL in 2008 when it was dirt cheap but now I'm tempted to go for it.  Bear in mind that the lesson of 2009 is that stocks can go even cheaper, so I'm willing to wait.  I'm also strongly considering taking a bearish position on YRCW (actually YRCWD for a while) by either buying puts or going short the stock.  I posted an update on YRCW last week and I'm finally tempted to actually make some money from this trucker's sad decline.  I'll let you know what I decide in a day or two. 

That's all for now.  Check back later for more genius updates.  I might as well remind people that my disclosures are not investment advice.  Consider my discussion to be a form of entertainment.  I don't give advice on what other people should do with their money.  I certainly don't take advice on what to do with mine. 

Manas Petroleum (MNAP) Drilling Three Oil Locales

I would never have thought that abundant oil could be found in Mongolia, the 'Stans Fergana Basin, and Albania.  Manas Petroleum (MNAP) is betting there's enough liquid black gold in those places to justify drilling programs. 

I'm confused about their corporate structure.  The one guy in the executive team who has any experience in oil, Dr. Werner Ladwein, has recently been named President in a move that supersedes the other corporate officers, including the CEO.  That's just as well, because the CEO and other execs all have finance and consulting backgrounds.  That lack of experience shows through in the company's financial results so far, with annual net losses going back to 2007.  Maybe Dr. Ladwein can turn things around. 

Their Mongolian property is probably worth further exploration as it surrounds known fields where Sinopec is producing.  Hopefully they can stay financially solvent long enough to maintain a focused drill program there; they've had negative free cash flow for four quarters straight.  The Fergana Basin properties in Tajikistan and Kyrgyzstan look attractive due to significant producing properties in the vicinity and road/rail/pipeline networks in place.

It is important to note that Manas vended its Albanian property to Petromanas Energy (PENYF) in exchange for cash and equity.  Many of Manas' directors serve on Petromanas' board as well.  Petromanas, although still a penny stock, is the more successful of the two strictly in financial terms.  Petromanas is earning $0.02/share versus Manas' -$0.31/share.  Farming out the more stable Albanian property gave Manas the cash it needed to continue its drilling program, and Manas can still benefit from Petromanas' Albania drilling. 

Manas is a young, high risk investment.  Its properties in Asia are currently considered "risked" because they are not producing fields.  A complete drill program in 2012 is needed to determine whether a producing partner will find the fields worthwhile. 

Full disclosure:  No positions in any companies mentioned.

The Limerick of Finance for 12/18/11

The WTO lets Russia join
Now that Moscow earns serious coin
State-owned assets did sell
We are like them as well
With stuff oligarchs will purloin

More Seaborne Stupidity From Blueseed

I posted a while back on the Seasteading Institute's hair-brained idea for a floating city.  My criticism of the concept was focused on the impossibility of economics, defense, and sovereignty for such an enterprise.  Well, the software and venture capital geniuses behind the Seasteading concept haven't given up on their bold vision to defy physical reality.  The entrepreneurs who've never built physical infrastructure are back with a brand new application of their knowledge gaps. 

Blueseed is the latest Silicon Valley effort at making an end run around national sovereignty.  Their concept of mooring a barge in international waters would theoretically allow high tech workers with H-1B visas to commute to jobs in Silicon Valley without revisions to U.S. immigration laws that otherwise limit foreign residency.  It's a less ambitious concept than Seasteading but it still has practical problems. 

Let's say they moor this thing "twelve miles southwest of San Francisco Bay" as the Huffington Post article says they will.  What ferry terminals are in that area that will enable the offshore residents to get from the barge to land transportation links into Silicon Valley?  A quick look at a Google map shows us that the closest feasible landing point for any ferry from such an area would be Half Moon Bay, because it's the only town of any size with a road link into Silicon Valley (Highway 92 to Highway 35 to CA-280 or US 101) and potential for berthing ferry ships.  Ferrying people twelve miles from a barge to the relatively shallow waters of Half Moon Bay is logistically feasible.  I have taken several ferry rides across Victoria Harbor in Hong Kong, including a long ferry all the way to Lantau Island.  Ferrys and hydrofoils were quite active along a distance comparable to the one Blueseed proposes to transit.  The feasibility of this concept will depend very much on the construction of an adequate ferry terminal in Half Moon Bay.  I've been to Half Moon Bay many times; the waterfront there can probably accommodate a ferry berth approximately half a kilometer south of the existing marinas.  Blueseed will have to build a brand new pier, roads, bus terminals, and parking lots to enable ground transportation links for disembarking ferry passengers.  The article's admission that "it hasn't been determined exactly which port Blueseed would use" is an understatement.

The page for concept vessels once again shows a glaring ignorance of logistics.  The residential barge has containers stacked up on one end, but there is no sufficient room for material handling equipment on deck to maneuver said containers into a storage area for offloading.  That's just as well, because the warehousing area appears to be nonexistent.  There's one photo of a passing containership offloading containers onto the barge with its own onboard crane.  That's pretty funny.  How much do they plan to pay for regular replenishment from a fully-loaded container ship that's on its way to Hong Kong?  I am not aware of any attempt ever in human history to offload a TEU container on the high seas from ship to ship.  Underway replenishment between ships is done by many navies but this involves a conveyor system hanging between ships for bundles and palletized loads.  Blueseed needs to ask the U.S. Navy how it resupplies ships at sea so they can see how challenging it will be. 

The article mentions that a "live-work space" on the barge will cost $1200 per month.  That's hilarious.  A one-bedroom apartment in San Francisco costs $1500 per month, in a city with a fully mature civil infrastructure that delivers energy, water, and goods in and waste out.  Doing those things at sea will cost a premium.  The MBA geniuses running the cost estimates need to at least triple that $1200 estimate for a conservative number, then ask themselves how many H-1B visa computer engineers can afford to pay that rent on Silicon Valley startup compensation levels. 

The existing leadership of Blueseed makes me wonder about execution.  They are all ex-Seasteaders with plenty of entrepreneurial zeal and zero experience in maritime engineering, civil engineering, mass transit, or other relevant disciplines.  I do respect their selection of Max Hardberger as a technical advisor.  If anyone could pull off a radically new seagoing concept, this guy can.  I heard him speak about his adventures at the Golden Gate Breakfast Club.  There needs to be an adult in the room among all of these wide-eyed kids with MBAs and law degrees.  I suspect Max is going to end up laughing all the way to the bank as he tells these kids week after week what the sea won't allow them to do. 

I think it's okay that rich Silicon Valley Internet entrepreneurs want to keep trying to secede from reality.  They're welcome to do so with their own money.  They should not approach the taxpayers of Northern California towns to subsidize this tomfoolery.  I truly believe that business leaders should spend time and money promoting pro-business immigration policy instead of residential sea barge folly. 

The Haiku of Finance for 12/16/11

Rare earth excitement
Lots of small miners looking
Get that high-tech edge

CrowdGather (CRWG) Repeats Early Internet Model

Mailbag time!  Did I blog about CrowdGather (CRWG) already?  I honestly can't remember.  These Web 2.0 stocks often look and sound like things I've seen before.  In CrowdGather's case, their business model of aggregating online forums and message boards is already done well by Yahoo and Google, and to a lesser extent by Facebook and LinkedIn.  Investors would need a very compelling reason to invest in a company that has a 1990s approach to Web 2.0.

A quick look at the financials doesn't give investors such a compelling reason.  Three years of net losses, negative retained earnings, and free cash flow give us little reason for hope.  The management team at present does have three serial entrepreneurs, so that's one good thing.  Maybe they'll pool their smarts and figure out how to monetize those message boards with advertising.  Actually, Google already does that with Adsense for blogs.  Google even bought the old Deja Usenet groups many years ago, and they still seem to exist as a kind of subterranean, antiquated part of the Internet. 

Who's responsible for sending me the teaser brochure?  Ah yes, Eric Dickson of Trinity Investment Research.  These constant mailed touts for Breakaway Stocks Online are beginning to bore me.  Click my "penny stock" meta tag on this post to see some other blog posts I've written about the absolute gems that Trinity's research uncovers. 

Full disclosure:  No position in CRWG or other companies mentioned at this time. 

YRCW Unloads Truckload Unit While Truckload Demand Rises

YRC Worldwide continues to compound its material weaknesses.  This Teamster-dominated company is selling off a truckload unit to focus on what it claims to do best - LTL.  The problem with this move is that YRCW simply hasn't been doing LTL very well at all.  The company's financial results speak for themselves. 

The company's Dec. 2 reverse split briefly raised the share price to avoid a delisting action.  That share price has dropped by over 24% since then because the company lost almost three times as much money in Q3 of this year as it did in Q2.  That Q3 loss is twice as large as the loss in the same quarter in 2010.

Divesting a truckload unit is exceedingly dumb given strong demand for truckload volumes in recent weeks. Maybe handling truckload freight really is too difficult for Teamsters. It would require them to drive non-stop for long hauls, whereas frequent LTL stops for load reconfiguration give them opportunities for more coffee and donut breaks while on the clock. 

This company's string of losses and odd strategic decisions continues unabated.   The reverse split has delivered bearish investors a unique opportunity to profit by temporarily raising the price out of penny stock territory.  This may prove to be a fleeting window to sell short outright or buy put options in anticipation of further share price declines.  That's not investment advice in any way; rather, it's a disclosure of strategic options under consideration here at Alfidi Capital.

Full disclosure:  No position in YRCW at this time, but seriously considering opening a short position within the next three business days.  Watch this space for a final decision. 

Zynga Prepares IPO For Web-Addled Investors

I stayed away from the original dot-com bubble because I couldn't understand how any of the companies hyped in Red Herring, Upside, and other now-defunct industry cheerleading magazines would ever make money.  Now a new Internet bubble is ready to carry away all of the investors who got carried away in dot-coms, real estate, CDOs, and other stuff that didn't work out. 

Zynga is getting ready to show the world why it deserves a valuation of almost $9B on net income of only $12M.  Maybe I should cut Zynga some slack since it apparently made a profit of $400M in 2010 (I'd sure like to know where the WSJ got that number).  Tomorrow's IPO will be a sweet deal for the founders once the lockup ends.  The company only earns revenue from 3% of its user base.  In other words, 97% of Zynga's brand-loyal users get a free ride.  I wonder if the percentage of Microsoft Office users worldwide who pirate the software even comes close to 97% of the total market.  Microsoft has the pricing advantage of an operating system accepted worldwide as a standard, with enormous switching costs and opportunity costs for businesses wishing to opt out on competing platforms.  Online gaming has no switching costs at all.  Continuously churning out hot titles is all that matters.  The "Angry Birds" company Rovio is now envisioning big paydays from an IPO.  Good luck with that.  I hope the founders cash out as soon as they're able. 

The dot-com bubble should have taught investors about the limits of a business model based heavily on giving away usable content for free.  LinkedIn currently trades at a P/E over 900.  That is clearly unsustainable.  A platform that attracted tons of potential customers with free content will only be able to convert a small number of them to subscribers at a premium price.  Investors chasing radical new business models need to know that customers accustomed to getting something for free can easily jump to another free service.  This is why Alfidi Capital offers free content to all users.  Let freedom ring. 

Full disclosure:  No positions in any companies mentioned at this time (except of course Alfidi Capital).  No intention or desire to participate in any future IPOs of said companies.  BTW, Alfidi Capital will never go IPO.  No way is anybody ever going to own me. 

The Haiku of Finance for 12/14/11

Asian shares are bears
Too much Europe debt sinks stocks
"Risk off" boosts dollar

Minimum Wage Law As Conduit For High Inflation?

The Fed's first QE action was an abandonment of its mandate to cap inflation.  The ECB leans in a similar direction but lacks both the political will and legal mechanisms to make big QE waves, hence the Eurocrats' push for full Continental integration.  A little inflation can turn into a lot of inflation quickly if central banks don't want to stop it by raising interest rates.  The only thing missing from the doomsday device of hyperinflationary policy is a mechanism to enact a constant wage-price spiral.

I'll nominate a new candidate for such a mechanism:  minimum wage laws.  My awesome city of San Francisco has just increased its minimum wage to $10.24/hour.  There is nothing in most locales' minimum wage laws to prevent raising the floor as frequently or as high as lawmakers would like.  Raising a minimum wage is politically popular and politicians in other areas are free to play catch-up with SF.  High unemployment would normally prevent a wage-price spiral because employers would be free to hire new labor at bargain wages rather than pay existing workers more.  Beggar-thy-neighbor minimum wage increases across the country would obliterate that macroeconomic roadblock to a wage-price spiral.  The circle would be complete once employers raise their prices to cover higher labor costs.

Economic stagnation has a lot of CFOs worried.  Rising wage costs give them one more thing to worry about.  This San Francisco action throws a pebble into the American economy that could ripple into more wage hikes, followed by more price increases.  This can easily escalate into uncontrolled high inflation.  Let's not go there. 

Hoarding And Stealing Dr. Copper

Hard assets devotees believe commodities help diversify a portfolio.  Some people take this to extremes.  Penny hoarders accumulate mini-mountains of the copper coinage in the hope that the coins' metal content is a better investment than the face value of the currency.  Folks are plotting ROIs on proposed changes in federal law that would allow them to liquefy these assets for their melt value.  That seems like a very long-shot chance but high copper prices encourage people to try their luck. 

Hoarding copper pennies is a benign form of investing in liquid hard assets.  They would be useful in a hyperinflationary scenario if low-denomination currency became worthless and copper recyclers were willing to risk melting them down.  The second-hand copper market may already tolerate lawlessness given the sharp rise in recent incidents of copper theft.  All of those torn-out copper wires, pipes, and fixtures are going somewhere.  There's a buyer for every seller.  I'm disappointed that law enforcement agencies aren't staking out metal recycling centers.

Penny pinching is one thing; penny hoarding is a big thing.  There can be too much of a good thing. 

Nota bene:  This author does hold a small amount of pennies, in a tin can at the world headquarters of Alfidi Capital.  They are currency, not a spare store of metal.  I typically drop a few into the hats of street musicians in San Francisco, especially if they're talented. 

The Limerick of Finance for 12/11/11

If Europe's bailouts are a flop
We wait for the last shoe to drop
It isn't much fun
Waiting for a bank run
The sovereignty crunch will not stop

Notes From The San Francisco Hard Assets Conference 2011

This year's Hard Assets Conference was as big as they come.  The last weekend in November always brings a ton of mining experts to The City.  Enough time has passed for the information discussed there to be actionable in the markets, so now it's time to review the show.  I'll summarize the main points of lectures I attended below, with my own observations in italics.

Ian McAvity, "Deliberations on World Markets" 
- The euro was designed to blow up in a crisis and North American markets are amazingly complacent about its implications.  All this time, I thought the eurozone was just another fox-hunting club for aristocrats. 
- Alan Greenspan's money creation did not help the stock market, citing Shadow Government Statistics' revised unemployment numbers. 
- Another debt ceiling showdown may shock markets.
- Retail investors are still selling equity mutual funds.  Maybe so, but somebody's still buying.  I wonder if pension plans and professional money managers are the dumb money.
- Ian predicts the DJIA will be under 8000 in 2012 and that gold is undervalued versus equities.  Specific price targets are usually trouble for market commentators.  I'll go along with a general bearish case but I'm not as brave as Ian to predict a specific goal for the market.  Fair value based on mean reversion to a P/E ratio at its historic average of 14 implies DJIA may eventually go as low as 5000 or so.  Whether gold is undervalued depends on whether it resorts to its own historic mean price in the low 600s per ounce.
- Plotting the price of gold against the DJIA indicates a technical trend of higher highs and lower lows.  My MBA-trained mind says those price moves are just a random walk.  The market doesn't do what you want it to do. 
- Ian thinks gold mining stocks lag moves in bullion and that only majors will provide good buying opportunities.  I think Ian should attend some of the company presentations at this conference.  Juniors with properties that have decent ore grades and logistical factors can break out. 
- The US and UK are arrogant to treat the rest of the world like colonies.  China and Brazil may lead a currency revolt.  True, but China would have to de-link the renminbi from the US dollar first, making its exports less competitive at a time when its main import markets - the US and Europe - are slowing down.

Keith Schaeffer, "Oil & Gas Investments Bulletin"
- Oil patch activity via horizontal drilling and fracking will change juniors.  You betcha.  This is already happening, with players in the Bakken formation and elsewhere paying top dollar for labor. 
- The market prices the value of discoveries in mining more quickly than in oil and gas.
- Shale formations resemble potash plays; relatively uniform geology means the market can price discovery more quickly.  Good observation, Keith.
- "Price per flowing barrel" juniors are picking up steam.  My interpretation is that juniors who actually produce at a mature wellhead deserve better valuations than those still in exploration.
- The US has several years of cheap natural gas ahead, with more discoveries possible.  We can thank fracking for this good news.  Tell your elected officials to keep the EPA out of a proven technology. 

Frank Holmes (U.S. Global Investors), "Looking For Super S-Curves"
- The average currency crisis lasts four years, based on 47 preceding crises in the last 400 years.  "This time it's different." The last world reserve currency to be dethroned was the British pound after WWII, but the transition was eased by the ready emergence of the US dollar as a replacement.  There is no such alternative on the horizon now.
- Many majors have such good fee cash flows they don't need to tap capital markets.  I hear you, Frank.  Too many juniors run out of cash too soon because they don't raise capital to match forecast spending.  Majors usually don't have that problem.
- China and India will see their share of world GDP catch up to their share of the world's population.  Not if they face resource constraints first.  China has coal and rare earth metals but needs oil and hydroelectric power.  India needs local infrastructure for "last mile" water delivery. 
- Rising US interest rates today would destroy the price of gold.  A surprise dollar collapse would cause such a spike.  Gold bugs ignore this at their peril. 
- Frank thinks gold is not a bubble now because the spike in gold prices in the early 1980s was driven by futures market buying, while today buying is cash driven.  Really?  What about allegations that GLD is stuffed with futures contracts and not bullion?  I shudder to think what a crisis of confidence - even if unfounded - around GLD's holdings would do to gold bugs.

Adrian Day, "The Resource Boom: Is It All Over?"
- Long cycles in copper's price history imply the boom isn't over.  But isn't Dr. Copper a reliable indicator of economic activity? Guess what happens to copper when the Great Recession gets cranking again.
- Adrian says even 5-6% annual GDP growth in China makes it attractive versus the rest of the world.  Adrian, China has needed at least 9% per year just to avoid social unrest, based on their population growth.  If GDP doesn't keep pace with population, unrest will destroy much of what the country has built. 

Axel Merk, "Currency Wars"
- The gold/inflation relationship implies inflation expectations are decreasing.  If that holds, investors are in for a shock when the Fed and ECB try to save their respective sovereign solvency by printing away.
- Chinese companies have pricing power due to artificial government support, so companies that compete successfully in China can raise prices even if the US dollar declines.  I'm not sure if the "successful" companies he means are those Western companies with operations inside China; I'm assuming so.  Chinese companies selling inside China shouldn't care what the dollar does unless their supply chains have sources in the US.
- Central bank balance sheets are proxies for currency printing.  The ECB has a different mindset than the Fed and is not necessarily inclined to QE-style printing.  The Fed has no desire to mop up excess liquidity by raising interest rates, as that would be as politically suicidal here as in Europe.    Interesting insights. 
- Axel advocates the "currency as asset class" philosophy.  I'll only agree up to the point that currency falls under "cash," as I still subscribe to the classic asset class definitions of debt, equity, and cash.  Everything else for me is a subcategory of those three things.  I truly believe currency is only useful as a hedge of other cash positions, not a something to use as a long bet or portfolio diversifier.
- The S&P is not a true international diversifier, as 90% of S&P listed companies hedge their earnings in dollars.  This is a good argument for owning international equities rather than international currencies as a diversifier.

Rick Rule (Global Resource Investments): Keynote
- He endorsed Frank Holmes' view that increasing freedom in emerging markets would lead to growth.
- Income growth in lower socioeconomic classes drives commodity growth because they buy more material "stuff" to improve their lives.
- Chinese per capita energy consumption has grown but is still only 9% of US energy use.  Hey oil shale frackers, have you made any contacts in China yet?  Just asking.
- Legacy supply issues from a bear market in 1982-2002 constrain resource supply now due to a lack of investment then.  Investors in hard assets tend to ignore things like capex requirements, which is why they get burned on junior mining companies that can't fund their exploratory budgets.  I'll say it again . . . the major producers don't have this problem.
- The 2-3 year lag between a mining company's preliminary economic assessment and its bankable feasibility studies bring arbitrage opportunities.  Buyouts happen at the bankability stage but discoveries happen before then.  I didn't know that.  Thanks Rick!
- Another liquidity crisis can destroy production finance, especially for capital intensive sectors like resources.  Rick Rule is far from the only speaker here to warn that another credit shock will create an enormous buying opportunity in stocks.  I've noticed a common theme of "bumpy ride ahead" at the Hard Assets Conference.
- Investors should seek more advantageous terms from junior companies.  Issuers like to give investors 2 1/2 year warrants but reserve five year full options for themselves.  I would call that evidence of an asymmetric information advantage of the company over the investor.

John Thomas (Diary of a Mad Hedge Fund Trader), "Rare Earths In The Global Context"
- The stock market now discounts worse GDP growth. 
- High frequency trading accounts for 80% of the trades in the oil market, driving huge price swings. 
- Rare earth elements are illiquid; prices peaked on April 29, 2011, mainly driven by China's actions.
- The US dollar has been declining in value since the birth of the Fed in 1913.  The many Ron Paul fans at this conference will like that one.
- Housing will fall until 2030 when Millennials will want to buy homes.  Right now 85M Boomers want to sell their homes to 65M Gen-Xers.
- Fracking has unlocked a huge US natural gas supply.  LNG exports to China will boom.  This makes me think of Japan's dependence on US oil in the 1930s.  The US oil embargo against Japan triggered their strategic decision to attack the US.  There is a huge lesson here for strategists looking for an inflection point that can trigger US-China conflict.  I believe resource access for China and India is one such inflection point, and possibly the single most severe one.
- John recently visited China to see if they were manipulating rare earth prices.  Key leaders there gave the official line that they wanted to give manufacturers an advantage in finished goods.  The Chinese government is tracking down unauthorized rare earth miners to get them to register in advance of consolidation.
- John is bearish on the platinum group metals because a likely recession next year will hurt the automobile market.  PGMs are used in catalytic converters.  Here's another expert forecasting a recession in 2012.  Pay attention, investors!
- I asked John if he thought the Congressional budget "super committee" deliberately failed to come to agreement.  John didn't think they conspired, but we shouldn't count on anything from our capital other than higher taxes.  I do think some surprise budget cuts are in store for discretionary spending. 

Mickey Fulp, "Mercenary Geologist"
- Rio Tinto wants badly to get into the Athabasca Basin and they've never lost a bidding war. 
- Mickey doesn't like insiders who sell their own stock when the company is under duress.
Readers, I have to tell you that I've learned a ton from Mickey's lectures at the Hard Assets Conference and its predecessor events.  His website is a terrific free education.   

Paul van Eeden, "Looking for Value" Keynote
- The bottom four quintiles of earners have seen declines in their percentage of the economy's overall income, even while the top 1% has seen huge after-tax income growth.  Don't tell the Occupy Wall Street crowd.  They might try to enter the exhibition hall.
- The bottom 99% owes 73% of the debt in the US but their consumption drives the economy.  This tells me that the postwar US model of debt-based consumption as a driver for growth is about to expire.  No middle class can survive burial under huge college loans that can't be torn up in bankruptcy court.  The next wave of growth - once Great Depression 2.0 has run its course - will have to be based on production. 
- Metals prices indicate the equity bull market is over.  China's new "ghost cities" drove its manufacturing growth; this is an unsustainable model.  Construction of capital goods without demand is malinvestment.  China's growth story experiment is thus destructive of capital.  Finally, some sanity on China.  I drank from the China punch bowl for long time until recently learning that much of the story is based on fraudulent finances, hidden debt, and trains to nowhere.  Now I'm stuck with FXI until China jump starts its consumer economy, if ever. 
- Chinese consumers can't afford overbuilt apartments (bought by speculators), so they fall into disrepair.  Yikes, looks like consumers will be on their backs for a while.
- Chinese GDP is calculated on production, not consumption.  Wasteful production of unneeded goods counts toward China's growth miracle.
- Paul thinks the Fed isn't dumb enough to force inflation up to intolerably high levels.  The thing about such high inflation is that it can come accidentally when you're just shooting for moderate inflation that will devalue sovereign debt.  The Fed may not be dumb enough to force this, but I don't know if they're smart enough to avoid it.
- Gold bullion prices typically move first, then majors, then juniors.  Juniors won't rally until the bullion price resets.  Boy am I glad this guy was a speaker.  The hits just keep on coming.  Please bring Paul back next year for more contrarian wisdom. 

Al Korelin, "What Twenty Years . . ."
- Al believes the equity markets are unsound and invests exclusively in hard assets.  That's pretty harsh; he's even more of a skeptic than me. 
- Middle East instability can make gold skyrocket.  Always remember that oil is priced in dollars, for now anyway.

Jack Lifton, Technology Metals Research
- Jack restated the contentions of his recent article on junior rare earth companies. Jack's bottom line is that only handful of publicly traded rare earth miners can produce all of the world's needs.    I won't repeat much of what Jack said because frankly the man is so brilliant that I don't think I could do him justice.  Read his articles for yourself to get the best view in the world on rare earth metals. 

John Kaiser, Kaiser Research Online
- He says gold's price rise is sustainable.  I disagree.  Everything reverts to mean sooner or later.  That mean for gold is in the low 600s.
- Gold miners' low share prices (relative to bullion) reflect anxiety that hyperinflation will make cash flows evaporate.  Excellent.  I would add that the majors have hedged their dollar exposure and will suffer less than juniors in such a scenario.  Pay attention, investors.
- The US's sovereign debt load makes us strategically weak and out military spending is unsustainable.  However, a US recession will hurt "parasite economies" like China due to their export-driven models.  That means the US can expect a GDP lead over China that will last another 20-30 years.  Hmm, that last bit is interesting, original thinking.

Michael Berry, Morning Notes
- Michael covered a lot of familiar ground on unpayable sovereign debt, China's malinvestment, the Fed's balance sheet, coming austerity in the developed world, and emerging markets' booming demand for commodities.  I frequently read his free "Discovery Investing" commentaries.  They are a good look into junior miners. 

Frank Trotter, EverBank Direct
- EverBank believes the big economies drive the world economy, not emerging markets.  He sounds like a contrarian at this conference given the many speakers who think the future lies with emerging economies. 
- The euro gave peripheral countries a "free ride" so they could borrow at lower rates.  Germany is not necessarily willing to take a big hit to GDP just to bail out the PIIGS.
- Positive drives of a currency's value include budget, debt, and trade numbers all in positive directions.  Norway is #1 by this standard but Canada and Australia also look good.  IMHO, these fundamentals are a more valuable set of metrics for currency investors than the "pips" traders watch.

John Nadler, (Kitco), "Silver's Cloudy Lining"
- The silver market is in surplus with record volume in 2010.  Government silver stockpiles have declined for years. 
- Average cash cost of production for the top 30 producers worldwide is now $5.20/oz.  This is extremely important to note.  Producers in the bottom quartile of production costs are more likely to add shareholder value.  It pays to be a cheap operator. 
- Investment demand has absorbed all surplus production; almost all of this demand came from silver ETFs. 

The final event is always the Bulls and Bears keynote panel.  Rick Rule, James Dines, Paul van Eeden, Ian McAvity, and Adrian Day held court.  Rick moderated and kicked off by asking his panelists to nominate black swans that kept them worried.  Count the swans: the end of our Bretton Woods system; a bank crisis that shocks China's growth and causes social unrest; resource scarcity; India awakening; Africa developing; overnight euro destruction. 

The panelists anticipate the failure of the eurozone.  These are very well-informed experts who have made a living for decades by being on the right side of the markets.  I take their conclusions seriously.  They were also very strongly supportive of gold's continued rise, except Paul, who thinks it will collapse to $850/oz.  I can't call the end of gold's bull run.  All I can say is that I'm not in love with any asset; my GDX holdings are just another asset class.  I reduced my concentration in GDX as gold climbed. 

Rick ended this year's confab by asking for things that could go right.  Where are the white swans?  The panelists responded:  Congress could enact an austerity budget; technology innovation over decades could solve the growth crisis; the Fed could return to sound monetary policy (yeah right IMHO!); an outbreak of fiscal integrity in DC and justice in due course for the victims of the MF Global collapse.  That last comment got a rousing response from the audience of hard -core hard assets investors who remained until the very end!

Thanks for another great year, Hard Assets Conference.  I should also note that Jim Dines once again had an excellent booth staffed with attractive female models.  That's one investment that never goes out of style.