The HRA Report: For resource investors
* David Coffin and Eric Coffin
Published 5/26/2009
resourceinvestor.com
There is a great deal of hand wringing in the market over the stress tests, thanks to multiple leaks and trial balloons on the subject. While there might be a couple of individual nasty surprises, we don't expect the overall scale or order of banks from best to worst to be much of a shock. Analysts have been stirring these entrails for months.
Despite improvements in independent numbers already out, unemployment is not to look “good” for a while. Employment is a lagging indicator. Markets turn well before unemployment peaks, but it still has an impact. Everyone expects a bad number so there is room for an upside surprise. Even if there is, the number will have to get much better before it the aggregate income for Americans is reducing debt loads. The US economy won’t see anything like potential growth before that happens.
Speaking of debt, we should note that some credit market indicators we watch have seen big improvements this month. The TED (Treasury - eurodollar) spread is down to 74 bps, a level not seen since last summer and LIBOR is back below 1% and sitting near all time lows.
One rate that doesn’t look so good is the TNX or ten year note yield shown in the top graph. 3% was thought to be Bernanke’s “line in the sand” which prompted his quantitative easing announcement in mid March. The rate is now at 3.18%, a six month high, and it will be tough to hold it there with so much new treasury paper being sold.
After the last Fed meeting, Bernanke said he did not expect to add to debt purchases. We’re not buying that thanks to that TNX chart. Its not about growing the money supply, its about holding treasury rates down. Ben has to be the bid, or US rates could easily run far higher as new treasury debt swamps the market. The US absolutely cannot afford skyrocketing interest rates for the next couple of years.
We expect a lot more money supply creation. The combination of expected new money supply and moves to riskier assets is impacting the Dollar, as shown in the bottom chart. The dollar index is currently sitting right on the trend line it has held every since the dollar bottomed last July.
Looming supply and generally better numbers in other economies could push the USD index down through the trend line. That could happen as soon as the stress test and employment numbers are out. Most currency traders are chartists; violating the trend would generate more selling, and in turn gains for both base and precious metals and other commodities. That should generate some higher highs in the resource space, at least in May.
Comments from the April 2009 Journal:
Cadiscor Resources (CAO-V, CADRF-Qbb; $0.58 on V, Strateco spinout)
After having its merger with Tiomin come apart, CAO is now in a merger with North American Palladium (PDL-T, PAL-N.Alt; $2.14 on T), owner of the Lac des Iles palladium mine north of Thunder Bay, Ontario that is currently on care and maintenance. PDL is offering to exchange 0.33 of its shares for each CAO share. PDL has also agreed to purchase two convertible debentures totaling $7.5 million from Cadiscor, the funds from which will be used to fast track pre production work at CAO’s Sleeping Giant mine.
This looks like a very fair deal for both CAO and PDL shareholders. Income from Sleeping Giant will be diluted, but realistically not by any more than market financings would require. CAO shareholders will also have an interest in a major, non-producing, palladium mine that will act as a hedge for better times in that space, much greater market liquidity, and enough funds on hand to bring Discovery and/or other deposits to production.
For PDL shareholders the deal makes use of existing cash and expertise within a much larger precious metals market that will offer up greater opportunities for growth. The Lac des Iles mine will not reopen at current palladium prices, but we think the very large gulf between the prices for platinum and palladium could mean higher prices for the latter given the relative efficiencies of the two in autocatalysts, at some point. However the palladium sector is dominated by output from nickel producers, we think it simply makes sense for PDL shareholders to trade some of their leverage to the palladium price for the greater leeway in gold.
This looks like a good deal to us, which should hopefully not share the fate of other recent merger attempts in which shareholders forsook growth to hold cash in place. The stock could be traded, or PDL could be held for higher palladium prices and a start of revenues from the Sleeping Giant mine, though the former might take a while. www.cadiscor.com and www.napalladium.com
HRA Dispatch
We did shave our concerns about the pace of copper’s gains between sending the last Dispatch and Journal. Since the Journal went out copper has moved to just shy of US $ 2.20 per pound ($4,850/t) before starting its current consolidation phase. This is the same price area at which it was seeing support attempts on the way down in mid October. The LME’s forward price curve has flattened, but continued stocks reductions suggest further support at this level is possible.
Recognition that metal buying can be a longer term store of wealth, in China or elsewhere, is likely helping support the price. A strong arbitrage gain on bringing copper into China is drawing down LME stocks; scrap copper is still not showing up at the levels China had been used to sourcing. The LME zinc price has gained for similar reasons, and other major metals have tagged on as well. Is this getting to be too much of a good thing?
Overall copper production in China is reported to have been up in Q1 by 8.7% on a year/year basis. Also, analysts from Antaike, a state sponsored metals market research group, indicates a three year plan by Beijing to stockpile 400 Kt of copper, a similar weight of lead and zinc, and 1000 Kt of aluminum. At the same time it will be phasing out old smelter capacity at similar levels. On top of that today was a rumor that Beijing’s metal traders have started to put purchases made earlier this year back into the market.
This seems at odds with earlier reports that 300 Kt of copper are to be stockpiled by the government this year, and begs the question of whether some policy had been revised. We think consistency is in the reality that Beijing wants an orderly market. Overly weak metal prices can mean supply constraint that would eventually push prices much higher and/or simply sideline growth, but that doesn’t mean a quick price jump now makes sense either. If that seems at odds with phasing out older smelter capacity, keep in mind China is replete with small inefficient smelters using too much power and expelling too much pollutant. Much has been made about the need to maintain job growth in China to still unrest. In fact, new polluting industry laying waste to the farmland that is the real “safety net” for China’s peasant class is the most likely source of disquiet.
A side note to the push to consolidate the smelter sector in China comes from the steel makers. The major foundries are in a continued stand-off with the Big 3 iron ore exporting companies about this year’s contract rate. To press their point the exporters are offering product to China’s small steel makers using bulk discount rates usually reserved for large buyers. Not surprisingly, China wants its steel making firms to consolidate as well. One policy that may deal with both an oligopoly and the masses at the same time seems sensible enough to us.
“China” is sometimes used as though an all encompassing thread connected its denizens actions (including by us, we admit), but it is by no means a monolith. We think the general thread that China’s government wants to replenish its strategic stockpiles is true, and certainly there have been musings from its higher ups about global currency backing using both baskets of national currencies and baskets of hard goods. How to achieve this while attending to the wounded west is still has large question marks attached to it. That rumors out of China are moving metal prices is the point of our seeking balance. This doesn’t mean China is uniquely capable of moving markets, or that it wants to be.
Alas, in the West meanwhile some formerly big banks have been putting out their Q1 results. These initially generated a bit of cheering at their seeming ability to meet low expectations. However, with enough detail out, combined with a trial balloon today from Washington on converting its bail-out preferred shares into common stock, the rally in the US financials sector appears to be over. A willingness to accept the presumption of capital within assets for which there still is no real market pricing seems to have been short lived. The wagering has moved away from recovery pricing in this sector, to the prices at which its worst off might be wrapped up. The naked empire unwinds apace.
In Q1 the resource over-weighted Toronto Stock Exchange generated 33% more financings than it had a year earlier (C $11.9 billion in ‘09 vs. $8.9 billion in ‘08). The heavy weighting in gold financings through the TSX that dominated the first two months of the year is shifting towards copper, and a few other minerals. This by no means indicates the mining sector is ready for a rebound, but it does speak to the relative comfort institutional players are finding in it. Gold sector spending indicates concerns about the US and its currency, but copper wagers are about the emerging East.
We continue to view a balanced approach to metals the as the best way to navigate the shifting winds of global commerce. Consolidation will be the market theme for the next while, and that means shaving positions and looking for the next opportunities does make sense. But we do think the next shift will as swift as this one has been.
Company Update
Capstone Mining (CS-T, CSFFF-Qbb; $1.70 on T) had three successive releases since the Journal review came out. The first indicated an operating cost of US $1.05 per pound in Q1, above the projected average $1 for the year. The second laid out further strong results from testing of the Minto North deposit, including a headline 26.7 metres at 2.3% copper & 1.1 g/t gold, and indicated the winter program had delineated the body as a fault bounded deposit with an area of 200 x 125 metres. The balance of the drill results are needed to firm up the outline, but based on results to date this suggests Minto North is a year plus of ore. The company will complete in-fill at Minto North and test another 6-8 similar targets this summer.
The third release was a bought-deal placement of up to 31 million shares (of which 27 million are firm) being done at C$1.85. Assuming the overallotment is filled this will mean share dilution approaching 19% (about 17%, fully diluted). The past month has seen a wave of copper company financings at this scale, similar to those for gold companies in the first two months of the year as institutions presumably seek the same sort of gold-copper balance we have been talking about. Given that, the CS deal is arguably a defensive move to allow it leverage similar to its peers. However, we still have to shave 20% from our per share earnings assumptions.
We are still comfortable the company is well priced relative to its peers, and that it has a considerable upside from this price level. Almost 10 million shares have turned over in the three days since the placement release. A similar trade-through is likely needed before CS regains traction, plus a stable copper market. Since we based our assumptions about Capstone on a US$1.50 copper price, we are still comfortable with them. www.capstonemining.com
The above market commentary and company comments by analysts David Coffin and Eric Coffin are recent samples of material from the three different HRA publications – the monthly HRA Journal, the Dispatch mid month update Service and the Special Delivery Alert. More about each of these services can be found on the back page along with subscription details. Subscription information can be found at www.hardrockanalyst.com. |
