Saturday, July 28, 2012

What we are reading- The death of peak oil (energy) has been greatly exagerrated edition

We had been skeptical of the notion that peak oil (energy) theories were bunk, noting the claims in recent months the theories were dead..The below article (for better or worse, as we could asserting our own biases) details a number of reasons why the rush to judgement against the theory of peak oil may just be an overreaction.

For a little background, the theory was first introduced by the geologist M. King Hubbert, who had worked at Shell Corporation between 1943 and 1964. Following his retirement from Shell, he worked by the USGS. His work is important because he showed that all depleting commodities will follow a natural production curve and the production growth will peak at a point that can predicted using the reserves and the production schedule with the annual production rates approximating a bell-shaped curve. He is credited with predicting the peak of oil production growth in the U.S, to almost the exact year.

Many have taken his work and expanded upon it to gauge peak energy production in various regions and for the world itself. For one, we have read many of the reports and research David Rutledge- a professor at Caltech ( who had called for peak coal production within the next 30 to 50 years. Although we are not Malthusian, we have been proponents of peak oil and energy theories. It is one leg of the stool in our long-term thesis for energy commodities.

Is peak oil dead?

This is a guest post from Chris Nelder, an energy expert who has spent a decade studying and writing about energy and related issues. He has written two books (Profit from the Peak and Investing in Renewable Energy) and hundreds of articles on energy and investing. He blogs at and writes the Energy Futurist column for SmartPlanet.
Is peak oil dead?
One might think so, judging by a slew of optimistic new forecasts for oil production. Even George Monbiot, notable for his thoughtful previous coverage of peak oil in The Guardian, threw in the towel with his July 2 mea culpa, “We were wrong about peak oil. There’s enough to fry us all.
Monbiot reversed his position after reading a new report by Leonardo Maugeri, an executive with the Italian oil company ENI and a senior fellow at a BP-funded center at Harvard University.
Maugeri forecasts new global oil production capacity of 49 million barrels per day (mbpd) by 2020, a number that is “unrestricted” by real-world circumstances, and “unadjusted for risk.” This constitutes a whopping 53 percent increase over the current claimed capacity of 93 mbpd in just eight years. While impressive, this headline number obscures some important details.
First, capacity is not production. The world has never produced 93 mbpd. Global oil production was 88.3 mbpd in 2011, according to the International Energy Agency (IEA), which uses a very liberal definition of “oil” that includes biofuels, non-associated natural gas liquids, and other liquids. Under a more restrictive definition used by the U.S. Energy Information Administration (EIA), which counts crude oil plus lease condensate (natural gas liquids that are produced and naturally associated with the crude), and liquids extracted from natural gas production, world oil production was 87 mbpd in 2011. Counting only crude oil and lease condensate, world oil production was 74 mbpd in 2011, a level it has maintained since the end of 2004 despite a tripling of oil prices since 2003.
Therefore, there is a 19 mbpd gap between actual crude oil production and Maugeri’s unverifiable claim of 93 mbpd of oil production capacity, depending on how one construes (or misconstrues) the meaning of “oil.” Much of the capacity and growth Maugeri foresees includes millions of barrels per day of natural gas liquids, of which only about one-quarter are useful as vehicular fuel.
Maugeri generally refers to production capacity throughout his report, not actual production. The only nod to actual production appears in a footnote on page 4, where he says “In the first quarter 2012, average world oil production consistently reached or surpassed 91 mbd.” Since he doesn’t specify the source of this data, we must assume he obtained it from his private, field-by-field database, as the IEA shows production in the first quarter of 2012 to be 90.7 mbpd.
Next, Maugeri adjusts his 49 mbpd increase by various risk factors, and finds that adjusted new production of 28.6 mbpd might be possible by 2020. He expects most of this additional production to come from 11 countries, shown in the following figure.

Maugeri’s Figure 3, of “Worldwide potential additional liquids supply out to 2020 (crude oil and NGLs, excluding biofuels)” for the 11 countries representing the majority of his projected increase.
Maugeri devotes several pages of his report to a light treatment of the risks he accounted for in this adjusted number, offering little purchase for a skeptical reader who might discount the risks differently. We are essentially left to take his word for it.
Finally, Maugeri adjusts for the depletion of currently producing fields and reserve growth, to come up with a final projected increase of 17.6 mbpd and a total world production capacity of 110.6 mbpd by 2020. This is where the really squishy assumptions come into play, which are core to his forecast.

Depletion and decline rates

Most oil analysts are careful to distinguish depletion rates from decline rates. A depletion rate is the percentage of the recoverable oil in a field that is being produced each year; therefore, if new technology were to increase the estimated recoverability of oil in a field, the depletion rate would fall. A decline rate is an annual percentage decline in the rate of production from a given field, so it does not depend on the size of the field. Maugeri mixes up the terms, defining only depletion rate as “The natural decline of an oilfield’s output after years of production. It could be partially offset by reserve growth.”
In 2008, CERA, a consultancy which has one of the few comprehensive databases of the world’s oil fields, and the IEA, which used CERA’s database, estimated decline rates for the world. The IEA found a global average production-weighted decline rate of 5.1 percent per year. CERA estimated the global average production-weighted decline rate of all fields at 4.5 percent per year. A similar 2009 study by Mikael Höök et al. found a production-weighted average decline rate of 5.5 percent per year. Other estimates have ranged as high as 8 percent. All of these studies find that decline rates increase over time, and they are higher for “unconventional” sources like deepwater and shale than for conventional fields. (Source)
Maugeri muddles these important distinctions, claiming that the aforementioned studies are in sharp variance when they are not. He goes on to allege overestimation of “depletion” (we assume he means decline) rates in the past, without any references, and finally concludes, inexplicably, that apart from Norway, the UK, Mexico, and Iran, he “did not find evidence of a global depletion rate of crude production higher than 2-3 percent when correctly adjusted for reserve growth.”

Reserve growth

As a global average, current technology and prices only permit about 30 to 35 percent of the oil in an oil field to be economically recovered, up from about 20 percent thirty years ago. Over time, new technology and techniques make it possible to economically recover more oil, and that additional oil may then be reclassified from resources (the oil in place in a field) to reserves (oil that may be legally claimed as recoverable). This process is called reserve growth.
Maugeri discusses reserve growth at length, emphasizing the vast quantity of remaining resources and asserting that new technology will soon make more of it accessible, particularly from unconventional oil resources. “In fact, the current decade could herald the advent of ‘unconventional oil’ as ‘the oil of the future,’” he claims, “changing the geopolitical landscape that has marked the oil market for most of the 20th Century.”
As an example, Maugeri cites the Kern River field in California, one of the longest-producing oil fields in America. New recovery methods have substantially increased the recoverability of oil from this field over time. What he does not mention is that waterflooding and other enhanced oil recovery methods that enabled reserves growth in Kern River are now routinely used early in the exploitation of oil fields, belying his suggestion that similar reserves growth will be achieved in the future. Nor does he mention that despite the intensive application of enhanced recovery methods, Kern River production has been declining since its last peak in 1985, or that it currently produces about 10 barrels of water for every barrel of oil, at a very significant energy cost. I have visited the Kern River field and studied its production, and found that its energy return on investment ratio is now probably on the order of four, which hardly makes it a shining example of new abundance.

Kern River production history. Source: Chevron
Therefore, while it is true that reserves do grow over time with the application of new technology, it is disingenuous to imply that it will lead to the enormous increases in production, or the far lower decline rates that Maugeri claims. Again, Maugeri only presents the summary results from his private database and does not disclose the recovery factors he is using, so there is no way to judge how realistic his model is.
However, we do know from more than 60 years of history with enhanced oil recovery techniques that they tend to lengthen and thicken the tail of a field’s production, not achieve new production highs. This is even more true today than it was decades ago, when the Kern River reserve growth Maugeri highlights occurred.
Even in the U.S., much of the apparent reserve growth over the past three decades had more to do with the technical reclassification of oil as “proved reserves” under SEC rules than technology, as petroleum geologist Jean Laherrère has detailed at length.

Reserve growth and price

Maugeri’s discussion of reserve growth elides the well-known exaggerations of proven reserves among the world’s major oil producers. Producers in the Persian Gulf, North Africa OPEC, Russia, Venezuela and Canada report “reserves” estimates that can only be economically produced if oil prices are at least double the $70 per barrel assumption in his analysis. He does not provide any further details about the economics of production in his analysis, except to say that “More than 80 percent of the additional production under development globally appears to be profitable with a price of oil higher than $70 per barrel.”
This claim seems highly dubious given recent estimates of production costs. Research by petroleum economist Chris Skrebowski, along with analysts Steven Kopits and Robert Hirsch, finds a new barrel of production capacity in deepwater, some OPEC countries, the Canadian tar sands, and Venezuela’s Orinoco belt will cost up to $80 or $90 a barrel. Canada’s Globe and Mail reported in June that $80 a barrel was low enough to cause several tar sands operators to slash their expansion plans. And a recent report from Bernstein Research found that the real floor of new production in 2011 was around $92 a barrel, and will be closer to $100 a barrel this year.
We also know that the cost of new oil production has been climbing sharply in recent years, along with the cost of all commodities, as shown in the following chart.

Source: EIA
Maugeri acknowledges this fact, noting, “Over this decade, another problem affecting the production of all shale/tight oil plays in the United States will be the inevitable rising costs of services, rigs, labor, and pipelines, caused by the inflationary pressure from the frenetic activity throughout the shale/tight oil and gas sector.” This does not square with this subsequent assertion that “the advancing knowledge of shale oil development and the gradual expansion of the infrastructure necessary to each shale play should balance the rising costs, and eventually drive them down,” and he offers no empirical basis for it.
Likewise, his acknowledgement that “the oil market will remain highly volatile until 2015 and prone to extreme movements in opposite directions, thus representing a major challenge for investors, in spite of its short and long term opportunities,” doesn’t square with his assumption of a minimum $70 per barrel holding firm through 2020 and beyond.

Bakken ballyhoo

Maugeri devotes the longest section of his report to the tight oil and shale gas “revolution” in the U.S., saying it “could be a paradigm-shifter for the oil world.” He extrapolates most of his forecast from the Bakken formation, a tight oil reservoir which underlies parts of North Dakota, Montana and Saskatchewan.
Unrestricted production from shale and tight oil could reach 6.6 mbpd by 2020 in his estimation, or as much as 4.2 mbpd after considering risk factors and depletion. The U.S. is currently producing about 0.9 mbpd from tight oil, so Maugeri’s forecast amounts to a more than four-fold increase in eight years, an extremely optimistic prospect. It is also far more than the EIA expects, having recently forecasted that U.S. tight oil would reach only 1.2 mbpd by 2035. For additional perspective, total U.S. production of crude oil and condensate today is 6.1 mbpd.
He does not mention that, on the basis of Bakken well productivity, it might take 50,000 new successful tight oil wells or more to achieve his forecast, plus many more unsuccessful ones as the productive areas of new fields are delineated. In the IEA’s recent forecast, another 500,000 new shale gas wells might be drilled by 2035, doubling the number of producing gas wells in America. Many of these new tight oil and shale gas wells would need to be drilled near where people live and work, rendering an “unrestricted” forecast for new development all but meaningless. Maugeri refers vaguely to this limitation, noting that “a revolution in environmental and curb-emissions technologies is required to sustain the development of most unconventional oils,” and that if the industry continues to fail to prevent environmental contamination from tight oil projects, “massive over-regulation” could result and new development could be delayed.
Maugeri assumes that oil will sell for at least $70 a barrel to achieve his tight oil production forecast. “Most of U.S. shale and tight oil are profitable at a price of oil (WTI) ranging from $50 to $65 per barrel,” he says, but an executive with an oil company producing oil in the Bakken, who was interviewed by Steve LeVine for Foreign Policy in February, said that if prices dropped to $70 per barrel, it could “create an extreme drop in drilling and field production really quickly” in the Bakken, and that “if oil drops to $70, a lot of people will lose money in the Bakken.”
Finally, Maugeri’s assumptions for the production profiles of Bakken wells appear to be far removed from reality. He uses a “combined average depletion rate for each producing well of 15 percent over the first five years, followed by a 7 percent depletion rate” for tight oil wells, while historical evidence shows that Bakken wells typically decline by 80 percent or more over the first five years.

Production profile of a typical Bakken well. Source: North Dakota Department of Mineral Resources
While tight oil production since 2005 has indeed been impressive, there is little basis for the Maugeri’s confidence that its growth trend will continue on its present trajectory through 2020, when real-world costs, siting issues, environmental concerns, and oil industry practices are taken into account.


Although Maugeri does not state explicitly what decline rates he is using, researchers Stephen Sorrell and Christophe McGlade derived an annual average decline rate from the data in his report of 1.6 percent, or about one-third the global decline rates estimated by IEA, CERA and others. After analyzing the IEA data, they found an aggregate global production-weighted decline rate of 4.1 percent per year. At that rate, they found that Maugeri’s forecast for 2020 would reach just 95.1 mbpd, not 110.6 mbpd—a gain of just 2 mbpd over today, not 17.6 mbpd.
We cannot independently evaluate Maugeri’s country-by-country forecasts without seeing the assumptions in his data model, but his summary expectations are optimistic in the extreme. For example, he sees production from Iraq expanding in the next eight years at rates that have never before been achieved, despite a great deal of uncertainty about the country’s stability, its ability to maintain security in the future, and its ability to attract Western oil partners with the knowledge and technology needed to exploit its resources. The failure of Iraq’s recent oil lease auctions do little to give one confidence that Maugeri’s extraordinary forecast can be realized.
More generally, his assertion that, of the countries with more than 1 mbpd of production capacity, only four will have reduced capacity by 2020 is impossible to square with the fact that production has been declining in more 50 of those countries since 2000.
Maugeri’s forecast does not mention a price ceiling at all, an obvious deficiency given the extreme volatility of oil prices over the past four years. We know that as prices approach $120 a barrel, demand shrinks, yet triple-digit prices are precisely what is required to bring much of the new supply Maugeri anticipates online.
To his credit, Maugeri acknowledges that his analysis “is subject to a significant margin of error, depending on several circumstances that extend beyond the risks in each project or country,” and he details numerous important caveats. And to the extent that he reveals the assumptions underpinning his forecast, his transparency is laudable. In the final analysis, however, it is insufficient. He fails to provide adequate justification that his assumptions, being widely divergent from most other industry estimates, are remotely realistic.
We must conclude that the key assumptions about reserve growth and its effect on decline rates in Maugeri’s report are muddled, speculative and unverifiable. And sprinkling those assertions with repeated declamations about how peak oil is a non-issue, insisting repeatedly that the only real constraints on his scenario have to do with political decisions and geopolitical risks, suggests that his report is more about grinding a political axe on behalf of the oil industry than offering a serious or transparent analysis. Finally we must note that Maugeri is well known for his hostility to peak oil, as is BP, which funded his report. After taking real-world risks, costs, and restrictions into account, the case for peak oil—which is about production rates, not production capacity or reserves—seems far more realistic.

Saturday Links

Nominal GDP targeting has become a buzz phrase in some circles
       - The looming question is why is demand down? Too much debt perhaps?

And here is some thought on the subject

Chinese steel companies creating a glut in the metal
   - leads credence to our call that thermal coal is better positioned than metallurgical coal

How gas prices effect employment trends- from Political Calculations

Behavioral Finance- is your brain wired to kill your investments. 
   - Our thought, maybe.

Weill comes out of the closet stating he thinks Glass-Steagall should be reinstated 
    - Now he tells us. That is being a little hypocritical

Why Chinese stimulus may be a worse than the disease.

The usefulness of useless knowledge

Live life without regret

Thursday, July 26, 2012

The optimism won't last

The optimism following comments from the ECB's Draghi is showing signs that it won't last.

The SPY began strong and has sold off through out today's trading. The price on the SPY briefly touched the swing level around the $136.4 level we previously mentioned but is showing no signs that it will pop over it.

On an intraday basis, every attempt at a rally has been on lower volume and met with sellers. The volume and trend appears to be with the sellers at the moment.

Traders Edge 7/26/12- Risk On, further monetary easing?

The futures staged an impressive reversal this morning following comments from Mario Draghi who stated that the ECB would do everything in its power to defend the Euro. In response, investors took this as a signal that it was Risk On time and began to get all lathered up. The Euro has rallied against other major currencies and is up more than 1% against the Dollar and the Yen.

In addition, bonds in both Spain and Italy rallied on the news and the yields on their respective 10-year bonds fell by about 35 basis points.

Is this an indication we are approaching an expansion or outright new quantitative easing program? We shall see. One measure we look at to gauge the probability of further easing (outside of employment data, which has come to the forefront in recent weeks) is the change in money supply and the market. On that basis, we doubt that Central Banks (at least in the U.S.) will expand their monetary easing programs in the short-term.

The above graph shows the annualized quarterly change in money supply and the S&P 500, on a weekly basis. This measure lends credence to the argument that we are close to a monetary easing program. However........

 ......The 13-week rolling average of this measure- which reduces the volatility- shows an annualized change of about 4%. This suggests anemic economic growth and that we are still a ways off from a new quantitative easing program. In addition, if one takes recent data and extrapolates it forward a few weeks, we see that an acceleration of growth in the weekly figures and the 13-week average that goes to about 2%. This is not to suggest that this is a likely outcome, and it fact we would bet it does not. We mention it purely for illustrative purposes, and to show that the data needs to get a lot weaker- at least in our estimation- before the Fed acts.

In any event, the SPY is trading up above $135 in early morning trading. The market may try for the $136.4 level, which is the last swing point on higher volume.

Wednesday, July 25, 2012

Mid-day links

Trading strategies around earning announcements- from Damodaran

IMF looks for Chinese GDP growth to moderate into an 8% rate

PBOC lets Yuan drop against the dollar 

The Fed may move sooner rather than later... is the article this go around's Jackson Hole speech?

A few days old and probably already digested but it is still good to look at... Fed President Williams suggests and open ended, MBS focused QE3..... or is this

Some interesting thoughts on QE3

Refis continue to run strong... for those that can get them.... will MBS purchases help 

Legendary investor Jim Rogers on Stock, bonds, commodities, and other investments

Biderman at TrimTabs is 100% bearish on stocks

 The NOAA predicts that above normal temperatures will persist for most of the country in August..... more energy production, higher gas/coal burn rates, and further drought conditions. 

Mind Hack- how your brain short circuits your goals

Feel like you are a fake?

Make Friends not contacts.

Proper running technique in 30 seconds

Traders edge 7/25/12- Coal and Watch the $132 level on the SPY

Futures are mixed this morning with the Dow Jones and S&P 500 futures pointing to a higher open while the NASDAQ futures, dragged down by Apple's less-than-expected results, point lower. Although we are insulated, to a degree, from negative market moves, our portfolios were hurt by the poor results in coal stocks. This follows Peabody Energy's (ticker BTU) second quarter earnings announcement. BTU's second quarter earnings were ahead of estimates, but third quarter guidance was light. It is our opinion the BTU's management have historically been conservative in their guidance, probably more so now considering the current operating environment.

If you can take the volatility, we would take the contrary position and continue to add to coal stocks, which we have been doing to own sort-term detriment. That said, we are long-term investors and our thesis is that many of the problems faced by the industry are short-term and are being exacerbated by transitory events, namely the weather. Unlike other industries, the weather can have an out-sized effect on coal demand and thus coal stocks. Our analysis shows that weather can affect coal demand by up to 50% of total demand. This should be taken into context that the warm winter last year put significant pressure on utilities' coal burn rates and helped create the back-up in coal supplies we currently witness. That said, the one thing you can expect concerning weather is that it will change.

The situation in the natural gas market did not help matters either, as the warm winter dragged down energy demand. In addition, natural gas supplies ramped up with increased shale gas drilling. We continue to see natural gas storage levels that remain higher than the five-year average as the industry works through the high storage levels. That said, we think these levels will normalize as the year progresses. First off, increased natural gas burn rates from both increased market share and an overall increase in energy demand, a result of hot summer temperatures, will reduce natural gas supplies. In addition, a decrease in natural gas rigs and lower capital spending by gas drillers show that the industry is rationalizing its operations. The market also seems to be anticipating a more rationalized market in natural gas, as the price per Mbtu is approaching $3.20.

Longer-term, we remain positive on coal stocks. For one, the group appears in a buy-range on our long-term technical indicator, shown below.

 The above chart shows the average price for coal stocks since 2003. (Note- we would typically use the coal ETF- ticker KOL- to represent the group but KOL has a short trading history and cannot be used appropriately in this context), and a low indicator suggests a buying opportunity. More short-term, we are also seeing positive divergences in the RSI, MACD, and stochastic versus the price chart of the KOL ETF.

Fundamentally, we think that a continued build out of infrastructure in the developing world will lead to increased coal demand. In addition, we see India and China being large drivers of the marginal demand, as both countries coal supplies are inferior to higher quality supplies elsewhere and both lack the infrastructure to mine enough coal to meet demand, especially India. We also see the beginning of natural gas exportation, estimated to begin in 2015, as being a positive long-term catalyst for coal demand in the U.S. Right now, natural gas supplies are essentially locked in to the country, thus creating a large discrepancy between U.S. based natural gas prices and world prices.

It is also our belief that many investors do not understand the dynamics of shale gas or fracking and equate these processes to conventional gas rigs. They forget that fracking is higher cost relative to conventional gas drilling and that the production schedules for fracking wells peak two or three years after the production begins, again adding to production costs.

Finally two items of note. First, coal stocks generally react positively to inflation expectations, as one would expect being leveraged to price fluctuation in a traded commodity. It is our belief that an increase in monetary supply and subsequent gain in inflation expectations would have an out-sized positive effect on coal stocks. Lastly, higher quality coal supplies are dwindling world-wide. In fact, the U.S. coal supplies have already passed peak energy content some years ago. We think that as the availability of higher quality coals diminish, the price of the commodity will react positively.

One quick market update, we think investors should watch around the $132 level on the SPY. This appears to be an important swing point and that a lot of information on the future direction of the market will be released at this price level.

Tuesday, July 24, 2012

The abbreviated "What we are reading today 7-24-12" or Housing is at a bottom

We got bogged in a number of items today, including earnings and the steep sell of of coal names, and our links post is abbreviated today.

Chinese flash PMI improved but still below the 50 level indicating growth
                More here

Why you are just unlucky and other are careless

U.S. housing is recovering according to Zillow

We think the Zillow report suggesting that U.S. housing is recovering is very important. It has been our contention that U.S. housing is in a bottoming process. For instance, look at the chart of the Dow Jone U.S. Select  Home Construction Index.

The above chart shows that housing construction stocks have been discounting a bottom in the market since around the end of 2011. The group continues to outperform in 2012 and is refuses to correct to any great degree in spite of general market uncertainty.

More importantly, we think the below chart from CSFB really describes a large reason why the housing market is recovering.

This is an older chart showing CSFB's estimates of the wave of mortgage resets that were to occur over the period from 2007 through 2016. What is obvious is that the large wave of mortgage resets are behind us. We believe that this implies that, despite a large shadow inventory and too many foreclosures, at the margin, the number of homes that will be forced upon the market and sold at discount prices will wane- if not falling already. A reduction in the number of homes being forced on the market reduces the pressure on home pricing.

One of the most important indicators, in our opinion, is the discrepancy between what one could get in rent payments for a particular housing unit vs. the expected mortgage on the same or similar properties. In many areas of the country (and we have to admit that we have not done an exhaustive search but it appears to hold for most of the regions we looked at) rental prices are above estimated mortgage costs, thus making these properties cash flow positive from an investor's point off view. In fact, we have read many articles in the last few months that state hedge funds and other investors are buying properties to get the rental income. This creates a natural floor under housing.

We think these are important signs that housing is in a bottoming process. However, this is not to say that there is only blue skies from here on out. Many structural issues remain. For one, economic volatility due to systematic leverage will likely make the ebb and flow of the housing recovery uneven. Another important point to remember is that there is likely a large pool of potential housing inventory. Both the actual housing inventory and the talked about shadow inventory levels are what we describe as the kinetic or near-kinetic, or more active, inventory. Potential inventory levels are a nebulous concept but is largely made up of those home owners that have tried to sell or would like to sell their homes but are unable to due to market conditions. Any substantial rise in housing prices may result in the potential inventory becoming kinetic, thus increasing the supply of homes and putting a ceiling on the rise in home prices.

Traders Edge 7-24-12- all that glitters

The S&P 500 took a drubbing (down more than 12 points or nearly 90 points) and so did our portfolios, due to our exposure to gold stocks. Precious metal stocks took a beating, as the Phily Gold/Silver Silver sector (ticker XAU) fell more than 2.7%. We expect the volatility in the precious metals and precious metals stocks to continue. However, we also think that silver and gold are tracing out a bottom.

The charts above are for the Spider Gold Trust (ticker GLD) and the Ishares Silver Trust (ticker SLV). What we see in the price action for both, since the beginning of May, is investor indecision following the profit taking that began in February. Although we are unsure of the timing, we think that Federal Reserve and other central banks in the developing world will embark on further monetary easing actions, culminating in money printing to pay down sovereign debts and the debasement of all fiat currencies. This would be a positive catalyst for the price of gold.

Looking at gold stocks, we updated our analysis of the of the price of the XAU index vs. the standard deviation of the gold prices relative to money supply.

Superior long-term entry points in gold stocks occur when the standard deviation of gold prices relative to money supply is less than -1 and improve with lower observed standard deviations. For instance, the average one year, buy-n-hold performance in the XAU since the end of 1980 is about 14.6%. This compares to an average one year return of 31.2% when an observed standard deviation is less than negative one. As for periods following a standard deviation less than negative two,  the average one year return on the XAU is 37.3%, almost 2400 basis points better than the base case. The current standard deviation of gold prices relative to money supply is -1.3 and we think investors would benefit from building positions in gold stocks.

Monday, July 23, 2012

What we are reading and watching...

Will Karzai step down to take up head of mining... Rupert Murdoch seems to think so.

Dealer inventories in the bond markets are shrinking, pushing up prices. Is this a result of monetary policy.

The Euro short trade may be getting crowded....

..... Ditto for the QE3 trade

The effects of high food prices may creep into inflation at a faster rate.... look to Brazil

Despite the growing anxiety towards global growth, the Aussie dollar has been rising

In addition, labor conditions in China remain fairly tight

Miles driven by U.S. drivers increased in May, but trend still is down

The downside of Chinese debt deleveraging

Interesting concept, having stage fright is selfish.

Traders Journal 7-23-12- Risk Off

The U.S. markets are set to get, in the words of a friend, crushed. The futures markets are pointing to a triple digit decline on the Dow Jones Industrial Average and a fall of more than 1% on the S&P 500, at the open. This follows world markets that are sharply lower. In Europe, the best performing index is the Swiss market, down more than 1% as of this writing. Both the Spanish and Italian equity markets are getting, well crushed. The IBEX 35 is sporting a decline a 3.8% while the FTSE MIB index has fallen a whopping 4.2%.

The above charts show the Ishares ETF's for both Italy (Ticker EWI) and Spain (ticker EWP), respectively, as of last Friday's close. However unlikely, we shall see if both can hold near supports levels. If the supports levels do not hold, there is no historic downside support for the EWI, swing point around $18 or $19 on the EWP. Provided that the Spanish and Italy equity indexes will continue ti move in tandem, our shot-in-the-dark guess where the EWI could find support is around the $8.5 level.

The culprit in today's decline appears to be the a negative shift in investor sentiment, as the risk-off trade is most definitely on. Yields on the Spanish 10-year bond are well over the 7% level and are trading up more than 20 basis points to nearly 7.5%. The Italian 10-year paper is trading up a similar amount (up 18 basis points) and is yielding 6.3%.

In contrast, the risk-off trade again appears to be pushing traders into U.S.-based assets. The yield on the 10-year treasury is trading at all-time lows of 1.41%, a five-basis point decline in yields. One would think that the dollar-index would benefit from this, and you would be right. The UUP (the Powershares dolalr bull index) caught a bid last Friday and traded up 70 basis points. The gains appear set to continue, and the UUP is up slightly in the pre-open, trading around $23. The $23 level looks to be an important inflection point on the UUP, and should be watched carefully for how traders react around this level.

On Friday, we further reduced our long market exposure and moved some positions into cash. It continues to be our belief that the equity markets will see correction of uncertain magnitude. We laid out our case in a previous post here-

Sunday, July 22, 2012

Sunday Links

Chinese financial system is about to change....

....and the Chinese are talking about an interbank gold trading platform

Jobless claims rise- a few more of these (directionally) and the odds of QE will rise

M&A to pick up- this is a positive, if it comes to pass

Spanish yields/spreads rise- will anything save Europe?

Nickel market in oversupply- could mean that the steel end market is slowing.

The Algos affects in the markets

Be more creative, effectively

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Creative Ideas born of rich networks