Saturday, February 21, 2009

The “Five Ms” For Picking Gold Stocks
An abridged excerpt from “The Goldwatcher: Demystifying Gold Investing,” co-authored by Frank Holmes, CEO and chief investment officer at U.S. Global Investors. The book, published by John Wiley & Sons, is available from and in bookstores.
By Frank Holmes
Investors can improve their odds by learning how to assess the fundamentals of the gold exploration companies. A good tool for this job is what I call “The Five M’s.”
By using the Five M’s, an individual investor can build a simple but powerful model to initially sort through the many hundreds of upstart gold companies to find better opportunities.
1. MARKET CAPIf a junior gold company has 10 million shares outstanding at $1 per share, the company is valued at $10 million. The question any investor should ask is, “Is this company really worth $10 million?”
If the market pays $25 per ounce of gold in the ground, the company should be valued at $25 million. If the company’s market cap is only $10 million, it may look undervalued. If the company’s market cap is $50 million, it may appear to be overvalued.
For larger gold companies, an investor can measure a company’s market cap against its production level, reserve assets, geographic location and other metrics to establish relative valuation.
2. MANAGEMENTOften the heads of junior companies are geologists or engineers who have no relationships in the brokerage business. This lack of relationships impedes their ability to generate market support.
Some of the most successful company builders in the gold-mining industry are what I call the “financial engineers”—people who have the relationships and understand the capital markets and who know how to hire the best geological and engineering teams. We tend to have more confidence investing in them.
3. MONEYA gold exploration company has to deliver reserves per share to have a chance at another round of financing. It has to convince the capital markets that it is an attractive investment on a per-share basis.
The gold-equities market is efficient at judging reserves per share, so if the exploration company doesn’t come up with the results necessary to get an evaluation, investors quickly lose confidence.
There is an old rule when it comes to exploration companies: don’t pay more than two times cash per share if there are no proven assets in the ground.
4. MINERALSGold companies have the highest industry valuations based on price to earnings, price to cash flow, price to enterprise value and price to reserves per share.
Companies operating mines that produce gold and a significant amount of another metal (typically copper) tend to have lower valuations than pure gold companies. But at the top of a gold price cycle, copper/gold deposits end up rising to the same multiples as pure gold companies.
So when it comes to picking stocks in anticipation of an upward price move for gold, the investor’s margin for error is reduced by selecting companies with both gold and copper production.
5. MINE LIFECYCLEIn the exploration and development phase, a price of a gold stock often follows a course that ends up looking like a double-humped camel (see graphic above).
First there’s euphoria over exploration results that are better than expected. The stock price rises as investors race to buy shares. Then reality sets in—this gold discovery is still years away from being an actual producing mine. At this point, there’s a huge correction in the stock price.
Assuming the company continues down the path to development, its share price drifts sideways until around six months before the first ounce of gold is expected to be produced.



Federal Reserve policymakers have downgraded their outlook for the US economy in 2009 according to their latest projections for real GDP growth, inflation and unemployment. more...


Treasuries remained in demand throughout this short yet active President’s Day week. The market is still trading very volatile, with double digit yield movements everyday this week. more...
Large-Cap Equities The stock market tumbled this week due to further weakness in the financial sector and fears of a deepening recession. more...
Corporate BondsThere were a handful of issuers that tapped the investment grade market this week as concerns regarding the stimulus package and bank rescue plan kept issuers at bay. more...
Mortgage-Backed Securities Mortgages performed poorly versus Treasuries as the latest US Government policy plan, the Home Affordability and Stability Plan (HASP), intended to stem the foreclosure crisis, may lead to a surge in refinancing. more...
Municipal Bonds The municipal market stalled this week. Two-year AAA-rated general obligation (GO) bond yields rose 3 basis points (bps) through Thursday, to 1.17%. more...
High-Yield The high yield market remains resilient, notwithstanding the onslaught of difficult macro news. more...
INTERNATIONAL MARKETSWestern European EquitiesStocks in Western Europe lost ground over the past week. The stocks with the worst performance were insurance (-19.0%) and banks (-16.1%). more...
Eastern European Equities The CECE index of equities traded in Central Europe (Czech Republic, Hungary, and Poland) lost -14.1% this week, while the Russian stock index RTS went down by -17.1%. more...
Global Bonds and CurrenciesSovereign government bond markets had a mixed week. The long ends of both the Bund and Gilt markets took their main lead from the US Treasury market, closing the week firmer. more...
Emerging-Market Bonds Emerging market dollar-pay debt spreads widened this week. more...


Next week, investors will be listening closely to Fed Chairman Ben Bernanke during his semi-annual testimony before Congress. more...

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Friday, February 20, 2009

Market Reflections 2/19/2009

Another 600,000 plus level in first-time weekly jobless claims together with another record level of continuing claims are raising talk of a 600,000 or more contraction in monthly payrolls. Employment data in the Philadelphia Fed's monthly report, like the Empire State report earlier this week, are strongly signaling deepening job losses and deepening contraction in the manufacturing sector.

Other data in the session included a surprise 0.4 percent gain in the index of leading economic indicators, a gain reflecting the massive monetary stimulus underway that most expect will help reverse the recession. And for the most part, the markets continue to show patience in anticipation that stimulus will in fact work.

But stocks once again closed at their lows, down 1.2 percent for the Dow industrials which is now below 7,500. The dollar edged back following its recent strength, giving back about 1 cent against the euro to tend at $1.2668. Money also moved out of Treasuries where the 10-year yield rose 10 basis points to 2.85 percent.

A rare draw in crude inventories gave a big lift to oil prices where the April WTI contract ended at just under $40 for a $3 gain on the day. Gold edged back a little, down $15 to $974 amid talk that selling by weak longs, that is first-time buyers who were attracted to gold's safe-haven value, could accelerate a down move.

Thursday, February 19, 2009

Gloom and Doom: The Federal Reserve

The Federal Reserve has revised down its economic outlook for 2009, and warned that the U.S.
is likely to face an especially gradual and prolonged period of recovery once it finally claws its way out of a deep global recession. Minutes from the FOMC’s late January meeting released today show that the Committee predicted the economy will contract this year by 0.5 to 1.3%, and that unemployment will rise to between 8.5 and 8.8%.
The nation’s steep declines in housing, trade, industrial production, spending, and employment rates are expected to overwhelm the government’s stimulus plans as currently proposed.

• Treasuries tumbled across the curve today as the Federal Reserve signaled it does not intend to buy U.S. securities to lower consumer borrowing costs anytime soon. 30-year bonds were little changed throughout most of the day until release of the January 28th FOMC minutes indicated the wait-and-see position. The Committee believes that buying mortgage-backed bonds and agency debt is more likely to have a positive effect on credit markets.
• Tomorrow the government will announce the size of next week’s 2-, 5-, and 7-year note auctions. Market observers expect the total to be $97 billion, coming on the heels of last week’s record $67 billion sale.
• At the market close: UST 10-yrs down to yield 2.76%. UST 2-yrs down to yield 0.95%. USD$$ slightly stronger at $1.2546 vs. the euro and stronger at $93.695 vs. the yen. Gold up strongly to $984.90/ounce. Oil relatively unchanged at $34.62/barrel.

Obama's Housing Plan: Legislating Conflicting Goals

by Eric Falkenstein
Obama has announced a new plan to help renters (oops, 'homeowners') who cannot afford their mortgages.
There are two types of people who aren't paying their mortgage bills, and it is not simple to separate them. There are those whose incomes are insufficient to make the monthly payment. Then there are current homeowners who are merely underwater, and do not want to pay (mortgages are limited liability, so they can walk away and not owe anything). So the government has some rule, and 30% of people with such mortgages get to basically write down their old mortgages to a new level that make them able and/or willing to pay.
There are two problems with this:
First, it directly lowers the value of the bank's assets. We are simultaneously trying to shore up banks. That the government is legislating this implies that banks will have to write down their assets more than they would have otherwise. So it is directly inconsistent with the Treasury's other objective, to strengthen banks.
Second, it generates huge moral hazard. Say 4 million mortgage owners take advantage of this as targeted. Those who were not targeted will look at what their neighbor did, on a house bought at the same time, and try to figure out how they too can write down their mortgage obligation. A good number will successfully navigate the lame top-down criteria applied, because any cookie-cutter criteria in Washington creates a very simple target to game.
This process will put more pressure on housing, because it creates zombie properties as owners figure out if they can get this done, and it creates a new wave of defaults. Thus, previously people who, while underwater on the property or in trouble because of standard vagaries of chance, might have otherwise paid their mortgage. But to do so in this environment is to be a sucker. Many will find this unethical, but many won't. This creates the second wave of mortgage defaults, the opportunists. I imagine there will be incentives on the demand and supply side to play this game.
The most melancholy of human reflections, perhaps, is that on the whole, it is a question whether the benevolence of mankind does more good or harm. - Walter Bagehot

8 Possible Targets for Exxon's Cash


Analysts for a while have been buzzing about Exxon’s position, speculating as to whether, or when, the world’s largest publicly traded corporation will make a bid to acquire a competitor. You could make an argument that Exxon (XOM) is currently in the best shape of any financial company in the history of the world. Their net income for the third quarter of 2008 alone was over $14B dollars and they currently have $38.43B dollars in cash, ready to be deployed. On top of this mountain of greenbacks, they also have roughly $165B in repurchased stock. Exxon has been fairly quiet on the M&A front since they bought Mobil last decade, but many feel things could change with the recent collapse of crude oil prices. I would like to take a look at a few potential targets for Exxon as well as a few other options that I see as very feasible.

Apache Corp.
Apache Corp. (APA) is one of the largest exploration and production companies in the world with excellent geographical resource exposure, something that Exxon dearly covets. Apache also has a stronghold on the Southeast Asian and Australian natural gas markets, two areas that Exxon would be very wise to enter. Apache also has the scale that would lead to a meaningful acquisition for Exxon. Even though Apache looks like a perfect target for Exxon’s management, it is very unlikely that a deal like this would occur because Apache is extremely sound financially. Apache has seen positive free cash flow for the past 22 years. This trend is likely to continue even in this financial crisis. The premium that Exxon would have to pay to acquire Apache would make the relative value of such a deal extremely unfair.
Chance of occurring: <5%
Anadarko Petroleum
Anadarko Petroleum (APC) is a company similar to Apache but with less of a natural gas bias. Anadarko has excellent exposure to Africa, another area that could be lucrative for Exxon to enter. Anadarko had built up a sizable amount of debt in 2006 and 2007 and it seemed like they could have possibly been a takeover target, but their CEO Jim Hackett has done an excellent job of paying down this debt and managing the company over the last few years. This is another situation where an acquisition would be unlikely, although slightly more likely than an acquisition of Apache.
Chance of occurring: <10%
Chesapeake Energy Corp.
Chesapeake Energy (CHK) has been all over the news over the course of the last year due to their stock’s roller coaster ride. Nobody was hotter than Chesapeake during the energy boom and no one has been in worse shape (until recently) when energy commodity prices came crashing down. Exxon’s natural gas exposure is not nearly high enough when considering the likely shift in the world’s infrastructure under the new environmentally conscious hydrocarbon ban, and Chesapeake is the leading natural gas producer in the United States. Chesapeake also has massive leaseholds in the Haynesville Shale, the United States' foremost natural gas play. They have superb management with CEO Aubrey McClendon and I doubt he would let them go down without a fight or a great offer. This acquisition of Chesapeake has a higher probability of getting done, as it makes a lot of sense for Exxon going forward.
Chance of occurring: 35%
EnCana Corp.
EnCana (ECA) is a company that has run into some problems recently with liquidity. They have over $12B in debt and less than $400M in cash on hand as of the end of the last quarter. On top of their abnormally high debt levels for a large energy company, they also had negative un-levered free cash flow for the last quarter totaling approximately $1.9B. This burn rate of cash is not sustainable, and management will have to significantly cut back the capital expenditure program in order to accommodate their new financial situation. Management had been quoted saying that there was a potential for the company to break into two “separate parts to unlock value,” but this seems unlikely given their current situation. Their reserves are mostly spread throughout the United States and Canada, so Exxon wouldn’t really gain any geographical exposure by acquiring EnCana. Still, it would help boost XOM's footprint in the natural gas markets and potentially unlock value if they could manage the company better than current management. An acquisition of this size could also be at risk of antitrust regulation.
Chance of occurring: 15%
Suncor Energy
Suncor (SU) is the type of company I would consider buying if I were in charge of Exxon. The resources are located in Canada, and these resources are oil sands, which are not conventional crude oil resources. Obviously oil sands are extremely out of favor right now, but to me it would make all the sense in the world to buy near the “low” of the market. Exxon could easily finance a takeover of Suncor with an all-cash offer, even with a substantial premium over the current stock price. Exxon has shown that they are really not concerned with environmental issues, and acquiring a company as environmentally unfriendly as Suncor wouldn’t be a problem for Exxon’s management or shareholders.
Chance of occurring: 20%
Royal Dutch Shell plc
As ridiculous as it may sound, Royal Dutch is a possible (though not extremely likely) target for Exxon. RDS.A has a large amount of international exposure that Exxon envies, as well as a fairly impressive reserve replacement ratio that well outpaces Exxon’s own. The key here is the regulators and anti-trust laws, the two main reasons why I don’t see this happening. Without these two factors in the way, I think Exxon wouldn’t hesitate to buy RDS and put to rest a rivalry that has lasted over 100 years between the spin-out of Standard Oil and the European oil giant. All things being equal, Exxon could even buy RDS in a stock only deal (if the shares of Exxon didn’t lose any value).
Chance of occurring: 5%
Foreign Government Joint Venture
This is the option that most of the analysts and writers are buzzing about. Unfortunately for their speculatively racing minds, I think that this is extremely unlikely. Exxon, along with most of the other oil majors, is already having enough problems with nationalized oil producers, Venezuela being a great example. The Venezuelan state-controlled oil producing company is refusing to pay Schlumberger (SLB) and Halliburton (HAL) a combined $1B, and it seems as if the companies will never see a penny of this money. Operating in these types of environments is not worth the risk of losing all your assets to nationalization; just ask ConocoPhillips (COP) and B.P. plc (BP). In case you missed it, ConocoPhillips just wrote down over $10B in Russian exposure in their last earnings report, and the BP-TNK venture has had a world of trouble since the day it was started.
Chance of occurring: 1%.
Resource Acquisition and More Share Buybacks
Now here is an option that not only makes sense, but is very likely. Some form of this will take place with Exxon’s cash load. This method presents a few benefits for Exxon that I believe are not as easy to see. Firstly, resource acquisition in many cases will dodge the regulation barrier that would come with any Exxon acquisition. This way, the oil giant can basically sidestep Obama. Don’t forget that Obama isn’t Exxon’s biggest fan; he had commercials that attacked their profit margins running throughout his campaign. With the public outrage over “big oil profits,” I doubt the U.S. Department of Justice lets anything of this nature slide through easily. Seeing the types of deals that are made around the industry almost daily as companies are scrambling for liquidity, it seems as if Exxon could easily outbid rivals for leaseholds that are up for sale from either other struggling smaller competitors or governments.
Share buybacks present not only an effective, but also an interesting scenario for Exxon. The market may not be able to price in the full value of an acquisition by Exxon, but whenever a firm announces share buybacks, it is much easier to calculate what this will mean for the share price. Often in our markets, irrational exuberance takes over and equities prices can run up higher than they should when share buybacks are announced. Exxon could use this to its advantage to acquire a company in an all-stock deal when their stock price is inflated beyond levels they feel are fair. This approach could potentially kill two birds with one stone. With roughly $40B in cash, Exxon could potentially set more than half of this aside to buy back shares and keep the rest on hand in case of any emergency or a sustained drop in energy prices, something that actually would not be a bad thing for Exxon in the long run.
Chance of occurring: 100%
Final Thoughts
Exxon will most likely choose at least one of these options; it is just a matter of time. Exxon’s management hinted that something was in the works during the fourth quarter earnings call. With Exxon holding that much cash it would be in the best interest of shareholders if they put it to work. Regulators will be the big question, and the option of not having to deal with regulators through the last scenario I listed is very attractive for Exxon.
In the meantime, do not expect Exxon to act quickly. Exxon has waited as crude has dropped from $147 to $39 and will not be afraid to wait longer in order to get the exact deal that they want. Exxon would rather miss calling the bottom and buy in somewhat into the upside than attempt to catch a falling knife with their cash reserves. While I have full faith in Exxon’s management to make the right decision, I would warn long investors to be aware of this pending acquisition before taking a large long bet on the world’s largest company.
- Charles W. Petredis
Full Disclosure: The author’s family as well as the mutal fund the author manages are long APA, CHK, and XOM. The mutual fund the author manages is long SLB.

See if you qualify for mortgage help

Official guidelines of the new mortgage plan won’t be available until March, but there are a few things it will ultimately boil down to: 1) Encouraging refinancers… and 2) Modifying loans that are underwater.

Folks with jumbo loans (over $417,000) won’t be eligible… speculators won’t be eligible… but for people who are underwater on their loan, it could be a big help.
By Les Christie, staff writer
Last Updated: February 18, 2009: 7:11 PM ET

NEW YORK ( -- The eagerly anticipated foreclosure prevention program unveiled Wednesday by President Obama targets 9 million borrowers for help - are you one of them?
The $75 billion effort, dubbed the Homeowner Affordability and Stability Plan, boils down to two basic solutions:
First, the government is aiming to help more homeowners refinance to take advantage of new low interest rates.
Second, it provides incentives to lenders and servicers to restructure your mortgage to more affordable levels.
Official guidelines won't be unveiled until March 4, but here's how to know whether you'll likely be able to take advantage of either of these options.
Help for those seeking refinancing

This part of the program targets borrowers who have kept current on their mortgages. Many of the homeowners in this group have been unable to lower their housing costs through refinancings because of falling home prices.
Right now, if you're underwater on your mortgage, owing more than the home's market value, forget about qualifying for a refi. In fact, at least 20% equity in your home is now a must.
The new guidelines should help. Even homeowners with debt that exceeds home value by 5% could be eligible. And there will be no prepayment penalties.
The Administration estimates that this will enable up to 5 million homeowners to obtain lower interest rate mortgages.
Who's not eligible. Homeowners whose property values have dipped severely, putting them underwater by more than 5% are out of luck.
Those with "jumbo" mortgages also don't qualify - only those with "conforming' mortgages do. To be absolutely sure what kind of loan you have, you need to check with your servicer or lender after March 4. But in general, until the past year, loans above $417,000 were considered jumbo mortgages, and Fannie Mae and Freddie Mac were not allowed to buy and guarantee them.
All borrowers will have to prove they have sufficient income to be able to keep up their loan payments, though what would be sufficient proof wasn't yet clear.
Mortgage modification help for at-risk borrowers
Homeowners in default or at risk of default may qualify for loan modifications, which restructure the terms of loans.
Anyone with high combined mortgage debt compared to income or who is underwater may be eligible for a loan modification.
Borrowers with high levels of other debt, such as car loans and credit card debt exceeding 55% of their incomes, may still qualify for a modification but they'll be required to accept debt counseling in a HUD-certified program.
If you qualify, your servicer or lender will reduce your monthly mortgage payments to 31% of your gross income.
The payment would stay there for five years and then gradually revert back to the conforming loan rates in place at the time.
The reduction would come mostly through interest-rate reductions, though in some cases, principal reduction also would be an option.
Borrowers would also receive incentive bonuses of up to $1,000 a year for five years for making payments on time.
President Obama estimated 3 to 4 million homeowners could benefit from the new modification procedures.
Who's not eligible. Speculators, those who bought homes for investment purposes, do not qualify for help -- all homes must be owner/occupied.
The program will also not reward homebuyers who were irresponsible in their borrowing. All applicants will be closely examined by lenders and those who acted unscrupulously by, for example, misrepresenting their incomes in no-doc loan applications, would not qualify.
And, in order to protect taxpayers from excessive expenses, no loans will be modified unless it results in a net savings compared with the costs of foreclosing. Finally, rates would not be lowered below 2%.
That will disqualify many borrowers who simply can't afford any reasonable mortgage payment because of illness, for example, or job loss.
"[The plan] will not reward folks who bought homes they knew from the beginning they would never be able to afford," said Obama. "In short, this plan will not save every home."
No mortgages for amounts above comforming loan limits would be eligible.

First Published: February 18, 2009: 6:57 PM ET

Market Reflections 2/18/2009

President Obama unveiled a $75 billion plan to help limit foreclosures especially for those who fail to qualify for refinancing because their homes have contracted in price. Unlike last week's Treasury stability plan which was met with disappointment, reaction to today's announcement was quiet though initial word of the plan did give the stock market a push last week.

The day's economic data was headed by a 17 percent plunge in January housing starts and a less frightening though still severe 5 percent plunge in permits. The Fed updated its 2009 projections calling for an unemployment peak of up to 8.8 percent. The rate is currently at 7.6 percent. The Fed also sees full year economic contraction of up to 1.3 percent. But the Fed is optimistic, at least for 2011 when it sees growth as high as 5 percent.

The Dow industrials were fractionally changed on the day while money moved out of the Treasury market where the 2-year yield rose 10 basis points to 0.96 percent. The dollar gained another 1/2 cent against the euro to end at $1.2553. Gold is pressing back toward $1,000, ending higher on the day at $988. Oil ended under $35.

Wednesday, February 18, 2009

Is the Obama mortgage plan a solution?

No. It is a political bastard. Govt wants to pay existing servicers to modify loans without giving them any meaningful incentive to do so. The rewards are trivial. The element of payment not to exceed 31% of income is kinda familiar, however it is, as usual a political solution with no real practical way to implement.

Jumbo mortgages are excluded: anything over 650 ish thou is unrefinanaceable.

The plan talks about refinancing at some level of house value; that is the one variable that in not definable,and anyway what is the real incentive for a homeowner upside down in his mortgage to refi under these terms and be paying off a mortgage forever with no hope of getting anything back at the end.

This is a horrible political creation, a compromise.

My solution puts govt directly into the business of writing mortgages; with a real end result that works for govt, homeowners and taxpayers.

The only unintended consequence is that govt is now directly in competition with banks and mortgage lenders, the vast majority are effectively insolvent and bankrupt with no hope of ever lending anything meaningful because that will deplete their statutory capital and govt will put them out of business...because threre is no way for banks to lay off their mortgage bets because the securitization market is gone, because there is no way to value mortgage assets on bank books ... and round we go.

This will spiral out of control very soon.

Obama has no concept of the problem. He is playing politics with US citizens homes.

Market Reflections 2/17/2009

It was concern over Japan and Europe that sank the U.S. markets on Monday. A 3.3 percent fourth-quarter contraction in Japanese GDP deepened concern over the global recession as did talk of European bank failures. Treasury International Capital data showed renewed foreign investment but not Japanese investment in Treasuries, another result of contraction in Japan. Data here showed record lows for the Empire State manufacturing report, data suggesting that the recession for the manufacturing sector continues to deepen in the first quarter.

President Obama signed the latest stimulus bill into law and, along with the Treasury Secretary, will offer tomorrow a foreclosure prevention plan for the housing sector. Other data in the session included another rock bottom reading for the housing market report from the nation's homebuilders. Bank stocks were heavily sold in the session as were shares of GM which was due after the close to report its status to the government. The Dow industrials ended at their lows, down 3.8 percent to 7,552.

Money moved further into safety including once again into gold which ended about $30 higher at $970. The dollar gained more than 2 cents against the euro to $1.2605 while yields fell sharply in the Treasury market with the 10-year down 26 basis points to 2.63 percent. Oil fell further with the March contract going off the board at $34.95. April WTI ended 8% lower at $38.55.