By Andrew Mickey, Q1 Publishing

The world agrees the U.S. manufacturing industry has been in steady decline.

Despite all actual evidence stating otherwise (the number of manufacturing jobs have declined, but productivity has increased greatly and the percent of GDP generated by manufacturing has remained fairly constant for decades), exporters and manufacturers have become some of the most politically-favored industries in the country.

The thing is though, the U.S. still does a really good job at making some things. One of those is coal-mining equipment.

Two of the world’s leading coal mining equipment makers, Joy Global (NASDAQ:JOYG) and Bucyrus International (NASDAQ:BUCY) are right here in the United States.

These companies have held out well against the economic downturn as China and India are rapidly growing their coal-powered energy infrastructure, but even they can’t win out against the environmentalists.

Virtually coinciding with another ho-hum monthly employment situation report, the Obama administration has announced a new policy to cost the economy more jobs.

The Wall Street Journal says in Employment, Environment at Odds:

For the second time in recent weeks, the Obama administration's environmental policies have clashed with its efforts to boost American jobs.

The U.S. Export-Import Bank, a federal body charged with promoting U.S. exports with loan guarantees, decided against backing a sale of coal-mining equipment to an Indian company. The guarantees were denied amid the agency's concerns about the mine's environmental impact.

Bucyrus International Inc. said it was likely to lose orders totaling as much as $600 million for mining machinery from a subsidiary of Reliance Power Ltd. of India because of a decision by the Ex-Im Bank against providing loan guarantees to help finance the purchase. The orders were contingent on obtaining the guarantees, which would cut the cost of financing for Reliance, part of a conglomerate headed by Anil Ambani.

A person familiar with the situation in India said Reliance has chosen not to purchase the mining equipment from Bucyrus because of the bank's decision.

The bank's chairman cited Obama administration policy against backing projects with heavy carbon emissions.

The decision means "throwing 1,000 jobs in the ditch," Tim Sullivan, chief executive officer of the South Milwaukee, Wis., maker of mining equipment, said in an interview. Bucyrus cited an estimate that the order would create or protect 984 jobs in 13 U.S. states.

Clearly, this is a stunningly ridiculous policy for two reasons.

First, it is based on preventing global warming/climate change. The reasons for a warming earth are varied and have yet to be proven beyond a reasonable doubt that carbon is causing. If you recall Al Gore’s win/win situation (either “I saved the world” or “I told you so”) politicians will always love it. And India will buy this equipment somewhere, so it’s not going to have any net effect on “climate change” to begin with.

Second, it just doesn’t make any economic sense at all. The failed government stimulus efforts were intended to “create or save” 3.5 million jobs. Even if it achieves those goals, which is highly dubious, it would do so at a cost of $246,285 per job. The India/Bucyrus deal would “create or save” nearly 1,000 jobs at negative net cost to the government. The profits, taxes, and tariffs created by the deal would increase government revenues.

The primary reason the U.S. economy hasn’t recovered is because of the uncertainty created by a government that has become and is becoming more hostile to private industry.

The markets will not recover until some sort of uncertainty is achieved.

With news like this, certainty is a long ways away.

It was an “outrageous” prediction.

About a year ago everyone was scared. The major indices were sitting at multi-year lows. Commodities were tanking. And it seemed like the bad news was only going to get worse and worse.

It was bleak. Most investors were cashing out. No one wanted to know where they opportunities were… they just wanted out.

At the time, we had the chance to get together with Juan Villarzu to get an inside perspective on the copper market.

As the former head of Codelco, the world’s largest copper mining company, and the Chairman of Apoquindo Minerals (TSXV:AQM), a rapidly unfolding South American copper story, he’s definitely someone that has to know the copper industry very well.

At the time we got together with him he told us, “Copper will be at $2 by the end of the year, and will be above $2 next year.”

It was a bit outrageous. Copper had just fallen from $4 per pound to below $1.50 in about six months time and few saw any type of rebound. But Villarzu, who knew the situation well, did see the light at the end of a short tunnel.

Since then copper prices have rebounded to more than $3.30 per pound today. That’s a gain of more than 160%.

But the recent run in copper has sparked resurgence of uncertainty in the copper market.

That’s why we’re glad to let you know today we recently got back together with Villarzu to get another insider’s take on what’s going on with copper now.

In an exclusive interview with Andrew Mickey, Q1 Publishing’s Chief Investment Strategist, Villarzu gives us a copper industry insider’s perspective on:

- Where copper prices are headed
- Whether current copper prices are really sustainable
- The real impact of the credit crisis on the copper industry
- What copper’s supply/demand picture really looks like
- Why you “must be in South America” if you want copper
- What he looks for in prospective mining projects
- and more…

All the details are below in Copper: An Insider’s Perspective.

Good investing,

 

Q1 Publishing Investment Research Team

 

Copper: An Insider’s Perspective

Andrew Mickey: With copper at $3 per pound, where’s the demand coming from?

Juan Villarzu: The answer is China. 68% of the expected growth in refined copper consumption between 2010 and 2014 will be explained by China’s copper appetite. Russia (7%), India (5.4%) and South Korea (3,6%) are the distant followers.

Andrew Mickey: Last month China posted GDP growth above 10%. But there has been a strong rebound in the economies of Thailand, Taiwan, and a few others. Do you see the periphery countries starting to play a larger role in the copper markets?

Juan Villarzu: Since the mid-nineties copper consumption has grown much faster in the developing economies than in the developed ones.

During this period, consumption in developed economies has shrank while average annual consumption growth in developing economies, excluding China, and China has been, around 5% and 11%, respectively, I expect this trend to continue for some time.

This is consistent with expectations of a fast growth with high copper content (urbanization, infrastructure, durable consumption goods).

Andrew Mickey: As you know, quantity demand is heavily impacted by price. For example, gasoline consumption starts to drop off when prices at the pump hit $3 a gallon.

At what price do you see copper prices going before there is a significant demand impact?

Juan Villarzu: I think that the real (constant purchasing power) price of copper will fluctuate at around US$ 3 per pound of fine copper during the next five years or more.

It is not going to be a smooth ride; as in the money and exchange rate markets volatility will be a permanent feature.

As recent evidence shows, this price level does not trigger major substitution initiatives. In fact, the higher price of copper has been accompanied by higher prices of aluminum and relative prices have not changed significantly. 

I would also like to point out that copper consumption growth is not entirely explained by GDP growth; recyclability, energy efficiency, antibacterial capabilities, are features that make copper an indispensable material. 

Andrew Mickey: John Mackenzie, Anglo American’s head of copper recently said he expects global copper stockpiles to fall over the longer-term. He specifically noted, “There aren’t enough high-quality projects in the world.”

Do you see a similar situation? Why?

Juan Villarzu: In the best of the scenarios…

***Learn more about what the man who ran the largest copper mining company in the world sees ahead for the supply/demand picture for copper, what he for looks for in copper development project, and get the inside scoop on the future of copper mining in South America in Part II of Copper: An Insider’s Perspective here.

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Andrew Mickey: John Mackenzie, Anglo American’s head of copper recently said he expects global copper stockpiles to fall over the longer-term. He specifically noted, “There aren’t enough high-quality projects in the world.”

Do you see a similar situation? Why?

Juan Villarzu: I agree with John Mackenzie. Copper consumption is expected to grow at a minimum of 5.5% per annum during the next three to five years, which means that in order to satisfy demand at the current stocks levels and scrap availability, production would have to increase at an annual rate of 900,000 tons of fine copper.

If you were to take into account the effect of declining ore grades in the existing mines, the need for new production would be 1,000,000 tons. In the best of the scenarios, mine production is expected to increase at an annual rate of 800,000 tons of fine copper.

The excess demand would be cleared through a combination of lower stocks and higher prices.

Andrew Mickey: What would you define as a “high-quality project” in the copper world? Also, what size is kind of needed to go from development to mining?

What are some of the things you look at, or maybe what attracted you to Apoquindo Minerals, that shows a project has “real mine” potential and higher odds of success? Is it size, grade, location or something else?

Juan Villarzu: The most important factors to consider when evaluating a mining opportunity are: the amount and quality of the resources contained in the deposit or the area to be exploited; the location; the availability of skilled labor and supervisors; the Capex, regulations, and business climate prevailing in the country where the resources are.

For example, to develop and build a copper mine in the north of Chile should be a profitable and satisfying experience. There you would be in the neighborhood of the largest copper mines in the world, with access to excellent infrastructure, close to ports, low risk of community interferences, low environmental requirements (desert), mining culture and a favorable business climate.

In mining, size matters and explains why major companies usually look at deposits of 400 million tons of mineral containing 0.5% or more copper. Medium and small producers tend to look at smaller deposits of higher grades, which can be quickly put into production to take advantage of favorable market conditions.

Andrew Mickey: You have worked for years in South America and all over the world. What has attracted you to South America now?

Juan Villarzu: If you are in the copper business, Latin America is by no doubt the best place to work or invest, in particular Chile and Perú. Mexico is also becoming a very attractive place to get into mining. This together with the possibility of working with very qualified, experienced and agreeable people were the reasons that attracted my interest and triggered the decision to join Apoquindo Minerals Inc.

Andrew Mickey: We all know the mining industry has some of the longest lead times in the world. In the face of rising copper prices, how fast can the supply side really respond?

Do you see any lasting impacts from the credit crunch of 2008? We know a lot of mines were placed on “care and maintenance” or shut down completely. How long does it take to bring a mine back into production if it was shut down for less than a year or so? Also, are there any impacts from the credit crunch most folks not in the mining industry probably just don’t see?

Juan Villarzu: I do no think that the credit crunch of 2008 had a major impact on the industry.

Marginal operations are certainly back in operation but supply response has been slow mainly because the leading players of the industry failed to anticipate the major structural changes produced by the transformation of China in an open market economy. It took them a long time to become convinced that China could sustain high rates of growth for a long period of time.

The best example is their decisions to put on hold investment for expansions, new projects and exploration when the price plummeted after having been at over US$ 4 per pound. After a short lapse, the price recovered rapidly and surpassed the US$ 3 per pound level. Fortunately, as of now the industry is moving at full speed but it will take some time to deliver 1,000,000 tons of fine copper per year.

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Andrew Mickey, Q1 Publishing

Forget the current estimates, the deficits are going to be much, much worse.

Just a few days after Senator Jim Bunning was labeled a “lunatic” for trying to enforce the recently enact Pay-As-You-Go laws, the Congressional Budget Office (CBO) releasted its analysis of the Obama Administration’s federal budget proposal.

The CBO forecast the massive deficit spending to add $9.7 trillion to the U.S. government debt. That was $1.2 trillion more than the administration had forecast. The CBO expects the government debt to increase to 90% of GDP.

The thing is though, these dire estimates are extremely optimistic.

The reason is because the assumptions the projections are based on are absolutely ludicrous.

The generous assumptions include NO recession in the next 10 years (it’s the 90’s boom time all over again! What…nobody told you?), record low inflation, and businesses across the country going on an unprecedented hiring spree, just to name a few.

When these hopeful assumptions never materialize, the ramifications will be widespread. And, as you’ll see in a few moments, we believe even more strongly in our statement our complimentary gold report  issued last March:

“Every few decades though, the right conditions come along to make an absolute fortune in gold and gold stocks. Right now the conditions are right.”

Although only time will tell how bad the deficit/debt will actually be, we can be pretty sure it will be far worse than both the White House’s and the CBO’s estimates. The reason is because they are based on five assumptions which, quite frankly, just aren’t going to happen.

Unemployment Rate:

Official Assumption: 6.68% 10-year average

Reality: The current headline unemployment rate is 9.7%. The last time it reached this high was in 1982.

Back then the government was cutting taxes and deregulating businesses. They were making mostly right moves. But even making the right moves still led to an average headline unemployment rate of 7.04% for the following decade.

The booming 80s couldn’t even bring unemployment down as fast as the Obama administration expects over the next 10 years.

As long as the economy fails to ever truly recover, unemployment benefits keep getting extended, and the cost of employment (taxes, mandatory healthcare, higher minimum wage, etc.) keep going up, the next decade averaging 6.68% unemployment is nearly impossible.

Inflation

Official Assumption: 1.61% annual average

Reality: We hear all the regular talk about how inflation isn’t a problem and how the Fed – despite its entire history - will know just the right time to start hiking rates. But if you take a look at the budget assumptions, you can see they truly believe the right moves will be made at just the right time that will lead to the lowest inflation rate in 70 years.

The budget assumption is for inflation in the next decade is lower than any decade since the Great Depression. It’s lower than the 40s, 50s, 60s, and on and on. It’s lower than the long run annual average (1913 to current) of 3.4%.

It’s not impossible, but it hasn’t happened in the past 70 years and none of those decades started off with near-zero interest rates and trillions of freshly printed dollars handed over banks.

10-year T-bond Interest Rate

Assumed: 5.06% average annual rate

Reality: Despite a deficit (as a percentage of GDP) nearly tripling the GDP growth rate and a debt that’s working its way to 100% of GDP, the administration believes it will still be able to borrow money very cheaply.

The assumption, however, is more than 20% below the 57-year average 10-year treasury interest rate of 6.35%.

Unless the government will be able to borrow money at lower rates as its creditworthiness deteriorates, the government’s ability to borrow at the rate of 5.06% is highly doubtful.

Average Interest on 3-Month T-bill

Official Assumption: 3.42% 10-year average

Reality: Same situation as with the 10-year T-Bond. As borrowers credit risk increases, the cost of borrowing does NOT go down.

The assumed 3.42% rate is one of the lowest decade-long average rates in the history of the 3-Month T-Bill.

And to give you an idea of the economic conditions necessary to create such a good environment, you have to go back to the decade between 1997 and 2006. The 90-00s boom years, when population demographics and low inflation were supporting strong GDP growth and low rates, the 3-Month T-Bill yielded an average 3.42%.

Right now, none of those pillars of economic growth are present. But the budget proposal is based on the presumption they are.

Real GDP Growth

Official Assumption: 2.5% annual average

Reality: This is probably the most plausible assumption, but it’s still very optimistic. A quick look at history shows why.

During the stagflationary years between 1972 and 1982 real GDP only grew at a 2.4% annual rate. So 2.5% seems realistic. However, the boom years between 1998 and 2008 was led by 2.66% annual growth in real GDP.

Right now, the government is expecting a return to prosperity despite a massive credit contraction, increased regulation, higher taxes, etc.

Clearly, 2.5% is very optimistic.

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The budget proposal, which assumes such a strong recovery and an era of unprecedented economic growth, is presenting a “best-case” scenario. And it is still expected to increase the federal debt level by another $9.7 trillion.

It’s yet another case of great expectations. And as we say in our free e-letter, the Prosperity Dispatch, great expectations inevitably lead to great disappointments.

When it comes to the budget, the disappointment will have a widespread impact.

Just think…What happens when the best-case scenario doesn’t materialize, the coming higher tax rates reduce tax revenue, additional entitlement programs get added to the mix, or the economic consequences of a random event like a natural disaster or another major terrorist attack are added into the mix?

None of the answers are good.

For anyone interested in maintaining and growing their wealth in the years ahead, the options will be limited in this kind of environment.

When interest rates rise, the government takes resources away from the most productive areas of the economy, and consumers are paying down debt, it’s going to be a tough run for the most popular investments over the past three decades – stocks and bonds.

The markets may look good for a while longer and this rally will last just long enough for most investors to get sucked into it, but now is the time when investors look to the classic stores of wealth – gold and silver – to help insulate themselves from the consequences of the ballooning government debt which, even under the best-case scenario, are not good.

Good investing,

 

Andrew Mickey
Chief Investment Strategist, Q1 Publishing

By Andrew Mickey, Q1 Publishing

The correction in gold prices has clearly unnerved many of the newly-minted gold bugs.

The simple fact gold is not going up $20 a day has sent the “hot money” running for the exits.

Investors willing to wait out the passing storms and keep their eyes on the big prize, however, are going to do exceptionally well.

In fact, this correction is likely creating another great opportunity to reload on your favorite gold stocks.

It’s not just me who’s seeing opportunity in gold stocks now. Secretary Geithner, Chairman Bernanke, and Mr. Market have all recently signaled now is the time to buy gold stocks.

Secretary Geithner: Words that Will Live in Infamy

Over the weekend on ABC’s Sunday political show This Week, the Treasury Secretary took to the airwaves once again with plenty of focus-grouped phrases to attempt to help create the image of how worse the economy would be without the stimulus, bailouts, etc.

It didn’t take long for Geithner to get off script though. Nearly halfway through the interview he started looking ahead into the future and making some bold guarantees.

The following exchange reveals a lot of how the current administration views the massive and growing fiscal deficits and its ability to continue issuing bonds:

Jake Tapper: Is the United States going to lose its triple-A government bond rating? And what happens when the credit markets are no longer willing to buy U.S. debt?

Secretary Geithner: Absolutely not. And that will never happen to this country…

If history is any evidence, when a government representative completely rules out something from happening, it’s pretty much a sure bet it’s only a matter time until it does happen.

That’s why when a reassuring Treasury Secretary says “absolutely not” and “never,” we know the dollar’s fate is pretty much sealed.

Of course, Geithner isn’t alone. The Fed Chairman continues to see the green light to keep to the printing presses running at full speed.

Chairman Bernanke: The Only Indicator That Matters

As we’ve discussed before in Is The Free Money Party Over?, GDP growth, unemployment, and other bits of the financial news media’s “top noise” simply don’t matter too much to the Fed Chairman. The key economic indicator Bernanke is watching is consumer credit.

After all, the economic theory du jour finds deflation as the creation of all economic ills. And simply preventing deflation by any means necessary can prevent a depression will lead to prosperity and growth.

Despite how many things are wrong with that rationale, we know that means consumer credit growth is what will signal when the Fed starts hiking rates.

Right now, consumer credit is still contracting. Last week the Fed reported consumer credit for the 11^th straight month. Consumers cut their debt loads by $1.8 billion in December. That’s a sharp drop from the $21 billion in November, but since it still signals a decline in consumer spending, it’s a green light for the Fed to keep fighting deflation handing out free money.

Mr. Market: Gold Stock Timing Indicator Says “Buy”

Bernanke and Geithner are signaling good news for gold is ahead, but it’s Mr. Market who is once again signaling now is the time to get back into gold stocks specifically.

In fact, the market is saying this is the best time to buy gold stocks since the markets were still jumping off their lows last spring.

The chart below shows the how many shares of Market Vectors Gold Miners ETF (NYSE:GDX) an ounce of gold will buy over the past three years:

As you can see, the current ratio is just shy of its highs from last April. That’s a very good sign for gold stocks.

We use this ratio as the market’s perspective on the staying power of gold prices.

A low ratio (high gold stock prices relative to gold) means the gold bulls are running strong and sentiment is high. Since the market believes the future of gold is bright, they’ll bid up gold stocks much faster than the price of gold. This is a time to sell gold stocks.

A high ratio (low gold stock prices relative to gold) shows sentiment is bearish the market believes gold prices are likely to fall. Investors sell their gold stocks as they expect earnings and cash flows to decline This is a time to buy gold stocks.

Right now, with the ratio well above its short-term levels and nearly double its long-run levels, Mr. Market is telling us it’s time to buy gold stocks again.

The Long and Short of It

At this point, the short-term outlook for gold isn’t looking too bright. Since the December highs, the price of gold has fallen more than 10% from recent highs. Meanwhile, the largest gold stocks are down more than 25%.

The medium and long-term outlook, however, hasn’t changed much at all. Consumer credit is declining signaling Bernanke will keep interest rates far too low for far too long. The U.S. government seems over-confident about the tremendous appetite from a government whose debt is growing at nearly three times rate as GDP.

The combination of bearish short-term sentiment and outstanding long-term fundamentals are likely creating another opportunity in gold stocks.

We at the Prosperity Dispatch (sign up here – it’s 100% free)If you’ve been waiting for a chance to reload on your favorite gold stocks, this time is as good as it has been since last spring. Don’t let it pass you by.

Good investing,

 

Andrew Mickey
Chief Investment Strategist, Q1 Publishing