Source: The Gold Report 11/10/2009

With anticipated GDP growth insufficient to sustain current market levels, Q1 Publishing's Founder and Chief Investment Strategist Andrew Mickey asserts that great expectations tend to lead to great disappointments. Although he's not foretelling a big crash, he tells Gold Report readers why it makes sense to expect the market to fall back to a fair-value level over the next six months to a year and there will still be plenty of opportunities for those in the right spot.

The Gold Report: In one of your recent articles, you suggest that even if good economic news continues coming out next year, the market is likely to drop 20% to 25%. Would you go through the logic that leads you to that conclusion?

Andrew Mickey: If we look back to the way the stock market has moved over the past 20 to 30 years, it has always been valued relative to earnings. The most common valuation for the market has 15 to 20 times the 10-year average annual earnings. That smoothes out the up-and-down years and brings you to a fair valuation—with the S&P 500 between 800 and 1000.

Granted the stock market goes much higher and much lower than that—and can stay at an extreme for longer than most investors expect—but it always returns to its fair value.

Now that so many stocks have had a great run, the S&P is up to around 1050, which means it is overvalued. The market basically has a lot of positive expectations built in. Earnings estimates are starting to rise, although all CEOs are still trying to keep expectations low. Economic expectations are rising. Expectations for everything are rising and we've learned consistently throughout the years—great expectations usually lead to great disappointments.

So as long as GDP growth is low the market will fall right back to fair value. That's why, even with the big picture news getting better, the very real risk is that it's still insufficient to hold the S&P up at 1050, 1100, or wherever it does eventually top out at.

We may not have an outright crash because everyone is still on watch, but probably a slow, steady fall over maybe six months to a year.

TGR: Are all sectors currently overpriced, or will some continue to appreciate?

AM: There will be some that will appreciate. But it won't be a case of great and greater returns like we've had. There is some great historical research done on the way stocks move. One important factor is the factors of market, sector, and stock. If you break it down, basically 50% of a stock's movement is usually tied the overall market. There's nothing you can do about that; it depends on the market. Another 30% of that stock's move depends on the sector. And the remaining 20% can be attributed to the individual company.

In other words, you can expect the initial impact across all sectors. We see it all the time when the markets go down. Just look at what happened last fall. Everything is very closely tied together. Over time though, there will be the divergence between the quality and value and all the speculative stuff.

TGR: How much focus should individual investors put on international investments versus North American-based investments in this environment?

AM: A lot of it depends on your time horizon. If you have five years or more, you can build a reasonable case for focusing 30% to 50% of your money in international stocks.

That's a very high concentration for any portfolio in any particular sector. If you're looking out that far, you definitely want to be in the emerging markets. In the short term, the falling dollar has been very helpful to some of the really large, high-quality U.S. companies.

But if we look at the massive U.S. dollar carry trade right now, we can see that is going to be driving everything. We watched the Yen carry trade last for about four years and then the credit crunch forcing the sudden unwinding of it. With the U.S. dollar carry trade, it is going be even bigger, could last even longer, and the when it is unwound, the volatility and fear even bigger.

TGR: In another of your recent articles, you said that junior gold stocks offer exceptional value because they're still in the relatively early stages of recovery. With gold up 30%, major gold stocks down 15%, and junior gold stocks down 60%, you asked, "Which one would you like to buy now?"

But with the greatest opportunities for appreciation, don't those juniors also present a correspondingly greater risk? If so, how do you minimize the risks of investing in juniors?

AM: There are two ways. The first is timing and picking the bottom, which is a very tough thing to do. The other is diversification; I'd recommend owning at least five to 10 across the board. In addition, you'd want to buy consistently. The way we see it, we'll be buying gold juniors for the next two years.

We don't want to exhaust all of our capital right away. It's a lot less stressful and you don't have to be exactly right to make a fortune.

Also, when they're still deeply undervalued on a relative basis, you don't have to risk nearly as much capital. So you could make 20% in big gold stocks, but you may have missed 50% to 100% in juniors. The juniors are riskier, but the amount of capital required to earn the equivalent nominal gains is less. Risk is always relative to a lot more factors than simple percentage moves, positions sizes are as equally important.

TGR: When you're looking at juniors, do you differentiate between current producers and near-term producers? Or JV models versus royalty companies?

AM: Most of our valuations are based on traditional metrics such as net present value of future cash flows for producers. Of course, once a company is producing and we know much gold it is producing, there's a clear way to value it through the cash flow model. That's how the big money values things, so that's how you have to do it.

If you really want to swing for something with just a little bit more upside potential, maybe you select a near-term producer. There's a lot more room to value them differently because as the big money managers continue to look at gold, they're going to have to come up with ways to value those stocks.

Think of it like the dot-com days. If a company had earnings, there was a way to value it traditionally. But if a company didn't even have a chance of being profitable, traders and investors would come up with all kinds of ridiculous ways to justify lofty prices and bid them up even more. That's why the worse a company was fundamentally, the better it actually did.

That happens in all euphoric bubbles. And when it does, it will feel great, but that's also the time to start taking money off the table.

TGR: Are any of those on your radar?

AM: One junior gold company I really like right now is in that larger junior tier, and that's Nevsun (TSX:NSU; NYSE.A: NSU). The first two years it produces it will produce mostly gold, and then it becomes basically a copper-zinc mine in the out years. It's fully financed now with debt from European and South African lenders, and Nevsun is comfortable with building a mine in Eritrea, Africa.

So, that one really makes sense to me, and it's really doing well. The stock is $3 now, and the biggest risk I see to it, aside from commodity price risk, is that it gets taken out at around $5 or $6 before it realizes its full potential. In a market like this, that's a risk worth taking.

TGR: Most of those you follow are really exploration companies. Would you share some of those with us?

AM: One that has me really interested is Otis Gold Corp. (TSX:OOO). It has a unique kind of deposit at its Kilgore Gold Project in Idaho. The early exploration results have been good mixed in with the occasional high-grade greatness, but I don't think the market completely understands what it may have at this point.

It's similar to past discoveries in Nevada in that it has small pockets of high-grade gold. Otis has discovered just one of those pockets so far, but that pocket has maybe 500,000 to 750,000 ounces of gold—and that justifies the current market cap of around $15 million excluding everything else.

It's fairly valued at that point if the company stopped all exploration right now and did nothing else. But if this is like the Round Mountain mine in Nevada, which also has pockets of very high grade gold in a large low-grade deposit, has already produced 10 million ounces and with almost 2 million ounces of reserves left.

You never know, of course, but at this point, the company is really cheap based on what is known and there's all kinds of potential. Since we start looking at things with a risk-first approach, we like the low downside mixed with the truly unlimited upside. The company's drilling. The results will be coming out over the next few months. And we'll soon have a better picture, which, at this point, can only add value to the company. It just seems like the right time.

TGR: So the market's basically only valuing the current pocket and there may be several more?

AM: That's what it seems like. There's no premium at all built into the exploration upside at this point.

TGR: You mentioned copper a bit earlier. We always hear about copper as the leading indicator of the market expansion, because building, construction, housing, electricity and durable goods are all very copper-intensive. Timber is apparently emerging as another such indicator, and not long ago, you referred to timber as "the next silver" in terms of its appreciation potential. Do you see timber's prospects greater than copper's?

AM: Copper demand and timber demand are both driven fundamentally by population growth, plain and simple. Where there are more people, they want more things—more copper demand. More people need more houses—more timber demand.

Over the long run, it really is that basic. During the housing bubble, timber shot up to $450 per 1000 board feet, and when the bubble burst, it fell two-thirds to about $150 just like almost every other commodity.

Now it's back up to the $180-$190 level now and still I can't find too many people remotely interested in timber.

It's not that I expect a housing bubble to return. I don't. But 660,000 houses are currently under construction in the United States. But just to keep up with average population growth, housing growth is pegged at 1.2% per year over the next 40 years. That means we need about 1.3 million more houses per year just to meet basic demand for new houses and replacement of old ones. That rebound would justify a lumber price of $250 to $300 per 1000 board feet. That's kind of the long-run average for timber and it'll rebound there over time.

But what timber has over copper is a supply problem that's potentially much more severe. This is caused in large part by the pine beetle infestation in North America. Over the last decade, the pine beetle has decimated the forests in British Columbia, and is now hitting the U.S., as far down as Colorado. Basically, the pine beetle has taken 20% of the future world timber supply off the market. Think about that in terms of other commodities such as copper or oil. If one-fifth of the supply went away, you know we'd see a big surge of demand. Once people start to figure that out, timber assets will really be worth something again.

TGR: Any other areas that interest you at the moment?

AM: As you may know, about 80% of manganese is used in steel production, but there's a new demand for it now in hybrid car batteries. If you like lithium and rare earths, you should look into manganese could be a big opportunity in manganese as well.

In that space, your readers may be interested in a company called Wildcat Silver Corporation (TSX-V: WS). Some of the same people are behind one of our top-performing picks we found February, Ventana Gold Corp. (TSX:VEN). Ventana was actually spun out of Wildcat, which owns 80% of what is basically a silver/manganese deposit in Arizona.

There's plenty of exploration upside there, and Wildcat's net present value is about four to five times higher than its market cap. It's something with the right mix to do well, but it's not going to be one the biggest gold discoveries of the decade, so it will take a little bit of time.

This is a snippet from a recent issue of the Gold Forecaster with

 Subscriber-only parts excluded.

Russia’s central bank has bought 180 tonnes since June 2006 and another Russian Agency holds off selling 50 tonnes.   What’s going on?

It takes a long time to buy useful quantities of gold in the ‘open’ market.   It has taken Russia over 3 years to buy 180 tonnes there.   We imagine that they set price limits on their buying.   This meant they bought more in one month than in the next, as the gold came onto the market.   There is no reason to believe that that policy has changed.

Then suddenly, out of the blue comes the leak of a sale of gold that Gokhran precious metals depository was planning to sell up to 51.44 tonnes by the end of 2009.   The leak then prompted a postponement until next year and now Finance Minister Alexei Kudrin said that Russia is considering selling gold on world markets to cash in on high prices as the government faces its first budget deficit in a decade.

Sounds like someone is opening their mouth, to change feet?   We have no doubt that the Gokhran precious metals depository did not consult the Russian central bank.   Indeed, when the leak happened and the world reacted, the news fed through to the Ministry of Finance, who had to say something and seemed to say the first thing that came to mind.   But this is not a new scene in the gold market.   In three gold holding countries politicians have tried to rule their central bankers and press for the national gold to be sold.   One governor of the Banque de France, M. Noyer, likened it to ‘selling the family jewels’.

Germany, France and Italy.

When the German government felt that gold in the Bundesbank should be sold.   There was a public debate that cost the job of the Bundesbank President.   He was replace by Herr Weber, the present incumbent, who also did not want the gold to be sold.   The independence of the central bank was established and the Bundesbank  was allowed to hold onto Germany’s gold.   They had the option to sell 600 tonnes under the second Central Bank Gold Agreement, which was not taken up.   Germany has not and will not sell their ‘Official’ gold.   Herr Weber pointed out why [this is now the opinion of the European Central Bank], when he said “gold is a useful counter to the swings in the $”.   Oh, how right that has been.   But now that extends to all currencies as we saw in the last week, when gold has risen 5+% against all currencies.

France faced the same dilemma, when M. Noyer Governor of the Banque de France, was pressed, by the then Finance Minister, Sarkozy, now the President of France.   M. Noyer bowed under the future President’s pressure and sold most of the 600 tonnes allocated for sale by France under the Central Bank Gold Agreement.   President Sarkozy must be regretting the loss to France now.

Then the Italian Parliament did the same thing and expressed a desire that their central bank sell some of their gold to help with their budget deficit.   This was prevented by the European Central Bank, who said that it went against the E.U. rules, so that potential sale came to naught.

It seems that politicians and central bankers just aren’t on the same page.   Please note that in two of the three scenes central bankers held onto the family jewels.   In the light of the past five years gold price rise, we are sure that France would hold onto its gold.  

Now Russia, so famous for its dominant bureaucracy seems to be following a well-blazed trail.   You would have though that one phone call from the central bank to the Precious metal’s depository would have solved the problem and kept them from looking bad in the public’s eye?

Tiny Impact on Budget Deficit

The sale could bring in around $1.7 billion [Rubles 49.385 billion].   As with the above countries, this money will barely dent the deficit.   Russia’s budget deficit next year is expected to be 2.9 trillion Rubles [$99.828 billion].   Russia is running a budget deficit of 7.7% of gross domestic product, its first in a decade and expects a 6.8% deficit next year.   Russia's gold and foreign currency reserves, the world's third-largest, stood at $423.4 billion as of Oct. 16, according to the central bank.   The gold reserves have risen 14% this year, to 611 tonnes [19 million troy ounces], worth nearly $19 billion [551.67 billion Rubles.   As the oil income to Russia has changed the face of government finances there, the rise in the oil price and the future potential rise, is likely to diminish if not eliminated this deficit in time.   So there really is no need to sell the family jewels.

Latest Development.

Having looked somewhat foolish in the world’s press, Finance Minister Kudrin said, “We will continue to study this issue and the decision may come in the next few days."

We now hear that the amount has dropped to 25 tonnes according to some Finance Ministry Official. Then the plot thickened as the Head of the Ministry’s Administrative Department said, “Maybe we will not sell abroad, but how can we refrain from selling altogether, when there is a presidential decree and a sales plan approved by the government?"   This seems to muddy the waters even more, for it still does not address the issue of the central bank diversifying its $ reserves into gold to the extent it has.  

In September the central bank bought its largest monthly tonnage of gold in the open market, 18.3 tonnes.   To say the least, the two policies would appear complimentary, allowing the Depository to sell its gold in one shot without any foreign exchange transaction and allow the Central Bank to benefit from the sale by buying locally rather than carefully in the ‘open’ market.   Dare we forecast that common sense will prevail and say that the Depository will sell the gold to the central bank in line with Putin’s stated objectives too?   After all it will take a very strong bureaucrat to take on Putin?   And he is on record as saying that Russia’s gold content of gold and foreign exchange reserves should reflect a 10% gold content.   At present they are nowhere near double figures on this front.

It may be possible that not only China but Russia are also currently in talks with the I.M.F. with a view to buying at least a portion, if not all of the remaining 203.3 tonnes of the 403.3 tonnes of gold on offer from them.   We expect an announcement shortly.

The Implications for the Gold Price

 For Subscribers only!   We will be sending out a review of the gold market to Subscribers only, which reveals why the gold price is being held well above $1,000, where it will go next and how the gold market has changed shape due to the changes in overall central bank policies, from selling gold to buying gold.

Gold Forecaster regularly covers all fundamental and Technical aspects of the gold price in the weekly newsletter. To subscribe, please visit www.GoldForecaster.com

Legal Notice / Disclaimer

This document is not and should not be construed as an offer to sell or the solicitation of an offer to purchase or subscribe for any investment. Gold Forecaster - Global Watch / Julian D. W. Phillips / Peter Spina, have based this document on information obtained from sources it believes to be reliable but which it has not independently verified; Gold Forecaster - Global Watch / Julian D. W. Phillips / Peter Spina make no guarantee, representation or warranty and accepts no responsibility or liability as to its accuracy or completeness. Expressions of opinion are those of Gold Forecaster - Global Watch / Julian D. W. Phillips / Peter Spina only and are subject to change without notice. Gold Forecaster - Global Watch / Julian D. W. Phillips / Peter Spina assume no warranty, liability or guarantee for the current relevance, correctness or completeness of any information provided within this Report and will not be held liable for the consequence of reliance upon any opinion or statement contained herein or any omission. Furthermore, we assume no liability for any direct or indirect loss or damage or, in particular, for lost profit, which you may incur as a result of the use and existence of the information, provided within this Report.

What are the questions that educated investors ask in oil and gas?

Last month I gave investors 10 questions they should be asking management teams, or searching for on the company website, in a recent article.  They were basic questions, and you can read them here. After those first 10 are answered, you know how much production a company has, how fast they’re growing, how much cash or debt they have etc.

But if you’re still not sure if you want to invest in the company after all that, or just want to know more…what are the right questions to ask?  What pitfalls or opportunities might an investor uncover?

1. Decline rates are something management teams don’t really hide, but don’t really talk about either.  Every well has declining production until it’s uneconomic.  The new shale gas plays often have 85% decline in production in the first year.  Tight oil plays (Bakken, Lower Shaunavon etc) have 75% initial decline rates. Decline rates are increasing over time now as the industry drills deeper and tighter plays.  Ask management what the initial decline rate is, both company wide, and specifically on their main, big play that they believe will be the growth engine of the company.  Then ask what the decline rate flattens out to—it’s usually 20-30%.

Why is this important? Because many investors, when forecasting growth, use the only public numbers given for a well – the ones in the press release.  Most companies have a production decline graph in their powerpoint, but few actually say what the production levels in the wells in the area flatten out at (and many research reports from analysts don’t either—don’t let The Machine fool you).

2. If the company is operating in a foreign country, what kind of political connections do they have – who from that country is in management or on the board of directors?

3. What is the break even cost, company wide, and in their main play, in terms of price per barrel?  Management should be able to tell you a very good ballpark number.

4. How much does it cost them to bring up a barrel of producing oil?  Costs can range from $8000 per flowing barrel to over $30000.  Obviously, the lower the better, as this will be more profitable.  Then you compare it to what companies are being bought out for.  If a company can produce a barrel of oil for $10,000, and the stocks are being bought or merged at valuations of $70,000 per barrel, that’s a very accretive oil or gas play!  Again, management should be able to answer that question on the phone.

5. What is the recycle ratio, both overall corporately and specifically on their main play that will be the growth engine for the company.  The recycle ratio is a key measure of profitability for an energy company.  It’s a fairly simple calculation, and many companies put it in their quarterly and a few even put it in their powerpoint.  Management will know this number off the top of their head like they know their wife’s name, so don’t be afraid to ask.

The recycle ratio is the profit per barrel (called the “netback”) divided over the cost of finding that barrel–“F&D”—Finding and Development Costs. Both the netback and the F&D costs are in all the quarterlies – usually broken out in simple charts and language in the notes.  The higher the recycle ratio the better.  Anything over 3 is great, 2 is really good and under 2 can still be OK if it’s a big field and lots of wells can be drilled.  Different companies report differently so not all recycle ratios are equal, but it will give you a general idea.

The higher the recycle ratio, the higher the valuation should be.

6. How much of their own infrastructure do they own?  And are they the operator of their plays? Infrastructure includes things like local or regional pipelines, storage facilities, processing facilities.  If they don’t own them, they have to pay charges to use them, and are subject to somebody else’s maintenance and upkeep.  And the market often pays a lot less for a non-operating interest in a play, as the operator gets to call the shots most of the time.

7. Ask management what kind of discount or premium they get for their production, from quoted prices like WTI crude or Brent Crude – and why that is.  For example, heavy oil gets a discount – up to 50% – from the WTI price or Brent crude price that is always quoted in the media.  Maybe their oil or gas has a high sulphur content (which would also give them a tougher time with environmental permits).  A company may say they are producing 10,000 bopd, but if their price is much lower than world price, their future cash flow could be much lower than you think.

8. How much stock does management own, which people on management are the largest shareholders in the group and how much hard cash – not stock options – does management have in the company.

9. If the company is operating in a foreign country, what kind of political connections do they have – who from that country is in management or on the board of directors?

10.  And lastly, ask open ended questions, like – what else is there about your company that you want to tell me? Where do you want to improve the most over the next 2-3 quarters?

The list of questions goes on and on.  I suggest that investors should remember that the answers to these questions are already priced into the stock; it’s highly unlikely you will find any bargains on the stock market from these questions.  But the answers will give you a better understanding of how stocks are valued and why, and give you more confidence in acting on your own intuition about a stock.

Contact Us:

Email: nichola@oilandgas-investments.com

Customer Service: 1-877-844-8606

www.oilandgas-investments.com

The Obama administration dispatched high-level members back onto the Sunday morning talk show circuit following a few bits of positive economic news.

On Thursday, it was announced GDP is back on the climb. That was followed with the claim one million jobs were created or saved due to stimulus spending. And that’s right on pace to meet the goal (imagine that?). So the best marketers don’t want to let an opportunity to take credit for the free exchange of goods and services between individuals.

But on NBC’s Meet the Press, Treasury Secretary Geithner may have inadvertently signaled the gold bull market has a long way to run. In the interview, Geithner said, “[The recent positive economic news] shows that -- when you act with force -- you can stabilize a crisis like this.”

Force…Force is good!?!

Cranking up the printing press, nationalizing major industries, and increasing taxes (healthcare, cap and trade, VAT, and whatever else happens after 2010 elections) will, in the long run, go a long way to preventing a genuine recover.

But this is part of the process. It’s training the monetary managers to make terrible mistakes, yet not realize they were mistakes. They’re learning the wrong lessons. And when the next downturn comes, whatever the catalyst, they’ll respond with even more “force.”

And it will be that move that pushes gold to much higher levels. In the interim, anticipation of that eventuality will help keep gold prices propped up.

That’s why now, with the markets showing their greatest weakness in months, gold stocks getting hit 10% to 30% across the board is a great time to continue getting in place for the next “forceful” response. Here are the two best spots to start putting your dollars to work in gold.

Exploration is Back

One of the hardest hit sectors during the credit crunch were the gold exploration companies. Their cash-draining business models were left for dead as gold price fell, institutional investors saved cash to meet redemptions, and hedge funds deleveraged.

That was over a year ago though and a lot has changed. Gold is setting new highs and money is flowing back into the exploration market. More importantly though, there have been some major discoveries in the past few months which will bring even more speculators back into the market.

The biggest discovery of them all has been Ventana Gold (TSX:VEN). It’s a Columbian gold explorer has leapt from discovery to development in a few short months.

Since we said Ventana  was “the next bonanza discovery” and that it “struck gold – lots of gold!” in our free gold stock report a little more than six months ago, its shares have climbed more than 700%. And the company now counts mining entrepreneur Ross Beatty and Brazil’s richest man, Eike Batiste, among its shareholders. Both now own more than 10% of outstanding Ventana shares.

It has gone from unknown penny stock with a small cash position and an aggressive exploration program to a bona fide discovery with a market cap of more than $800 million which just closed $40 million financing deal.

This is the type of discovery and massive gain (Ventana went from 20 cents per share to $10 per share in about a year) which sparks the greed necessary to help keep the money flowing into gold exploration stocks.

Of course, a lot of things have to come together before gold exploration really gets going. The combination of high gold prices, rising stock market (increasing risk appetite), and a couple of major new gold discoveries have made it a much more enticing though. Right now, there are still a lot of small exploration companies trading for less than $20 per ounce of gold in the ground and they were fetching as much as $50 per ounce of gold in the ground two years ago.

It’s not just the high-risk/high-reward gold exploration stock sector getting some attention; junior gold stocks are still in the relatively early stages of recovery too and offer exceptional value.

Junior Gold Stocks: 60% Undervalued

The other gold sector which just got a lot more attractive in the past week has been junior gold stocks.

A quick look at the  McEwen Junior Gold Index shows it all. The index tracks junior gold stocks that are actively traded (minimum $50,000 average trading volume) and have minimum market caps of $50 million.

Since November 2007 when the index was hitting all-time highs, gold prices have climbed 30% and the junior gold index is down 60%.

That’s just half the story though. Their outlook gets even brighter when you look at the big gold stocks. The Philly Gold/Silver Index (XAU), which tracks the major gold and silver miners, is down only 15% from its November 2007 highs.

This is a really simple one. Gold is up 30%, major gold stocks are down 15%, and junior gold stocks are down 60%. Which one would you like to buy now?

If you like gold, you have to love the juniors.

The Trend is Still Up

Those are the best two opportunities in gold right now and this is as good a time as ever to start reloading on gold stocks.

You can practically see the confidence of administration and Federal Reserve officials growing by the day. They are now trained and will know exactly what to do next time. Regretfully, that move will likely be what propels gold prices to the next level.

It’s no wonder that while the government claiming “success” and “back from the brink” talk abounds, some of the world’s best investors are loading up on gold and gold stocks. Hedge fund manager John Paulson has led the headlines, but the ranks of newly minted “gold bugs” now includes top-performing investment managers Steve Leuthold, David Tice, and many others.

They see what’s coming and I hope you do to. Now, you just have to maximize the opportunity.

Good investing,

Andrew Mickey
Chief Investment Strategist, Q1 Publishing

Editor’s Note: Gold is back on the rise and there’s never been a better time to get involved. In his latest update, Andrew reveals the 5 best gold investments to buy now. Early readers have had the chance to earn total gains of 1646% while gold prices rose a mere 13%.

Now, we’re looking at a situation which could deliver even more. Learn more how to get your complimentary copy by following this link.

A few months ago we surely seemed like those folks with stacks of dried food, jugs on top of jugs of fresh water, and gold coins stowed securely in a personal bomb shelters.

Now, the mainstream media is finally catching on and could spark the next leg up for agriculture stocks.

In our prediction for an Agriculture Re-Boom, we stated three catalysts:

1. Record low stockpiles
2. Apprehensive farmers cutting back on fertilizer consumption
3. Weather problems affecting production (excessive moisture effecting timing of planting and harvest)

It’s all starting to play out now though. And those of us who have been picking away at agriculture stocks all summer are about to reap the rewards.

Two out of Three isn’t Bad

There are so many things that can go wrong, something has to go wrong eventually. The way things are shaping up, there’s not a big enough buffer to make up the different. Agriculture stockpiles are still sitting at record lows. According to a recent United Study, global agriculture stockpiles are at 50 year lows – and trending lower.

On top of that, farmers aren’t being too aggressive either. Fertilizer consumption hasn’t rebounded yet either. The latest round of earnings reports from the major fertilizer producers provided all the proof. Mosaic (NYSE:MOS), a diversified fertilizer producer, recently announced a 91% decline in quarterly earnings on a 66% decline in revenues.

Three out of Three is Even Better

Weather, the constant variable which makes agriculture prices volatile and unpredictable, has been a farmer’s best friend and worst enemy this year.

The weather couldn’t have been worse during the spring planting season. Plantings in many of the top agriculture producing regions in North America were weeks or months behind. The late plantings have just added to the potential explosiveness of the agriculture situation.

Over the summer, the weather was as close to perfect as you’re going to see in most regions. When farmers wanted rain, it rained. When they wanted sun, there wasn’t a cloud to be found. Granted, exaggerating a bit, but you get the point.

The eventual agriculture catastrophe was averted for another year. The weather would just have to hold out of for the harvest season and all would be well.

Well, it’s fall and the weather is not holding out and crop prices reacting. Agriculture commodities rose 8% last month.

The Omaha-World Herald reports: Crop waits for sun to dry fields:

One of the slowest corn and soybean harvests on record has Nebraska and Iowa farmers biting their nails, waiting for wet and wintry weather to abate so they can bring in what experts have predicted will be a record crop.

In Nebraska, only 15 percent of this year's corn crop has been harvested, the slowest harvest on record since 1982.

In Iowa, only 12 percent has been harvested, which may be the slowest harvest since 1957 — though a state agricultural official says so much has changed in corn farming in the past 50 years that he's uncomfortable comparing eras.

Farmers say they're uncomfortable with the amount of grain that's sitting in the fields and not in their bins. In early October, the U.S. Department of Agriculture predicted record corn yields for both states.

The agriculture market is as tight as ever. It’s easy to see in that a delayed harvest sends agriculture commodity prices 8% higher in a few weeks time.

This is a massive opportunity. Agriculture prices are still up even in a record year for production. Not every year will be a record year and the market is still tight.

If you take a step back from the short-term news and look at the big picture the opportunity becomes more apparent. The price of corn is 50% higher than it was than it was in 2003. That’s before worldwide demand really started to increase. The trend is still up and the only thing which has prevented a genuine surge in agriculture prices again is record production years.

One of these years the weather will not work out so well for agriculture production. No production records will be set, crop prices will soar, and then the rest of the world realize the opportunity here. Most importantly, you’ll be glad you took this opportunity to load up on high-quality agriculture stocks now.

Good investing,

Andrew Mickey
Chief Investment Strategist, Q1 Publishing