Financial markets in the United States and Europe fell modestly as investors and traders waited to see what happens next after Turkish fighters shot down a Russian war plane near the Turkish-Syrian border. The Turkish military is saying that the Russian plane had entered Turkish airspace and was shot down after repeated warnings. Russia is denying that its plane had violated Turkish airspace and that it was operating against terrorists in Syria.
As of 10 a.m. New York time traders were selling down risky assets—such as the Russian ruble and the Turkish lira, the MSCI Emerging Markets Index, and European equities—although declines are, so far, measured, with the Emerging Markets Index, for example, down just 0.3%. On the other side of the trade, safe haven assets such as the yen and gold have climbed with gold rising 1%. Oil has gained on speculation that something might happen to disrupt production somewhere. U.S. benchmark West Texas Intermediate was up 1.7% this morning.
The situation is full of potential pitfalls. Since Turkey is a NATO member this incident immediately increases tensions between the Western alliance and Russia. Russian planes in operation on this section of the Syrian-Turkish border have been targeting, Turkey and the United States say, Turkmen villages fighting against the Assad regime and not ISIS positions. The Russians have been flying bombing missions in support of an offensive by the Syrian army, Iranian-affiliated militias, and units of Hezbollah, Turkey has protested. The Sunni Muslim Turkmen minority in Syria is regarded by many Turks as ethnically Turkish. Iranian militias are Shia Muslim.
The Turkmen villages facing the Syrian army/Iranian militia/Hezbollah offensive are also seen by the Turkish government as an important buffer zone not just against the Syrian fighting but also against the expansion of Kurdish forces along the Turkish border.
If you think this is a mess, you’re right. The most likely outcome, though, is a step down in tensions short of more military incidents after a wave of intensive diplomacy by countries such as France that are trying to put together a coalition that includes the Russians and the Turks against ISIS. Russia is Turkey’s second largest trading partner and the source of 60% of its natural gas.
These factors don’t mean, however, that we won’t see other incidents in the short-term. (Both Russia’s Putin or Turkey’s Erdoğan are proud nationalists and aren’t known for shrinking from confrontation.)
Any short-term incidents are likely to increase downward pressure on risky assets.
How to trade this situation?
If tensions do ratchet upward and risk assets do sell off, I’d look to buy positions in stocks or bonds or currencies that you’ve been avoiding because they were too pricy. I’d be particularly interested in any sell off in U.S. market favorites on a movement away from risk. I don’t see any reason that these tensions should radically depress the prices of high-PE U.S. stocks such as Netflix (NFLX) or Facebook (FB) but I would note that both are down today by 2.7% and 1.6%.
Oil and gold will both move up if tensions continue but I don’t see those moves as sustainable unless this turns into a much bigger conflict than currently seems likely. You might use the bounce to trim positions that you’ve been looking to sell in these assets.
One of the most interesting non-financial effects to watch is whether this incident has the power to change rhetoric or positions among Republican and Democratic presidential contenders. Will it cause anyone to re-think the dangers and difficulties of imposing a No-Fly zone in Syria? Will it lead to any reconsideration of calls for a coalition of local powers to fight ISIS? Considering how U.S. politics works there days, I’d doubt it.
Commodity prices continue to tumble and are now down to the lowest levels since dinosaurs walked the earth.
But both the gold futures and spot market broke below $1100 an ounce this morning before rebounding to slightly above that level. That puts gold near a five year low.
And gold isn’t alone.
Both West Texas Intermediate and Brent crude have ended the recovery that had taken oil from a six-year low. U.S. benchmark West Texas Intermediate is back below $50 a barrel with futures touching $49.92 this morning. That’s the lowest intraday price since April 6. Brent crude has continued a decline that began in June to drop well below $60 to $56.51 in London.
And copper, widely seen as the commodity most sensitive to growth rates in the global economy because it is used in so many sectors from construction to electrical goods, continued to fall, declining another 1.44% in London to $5480 a metric ton.
I can see three reasons for the drop across all these commodity sectors.
First, the continued strength in the U.S. dollar is depressing the dollar price of all commodities. The widely held belief that the Federal Reserve will raise interest rates in 2015, perhaps as early as its September 17 meeting, contributes to a belief that the dollar will continue to climb.
Second, forecasts continue to say that the global economy in general and the Chinese economy in particular continue to slow and that in the absence of faster growth, supply is in excess of supply. This is especially true for commodities such as oil and iron ore where increases in supply have overwhelmed demand. Iron ore, for example, has recovered from the panic selling that accompanied what looked like an uncontrolled plunge in the Shanghai stock market. That panic took iron ore down to $44 a metric ton, a 10-year low. But even today’s price above $50 a ton is shockingly low when you remember that iron ore traded at $120 a metric ton as recently as June 2014.
And third, traders and investors simply have no appetite for commodity positions in their portfolios and without a reason to buy, they are cutting back their allocation to commodities in general. Whereas not so long ago, I heard recommendations for a 5% to 10% allocation to gold, for instance, today I’m hearing recommendations for 2% to 3%. Even a price drop to $1100 hasn’t led to an uptick in demand from the world’s two swing markets in gold—India and China. In Mumbai, for instance, gold typically trades at a premium to London, since jewelry demand in India helps support gold prices in that market, but right now gold in Mumbai is trading at a discount to London. It looks like Indian and Chinese retail purchasers of gold, known for waiting until the price is low before buying, have concluded that prices are still headed lower.
That seems likely, not just for gold but also for commodities in general. Inflation, a key driver in past commodity rallies, is conspicuously absent this go round. The Federal Reserve will raise interest rates in late 2015 or early 2016 and that will push the dollar higher. While it looks like the Greek debt crisis has been postponed and that China’s bear market in Shanghai and Shenzhen has stabilized, temporarily I believe, there’s not much evidence of a recovery in economic growth in emerging world economies, especially China, that would push demand for commodities higher. And, finally, from oil to iron ore, supply in key commodities looks likely to growth over the next 12 months.
In other words it looks like it’s too early to buy crushed commodities or the even more savagely depressed shares of commodity producers. For some of these commodities—gold is a prime example—asset sales are ramping up as the most stressed companies look to raise cash. Oil production is still climbing as Saudi Arabia and Iran both position themselves for a fight for market share. The big iron ore producers have cut back on capital spending but the pipeline is still full of new projects scheduled to come on line next year and into 2018. The one commodity to keep a close eye on is copper, where some projections show a supply deficit as early as 2016.
I’m going to sell Goldcorp (GG) out of my Jubak’s Picks portfolio http://jubakam.com/portfolios/jubaks-picks/ today, June 23. I still think that portfolios need gold as a hedge on inflation fears. But gold and more especially shares of gold mining companies have rallied big time on worries that the Federal Reserve is getting complacent about inflation.
I think the next step in the price of gold and gold mining shares is likely to be a pull back as traders and investors decide that inflation is not an immediate threat and then move to take some profits. I’d be surprised if both gold and gold mining stocks didn’t pull back by 10% or so over the next month before resuming an upward trend. The last stages of a rally like this off the May 27 bottom in an asset that has been so scorned lately is largely composed of traders who sold short and who are now buying shares to cover. When that buying for short covering ends, it removes some of the fuel that had been driving shares higher. I’m not sure that we’ve seen a wide spread conversion from gold skeptics to gold believers in this move so an end to short covering could easily produce a pullback.
What I’d like to do is sell part of my gold position now to take profits with the intention of buying back into gold after any pull back. I don’t want to just buy and sell the same asset. My strategy is to sell a stock, such as Goldcorp that has seen a bigger than average gain and then to buy a stock, such as Randgold (GOLD) that hasn’t gained as much and that has a better cost and production profile than the stock I just sold. (Any purchase will come after the pullback, if we get it, and is almost certain to come after the July 4 weekend.)
Shares of Goldcorp were up 15.75% since the May 27 through June 20 and were up 20.56% during the same period. At $27.88 at 2:30 P.M. New York time on June 23, the shares are way above my target price of $17 a share. (I’m still looking at a loss of 27.3% since I added these shares to the picks portfolio on November 5, 2009.
One of my reasons to sell Goldcorp here (besides it recent appreciation, that is) is a curious gap that showed up in a chart of the company’s production pipeline in its presentation for its April 10 investors’ day. The chart showed very attractive prospects for six projects in the execution stage moving into the production stage. That should push up free cash flow at the end of 2014 and into 2016. (The company projects reaching free cash flow positive—that is cash flow including capital spending—in the fourth quarter of 2014.
But then there’s a big gap in the pipeline with only two in what the company calls the feasibility group—the category that most immediately feeds into execution—before the pipeline fills up again with nine projects in the scoping and pre-feasibility categories. The consequence of that, projections from Credit Suisse show, is that while free cash flow rises dramatically in 2016 the growth rate slows in 2017 and then free cash flow actually falls in 2018.
Now 2017 and 2018 are indeed a long way off but the nearer term increases in free cash flow are likely to get revised downward as the gold mining sector recovers and companies begin to increase capital spending again. Think of a robust pipeline as the margin that ensures that free cash flow will continue to increase even as capital spending does.
A gold mining company’s production pipeline is also leverage for the future that will multiply the effects of any increase in gold prices
Goldcorp has less future margin and less future leverage than I’d like at current share prices. I’ll be looking to upgrade in those two areas if we get a pullback after this rally
Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. When in 2010 I started the mutual fund I managed, Jubak Global Equity Fund, I liquidated all my individual stock holdings and put the money into the fund. The fund shut its doors at the end of May and my personal portfolio is now in cash. I anticipate putting those funds to work in the market over the next few months and when I do I’ll disclose my positions here.
Shares of Thompson Creek Metals closed up 9.4% Friday, April l1, as the company’s first quarter earnings report showed that the miner made essential progress in its transition from a molybdenum producer to a molybdenum/copper/gold producer with an emphasis on copper and gold. (Thompson Creek is a member of my Jubak Picks 50 portfolio http://jubakam.com/portfolios )
The company still isn’t out of the woods—there is simply not very much room for error in Thompson Creek’s cash flow and debt load. A drop of another 10% in metals prices would put the company in the position of needing to raise more capital perhaps as early as 2015. And Thompson Creek has an earthmover’s worth of debt to refinance in 2017.
But the company has moved away from the brink of a liquidity crisis that looked very likely in 2013. I certainly wouldn’t bet the farm on this very risky member of my long-term Jubak Picks 50 portfolio. But I think there’s a good chance that another good quarter could take the shares back to the $3.50 level that they hit in November 2013 before falling to $1.84 in December. From the April 11 closing price that represents a potential 22% gain over the next three months or so.
In the first quarter the company reported strong copper and gold production from its Mt. Milligan mine. Ore grades at mine were in line with projections and the still ramping mine is on track to achieve throughput of 75% to 85% of capacity by the end of 2014.
It’s good that the story from the Mt. Milligan mine was so strong, because Thompson Creek’s older mines were disappointing. The Endako Mine showed an 8% drop in production from the prior quarter on lower ore grades and operational problems at the mine. Production at the Thompson Creek Mine was up 19% from the prior quarter but water from spring run off looked likely to cut production levels this spring.
The big disappointments at the company’s older molybdenum mines, though, were long term. The company reduced the projected life of the Endako molybdenum mine to three to five years based on a revised projection of molybdenum at $10 a pound. (Previous projections of reserves at higher molybdenum prices had estimated that the mine would last until 2028. That reduction in reserves does create the possibility for big upside if molybdenum prices climb and the company can increase its reserve projections for Endako.) Thompson Creek also announced that it would suspend molybdenum production at its Thompson Creek Mine in late 2014 in response to lower molybdenum prices. Molybdenum prices have fluctuated recently from $9 a pound in mid-2013 to a recent $11.50 a pound. Forward contracts for 2015 have been bid recently at $12 a pound.
An increase in molybdenum prices to $12.50 a pound along with an increase of 10% in the price of copper (to $3.30 a pound) and a 10% increase in the price of gold to $1441 an ounce would increase free cash flow to $105 million in 2015. At current prices free cash flow in 2015 comes to about $50 million.
The company finished the first quarter with a cash balance of $234 million. If everything works out as now projected the company should finish the year with about that level of cash on hand. If metal prices fall by 10% and the production at Mt. Milligan doesn’t reach projected capacity by the end of 2014, the cash balance will be closer to $160 million. That’s probably not low enough to revive fears of a liquidity crisis—which in itself is a measure of how far Thompson Creek has come in the last year. But that kind of drop in cash on hand if combined with fears of a further drop in the price of molybdenum, copper, and gold would certainly mean that shares of Thompson Creek wouldn’t finish 2014 higher than they are now.
Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. When in 2010 I started the mutual fund I manage, Jubak Global Equity Fund http://jubakfund.com/, I liquidated all my individual stock holdings and put the money into the fund. The fund did not own shares of Thompson Creek as of the end of December. In preparation for closing the fund at the end of May, as of the end of March I had moved the fund’s holdings almost totally to cash.
It’s always hard to judge the bottom of a cycle—and it’s certainly hard for gold right now. I suspect that the recent rally in gold to a close of $1320.90 an ounce on February 20 isn’t likely to hold and that we’ll get a retreat back below $1200 before the year is done. But that’s only my best projection and the market is deeply divided right now between analysts calling for gold to move higher from here (and to finish 2014 higher) and those projecting an end of the year price at $1050 an ounce or so.
In this context I can’t say whether this is the time to start buying shares of Yamana Gold. If gold moves lower so will the shares of gold miners. Those shares have by and large outperformed gold itself in 2014.
But I do think that Yamana’s fourth quarter earnings report, announced on February 19, does represent something very like a bottom for the company: big impairment charge, big cuts to capital budget and to the dividend, and what looks like a stabilization of the all-in cost of production at a very low level.
Impairment for the quarter came to a whopping $682 million against operations in Brazil because of a delay in starting operations and against several exploration projects. That took the loss for the quarter to $536 million. Excluding these items the company earned 5 cents a share in the quarter, down from 26 cents a share in the fourth quarter of 2012.
Gold reserves fell by 8%. That is a relatively small reduction in comparison to those being declared by other gold miners recently—Goldcorp (GG), for example, declared a 15% reduction in reserves. Read more