May 2006 Archives

I agree with Adam in his Mine Over Matter article concerning Pan American Silver Corp PAAS and iShares Silver Trust (SLV).

It just strikes me as a classic "buy the rumor, sell the news" setup. Miner shares in both gold and silver have just been plowed recently relative to the commodity (check out the chart above on PAAS vs. silver) on fear that Bolivia and Peru are both going to nationalize everything in sight. No way for any mortal to determine exactly what is priced in, and what isn't. But none of this is unknown, so I suspect much is factored in already. And there's all that put volume across the sector.

I am long delta/long gamma in PAAS and a couple gold stocks, but have no position in GLD or SLV. But I would sooner take my chances shorting them against the stocks than piling on and going the other way.

Both Adam and I referred to Kopin Tan's article in Barron's. My comments are found in my article Peru's Election and Its Mining Industry. Adam states his case more forcefully and eloquently than I do, but it is the same message.

As an aside, I note that on Kitco, the silver price is up $0.53 to $13.20 bid $13.30 ask for a gain of 4.2%. By looking at the 30 day chart on Kitco, I think that silver might have reached a bottom. For a while it was plummeting every day. But it seems to have at least stabilized near the $12.50-$13.00 per ounce price. As I have said in the past, silver is notoriously difficult to forecast because the supply demand dynamics are difficult to understand. But I remain longer term bullish on silver.

As a matter of disclosure, I remain long Pan American Silver shares.

Kopin Tan wrote Messy Mañana for Miners (subscription required) in Barron's Magazine.

One of my key stock holdings Pan American Silver Corp. was featured in the story as a company that has the potential to be adversely affected by the nationalistic tendencies in South America, and Peru in particular.

Nationalism is to South America what eyebrow-shaping is to men -- a troubling recent trend -- and Venezuela and Bolivia have already pushed to reclaim oil-and-gas assets. Peru is the world's second-biggest producer of silver, third-biggest producer of zinc and fourth-biggest producer of copper; it accounts for 40% of sales at Denver-based Newmont Mining (ticker: NEM) and about 67% of sales at Pan American Silver (PAAS).

No surprise, then, to see increased hedging of stocks with Peruvian exposure, though some likely has been driven as well by the recent pullback in metals stocks. Option prices and projected volatility have risen noticeably in Newmont, Pan American, Barrick Gold (ABX) and Southern Copper (PCU). In Newmont's case, for instance, traders have accumulated 0.94 puts for every call outstanding, the highest ratio in a year.

Potential fallout may prove less than election rhetoric suggests, and even Señors Garcia and Humala both must realize the importance of foreign investment. But analysts at the very least expect international mining companies to owe increased royalties and face greater pressure to share more of their profits. Nor should short-term risks be underestimated, as news headlines and post-election chest-thumping could keep stocks volatile.

I have been surprised by the low valuation given to Pan American in light of the still strong silver price at nearly $13 per ounce. But uncertainty does take a toll on valuation.

As the article suggests, some might have shorted Pan American with a long in iShares Silver Trust (SLV). If Peru nationalizes or increases taxes against Pan American Silver and other companies, silver production, in time, would likely be adversely affected and thus silver prices would likely rise. If this situation were to play out, Pan American would go down or stay stable, but iShares Silver Trust should increase.

Given that the leading contender Garcia is not a big fan of Chavez, I am not nearly so certain that he would increase taxes aggressively. And he certainly would not nationalize mining companies. Thus, I think the negativism might be overdone.

As a matter of disclosure, I remain long Pan American Silver shares.

As regular readers know, I like to follow developments in South America. In today's Wall Street Journal on Page One, José De Córdoba and David Luhnow wrote an article New President Has Bolivia Marching To Chavez's Beat (subscription required). As the title suggests, the article discusses how Bolivia's president Evo Morales is following the lead of Venezuela's president Hugo Chavez.

Bolivia represents Mr. Chavez's greatest triumph in his drive to use Venezuela's oil wealth to create and lead a bloc of anti-American countries in the region and beyond. He has thrown a lifeline to Cuba, lent hundreds of millions of dollars to Argentina and Ecuador and has twice voted to support Iran's nuclear ambitions in the International Atomic Energy Agency.

For the U.S., Mr. Chavez's tightening alliance with Bolivia both threatens to undo years of political and economic liberalization in South America and is the latest in a series of energy-security threats. President Bush on Monday said he was "concerned about the erosion of democracy" in Bolivia and Venezuela. Venezuela boasts the biggest oil and natural-gas supplies outside the Middle East, and Bolivia has South America's second-biggest natural-gas reserves.

Some day this will all end badly.

Some gurus believe that commodities are the latest bubble. According to a Financial Times article Warning on market risks as prices fall (subscription required), Stephen Roach of Morgan Stanley and Richard Bernstein of Merrill Lynch are two such gurus.

About $90bn of funds track commodity indices, a sixfold increase in the past four years. Now that commodity prices are falling, some investors may be abandoning their positions, although one Goldman Sachs executive said “on balance, we are still seeing net inflows into funds following the indices”.

Stephen Roach, the chief economist at Morgan Stanley, said this week that the commodities market had become the latest in a series of bubbles. “It too will burst, the only question is when.” And Richard Bernstein, US strategist for Merrill Lynch, said there was a 50 per cent speculative premium in commodity markets at the end of April.

I am certainly no guru, but I do not agree with Roach and Bernstein. To put $90 billion of funds tracking commodities in perspective, ExxonMobil Corporation (XOM) has a market capitalization of $366 billion and Chevron Corporation (CVX), $130 billion. These are just two American oil companies. If all commodity companies from all countries around the world were added together, then $90 billion is a very small number in comparison.

Rather than focusing on the amount of money tracking commodities, I would prefer to understand the supply demand for commodities. Can the world continue to grow oil production at two to five percent per year, every year? Can we continue to supply more electricity to meet heating and cooling needs? Can we supply sufficient quantities of gold, silver, copper, lead, and other metals as emerging countries join the developed countries?

With respect to oil and gas, both commodities are becoming harder to find and more expensive to find. Moreover, both commodities are often located in some of the more challenging places in the world, resulting in increased risks to companies. Finding and developing new mines is similarly harder and more expensive. New mines require much more environmental assessments and remediation. The permitting process takes longer. And governments want higher royalties or taxes or both.

So I believe the commodity landscape has changed. There will still be the inevitable peaks and valleys with respect to prices. But that does not deter my longer term bullish outlook. That said, prices cannot rise more than consumers can afford to pay. But consumers might find that they have to allocate more of their budget than they have in the past.

As both commodity bulls and bears argue their cases, commodity prices are bound to be volatile. Time will tell which side is ultimately correct.

Pan American Silver Corp. (PAAS) and silver prices have disconnected. In early January when silver prices were near $9.00 per ounce, and Pan American Silver was near $20 per share. Now in mid May, silver prices are at $13 per ounce and Pan American Silver is near $19 per share. Despite an over 40% increase in the price of silver, Pan American Silver is actually less per share now than it was back in early January. I listened to the conference call, and I did not find anything alarming or concerning. In fact, I was rather pleased with the conference call.

I can think of only only two reasons for the disconnect. One, the uncertainty surrounding the Peruvian elections. The runoff election will be held on 4 June 2006. So far, Garcia is favored to defeat Humala, which is a strong positive as far as the mining industry is concerned. The other reason is that some investors might have sold Pan American Silver to invest in iShares Silver Trust (SLV). As an aside, as I noted in my article Outlook For Silver, on 12 May 2006, the fund held appproximately 65 million ounces of silver. According to the website this evening, as of 16 May 2006, the fund holds approximately 69 million ounces of silver. Obviously, investors and speculators are still purchasing iShares Silver Trust.

Despite the recent correction, I remain bullish on silver prices and on Pan American Silver.

As a matter of disclosure, I remain long on Pan American Silver shares.