February 2008 HRA Journal
Rinse Cycle
David and Eric
Coffin's
Hard Rock Analyst Journal
Feb 22, 2008
By putting US $534 billion
of sub-prime mortgages and CDO on either downgrade or review,
S&P is finally getting to the magnitude of the bad debt issue
in the US. Had they let auditors do their year end jobs without
this, the music would be much louder down the road.
We'll put aside the irony of
bond rating groups with very central culpability in this mess
having the ability to call any shots aside for the time being.
We hope the rating agencies have galactic sized liability insurance.
We're pretty sure they will need it.
For the rest of 2008, we expect
to see a tug of war in the market between optimistic bulls and
bears who fear the entire credit sector is about to collapse.
Both sides have some merit to their arguments.
We come down somewhere in the
middle. We expect to see a lot more write downs and melt downs
so we remain cautious about the market. Notwithstanding the addition
of two companies to the Journal list, we think a trading stance
that includes harvesting of profits when offered is a good idea.
We continue to be worried about
credit markets but we are definitely not in the doom and gloom
camp. The knock on effects of credit tightening are well known
and dangerous, but so far the casualties have largely been foolish
lenders and borrowers. There are A LOT of both, so the effects
could still be severe but there was some good news with the bad
this month.
The obvious positive spin for
the month of January is the hyperactive Fed. Bernanke embarked
on one of the fastest rate cutting campaigns on record. He's
been castigated by many for bowing to the orders of Wall St.
We don't think that is what's going on here. The Fed got behind
the curve and was shocked at how quickly the credit market deterioration
accelerated.
Cutting 125 basis points also
clearly did wonders for equity markets that were in full crash
mode when the first emergency rate cut was made. We were hoping
to be able to point to January 21 as at least a short term capitulation
day. We not sure it can be called that since the Fed really didn't
give US markets a chance to sell off.
Back to back rate cuts made
for heavy program trading and the best week the S&P has had
for many years. That doesn't automatically mean the bad stuff
is all over with. We suspect a lot of that pent up selling is
on hold but not forgotten. The bears are still stalking the canyons
of Manhattan and are likely to pounce at the first sign of weakness.
In the meantime, the cascade of liquidity has cleaned up the
markets and reinvigorated the bulls.
For all of the fear in the
market the economic numbers are still best described as "mixed".
Q4 growth came in at 0.6% which was not unexpected given earlier
consumer spending and employment numbers. The January labour
report was more shocking, with 17,000 jobs lost, though a respected
private survey (the ADP Survey) estimated a 150,000 job gain.
Construction sector and housing numbers went from awful to more
awful, but the ISM survey for January showed mild expansion in
manufacturing, something predicted by exactly no one.
All in all, numbers continue
to be confusing and contradictory. The US economy is clearly
stalling out, but things are not yet as bad as many fear. We
think most of the potential write offs referenced in the first
paragraph will arrive. The question is where, when and what the
market reaction is. A hundred hedge funds writing off $3 billion
each might not scare the market very much while a major investment
house writing off $30 billion would terrify it. Only time will
tell which version we get.
The problem is still lack of
information and that won't change soon. On the bright side, it
looks like Wall St's ADD personality is already dampening the
impact of bad news. Swiss Bank UBS reported a $14 billion sub
prime write off last week, twice analyst estimates, and lost
only a couple of percent.
Traders are getting bored of
the endless bad news from the financials and starting to assume
its all priced in. We're not willing to make that assumption
ourselves but its wise to remember the markets are efficient
discounting mechanisms. The market will bottom before the write
offs end, not after.
Bernanke is fighting off credit
contraction. He also cut quickly and deeply enough to have steepened
the yield curve. This increases spreads for banks, helping them
earn their way out of their mistakes. Monocline bond insurers
and derivatives are still huge issues. Neither has had much direct
market impact yet but either one could flatten the financial
sector. There are too many risks around for any of us to be complacent.
Trading smart and taking profits should continue to be central
strategies. No "all clear" yet for the markets but
no panic either. If we thought you should just sell everything
we'd say so. We haven't come to that yet.
It's (still) the Supply, Stupid
We've spoken at a lot of venues in the past couple of months.
One thing we've noticed is extreme bearishness on the part of
almost all analysts other than us. We've warned of selling in
the base metals too, but we are thinking in terms of 10% drops,
if that. Part of our relative bullishness is simply recognition
that many base and industrial metals have already seen
big price drops. We see no reason why there should be yet larger
ones in their future.
The second reason for our view
is that the supply side of the market simply isn't keeping up
for a wide variety of reasons. The problem is acute enough that
supply disruptions can keep prices stable or even move them higher,
even in the midst of a shaky market backdrop.
This month brought multiple
evidence of those difficulties, as problems both natural and
man-made added to the woes of producers.
1.Winter weather in China is
playing havoc with road, rail and power infrastructure. A number
of China's largest base metal smelters have cut back production
or shut down completely. This is obviously a temporary issue
but the scale of the cutbacks means the predicted base metal
surpluses will have to be cut back yet again.
2.Monsoon rains in Australia
that just won't go away have flooded a number of the countries
largest coal operations and several large iron ore mines as well.
BHP has declared force majeur on deliveries.
3.Heavy rains in South Africa,
crippled the local utility, ESKOM. ESKOM has cut back power to
the country's biggest users-miners- by 10-20%. The hoists and
ventilation systems for South Africa's deep mines require full
power. A number of mines will have to be shut for safety reasons
if 100% grid power cannot be assured. ESKOM has stated the only
real solution is more power plants.
4.Barrick Gold has signed a
long term tire (yes, tire) purchase agreement with Yokohama Tires
of Japan. The 10 year deal includes a $35 million loan by Barrick
to help fund expansions of Yokohama's plants for producing large
off road tires
5.China's biggest aluminum
producer spends billions on a minority stake in RTZ to help block
a potential merger with BHP.
A cynic would argue these are
all "temporary" issues . Stuff happens. But as we have
noted for years "stuff happens" the most when capacity
is strained. The fact these issues are news reinforces our view
that the fun's not over yet. There are bumps in the road and
our short term cautions remain but metals haven't lost their
luster.
David Coffin
& Eric Coffin
Editors HRA Journal
email: hra@publishers-mgmt.com
David Coffin
and Eric Coffin are the editors of the HRA Journal, HRA Dispatch
and HRA Special Delivery publications focused on metals exploration,
development and production stocks. They were among the first
to draw attention to the current commodities super cycle and
have generated one of the best track records in the business
thanks to decades of experience and contacts throughout the industry
that help them get the story to their readers first. Please visit
their website at www.hraadvisory.com for more information.
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