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PRECIOUS
POINTS: DECOUPLING FROM OIL?
by Oroborean
TradingTheCharts.com
November 5, 2006
This
week saw a gratifying, almost universal shift to bullish sentiment on
gold and silver. Of course, readers of this update heard it here first
on Oct. 26,
when we not only predicted the move, we explained why it would happen.
Now some analysts are predicting that metals and miners will be one of
the hottest sectors of the next year, so beginning this week, in
addition to commentary on the precious metals markets, this newsletter
will also feature regular commentary on selected mining stocks in an
effort to provide timely and actionable information to help you make
money in the precious metals and derivatives markets.
There’s
no doubt the Fed got the payroll number it was looking for on Friday.
Last week’s FOMC policy statement said that relatively low energy
prices would drive an “expanding economy” and continued “high
resource utilization.” But we interpreted the fact that the Fed
statement omitted language including commodity prices as a measure of
inflation as indicating that rises in commodities prices were inevitable
and would not stand as an obstacle to future interest rate-cutting like
energy and economic data. We called it a “buy” signal.
The
early part of the week saw the new Fed stance play out with a more than
3% rise in gold and silver, increased odds of a rate-cut in early 2007,
and the appearance of several new market analysts proclaiming a strong
technical outlook for gold and silver. In addition to illustrating the
strong performance of the metals in the wake of the Fed statement, the
chart above shows what appears to be a decoupling with oil, a sign
we’ve been anticipating as an indication of renewed investor interest
in the metals sector. The mother of all the commodities markets,
fluctuations in investment demand for oil tend to swallow the smaller
gold and silver markets and this will probably happen again at some
point in the future. Decoupling is an assertion of the metals’ own
bullish fundamentals. With many energy stocks underperforming the market
on the last rally, some of the money that would be going into energy
might now be heading towards the metals. Furthermore, rising gold and
silver over flat oil would exactly match the FOMC forecast and hey,
they’ve done a pretty good job so far.
Equities
markets struggled this week because of uncertainty about the economic
slowdown. Higher wage inflation and lower productivity boosted inflation
fears and kept potential dip-buyers mostly on the sidelines.
Hand-wringing over gold, though, as it retook the $600 level, was
misguided given the October statement. Unless there is a parabolic move
that clearly evidences a speculative bubble, the Fed will use economic
data, not commodity prices to determine its future interest rate policy.
With straight months of gains on the major indices, it’s not shocking
that stock market bulls saw the week as a chance to lock-in profits,
while fund managers at the end of their fiscal years declared victory
and made adjustments to their strategies for the quarter ahead.
Friday’s strong payroll report breathed new life into the
“soft-landing” hypothesis, but couldn’t stem the tide of red ink
because tighter payrolls could be inflationary in the Fed’s view.
Rate-cut odds for early ’07 dropped accordingly and the question now
is what effect this will have on gold and oil.
Clearly
silver was too cheap under $12 and gold under $600. Now that we’ve
entered the strongest season for metals, historically, and the word is
out that the metals are likely to be a hot sector over at least the next
quarter, we’re up above those psychological levels and close to near
term resistance. Still, we should expect money to rotate into the metals
and the miners at a fairly steady pace next week to help push them
beyond. Over the coming weeks gold could be on its way to as high as
$650-675 and I’ve already stated my expectation for silver to retest
$13, probably by the end of the year. But, at this point, we simply
don’t have the underlying fundamental picture in place for either
metal to seriously challenge the May highs.
Despite
the decoupling action we saw this week, oil will continue to be an
important factor. The so-called “Goldilocks economy” has come into
question repeatedly over the past few months, but was reaffirmed every
time either by very conveniently timed economic data or well-received
remarks by Fed governors. But two numbers that don’t respond
particularly well to Fedspeak or data are consumer confidence and retail
sales, both of which have recently declined. The last FOMC statement
called for an expanding economy, but the latest backward-looking data
still show a slowing economy and the overall effect of the housing
slowdown is still not clear. We’re quickly approaching a critical
period where the economy will either rebound decisively or drop
irrefutably into recession. To put it mildly, the economy needs cheap
oil right now.
It’s
not certain exactly when the Fed anticipates economic expansion to
appear in the data, but it continues to credit the economy’s
“moderation” to its own string of quarter point rate hikes. But the
truth is that the spigot has been wide open, with total Fed credit
expanding and fractional reserve and margin requirements shrinking.
Banks continue to target subprime borrowers and offer creative mortgage
options. Not surprisingly, the rise in gold and silver matched a
simultaneous downturn in the dollar. If the data continues to worsen and
they are forced to reverse their view of the economy, this could
increase odds of a rate-cut and should continue to boost metals, if not
mining stocks, but this can’t be considered a foregone conclusion.
Next
week we’ll see a new crude inventory figure, which could be important,
but it seems like $60 oil is an acceptable level for all parties at the
moment and the price probably won’t move too far from there in either
direction for a while. We’ll be watching mostly to see if the metals
continue to act independently or return to lockstep. For more immediate
analysis and updates, visit www.tradingthecharts.com
oroborean
Featured
Mining Stock:
Coeur D’Alene (CDE)
Until
very recently, Coeur D’Alene was the world’s largest primary silver
producer. The company’s very capable management has worked
aggressively in the past year to reduce its cost per ounce to about $4,
and, though it struggled to turn a profit during a period of acquisition
and low silver price, advances in the price of silver have created
impressive year-over-year comparisons in recent quarters. New
development and acquisition promise to soon return Coeur to its status
as largest primary silver producer.
Going
into its quarterly report and conference call next Monday, however, the
company has two strikes against it, as far as many investors are
concerned. Still, if the company’s past statements prove true, Wall
Street may be grossly over-exaggerating their effect on its bottom line
and setting the stage for an aggressive comeback.
First,
in it’s San Bartolome property, CDE has committed the cardinal sin of
attempting to mine in a politically hostile region. Otherwise a
promising operation ultimately estimated to yield 6 million ounces of
easily obtainable silver each year, the San Bartolome project has the
unfortunate condition of happening to be located in Bolivia, a
tumultuous country where recently elected president Evo Morales has
publicly promised to nationalize the country’s energy and mining
industries and radically alter its tax policies. In May, Morales sent
soldiers to enforce his nationalization policy at oil fields owned by
Exxon Mobil and others. Coupled with occasional socialist violence in
the region, he’s generally made himself an albatross around the neck
of any company with Bolivia exposure.
Despite
the fast pace of energy nationalization, details about mining reform
have been scarce. Morales already stated he would not nationalize
existing mining projects outright, but will rather seek to encourage
foreign investment in aiding his country’s mining and processing of
its resources. Spokespersons for CDE are quick to note that Bolivia
already owns all the natural resources at San Bartolome and that the
company only leases mining rights at the property through a wholly owned
Bolivian subsidiary. Still, investor sentiment can be difficult to
reverse and Bolivia continues to be seen as a high-risk investment.
Uncertainty
about the political climate in Bolivia continues to weigh on CDE’s
share price, but actual harm seems unlikely. Management has even gone to
the length of extending the construction period and insuring their
assets in the region for $155 million against appropriation and
political violence. Morales’ admission on Tuesday that his country
cannot even afford to nationalize its mining operations, in addition to
the company’s quarterly report and conference call on Monday, will
likely be a catalyst for this stock in the coming weeks.
Strike
two is a lawsuit by the Sierra Club against CDE’s Kensington mine in
southeast Alaska. Since 2004, construction at the site has run afoul of
several environmentalist groups despite progressing as permitted and
reviewed by the U.S. Forest Service, EPA, U.S. Army Corps of Engineers,
and Alaska Coastal Management. Several attempts to revoke the permits
have failed, but under pressure from local activists, the Army Corps of
Engineers has now voluntarily suspended CDE’s wetlands permit pending
further review, and the Ninth Circuit has issued an injunction halting
construction at a tailings facility on Lower Slate Lake. CDE maintains
it has acted at the highest standards of environmental, safety, and
health compliance and even received a Bureau of Land Management award
earlier this year. Drilling and exploration on the Kensington property
have continued in non-wetlands areas and the company does not expect to
suffer materially as a result of the ongoing challenge to its operations
in Alaska.
Another
topic that needs to be discussed at the conference call Monday is the
entrance into a Rule 10b5-1 plan to publicly sell
up to 500,000 shares of the company's common stock by Dennis Wheeler,
the company’s Chairman, President and CEO. As of the date of the
filing, Mr. Wheeler has not made public his intentions regarding the
plan.
These
two strikes have depressed the value of CDE shares over the past year
and caused the stock to underperform other stocks in the sector. But, as
neither mine property is yet in a revenue-producing stage, neither
setback is expected to influence the current quarter results. Further,
as these issues become resolved, and the new mines’ production comes
on line, sudden corrections upward may occur. For Monday, analysts
are expecting earnings of $.06 – .09 per share ($.08 consensus, up
from $.01 last year) on revenues of $58.88 million (up from $44.1
million). We should note that the widely lauded Silver Wheaton (SLW)
has a similar cost per ounce and annual EPS, but is valued well above
CDE at 57 times earnings, and trades substantially higher. As this fact
becomes more widely recognized, CDE could easily
move above the $6 level in a favorable trading environment.
©
2006 Oroborean
tradingthecharts.com
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