Gold rush 2009 is on, as gold is the front-runner in precious metals, so far. Gold is now only 10% away from its early 2008 high; silver is off 39%; platinum is still off 57% from its high; and palladium is still off 67%.
Don't buy the front-runner, buy the laggard, palladium! Chasing the front-runner and big crowds is the fastest way of losing money. Just look at recent bloodshed in DryShips (DRYS), a front runner in shipping stocks. I switched from DRYS to Excel Maritime Carriers Ltd. (EXM) and cautioned about DRYS in mid-January 09. So, I was lucky to have avoided the massacre in DRYS. There are inherit problems in DRYS that are now exposed, but big crowd sentiments added to the severity of plummet.
Gold is currently the front-runner of precious metal because most people know what gold is, but few people have heard about palladium. Recent stories from Russia and South Africa indicate that palladium and platinum have the most bullish fundamentals among precious metals, while gold has the weakest fundamentals.
First, let’s look at palladium. Norilsk Nickel (NILSY.PK), the producer of 45% of the world's palladium, just released its Q4 and full year 2008, production numbers. The palladium production dropped to 2.702M ounces, much lower than the 3.05M ounces in 2007, even though the nickel production is in line with 2007. Norilsk expects another drop of 7% in palladium production in 2009 to bring it down to about 2.5M ounces. The reason cited is lower grade of PGM content in the ores. I explained before that Norilsk has two types of minerals: the one high in nickel and low in palladium content, and the one low in nickel and high in palladium. Due to current low nickel price, they must opt to mine the high nickel ores, hence produce less palladium.
Base on my calculation of its mineral ores grades, if company produces the highest nickel grade while maintaining the nickel production level, the 2009 palladium production could only drop to 2.0M ounces, from 3.05M ounces in 2007. It is more likely that Norilsk will be forced to cut nickel production in order to meet weaker global demand. In that case, palladium production could fall significantly below 2.0M ounces.
Adding to the bullish case is news from South Africa of a looming mining worker strike to protest against the job cuts. I think the mining companies there, hurt by low PGM prices, and would LOVE to see the strike proceed in order to drive up the metal prices.
The bullish case of palladium cannot be better. Looking at the supply/demand picture starting with data from Impala Platinum (IMPUY.PK), we are talking about a global demand of roughly 8.215M ounces. On the supply side, South Africa could provide roughly 2.2M ounces, if current production cuts are implemented, Russian would provide 2.0M ounces, North America would provide about 0.33M from Stillwater Mining (SWC), other sources count for about 0.3M, and there would be little recycling as a low palladium price discourages recycling.
In summary, we are looking at about 4.83M in palladium supply, versus 8.215M in industrial demand, not counting any investment demand on the physical metal. The deficit will be 3.385M ounces, or 41% of industrial demand. No other metal has such a large margin of deficit! Remember, a less than 4% deficit in rhodium was all it took to drive the metal from $300 to $10000 per ounces! What would a 36% deficit in palladium do to the price? What would investors do, when they jump on the palladium shortage wagon and help drive up the price?
Keep in mind that the Russian Government is trying to help Norilsk Nickel with its financial difficulties due to current low metal prices. There has been talk that the government would purchase some of the precious metals from Norilsk Nickel and re-stock the government's depleted strategic stockpile. The Russians could easily drive palladium price up to $2000, $3000 or even $5000 per ounce, if they so choose. I don't see why not as they want to make money just like everyone else does.
In 2000/2001, one false rumor that Russian government was terminating the annual palladium stockpile sale, and the ensuing panic buying, drove up the price of palladium from $300 to $1100 per ounce. There was only one investment fund that noticed the palladium rally, and profited from it, because at the time, gold was at its low and there was no interest in precious metals as safe haven assets.
Today, the reality is that the Russian government stockpile sale has ended, and Norilsk's palladium production is down. The Russian government may be buying the metals to help Norilsk, as well as replenishing its strategic stockpile. As the current financial crisis unfolds, there is plenty of interest in all precious metals as safe haven assets. Rest assured, this time, there will be a lot more investment interest in palladium then last time. It's not too late to buy physical palladium, or to buy some of the world's primary palladium producers, Stillwater Mining Company (SWC) and North American Palladium (PAL), stocks.
I am openly calling these two companies to consider how they can help the average investors to acquire the physical metal easily, and as a result, be able to participate in, and gain from, the coming palladium boom. I believe that the precious natural PGM resources are NOT the private properties of mining companies, but belong to the people. These two companies, blessed with the privilege to produce the natural resources, have the social responsibility that they must maximize the value of the metals they produce in order to pay back the community.
Likewise, the U.S. and Canadians governments have the responsibility to ensure any minerals produced from their soil must maximize the values and must not be sold below cost. If the metals are priced below cost, then the governments should purchase and stockpile these precious strategic metals. The Chinese government is already stockpiling strategic metals to protect its domestic mining industry and take advantage of recent low commodity prices. The U.S. and Canadian governments must do the same for their respective national interests.
Let’s look at gold, now. The current price of gold is about $900 per ounce, which I believe is fairly priced since most gold mining companies are making comfortable profits. I believe there is now no good reason for the average Joe to buy gold at this price. Joe makes $40K per year, or $28K after taxes, which means he makes $112 per workday after taxes, so, in order to buy a single, one ounce gold coin, he would need to work at least eight full workdays in order to earn enough money to pay for it.
Joe might as well take eight days off to go prospecting for gold, since some gold prospecting web sites claim you can collect up to two ounces of gold a day. This sounds like a better deal than having to earn a salary to buy gold. The economic incentive to prospect for gold rather than to buy gold puts a reasonable natural cap on gold price, in terms of purchase power. However, silver, platinum and palladium are different as you can NOT prospect for these other precious metals, as a result, these other precious metals should have more room to make gains.
My only advice is stay away from ETFs like streetTRACKS Gold Shares (GLD) and iShares Silver Trust (SLV) and buy physical metals and precious metal mining shares, instead. After browsing through their physical metal bars serial number lists, I became suspicious of these two ETFs. I will not elaborate here, but it you have some time, scrutinize the lists yourself, and see if you find any red flags.
What is happening in shipping and what about recent bloodshed in DRYS? The Baltic Dry Index (BDI) has been going up strongly for TEN consecutive trade days in a row, and has now reached 1099, up from its low of 666 on Dec. 4, 2008. How often do you see something going up 10 days in a row? That says that shipping is recovering strongly, and indicates that last year’s drop in shipping rates was largely due to credit crunch freezing up trading activities, and was NOT due to supply and demand. As the credit now eases up, there will be pent-up demand to clean up the goods previously piled up on harbors.
The short-term outlook of dry bulk shipping is bullish, while the long-term prospect is even better, as governments around the world, particularly China, are preparing gigantic economic stimulation programs.
What do I think about DRYS's recent plummet? The panic was caused by DRYS's disclosure that two banks notified it that it was in breach of the loan covenants, as the fair market value of its ships has fallen below a certain percentage of the debts, and that DRYS was trying to raise $500M cash by selling shares in the open market, hence dilute the share value.
I do NOT think the loan covenant thing is too much a deal. How do you define a ship's fair value? I think any physical property's fair value is its replacement cost, but the convention is use recent market transactions of similar properties to determine the "fair market value." I think such terminology is ironic! The market is never a fair place to begin with, so the word "fair" and "market" don't naturally go together. Why would it be a "fair price" when under financial stress, a ship owner is coerced, into selling its ship at a price that is far below its inherit value? The unfair price is then used as "fair price" in order to undercut the assets of everyone else and force many more defaults and stress sells, further escalating the crisis. This unfair "mark to market" rule results in distorted values of physical assets, and is one of the major culprits in the current crises in real estate and other sectors. It must be abolished and replaced by a "mark to cost" rule.
In light of the continuous surging BDI index, the value of ships goes up with BDI. Banks know this and don't want to bring an unnecessary crisis upon themselves. Instead, they will work with shippers to find acceptable solutions to the loan covenants because it’s in their best interest to do so.
My biggest worry about DRYS is the ongoing selling of its shares in order to raise $500M, which will greatly dilute their value. No one knows how much dilution will occur, so even though DRYS has become much cheaper, I would advise waiting a little longer, until the dust settles, in order to see what the share dilution factor really is. In the meantime, I believe other shipping stocks like EXM, Eagle Bulk Shipping Inc. (EGLE), Genco Shipping & Trading Ltd. (GNK), Diana Shipping Inc. (DSX), TBS International Ltd. (TBSI) and Navios Maritime Holdings Inc. (NM) are better buys than DRYS, until we know more about DRYS's share dilutions. For the same reason, avoid OceanFreight, Inc. (OCNF), for now.
Full Disclosure: The author is heavily invested in SWC, EXM and EGLE. I also own shares of OMG, PAL, TBSI, DRYS and USO. I do not own other stocks mentioned but positions may change at any time.