In June, international markets recovered some of the ground they had lost during May. South America was not an exception, and neither was this model. The upturn was driven by the partial recovery of the general market, although some positions deserve special mention. Banco Santander Chile (stocks.covestor.com/san">SAN), which we enlarged last month, and Gafisa (GFA), opened early this month.
These outperforming positions, and the rest that were more in line with the overall South American markets, compensated for the weakness in our smaller miners Exeter Resources (XRA) and Solitario Exploration & Royalty (XPL), which declined following declining prices in base metals. Even though both companies explore for precious metals too, some of their current valuation is supported by copper in the case of Exeter, and zinc in Solitario’s. Nevertheless, the prices of these industrial metals are recovering while their inventories are declining fairly quickly. Moreover, these miners also possess property bearing precious metals, which have increased in price, and their stock value is not dependent on increasing commodity prices but may also be driven higher by the “de-risking” of their projects as they advance, even with metals at the same or lower prices. Therefore, I think these stocks’ potential is intact and I look forward to a recovery, hopefully during July.
I am optimistic not only about these small miners but about all our positions. Valuations are still attractive and now enjoy upwards momentum. I hope that we can end July celebrating the persistence of the upwards movement of the past weeks. But if the markets happen to resume their choppiness, it is important that we keep invested as long as there is solid value behind our positions, which I believe to be the case with all of the stock in this model. As I commented last month, we need to give our portfolios a fair chance for recovery. The upturn experienced by this model since its May lows provide yet another example.
I think it is worth writing some words about one of our holdings, Petróleo Brasileiro (PBR), also known as Petrobras (pronounced “petrobrass” stressing the “a”), because it has received some attention in U.S. media this month, in connection with the spill in the Gulf of Mexico. As I mentioned briefly in my last report, the Gulf disaster may be bullish for oil production performed elsewhere. If this tragedy slows down extraction there, it will probably decrease costs for the global industry and raise oil prices. A news commentator went as far as suggesting that the new-drilling moratorium proposed by President Obama was part of a conspiracy to favor Petrobras, linking it to George Soros’ heavy investment in the oil company last year and, including in the package, the $ 2 billion loan from U.S. Ex-Im Bank in 2009. I think this shady picture lacks some important facts.
To begin with, it is not so bad for the U.S. if oil extraction done elsewhere is propelled while the country feels it has to slow down to put its industry in order. America is more dependent on oil than other nations, mainly due to its particular transportation needs. Meanwhile, the world is running short of cheap oil. Cost of extraction of about 80 dollars a barrel could be the norm for new wells in not-too-distant years, with an increasing participation of offshore production. The resources that will have to be divested from growth into the transformation of energy production and use, will constitute a challenge for the world, expressed through relatively-high energy prices. For the U.S. it will be particularly challenging, and every extra source of oil in the world markets will alleviate the problem and help the country sustain its competitive advantages while it goes through the transition.
I am not trying to paint a gloomy picture – I believe there is much room for improving energy use and production. On the demand side, current and future technology will be able to help significantly. Much electricity is not well used, like street lighting that remains lit during the day because of poor maintenance, or spending 150 watts of electricity to write documents and emails on a desktop PC when those tasks can be performed with a consumption of 5 watts or so. Regarding transportation, which is the main use of oil, the fuel efficiency of cars can be improved. According to a report by the Pew Center on Global Climate Change, new passenger vehicles in the U.S. consume about a 65% more fuel per mile than their European and Japanese equivalents. The development of public transport and new vehicle technology (hybrid, electrical, etc.) also holds promise. On the supply side, there is surely much oil underwater to be found once the incentives are in place for searching more actively, and biofuels may offer a marginal but important quota. By the way, Brazil produces very efficient ethanol from sugar cane – Cosan (CZZ) is in that business and it is one of the stocks I am keeping an eye on.
Nevertheless, this transition in supply and demand patterns will require investment, effort and time, and every extra oil in the market will mitigate its risks and lower the hurdles.
In recent years there were massive offshore discoveries in Brazil, giving this country the potential to become one of the major oil producers worldwide. Petrobras holds a majority stake of these “pre-salt” projects. For the reasons stated above, it makes sense for the U.S. to lend $2 billion so that this solid company, located in an trustworthy country for America, buys U.S. products (thus creating jobs in the U.S.) to expand and develop these oil resources. Let us bear in mind that Ex-Im Bank is self sustained, therefore those are not taxpayer dollars, and that the credit line is for the purchase of U.S. goods and services only.
Soros investment in Petrobras can be understood without involving a conspiracy, as can the Ex-Im Bank loan. Another argument that was presented was that it would be a double standard to aid offshore drilling in Brazil but suspended it in the U.S. The key to understanding that is that safety regulations are different. Brazilian legislation is stricter than U.S. Brazilians have based their model on the Norwegian one, which does not rely on self-regulation as much as the American. To give an example, according to an article in the Wall Street Journal, this stricter legislation requires the installation of a remote-control switch to activate a critical device, called “blowout preventer”, meant to shut down an out-of-control well. Deepwater Horizon lacked this feature, as it is not mandatory in the U.S.
We do not know yet if the self-regulatory approach was one of the reasons for this accident, of if it is crucial to implement changes like the remote-control switch that are optional in the U.S. But I find it reasonable to say that reassessment of U.S. legislation and installations are required. It was not just this accident. According to the International Association of Drilling Contractors, from 2005 to 2009 there were 9 fatalities during drilling in U.S. waters but only 2 in European seas. There were more hours worked in the U.S., but only about a 15% more.
I cannot tell if a drilling moratorium in the U.S. is necessary or not, but I see a valid rationale behind treating each country differently.
In future reports we will return to Petrobras, as it happens to be the largest company in South America. I wish you the best for July, and thanks for your interest in this investment model.
Disclosure: Long all positions