Daily Dose of Optimism

60 Minutes on Coal Safety in Harlan County, Kentucky

60 Minutes ran a piece on coal mine safety this Sunday. The piece looked at the spate of recent deaths in Harlan County, and focused on the efforts to improve mine safety by wives of men who were killed in recent accidents. I found the piece interesting, but lacking in substance.

I think the deaths we have seen in mines recently were driven by record coal prices over the past few years, a large amount of formerly dormant capacity being brought online in a short period of time to take advantage of pricing, and greed, by both mine workers and operators, to haul as much tonnage as possible. Everyone in a mine makes more money based on the amount they can take out of the ground, so while owners are generally most culpable, everyone potentially shares some of the blame.

Take a look at the graph below, and notice that the price of anthracite coal (the good stuff) is about as high as it ever has been (non-inflation adjusted) in the past few years.

Source: CRB, through 2004 (sorry, free historical data ain't always up to date)

Looking at current data (last three years) notice that among all the coal regions in the US today, that Central Appalacian Coal (where Harlan County is located) commanded an astronomical price, at least through the middle of 2006. Central Appalachia is also where the accidents have occured:

International Coal (ICO), which owned one of the mines (Sago) that had the worst single accident, was formed just a few years back from a bunch of bankrupt mine operators. The Sago accident exemplifies the challenges the industry is facing right now: upstart firms bringing dormant capacity online to take advantage of record pricing. Harlan County is about a five hour drive from Sago, and both have the priciest variety of coal.

The miner's wives are right to push for mine safety, and I hope they are successful in doing so. My only gripe with the episode of 60 Minutes is the application of Occam's Butterknife to trying to understand why mining deaths have increased lately. With a multi-million dollar production budget, understanding and explaining issues should not be out of the question.

The answer, in short, is that we're in the middle of a bull market in commodities.

Of course, don't expect 60 Minutes to actually interpret the world for you (that's what the DDO is for). With a bunch of touch-feely septuagenarians at the helm, 60 Minutes basically reveals that it is painful to lose a husband in the mines, that mine owners are greedy and camera shy, and that a lawyer fighting this very issue in court will not admit to sh*t.

One plaudit for 60 Minutes is this interesting video from the same segment on how miners actually get the coal out of the ground. Scary, and fascinating. - Ed

US Coinage Hoard/Spend Index: Value of Metal in US Coins

Times were, when kids asked their parents why nickels were called "nickels," they got an answer about how the coin was once made out of the metal nickel, even though they are now made primarily from copper.

You will soon know how old you are when you tell your kids about buying anything with pennies, nickels, quarters, or dimes, and they ask you what the hell a penny, nickel, quarter or dime is, as that type of money won't exist anymore. Then, you will remember that metallic currencies were phased out around 2015 when the price of the metals used to make those coins was prohibitively expensive, and you will kick yourself for being old.

I have written for about the value of the zinc in pennies, and said that the metal in a penny would be worth more than a penny when zinc hit about $3,200 per metric ton. (Turns out that figure wasn't exactly correct - new calculations say, depending on the price of copper, that this would be around $3,900 per metric ton.)

I now realize that we are probably just a few years away from a scenario where the US decides that all money is either paper or electronic. Why would I say this, after calculating for myself the prices of just a few coins?

Take a look at the US Coinage "Hoard/Spend Index" below (a DDO exclusive!). Coins to hoard have a metal value greater than the currency value. Coins to spend have a metal value less than the currency value.

Conclusion? Dimes and quarters still have a few years left as coins. However, pennies and nickels have either outlived their usefulness, or are close to it. - Ed

Note: I am not factoring in the cost of producing the coins, and only have pricing for high grade metals. Metal prices:

Commodity Futures Forward Curves

I have been doing a fair amount of homework on commodities for the past few months.

I'm happy to report that I have now found a number of great websites that provide extensive free news and pricing for commodity futures and options, but one of the things I've had a hard time finding was any information on the term structure of commodity futures contracts.

Hence, I went ahead and created something for my own purposes so I could see how the prices of various futures contract maturities were changing over time.

Take a look and let me know what you think :

Download Futures_Forward_Curves_9-29-06.pdf

This is a first draft, so feedback is appreciated. - Ed

Note: file has been fixed, for anyone who was unable to download on Monday.

The Relation Between Copper Prices, Warehouse Stocks and Currencies

For those of you reading (or writing) that copper is in a "bubble" simply because the price is up dramatically, I thought I would share this graph with you showing the relation between the spot price of copper and the warehouse stocks (aka inventory) of copper at the COMEX since 1974. Admittedly, the COMEX is not the only place that copper can be stored (can't forget about LME) but it is a good start.

This graph is a little out of date (hey, this is free information!) but I think the supply-demand picture is pretty clear. Add into this USD weakness against global currencies, and you should be able to put the moves in the price of copper into context (supply, demand and currency). Current COMEX Copper stocks are ~20k short tons, and LME copper stocks are ~116k metric tons.

Enjoy, and any feedback is appreciated. Copper is priced in dollars and cents per pound, and warehouse stocks are given in thousands of short tons, with a "short ton" being the name for a US ton (2,000 lbs), equivalent to 0.907 metric tons. - Ed

Putting Together the Increase in the Price of Copper
Copper Spot Price, 5 years

LME Warehouse Stocks, 5 Years

NYMEX/COMEX Warehouse Stocks, 60 Days
(Notice how low current inventory is relative to the 1974-2004 graph above) 

USD to EUR, 5 Years

Jim Rogers Moving to China

For those of you who attempt to divine trends by watching what better informed and more successful people than you are doing (as opposed to merely saying), I have an interesting data point for you, and yes, this item is from today (Tuesday), so I should get a little credit for giving you something on time, as opposed to months after the fact:

II.com: Rogers Going Where The Action May Be

Apparently Jim Rogers, who back in 1970s co-founded hedge fund Quantum with George Soros, is leaping into Asia, just as he said he would in March. Rogers, who is also an author of several books, including Investment Biker, reportedly is putting his New York townhouse up for sale and moving to Asia. He bought his not-so-humble six-story digs for $107,000 29-years ago and is asking $15 million. The house has a greenhouse, gym, wine cellar and a view of the Hudson River to die for.

Rogers, according to Bloomberg News, is giving it all up to relocate to the Far East because he expects a boom soon in Chinese stocks. Rogers reportedly is not sure yet where he and his family will settle, but he told Bloomberg News he’s looking for a “Chinese-speaking city” since his child is bilingual in Mandarin and English.

Not mentioned in the Bloomberg article was Rogers' likely desire to avoid rabid Rogers International Raw Materials Fund investors, but that would be some irresponsible speculation!

So there you have it: Rogers says now is the time to start looking at Chinese stocks. Interesting. When I know more about this, I will make sure to position my portfolio accordingly and then write about it for you to copy. (Just kidding).

Rogers' last major accomplishment was the performance of his commodity index, as well as the timeliness of his call (basically, at a 25 year absolute bottom in commodities). The index he designed and launched in 1998 is up 263% since inception (follow link for details).

(Note: I am talking about his INDEX and not his FUND, so if you have issues with the fund, which I understand, we can talk later...)

Also, if you consider yourself a serious investor, but have not read Hot Commodities, or don't already know the price of a bushel of corn, then buy it and read it today. You can thank me later. - Ed

NYT Dealbook: Bankers set for a boom, Commodities set for a bust

The New York Times DealBook recently saw fit to post, without noting any irony whatsoever, the following two posts within six minutes of each other. If you like data points on sentiment for commodities vs. other opportunities, this is a great example:

Here's the first, at 8:04am:

London’s Bankers, in Short Supply, Get Fat Pay Packages (May 12, 8:04 am)

Financial workers in the City of London are “holding most of the aces” in the recruitment market as banks desperately search to fill vacancies created by the surge in corporate activity, a new report claims.

Recruitment firm Morgan McKinley said pay packages are becoming more attractive and staff are moving jobs more frequently to meet demand. According to the report, the number of new positions on offer in April was 20.4% higher than last year. (Link)

Here's the second, at 8:10am:

Commodity Traders Should Plan for the Bust of Their Hiring Boom (May 12, 8:10 am)

Being a commodity trader is the hottest job in town. After years in the doghouse, these experts in the arcane arts of contango and backwardation are suddenly worth millions.

In this booming market, anyone who can say “crack spread” without laughing is getting hired, says Breakingviews. But while banks want to pay up now while prices are still high, they’ll be just as fast to fire. Wise traders should ask for multi-year contracts. (Link)

Interesting how one article pretends to understand the future - clearly, commodities are set for a fall - and one is simply telling what we already knew - that bankers are valuable.

I realize that the NYT DealBook'ers simply report what is being written around the web, but they also made the editorial decision to post these right on top of each other without comment.

Ed's wild guess: there are 10x more investment bankers reading newspapers than there are commodity professionals. As such, interpretating hot demand for bankers as "normal" and hot demand for commodities traders as a "bubble" is a journalistic strategy for success: flatter your target audience.

Usually, the things people talk about as a great place to be are peaking, and the things people are fearful (or ignorant of) are still in a bull market. Commodities are getting a lot of play as a phenomenon that is close to "done," and the argument typically given for why commodities are ready to fall is that "this rise can't go on much longer."

On the flip side - in line with the demand for investment banker-types and investment banking services - is how private equity funds continue to raise record levels of capital, and are doing ever larger deals that are dependent on a low cost of funds...in an environment of rising rates.

Simply borrow money to buy a company with almost "no money down," borrow some more money to pay yourself a hefty "dividend," and then sell the equity of the company to the lumpeninvestoriat of mutual funds, "hot" deal chasers, and retail.

From the worldview of Dealbook (and others), private equity is an activity that can (and should) continue indefinitely. But 3 years of high gas prices...can only be the work of anti-American communists. - Ed

Japanese Interest Rates and US Equity Market Volatility

For those of you wondering why US and global markets experienced such rapid declines over the past month or two, let me draw your attention to some information you may have missed. Basically, the Bank of Japan indicated back in March that it planned to end its zero-interest rate policy.

How do low bond yields overseas affect international markets? Via the mechanism of the "carry trade":

“Carry trading” is not something the average reader is likely to run across in his spare time. What it amounted to was borrowing yen at low interest rates, converting them to dollars and re-investing the money at a higher rate of return. Simple enough in theory, but you need large amounts of money to do it. And it involves a fair amount of risk; while yen lending rates may be low, a rise in the value of the yen could wipe you out. [...] As the real cost of money rises in Japan [via higher interest rates], the yen carry trade stops working. It needs to be “unwound.”

To get a sense of how this works, see current Japanese government bond yields, and compare with US and Brazil. Imagine earning that spread with huge leverage. Here's the explanation of how Japanese liquidity impacted US market volatility (from May 30th):

“The Bank of Japan is signaling an end to its zero-interest-rate policy. Speculators who have been borrowing Japanese Yen are simply racing to the exits,” said Dan Amoss, a commodities expert and contributing editor to The Daily Reckoning.

Amoss believes that traders are dumping assets in hopes to eliminate credit balances in Japan before rising Yen value and spiking interest rates spoil profitable investments. “Speculators are relieving the pressure on their short Yen positions through the liquidation of whatever assets they had been buying.”

A serious depression scare in 1999 caused the Bank of Japan to cut interest rates to zero. Savvy U.S. speculators and hedge funds took out enormous loans from Japanese banks and invested in a variety of international bonds and commodities.

Interesting. A recent headline from Bloomberg (June 15) indicate that the Bank of Japan is backing away from any moves in the near term due to its impact on the Japanese equity markets:

The Bank of Japan kept its key interest rate near zero percent two days after the Nikkei 225 Stock Average sank to the lowest in almost seven months.         

The decision by Governor Toshihiko Fukui and his eight board colleagues, who have signaled since March they're preparing to increase rates, was unanimous, the bank said in Tokyo today.

Markets make big moves on the marginal liquidty created by hot money. For more global impact of this news, see my earlier post on the Saudi Arabian Stock Market Crash. - Ed

Bill Miller Down on Commodities

When Bill Miller says something like this, you have to consider his argument:

Now may not be the right time to pile into metals, oil or other commodities even as many streak to new highs.

At least that is what veteran stock picker Bill Miller, the only man to have beaten the broader U.S. equities market for each of the last 15 years, writes in his quarterly comment.

Miller, who personally invests roughly $23 billion at Baltimore-based money management firm Legg Mason, this week threw cold water on one of the market's hottest trends: commodities.

"It takes a determined optimist to say that now is time to be putting money in commodities," Miller wrote in a sharply worded commentary, adding, "The consensus does tend to be wrong at the turning points, being invariably bullish at the top and bearish at the bottom." (Link - CNN/Money)

I'd bet Miller is probably a little upset to have ~30% of his fund in technology (see for yourself!) when all the action is in gold miners, E&P, refineries and the like, but this particular point from his letter is key:

Since the rally we are experiencing is already bigger and longer lasting than the one that kicked off the 70’s, it takes a determined optimist to say that now is time to be putting money in commodities.

The reason to own commodities may be that one believes they provide equity like returns with little correlation with equities. The time to own commodities is (or at least has been) when they are down, when everybody has lost money in them, and when they trade below the cost of production. That time is not now. The data showing the returns of commodities will look very different if you start measuring just after prices have tripled.

Every commodity we can get data on trades significantly above both the average and the marginal cost of production. Copper, for example, has an average cost of production of around 90 cents per pound, and a marginal cost of about $1.30 per pound. The marginal cost should approximate the equilibrium price over time. The current price is around $3.25 per pound. It is not a question of if copper prices are going down, it is a question of when. (Link - Miller's Complete 1Q06 Letter (PDF)

This means there is more homework (for Ed) to be done as to how prevailing prices correspond to with their marginal costs.

If anyone has references for how to find marginal production costs for base metals, precious metals and coal/gas/oil, I'd appreciate it. - Ed

Mnemonic for Remembering Commodity Expiration Months

Trying to remember the letters for the expiration month of commodity futures? Try this:

1   F irst
2   G reat
3   H eroes
4   J ust
5   K now
6   M any
7   N ew
8   Q uestions
----------
9   U ltra
10 V iolet
---------
11  X
12  Z

If anyone has a better mnemonic, I'm all ears. - Ed

Energy Analysis - BP's Charting Tool

BP has a nifty Java-based webpage which allows you to chart energy consumption by product and region in the world back through 1966. Definitely a useful tool for those trying to get their heads around where we've been, energy wise. - Ed