Tuesday, July 27, 2010

Why You Should Avoid MLP ETFs Until the "Froth" Subsides

Wall Street is going crazy for MLPs these days!  The safe, stable, dividend yield of a master limited partnership (MLP) is all the rage right now with investors.  Which is precisely the reason you might want to steer clear of this sector for a bit.

Tom Dyson elaborates in his Daily Wealth column:
Whenever you see Wall Street creating lots of new investment products to sell to the public – especially ETFs – you know investors must love the idea... and prices might be forming a bubble. You should be extremely wary of buying or holding stocks in these sectors. Chances are, they're about to enter a severe correction.

So what's the hottest new ETF sector right now? It's master limited partnerships...

A master limited partnership (MLP) is a special business structure available to a small number of firms trading on the stock market. Right now, there are 91 companies in the sector. MLPs treat their shareholders as partners in a business instead of owners of a corporation. This way, they avoid corporate tax. Many different businesses can qualify for MLP status... including real estate businesses, shipping lines, and money-management businesses. But the biggest companies in the MLP sector are all pipeline businesses.
You can read Tom's full piece here.

If the stock market tanks again - as we're anticipating here - then MLPs might be a great place to look for stable, 10%+ dividend yields.  But at just 6%, I agree with Tom that you're probably best served until some of the current froth is blown off.

More on ETF launches as contrarian indicators:
Ed. Note: This article was originally published in our sister publication, The Contrary Investing Report.

3 Reasons You Should Buy Gold Right Now

Should you take advantage of the current pullback to increase your gold holdings?  Our precious metals guru Jeff Clark believe so.  Read on as Jeff puts together some historical price action data...
Is Now a Good Time to Buy Gold?
By Jeff Clark, Senior Editor, Casey’s Gold & Resource Report

While we’re convinced gold and gold stocks are destined for much higher levels, buying when prices are low can mean the difference between a double or triple and a ten-bagger... a week in Malibu vs. a week in Milan. 

There’s no secret formula to buying low, and we aren’t holding the right hand of Midas, but there are periods when prices tend to be lower than others. And if those tendencies play out, it can give us the opportunity to snag a high-quality asset at a bargain price.

So, how do you get a bargain price? You cheat.

I think the secret to getting a low-cost basis on all your gold and gold stocks is this: only buy on significant price pullbacks.

And this can be done without trading or using technical analysis.

I think there’s a good chance we can cheat this summer. For example, here are the average monthly increases in gold since our bull market began in 2001.

In our current 9-year bull market, June and August have seen the lowest average return for gold, representing one of the best times to buy. 

You’ll see that in the bull market of the 1970s, summer was also a good time to buy gold.

What about gold stocks? Since 2001, June and July have been among the weakest months and thus one of the best times to buy.

Obviously, these are price tendencies and not certainties. There were Junes when gold was up, and some Julys when gold stocks were up. Meaning, we’d avoid using these charts for trading purposes or in anticipation of an immediate gain. Instead, use these “trendencies” to look for possible price weakness. And if it arrives, use the opportunity to add to your holdings and position yourself for the next leg up in the bull market.

What are the odds of a correction in gold and gold stocks this summer? 

►Since 2001, almost every precious metal stock, in every summer, has moved lower from its May high. This includes gold and silver. There’s no guarantee this won’t be the summer of galloping unicorn herds, but the record is hard to argue with.

Here are the buy zones I identified for gold and silver, based on a tally of how far they’ve corrected from their May high to their summer low, in each year of the current bull market.

You’ll see that the average price of all pullbacks in gold, from the May highs to the summer lows, is 8.9%, and would take the price to $1,126.98. That’s not to say this price will be hit, but it tips you off that a fall to that level would not be out of the ordinary – and would also be an invitation to buy. You can also see the smallest summer decline, which we’ve already exceeded. We wouldn’t wait for the largest drop to materialize; there’s a good chance you’d be left empty-handed and chasing the stock higher.

Silver is naturally more volatile, allowing us perhaps a better opportunity to buy low. The average summer decline for silver is 16.6%, which would take the price to $16.39. However, the furthest its fallen so far this summer is $17.36, meaning strictly on a historical price basis, a 10% correction from current levels would be perfectly normal. And again, an invitation to buy.

Whatever price (or prices) you select, I’d only use the charts to add to current positions, not for trading. The currency crisis Casey Research believes is inevitable could strike suddenly again and will eventually hit the U.S. dollar, and the last thing you want is to be left standing on the sidelines if gold and gold stocks surge higher. In our opinion, being completely out of precious metals in the middle of a once-in-a-generation bull market would be a mistake. Instead, keep adding to your savings every month and buy when it feels like you’re cheating.

See you in Milan?
Want to see the buy zones for all our recommended gold and silver stocks? Our Summer Buying Guide is an invaluable resource for buying low. And check out our just-released July issue, where a respected bullion seller tells you why in the near future you may not be able to buy gold, at ANY price. Try a risk-free subscription for only $39 per year. Details here.
Ed. Note: I am a Casey Research Affiliate, Subscriber, and Phyle coordinator.

Wednesday, July 14, 2010

Can Coffee Keep Rolling? A Look at Supply/Demand Fundamentals

Coffee's been one of the hottest commodities on the board to date in 2010 (remember, the broader CRB Index peaked in early January) - can everyone's favorite pick-me-up continue it's run?

The supply/demand fundamentals are very intriguing, writes Julian Murdoch for our friends at Hard Assets Investor.  Coffee demand has doubled in the past 10 years (!) - and farmers can barely keep up.  While they have boosted supply, demand has rocketed up faster - as a result, global coffee stocks sit near all-time lows.

You can read Julian's full coffee supply/demand analysis here (with some excellent charts included).

If you're thinking about going long coffee here - be careful.  Coffee is one of the most volatile commodities you'll see, and can produce some truly nauseating volatility for traders (take it from a guy who's been on the coffee beat for a little while - through both good trades and bad!)

I'd prefer to punt on a coffee position if we see another nasty wave of deflation that kicks the prices of everything to the floor once again.  If that happens, coffee might be one of the first to "perk up" (sorry, couldn't resist!) as people start to find jobs once again when we eventually emerge from this Global Depression.

But let's part ways on a cheery note...and revisit everyone's favorite part of waking up.  From a time when America actually went to work, and unemployment was actually falling, here's a blast from the past...

Tuesday, July 13, 2010

Why the Gulf Oil Spill is an Utter Catastrophe for Obama's Energy Plan

What has the BP oil spill done to Obama's energy policy?  According to our energy expert Marin Katusa, it's pretty much turned it on it's head.  According to Marin, Obama's down to only two options - both of which are perceived as pretty undesirable from a tree hugger's point of view!

But for us red blooded capitalists, Marin does have a couple of ideas about how we can profit from these trends that now appear to be baked in the cake.  Read on to learn more...


Has the Gulf Spill Opened Pandora’s Box for Obama?

By Marin Katusa, Chief Energy Strategist, Casey’s Energy Report

The White House might be gaping in shock that the U.S. federal court overturned the six-month drilling moratorium, but it really isn’t all that surprising. Amid the finger pointing and political posturing, the Obama administration seems to have missed a vital detail – the U.S. oil industry is in a spot of bother.

It’s not just America’s oil supply and energy security that’s in danger after the BP oil spill and the subsequent drilling ban. The Gulf economy is hanging by a thread, and it won’t take much to send it over the edge.

Thousands upon thousands of rig workers were effectively laid off when the 33 rigs operating in the Gulf stopped drilling. The full economic impact of the ban is still unrealized, with the layoffs just starting, but estimates put the figure for lost wages as high as US$330 million per month.

Given the potential economic losses, BP’s US$100 million compensation fund for rig workers starts to look rather paltry. It doesn’t end there either. There’s a domino effect in play as well – each rig job supports up to four additional jobs for cooks, supply-ship operators, and those servicing the industry.

And should the drilling ban become permanent, the consequences could be dire. Just like the towns that died in the Upper Midwest after the demise of the auto plants and steel mills, the entire Gulf Coast – where deepwater drilling is crucial to the economy – could fade away.

All in all, not the best news for a country whose economy can be best described as fragile at the moment.

There’s also the question of America’s energy security. The Gulf accounts for up to 30% of all the oil produced in the country. Should the Gulf be put off limits, that shortfall has to be made up from somewhere. Obama’s renewable energy might be the future, but it’s not up to the challenge of meeting the needs of the present.

And attractive, viable options are far and few in between. Russia may be a friend now, but its tap-twisting history with gas in Europe does not strike up a positive note. The Middle East is hardly America’s best friend, not to mention its royalty structures, which leave much to be desired. And in Venezuela, Hugo Chavez just recently nationalized 11 oil rigs belonging to a U.S. company.

In the end, only two real options are left in the hands of the U.S. – the oil sands of Canada or rethinking the drilling ban.

A revised drilling ban would still see higher taxes on each barrel produced and tighter regulations for companies coming to the Gulf. Any lease application would come under intense scrutiny and face higher insurance rates. For smaller companies interested in the Gulf, the rising production costs mean that the death knell has been sounded.

Option two is the friendly neighbor to the north, Canada. The country already plays a big role in U.S energy. One in every six barrels of oil consumed daily in the U.S. comes from the oil sands in Alberta, Canada. The oil sands are pretty controversial stuff, however, associated with derelict, broken landscapes and carbon emissions.

But this is an image that’s going to change very soon. The future of oil sands is here: they are cost effective and their face is green. Steam Assisted Gravity Drainage (SAGD) pumps steam into the ground to liquefy the bitumen and stiff crude oil, making it thin enough to be pulled out of the ground. No giant holes or toxic tail-ponds – just two horizontal pipes, one above the other, puffing away efficiently.

That the Gulf spill is a game-changer for the U.S. oil industry is yesterday’s news. For now, it’s about making ends meet. And while we expect the U.S. to shift towards renewable energy, and maybe even rethink its energy use, for now there’s an unmet demand that’s not going anywhere.

As far as an investment portfolio goes, both options bring with them opportunities. If the U.S. federal court allows a somewhat watered-down version of the drilling ban, the long delay means that there’s potential to pick up some great stocks at a cheap price. On the Canadian side of things, there are some well-run companies perfectly combining cash-flow and SAGD technology. The Gulf spill might be Obama’s Waterloo, but for the careful investor, the winds of change could just blow in a fortune.


Marin Katusa is the editor of Casey’s Energy Report, your single best source for ongoing coverage and profitable recommendations in the energy sector. Learn more here.

Ed. Note: I am a Casey Research Affiliate and Subscriber.

Sunday, July 11, 2010

Why We Are Shorting The S&P Like Crazy - Thanks to This "Mini-Rally" Gift!

Here's your weekly investing outlook from CommodityBullMarket.com - and even though commodities are likely to run into some serious headwinds in the short term, we're still firing away with some contrarian investing and trading ideas!

If you're not yet subscribed to our new (and free) daily newsletter, The Contrary Investing Report, you can request a free subscription here

I'd highly recommend this, because we post articles and news throughout the trading day!  All this and more on our new site: http://www.contraryinvesting.com/
Now for the week's lead story...

Why We're Short the S&P - Again - Thanks to This Mini-Rally!

Two weeks ago, we picked up a story courtesy of Bespoke Investments that showed just 4% of S&P 500 stocks were above their 50-day moving average - a level not even seen during the March 2009 lows!
So we thought a stock market bounce might be on tap - and sure enough, this week we got it.

Now after 4 straight up days, where do we sit?  We're now out of extreme territory - now with 29% of S&P 500 stocks above their 50-day MA.  To illustrate the relationship between this ratio, and the actual price of the S&P 500, I plotted both below for the year to date:

S&P Stocks Above 50 Day Moving Average
S&P 500 Price Chart July 8 2010

Of course this is a crude technical indicator, and one based on trailing prices at that.  But it has been effective at identifying extremes - especially oversold ones.  Not as much during overbought situations (like February to April of this year).

So where to from here?  I still see this ship heading down (here's the big picture of "why").

But we could rally further from here.  We closed Friday at 1077 on the S&P.  A rally up to but not surpassing the June highs around the 1130 mark would keep our bear market signature of lower highs and lower lows intact.

But I don't think a run up to 1130 is likely.  We've retraced roughly 50% of the last decline at this point.  So we could go farther - but that is not required at this point.  We're already halfway there - this mini-rally is livin' on a prayer!

Bottom line: Any further price appreciation will certainly leave a bear like me licking his lips for a chance to reinitiate a nice, juicy short position!  So, we initiated a short position on Friday.

And if you're new to our "shorting the S&P 500" mini-series, you can get caught up on our trade history - and thought process behind the trades - in the Shorting the S&P 500 section on our blog. 

More Investing News...
Stock, real estate, precious metals OK...just stay clear of bonds!

More than forecast - would you believe it?

Look out below, global economy! 

The public fiscal train is hurdling out of control

Wednesday, July 07, 2010

Energy Investing Outlook for 2010 and Beyond: Geothermal, Natural Gas, Peak Oil, and More!

With oil back up in the $70 range, what's the current energy outlook for the global economy?  And more importantly - how should we invest?  For some insights, we're going to turn it over to our pal David Galland, who's rounded up two of Casey Research's energy experts for an insightful interview...

The Doctor and the Dealman: An Energy Update

By David Galland, Managing Director, Casey’s Energy Report

At first glance, no two individuals could seem more different.

The Doctor, middle-aged and balding, could be the very archetype of the college professor. The Dealman is young with a full head of well-styled hair: more than a few people have compared his looks to Elvis in his prime.

The Doctor is quiet and soft-spoken. The Dealman is outspoken and, under the right circumstances, even outrageous.

On further examination, however, you begin to uncover the similarities that make them one of the energy sector’s most potent teams, starting with the fact that they each possess an intimidating intelligence.

Case in point, while only 23 years old, the Dealman taught advanced mathematics at the university level.

The Doctor, an elected fellow of the Royal Society of Canada, is a PhD professor of petroleum and coal geology at the University of British Columbia and the winner of the coveted Thiessen Award, the highest award presented by the International Committee for Coal and Organic Petrology.

They also both share a passion for the energy sector, though as is typical with this atypical team, they approach the sector from two different perspectives.

The Doctor, one of North America’s leading experts in “unconventional” oil and gas, loves to analyze every aspect of modern-day hydrocarbon exploration and production.

While fully conversant in the technological and geological facets of the global hunt for energy, in his work as the chief investment officer for Casey Research’s Energy division, the Dealman lives to find the next big money-making energy play. Even if it requires working almost around the clock, he is passionate to uncover companies with the magical combination of the right management, the right commodity in the right place and with the right geology. And, most important, the right financial structure at the right price that allows investors to lock in serious upside potential but with very little downside risk.

Individually, the Doctor, Dr. Marc Bustin, and the Dealman, Marin Katusa, are powerful resources when it comes to separating facts from fiction about today’s energy scene and where the real opportunities for investors are to be found. But working as a team, they become a force of nature.

With oil gushing into the Gulf, the global economy under pressure as well as the prices of energy and energy stocks, and with the new American Power Act lurking in the background, John Mauldin called to ask if we could provide an update for readers on the always-important energy sector.

And so, with that goal in mind, I arranged to sit the Doctor and the Dealman down for a chat. The highlights of that chat follow.

Q: Let's start by asking your opinion, Dr. Bustin, on the sinking of the Deepwater Horizon rig off the coast of Louisiana and the impact that could have on oil exploration in the U.S.

Bustin: It’s an environmental ecological disaster, and everything else pales besides that fact. That said, I think what we're looking at is a major shutdown in offshore exploration off North America.

In addition to the Obama administration, the Canadian government has also come out and said that there will be no further offshore exploration until we understand what went wrong and there is something in place to better control a similar incident should it happen.

The impact of the disaster is already being felt in that Obama had only recently announced an expansion of offshore drilling, but that's now dead. Likewise, probably for the rest of my life, offshore Western Canada won't go ahead, so it's a huge impact, and of course this is going to affect the mid-term oil price.

Katusa: It is really important to understand that, for companies with existing drilling permits, the costs are going to be significantly higher… in terms of construction and maintenance costs, labor, permits, battling lawsuits filed by environmental groups and others with an interest in the water – the fishing industry, for example. Then there is a big increase in insurance costs, more taxes, and special clean-up funds.

As a result, when you start looking at the bottom line impact on companies you might want to invest in, when it comes to offshore projects, the netbacks are going to decrease significantly, so your profits are going to decrease significantly. Then there’s the overhang of the potential for another actual disaster and the clean-up costs.

Q: So this is clearly going to be a setback to offshore drilling. What are the implications from a supply perspective? Are you guys believers in the whole Peak Oil thing?

Bustin: Fundamentally, I'm a believer in the concept of Peak Oil. Yet, with the new accessibility to reservoirs made possible by technologies that allow us to drill horizontally and release petrocarbons unconventionally through fracking, I am not sure we have actually seen Peak Oil. Ultimately, however, we are burning through an awful lot of what is undeniably a finite resource.

Katusa: David, the problem with the Peak Oil theory is, it doesn’t take into account the increase of production and supply and the economic value of the reserve using unconventional technologies, which are always improving. Moving forward, we are long-term bulls on the oil price, but we've been consistent in telling our subscribers to stick to the fundamentals – that the companies they should be investing in are those that are able to produce at the lowest costs. Viewed from another angle, if a company in your portfolio needs $150 oil to make a profit, you should be a seller.

Q: What cutoff price do you think investors should be looking at for a company they want to own?

Katusa: In our in-house calculations, we use US$45 per barrel. If a company cannot produce economically and with a solid netback at $45 oil, they are not a low-cost producer and should be avoided.

Q: For the readers who are not familiar with the term, can you define "netback"?

Katusa: Netback is basically the difference between your production costs and what you sell your oil for at the well head. Let's say the spot oil price you are receiving is $75 and your all-in costs are $40, your netback would be $75 minus $40, for a netback of $35.

Q: On the topic of unconventional production, there's clearly a trend towards viewing the oil sands from an environmental standpoint as being a bad thing. Do you anticipate there being additional taxes levied or even a complete ban on the sale of oil from oil sands?

Katusa: The oil sands have too big of a production profile for them to be banned as a source. Already, one out of every six barrels of oil consumed by a U.S. citizen comes from the Canadian oil sands. We’ll almost certainly see increased taxes, however, that assure that oil sands are not going to be our cheap source of oil, though it will continue to be a sure source of oil.

Q: Won't that ratchet overall prices higher?

Bustin: The overarching problem is that the oil sands projects are so capital intensive – we're talking about 60-80 billion dollars already invested, with potentially another 300 billion dollars yet to be invested to maximize the resource. You can't put together projects with a capex of that magnitude unless you have a predictable price of oil.

Katusa: It’s worth noting here that the existing production is profitable at a cost of around $40-$45 per barrel. But of course, that doesn’t take into account any new taxes.
For the time being, taking into account the netbacks being earned by both conventional and unconventional producers – with even the oil sands operators currently operating at margins of close to 100% -- we see the potential for some downward pressure in the price of oil in the short term. Remember, for years and years, the big oil companies were running at 10-15% margins.

Q: Do you think we’ll see a carbon tax – cap-and-trade and all that?

Bustin: Absolutely.

Katusa: Whether you like it or not, it’s coming. While we all know it’s complete nonsense, if there is one certainty in today’s world, it is that the governments are going to tax whatever they can, and most of the people who support the current government in the U.S. believe that a carbon tax is good because they’re taxing the bad polluting companies that have billions of dollars in their banks. So it's coming.

Right now the voluntary market for CO2 is trading around $8-10 per ton, but in Europe, which has a mandatory market, the cost is double that. That's a big cost.

Q: Let's talk a bit about natural gas. From the geological perspective and also as an energy investor. Dr. Bustin, what’s your outlook for natural gas?

Bustin: In North America, we see natural gas lingering around the $5-or $6 range probably for the rest of the year. There really is a lot of natural gas available. Also keeping a lid on prices is that there are a lot of projects on line that aren’t quite economic at current prices. However, as soon as prices start moving up a little, a large amount of gas will become economic and therefore hit the market.

Prices in Europe are starting to decline significantly from a year ago as well, thanks also to increased supplies, so we're pretty soft on natural gas. That doesn’t mean you can't make money in natural gas or by investing in natural gas-producing companies – you can, but you have to be very selective and focus on low-cost producers.

Katusa: Moving forward, there are two things that will be very important to the sector. The first is that, thanks to unconventional technology becoming increasingly streamlined and effective, there are thousands of wells that have been drilled, fracked, but not completed. Those wells can come on stream with between 2-10 BCFs per day and are just sitting there. Think of it as a shadow supply of natural gas in the U.S.

The second thing to keep in mind is that the success that companies have had in exploiting the shales has resulted in massive new deposits.

Finally, it’s important to understand some of what’s going on with the oil-to-gas-equivalent ratio, which has traditionally been around 6:1. Consequently, at current spot prices, many analysts and promoters are saying, "Well, natural gas is cheap relative to the price of oil." Be careful when you hear that.

For instance, a lot of oil companies are purchasing gas companies because lower gas prices have made the companies cheap. The oil companies then look to boost the reserves on their balance sheets by reflecting the gas they acquire as BOEs, or barrels of oil equivalence. They will then actually book it as a barrel of oil to analysts at a ratio that is something like 22:1 today.

Q: What are the implications to us as investors?

Katusa: It all comes down to what a company is actually worth, which will guide you in what you pay for it. If a company says it has a billion barrels of oil equivalent in the ground, it will command a much higher price than if it showed its actual oil reserves and that it also had, say, three TCFs (trillion cubic feet) of gas. A surprising number of companies are doing this, including mid-tiers and majors. Imagine the implication to shareholders if this con is exposed for what it is?

Q: Can these companies actually convert their gas into usable oil?

Katusa: No.

Q: With the oil/gas ratio skewed in favor of gas, what about the market for substituting oil with gas?

Katusa: You have to ask, can we create a market for the natural gas that actually substitutes for oil? Of course, the big one would be having more compressed natural gas stations to encourage car manufacturers to make the switch, and there are a number of companies in North America looking to do just that. The big movers in that initiative are Canadians, but the idea has a lot of potential given the general theme of trying to reduce reliance on oil from foreign sources.

Q: Isn’t an increasing amount of base power generation switchable from oil to gas?

Bustin: With a lot of effort. Of course, the big one is the switch from coal to natural gas. Natural gas is much cleaner burning. In Canada, just a couple of weeks ago, legislation was passed calling for no new coal-fired plants. I think after a period of 15 years, they won't allow the existing coal-fired plants to be refurbished and continue to burn coal. So there's going to be a huge shift towards natural gas-fired electrical generation in North America, because of the carbon issues.

Q: I know you guys like coal, which is kind of counterintuitive, seeing how most people view it as dirty and dangerous. What's driving your outlook on coal – again from a fundamental standpoint and also in terms of finding investment opportunities?

Katusa: Start with the big picture. As much as 75% of China’s electricity generation currently comes from burning coal. That’s not going to change anytime soon. In fact, 2009 was the first year ever that China actually imported coal. Not so long ago, it had been a big exporter. But already half of the coal in the world that is produced is used by China.

On top of that, and this is pretty ironic given the popular view of coal, is that the U.S. is the second largest consumer of coal in the world, after China – with India being a distant third. Everyone is saying coal is dirty, coal is ugly, coal is smelly. It's done. We're going green. Even Obama said so. Yet if you’re careful, it’s where the profit is to be made. In fact, coal has been the biggest winner of all the energy subsectors over the last 12 months.

Q: How do we invest?

Katusa: In terms of investments, we like those related to met coal, versus thermal. As a reference point, there have been contracts signed in China at $105 per ton of thermal coal, but and as high as $500 per ton of met coal.

That’s because on the order of 90% of all steel production is dependent on met coal because of the temperature it produces. In North America, there are serious difficulties bringing on a thermal coal project, starting with environmentalists and government regulators, but also because transportation of the coal is the largest cost of a coal project – and therefore the deciding factor in the economics. Simply, at today’s prices, if you don’t already have a train running almost right up to your new thermal coal mine, it’s almost certainly not going to get off the ground.

So we have decided to stick with met coal for North America. On our North American met coal plays, we have recently recommended two in our alert service. They are doing well, and we expect them to go a lot higher.

Q: You like companies with significant upside as opposed to run-of-the-mill returns. That typically means small-cap companies. Are there smaller coal companies investors can get into, or are these all large companies?

Katusa: The coal companies have huge amounts of cash right now, because they’re kind of like the base metal of the energy sector. They’re boring, but they make a lot of money.

There are ETFs you can use to play the coal sector, but the reason why I like the juniors is the share price can go up ten times, as was the case recently with Western Canadian Coal. Of course, there are big companies with good coal exposure, like Peabody or Nobel or Teck Cominco. They have great assets, but the bang for your buck is not going to be as high as with a small-cap play.

Q: Let’s talk nuclear. There has been a lot of talk about pebble-bed reactors dotting the Chinese landscape, yet here they are scrambling for coal. Whatever happened to the dozens of new nuclear plants that were supposed to be headed for China?

Katusa: Despite popular conceptions, the pebble-bed reactors are actually an old technology, initially developed by the Nazis. The Chinese bought the technology off the Germans.

Pebble-bed reactors were supposed to be the Henry Ford Model T of nuclear reactors. They would actually be built in an assembly line. Imagine it like a LEGO set. As a town grows, you add a module. As the city grows and the energy requirements grow, so does the number of nuclear reactors.

However, the technology is still not ready for prime time. In fact, it's years away. That said, in the not-too-distant future, the demand for power and the need for governments to launch make-work projects will almost certainly kick off a rush to get a piece of the action. Especially in China.

Q: How would you play it as an investor?

Katusa: The best way is through a small-cap uranium company with a substantial economic resource, because these reactors are going to need a lot of feed. The time will come when the spot price of uranium is going to return north of $100 per pound. The last time that happened, a lot of the early investors in the better uranium juniors – most of which are Canadian – made a lot of money.

Q: What's your time line for uranium to push back over $100 per pound?

Katusa: I'd say 3-5 years.

Q: What are the fundamental reasons for this?

Katusa: The HEU Agreement, which involved nuclear warheads being dismantled and the uranium blended down to nuclear fuel has now come to an end and it will be three years before it is renegotiated. The last time it was negotiated, Boris Yeltsin was in power and Russia was on its knees. That's not the situation today. Russia is very powerful and Putin is still running the country behind the scenes. This time around, they’re going to negotiate a much different agreement. And don’t forget that today, unlike back when the last treaty was negotiated, the China factor is huge.

We would expect the Russians to go to the Chinese first before they renegotiate with the Americans. So the Americans are a victim of their own success by depending on the cheap Russian nuclear fuel. That time is coming to an end in three years, and within five to six years you'll see spot prices very high.

With the world increasingly looking to ramp up nuclear energy production – as it very much is – any of the companies with large reserves and the potential for low-cost production are going to be trading at a nice premium to where they are today.

Q: As an investor, where in the energy sector is your biggest focus right now? Where are the big opportunities in the relative near term?

Katusa: Before you can talk about specific opportunities, it’s important to be sure you have the right strategy to bringing those opportunities into your portfolio. These are very fragile markets, and so our strategy has been very conservative for some time now.

For instance, we spend a lot of time identifying great management teams that are personally heavily invested in their own companies – and then wait for them to raise cash through private placements that allow investors to pick up both a share and a warrant on favorable terms. Once the holding period is over, which can be as little as a few months, selling the shares and riding the warrants can be a good move as it gives you most of the upside with none of the downside if the markets tumble.

Likewise, we don’t chase stocks but instead decide what we’re willing to pay for a stock – which in these volatile times might be 20% below where it currently trades – and then wait patiently for it to come to us. That approach doesn’t always work, as sometimes we don’t get filled, but we’re okay with having a greater-than-normal allocation to cash at this point.

Another technique we use is what we call the Casey Cash Box – which involves running regular screens of a universe of small to mid-sized energy companies, looking for prospective companies selling at discounts to cash and other liquid assets. You might say we look to buy dollars for quarters.

Finally, when we get the desired result from our analysis – i.e., we buy good companies cheap and watch them move higher, we don’t hesitate to cash out our initial investments and take a free ride on the balance.

These are dangerous markets, and being cautious while building a diversified portfolio of energy plays makes a lot of sense. At least to us.

Okay, with that foundation, where would I invest today?

For starters, I might try to get ahead of the large sovereign wealth funds. And they are being pressured to invest in green energy. That’s one reason we’re more bullish than ever on green energy plays with the real potential to be economic.

Q: So which of the green energies are potentially economic?

Katusa: Geothermal and run-of-river are two we particularly like just now.

Q: Geothermal is not a new technology. It’s been used in energy production for something like 100 years, right?

Katusa: That’s correct.

Q: So why isn't it in wider use? What percentage of the base load in electricity in the U.S. comes from geothermal?

Katusa: Less than 1%.

Bustin: Economic geothermal projects are found in areas where you have very high heat flow or fluids near the surface. Of all the deep dry rock geothermal projects, where the real energy potential exists, none are actually economic. Currently they’re still in the experimental stage. At some of the more prospective sites in Australia, they ran into some significant problems, so it's still in the science box.

As a consequence, most of the geothermal projects you see are not where the real future is, which is in the deep dry rock geothermal projects, and those are going to take more time and a lot of money to get right.

Q: Aren’t government subsidies that can help the geothermal companies try to reach economic sustainability a big part of the attraction just now? Isn’t that also the case with run-of-river?

Katusa: No question, depending on the jurisdiction a company operates in, the subsidies for green energy projects can be very substantial. So much so that it makes it almost impossible for a company to lose money. Which, of course, all but eliminates the risk to shareholders as the company tries to build something that can last.

As for run-of-river, which involves diverting flow from a strongly running river, using it to turn a turbine, then returning it to the main river, there are actually quite a few opportunities. In fact, our latest look at the sector found over 45 small-cap companies. We recommended two, and one of them gave us a double that allowed us to cash out all of our initial investment, giving subscribers a free ride on the rest.

Overall, the prices on these companies have reached the point where we are holding off on any new recommendations in the sector, but we expect the prices will come back to an attractive level in the not-too-distant future. We’ll be ready when they do.

Q: Dr. Bustin, we’ve heard from the Dealman. Now, speaking from the technical perspective, are there any particular energy sectors now attracting your attention?

Bustin: Well, I'm really concerned about the coal sector. We're so dependent globally on coal. If we start slapping some major carbon taxes on coal, it's going to be catastrophic. I'm not quite sure how it's going to work out, because there is no way China and India and a lot of the developing nations, particularly in Southern Africa, which are so dependent on coal, are going to be able to manage. If they have to face these carbon taxes, I'm not sure where the world economy is going to head, because there's no way we can free ourselves from coal.

Q: I've heard the idea to use taxes to level the playing field between the dirty and the clean sources of base power. So coal would be weighed down, if you will, by added taxes to the point where there is no cost advantage to using it over natural gas. Have you heard the same thing?

Katusa: The beauty of coal is, it's base load. It's cheap and it's easy. The problem with solar is nighttime, and the problem with wind is no wind. And even run-of-river, which we like, fluctuates according to the climate, which is why geothermal is our favorite green energy because of its base load potential.

Taken together, these alternative energy sources are okay as secondary sources to meet excess demand, but they’re not your go-to sources. What most people don’t realize is that much of the power used isn't from people charging their Blackberry or running their computers, or any of that. It’s used by big commercial industries, such as manufacturing and mining, for example.

Q: In the past, Dr. Bustin, you’ve said that is the question is not so much about which energy sources to use, but rather that, in order for the world to maintain even the status quo, the answer will be “All of the above.” In order to avoid the economic devastation of runaway energy costs, we're going to need every single source we can get over the next ten years. Fair statement?

Bustin: Yes, it is. Unfortunately, when we look at our gross national product per capita, it's directly proportional to our energy consumption. And, of course, if you look at multiple billions of people who have very low standards of living and if you want to give them a gross national product per capita comparable to that we enjoy in the developed world, you have to expect global energy consumption is going to continue to skyrocket.

As I’ve tried to indicate, the only way to even come close to meeting that energy demand is with coal. There is just no alternative for the foreseeable future, until we get into bigger reactors or some other interesting usage of nuclear power. Bottom line, we're stuck with fossil fuels, and the fossil fuel that is readily available and most economic is coal.

Q: Are you looking from an investment standpoint at any offshore opportunities to tap into some of that demand for coal coming out of China?

Katusa: We've got one on our radar screen now, but it’s premature to mention it here. I've actually visited the site twice and like the story. It's a great project, the management is heavily invested in it themselves, but we haven’t recommended it yet because we are waiting for a couple of financings to come free trading, which will result in more stock available – and that will create downward pressure. By being patient, investors should be able to get it at a cheaper price. That theme, of being patient, can’t be stressed enough. Especially in markets as volatile as these.

Q. Good advice, and a good place to leave off. Thanks for your time.

David Galland is a partner in Casey Research, LLC., an international firm providing research and investment recommendations to individuals in over 150 countries. Prior to joining Casey Research, he was a founding partner and director of a successful mutual fund group (Blanchard Group of Mutual Funds), and well as a founding partner and executive vice-president for EverBank, one of the biggest recent successes in online financial services.

If you’re interested in the staying closely in touch with the ever changing investment opportunities in the energy sector, you’ll find no better team than Marin Katusa and Dr. Marc Bustin as your guides. Just recently they tapped into one of the best-kept secrets in European energy policy – a sure-fire winner. Read more here.

Ed. Note: I am a Casey Research affiliate and subscriber.  I also head up their Sacramento Phyle.

Most Popular Articles This Month