Friday, July 19, 2013

Gold: Fever Or Cure? Uranium: Japan Readies Reactor Restarts -

Is Gold Now Just Another Four-Letter Word?

For a decade since 2001, gold outperformed every investment sector I can think of—commodities, stocks, bonds, real-estate etc. Back then gold was around $260/oz., and by late 2011 it sold for over $1,900—a 7+ bagger or over 630% return. Gold—bullion more than mining shares—was an investor's consistent darling for so long that corrections should be expected.

In fact there were significant gold price corrections in 2006 and in 2008, which after a few to several weeks promptly resumed its up-trend. However the depth, duration, technical to even psychological damage of gold's current correction may be causing even the most religious of gold-bugs to question their faith. UBS and others seem determined to pluck the cherry from gold's bull-market cake by recently declaring that the Commodity Supercycle is probably over.

For latecomers to the party, GOLD must seem like a four-letter curse word. Since April's sudden $200+/oz. sell-off to $1,321.50/oz., metals prices continue making new near-term cycle lows. Trashed mining share prices will likely lead to even weaker than usually low summer trading volumes as investors seem caught like deer in the headlights. Instead of gathering the courage and tools to try and figure out where gold's bottom will be, many have simply given up! That's Capitulation!

Gold is at an interesting inflection point. On one hand gold prices have come down, while costs to develop and operate mines have gone up significantly. Many mines have all-in costs that exceed the recent gold price of around $1,200/oz. If the price continues going lower, the pace of production delays, development deferments and outright mine closures may increase significantly.

On the other hand, how much more blood in the streets is needed before metals become oversold and a screaming buy again? I mean we all know that markets tend to overshoot on both the upside and the downside; how much lower can gold get before value investors say its low enough and take charge?

Gold's Glitter Gauges

Oil is the world's benchmark energy component—a major input expense that has led to higher mining costs over the past decade. The Gold / Oil Ratio indicates that gold—after years of being relatively expensive—now seems undervalued compared to oil. The historic gold/oil ratio is around 15; it was around 21 as gold touched $1,923/oz. on Sept. 6, 2011. During the last major commodity up-cycle in 1980, gold peaked at over $850/oz. as oil topped $40/bbl.—also a ratio of 21. Today it's less than 12!

As for the China slowdown argument, whether or not China's growth rate drops from 8% to 7% shouldn't really matter. It should even be expected—with further growth percentage drops—as growth dynamics of a small economy cannot be maintained as it becomes a developed large economy. China has real-growth of a much bigger industrial base than before—whereas our stock markets swoon over dismal and debatable fuzzy-growth based mainly on borrowed consumption funded by cheap money.

Call it TARP, Quantitative Easing, Tapering or whatever—I simply call it BB's Magic Money Machine—this continuing flow of trillions of extra U.S. debt and dollar dilution spells even more room for China to grow as this eventually gets factored into the Purchasing Power Parity (PPP). As the Yuan continues to strengthen and we hear about the Chinese buying more and more gold, we should wonder what value backs our ballooning extra currency circulation other than lip service.

While China is now the world's second largest economy, its GDP is still only around half of the U.S.'. This leaves lots of room for China—and other emerging economies like India—to lead the world's growth forward as living standards there increase. China realizes the benefits of developing its own value added retail markets—vs. depending on wholesale exports—at quadruple the U.S.' population.

China's economic engine may have to gear down periodically to prevent overheating, while the U.S.' remains flooded and stalled—now with a $60T-lb. gorilla of debt to drag along. Will the rebound in industries such as housing and autos save the day—ask any under-funded U.S. city or state pensioner how they feel after today's news that Detroit Declares Bankruptcy? Paper money only has value because we believe it does. This value perception is carefully massaged to avoid any major reality spills that could send gold flying—a Fed confidence cocktail that's stirred but not shaken... yet!

As time tested Real Money, gold has always been a proxy for the amount of fiat currency in circulation. As more debt and currency is issued, each unit of gold should become more valuable. This is not unlike when a company issues more shares, each share then represents a smaller slice of that company's assets and earnings pie—think of dollars as USA Corp. shares.

Even if you believe the growth, employment and inflation stats, this is still not enough to service—let alone repay—the accumulated debt bubble, even if interest rates stay at zero forever. At some point interest rates will have to go up—either to slow inflation or to hold support for the Dollar, Euro and Yen. Unsuccessful massaging under either scenario might result in a late 1970's style gold spike.

Finding Gold's Bottom

Remember that cough syrup ad?—It tastes awful. And it works. Look at any major index 5-year chart and ask yourself how many stocks you bought back in March 2009—around the bottom of that giant V-Formation. Unless you believe the currency tap and debt bubble can be deflated slowly without causing a major depression, or not deflated while still avoiding hyperinflation, only then will gold prices possibly persist in hibernation. However, history shows that bubbles tend to suddenly pop!

Nobody knows where gold will bottom, or if prices will go into another big sleep or come roaring back in a V. Deficits and debt are still the main symptoms of the same Devaluing Dollar Disease. Gold's bull-market of the 1970's didn't resolve this until prices went parabolic—we haven't seen this yet! We should pay attention this fall to the debt ceiling debates—the Credit Rating Agencies will!

Fibonacci Retracements of the $792/oz. closing low—during gold's August 2008 correction—to the $1,923/oz. high—in Sept. 2011—shows that today's spot price has already sliced through the 23.6%, 38.2% and 50% support levels—$1,656, $1,490 and $1,357 respectively. Now $1,295/oz., gold sits above the key 61.8% Golden Ratio level of $1,224—although on June 27 briefly touched $1,199.

Swing Traders watch these levels closely for technical bounces; Value Investors—even if they think gold is oversold—tend to nibble at each new low. Who knows how low gold's Limbo Dance can go?

Like you perhaps, I'm struggling to figure out if/when to step into this falling knife. Early in 2008 (NYSE: ABX)(TSX: ABX) Barrick Gold Corp.—world's largest producer—traded over $50/share. I said to myself then, if ABX ever gets back to $20, I'm in for the long-term. So did I buy ABX during the financial crisis later that year as it breached $18—or on its way back up to $55? No!

ABX remains on my Watchlist & Alerts—emailed daily from our website—but I'm still not in, not at $20 or even as it made new 10-year lows on July 5 at $13.43. When will they be profitable again, how will Pascua-Lama cost overruns and delays be resolved, is their 5% dividend safe, and what other warts am I missing? I may pick my spot soon—hopefully before ABX or gold snaps back much more.

ABX is just one example; all gold Majors are beaten down—from both industry related and company specific events. I also track various liquid Gold ETFs: (NYSE: GDX) Market Vectors Gold Miners and (NYSE: GDXJ) Junior Gold Miners—baskets of large to small-cap gold stocks, plus (NYSE: GLD) SPDR Gold Trust and (NYSE: SLV) iShares Silver Trust—largest paper gold and silver ETFs.

Then there's the Juniors. You've likely heard that hundreds may die off this year—I don't dispute this. Many exploration stocks either disappeared or morphed into Dot-Com stocks after the Bre-X Scandal in the 1990s. However like then, many others have adequate cash on hand—with real projects and established resources—to not just survive, but to advance discoveries and build shareholder value.

With gold having its worst quarter in 30-years, everything seems washed out to the point that I may just take a buckshot approach when it comes to the majors—top names on dips and over time. A rifle with a scope is always needed when assessing the juniors, although I can't recall there ever being as many cheap small-cap gold, silver, base metals to even rare earths exploration stocks—we're talking with as many as possible and hope to feature more of these companies in our newsletters again.

Will Uranium Prices Play Catch-Up To Oil?

Commodity prices went on a tear from 2001 until after the Great Recession started in 2007—from base to precious metals, agriculture futures to energy. Uranium—as a mined metal and as an energy component—benefited from both the new millennium's mining boom and in sympathy with growing world energy demand and record high oil prices. Oil topped out at $147/bbl., U3O8 at $137/lb..

As analyst's debate whether the current economic recovery is for real, oil continues to stubbornly resist calls for lower prices—now going the other way at over $100/bbl. again. However uranium prices are not even close to keeping pace this time—spot U3O8 sits just under the $40/lb. lows last seen after the financial crisis in 2010 and 4-years earlier in 2006. Will U3O8 converge with oil again?

Uranium stocks were one of the best performers up until the Fukushima nuclear plant accident in March 2011. We still believe in uranium because the growth fundamentals of nuclear energy—instead of deteriorating—have actually improved. Japan's record 9.0 earthquake and tsunami was a rare event, and time was needed to assess and adjust safety needs. However the demise of nuclear power that some predicted, was clearly an overreaction—more reactors are in the works today than ever before.

We said this would play out as a deep dip within a long-term up-trend, and uranium has generally lagged gold and other metals post Fukushima—especially up until late 2011. After gold's correction from its all-time highs became apparent—having intensified since April's whammy—uranium stocks that had already sold off hard have formed their base, and have lately been a relatively safe haven.

Contrarian Investors should see uranium as a beaten-down mining play that is probably several months ahead of gold and other metals in its recovery phase. Uranium as an energy component may also start to play catch-up again as high oil prices persist.

Uranium's Deep Value Proposition

Value & Growth Investors should recognize the inherent competitive advantage that uranium has over other fuel sources. Nuclear reactors have provided reliable, low-cost and environmentally friendly power since the 1950s. While coal, natural gas and other fossil fuels—when less expensive—can often replace oil, there is no commercially available substitute for reactors to use other than uranium.

However as U3O8 prices start to rise—even to multiples of the current spot price—end-user power rates and profits for nuclear utilities are not impacted that much. High capital costs and securing uranium supplies are bigger concerns—fuel costs represent only 15%, with half of this for conversion, enrichment and fabrication. See the World Nuclear Association's: The Economics of Nuclear Power.

Nuclear power plants are big projects—e.g. (NYSE: SO) Southern Company units 3 and 4 being built at Georgia's Vogtle Complex—that typically cost over $7B per reactor. They are made to last several decades—so dependable long-term uranium supplies are crucial. The earth contains abundant uranium resources to power all of the world's planned reactors for more than 80-years, but these projections were based on uranium mining projects that are not profitable until current spot prices double.

We have written about major producers that have been cancelling developments—e.g. (NYSE: BHP) BHP Billiton's Olympic Dam (world's largest known uranium ore body) and its mine expansion—to closing uneconomic mines. More production is needed, not less, as the world already consumes more uranium than it mines each year—with the number of reactors set to more than double by 2030.

To make supply matters worse, the Megatons to Megawatts HEU program—down-blending uranium from Russian warheads—provides ~24Mlbs. per year to U.S. utilities, and ends this year. In total, 60Mlbs.—over 1/3 of the world's current annual consumption—has already or will soon be taken off the market. Only much higher uranium prices can resolve the obvious supply deficit that's developing.

The main reason that metals tend to overshoot their price trends is that it can take several quarters for miners to adjust their production. It can take several years to finance, discover, permit and construct new mines. Uranium is the most regulated type of mining—taking significantly longer.

Uranium's Fog Is Clearing Fast—Japan's Reactor Restarts

Our past newsletters have mentioned various near-term uranium catalyst events—most important on the supply-side being mine closures and the end of the HEU program, and for demand the restart of Japan's reactors. We continue to believe that U3O8 put in its bottom late last year going into Japan's December elections, resulting in a pro-nuclear government and the spot price rallying over 10%.

Japan was getting 1/3 of its power from nuclear—with plans to increase this to 50%—before Fukushima. Japan still has one of the world's largest fleet of operable reactors—equal to half the number of U.S. reactors that supply 20% of its electricity—however only 2 of Japan's 50 reactors are currently operating. We have always said the question is not If they would restart, but When!

Last fall, Japan formed an independent Nuclear Regulation Authority (NRA) to come up with a new safety legal framework by July 2013, to enable the country's idled nuclear power reactors to restart. To operate, nuclear companies have to show their reactors can withstand large scale natural disasters, to even terrorist attacks or war. This includes stronger and higher tsunami walls, waterproofing key buildings, manually operable valves, filtered vents (within 5-years for pressurized water reactors), foam or water cannons to help stop airborne radiation, etc. Within 5-years they will also have to retrofit with core catchers, plus have a secondary: control room, power supply and water source.

On July 8, the new safety guidelines went into effect, with four Japanese utilities—Hokkaido, Kansai, Shikoku, and Kyushu—applying to the NRA for restarts at five separate facilities. The NRA review is expected to take a few months before local authorities give the go-ahead to restart. This means that up to 12 of Japan's reactors could be back online at around the end of this year.

Markets tend to move in anticipation; as Japan's restarts progress—with 38 more reactors to follow—uranium's price recovery may have already turned into a bull-market by then. Other than positioning early, timing this can be difficult. A 10-year chart shows that spot prices—instead of gradually building—tend to spike, from $10 in 2003 to $137 in 2007, and from $40 to $72 from 2010 to 2011.

Uranium Plays—Uranerz Energy Corp.

U3O8 doesn't have a liquid futures market like other commodities, and can't be held like gold bullion—it's radioactive. There are a few ETFs, such as (TSX: U) Uranium Participation Corp. which holds oxide concentrates or hexafluoride—managed by (TSX: DML)(AMEX: DNN) Denison Mines Corp..

The way to participate in both the long-term growth of nuclear power and the near-term recovery of U3O8 prices is uranium mining stocks. The world's largest producer is (TSX: CCO)(NYSE: CCJ) Cameco Corp., which in June received its Cigar Lake mine operating license. Junior explorers are another option, which we hope to focus more on later as the next uranium bull-market develops.

The best positioned uranium mining stocks may be mid-cap development plays, offering the certainty of established resources and an operating mine or one under construction—while still small enough to provide added leverage to higher U3O8 prices. We have mentioned several of these stocks in the past.

Our focus is on (AMEX: URZ)(TSX: URZ) Uranerz Energy Corp. which is nearing completion of construction of its first In-Situ Recovery (ISR) uranium mine, called the Nichols Ranch project—located in the prolific Powder River Basin (PRB) of Wyoming. Production is expected to commence later this year, at an initial annual recovery rate after ramp-up of 600k-800k lbs. of U3O8.

Uranerz has lots of room to grow; its last resource report shows over 19Mlbs. of U3O8 from just 7 properties explored so far—out of URZ' 30 PRB projects. Most of their initial production is committed via off-take agreements with utilities such as (NYSE: EXC) Exelon Corp.—signed when uranium prices were higher. This provides some safety of cash-flow at a set margin, with the balance of production levered to higher U3O8 prices. Nichols Ranch is licensed for up to 2Mlbs. per year, and as resources build on URZ' satellite projects, these can be produced via permit amendment provisions.

As an update, last month URZ did not make the cut to remain in the Russell Indexes—based solely on market-cap. Anticipation of this may have contributed to URZ dipping briefly below $1/share over a month ago. However on Friday, June 28, as Funds completed their index adjustments, URZ' price had barely changed after trading over 5M shares—over 17-times its normal daily volume.

URZ was trading at close to $6 a month before Fukushima—now $1.15 with a market-cap of US$90M. Some have cited URZ as an obvious takeover target for major producers wanting to get into the PRB, or to consolidate existing land positions there. Cameco already has a relationship with Uranerz, as uranium loaded resin from Nichols Ranch will be processed at Cameco's nearby Smith Ranch-Highland plant—the largest uranium production facility in the United States.

Three uranium analysts recently updated their URZ targets—each to over double the current price—and while takeover potential is mentioned, it is not factored in. Short-term events to watch for are the closing of Uranerz' $20M Wyoming state loan, and when their two Deep Disposal Wells will be completed. This is one of the last steps before mine commissioning—and URZ being re-rated as a producer—just as the fog over uranium prices should already be clearing with Japan's reactor restarts.

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