Earnings Growth to Ramp Up? Call Me a Skeptic

By Sheraz Mian

Stocks have performed impressively this year and have largely been able to hold on to the gains despite monetary and fiscal uncertainties and the less than inspiring economic and earnings pictures. In a price-earnings framework for the market, most of the gains this year have resulted from investors’ willingness to pay a higher multiple for pretty much the same, or even lower, earnings.

Reasonable people can disagree over the extent of the Fed’s role in the market’s upward push, but few would argue that the Bernanke Fed’s easy money policy has been a key, if not the only, driver of this trend. If nothing else, the Fed policy of deliberately low interest rates pushed investors into riskier assets, including stocks.

But with the Fed getting ready to institute changes to its policy, investors will need to go back to fundamentals to keep pushing stocks higher.

We don’t know when the Fed will start ‘Tapering’ its bond purchases, but we do know that they want to get out of the QE business in the "not too distant" future. What this means for investors is that they will need to pay a lot more attention to corporate earnings fundamentals than has been the case thus far.

The overall level of corporate earnings remains quite high. In fact, aggregate earnings for the S&P 500 reached an all-time record in 2013 Q2 and are expected to be not far from that level in the ongoing Q3 earnings season as well. There hasn’t been much earnings growth lately, but investors are banking on material growth resumption from Q4 onwards. This hope is reflected in current consensus expectations for 2013 Q4 and full year 2014.

I remain skeptical of current consensus earnings expectations and would like to share the basis for my skepticism with you. The goal is to convince you that current earnings expectations remain vulnerable to significant downward revisions.

Negative estimate revisions haven't mattered much over the last few quarters as the Fed's generous liquidity supply helped lift all boats. But if the Fed is going to be less of a supporting actor going forward, then it's reasonable to expect investors to start paying more attention to fundamentals. It is in this context that the coming period of negative revisions could potentially result in the market giving back some, if not all, of its recent gains.

This discussion is particularly timely as we are in the midst of the 2013 Q3 earnings season that will help shape consensus estimates for Q4 and beyond. In the following sections, I will give you an update on the Q3 earnings season and critically review consensus expectations for Q4 and beyond.

The Q3 Scorecard

 

As of Monday, October 21st, we have Q3 results from 109 companies in the S&P 500 that combined account for 31.6% of the index’s total market capitalization. Total earnings for these 109 companies are up +7.5% year over and 63.3% of companies beat earnings expectations with a median surprise of +2.1%. Total revenues are up +2.1%, with 45.9% of the companies beating top line expectations and median revenue surprising by +0.02%.

The table below presents the current scorecard for Q3



Note: One sector, Aerospace, has not reported any Q3 results yet. NRPT means ‘no reports’; NM means ‘not meaningful’. 

With results from more than 30% of the S&P 500’s total market capitalization already out, we are seeing the Q3 earnings picture slowly emerge. This is particularly so for the Finance sector, where 51.8% of the sector’s total market cap has already reported. Other sectors with meaningful sample sizes include Transportation (47.3%), Consumer Staples (40.4%), Technology (36.9%) and Medical (25.2%).

Finance has been a steady growth driver for the last many quarters and is diligently playing that role this time around as well despite anemic loan demand, wind-down of the mortgage refi business and weak capital markets activities, particularly on the fixed income side. Outside of Finance, total earnings are up +4.4% for the companies that have reported already.

How do the 2013 Q3 results thus far compare with the last few quarters?

The short answer is that they are no better than what we have seen from this same group of 109 companies in recent quarters. In fact, on a number of counts the results thus far do not compare favorably to either the preceding quarter (2013 Q2), or the 4-qurater average, or both.

Specifically, the earnings and revenue growth rates and revenue beat ratio are tracking lower, while the earnings beat ratio is about in-line



The charts below compare the beat ratios for these 109 companies with what these same companies reported in Q2 and the 4-quarter average (beat ratio is the % of total companies coming ahead of consensus expectations).



The trends we have seen thus far will shift to some extent as the rest of the reporting season unfolds, but not by much. A composite look at the Q3 earnings season, combining the actual results from the 109 companies with estimates for the 391, is for +2.1% earnings growth on +0.8% higher revenues, as the summary table below shows.

 

Earnings growth rate has averaged a little over +3% over the first two quarters of the year and will likely stay at or below that level in Q3 as well. With respect to beat ratios, roughly two-thirds of the companies come ahead of expectations in a typical quarter and the Q3 ratio will likely be in that same vicinity.

The ‘Expectations Management’ Game

 

In the run up to the start of the Q3 earnings season, consensus earnings estimates came down sharply. The primary reason for the estimate cuts – guidance from management teams. Companies guided lower for Q3 while reporting Q2 results, a trend that has remained in place for more than a year now.
The chart below does a good job of showing the evolving Q3 earnings expectations over the last few months.



The Q3 estimate cuts weren’t unusual or peculiar to the quarter, as we have been seeing this trend play out repeatedly for more than a year now. The chart below compares the trends in earnings estimate revisions in the run up to the Q3 and Q2 reporting seasons



These expectations mean that Q3 wouldn't be materially different from what we have become accustomed to seeing quarter after quarter, with roughly two-thirds of the companies beating consensus earnings estimates. This game of under-promise and over-deliver by management teams has been around long enough that it has likely lost most of its value in investors’ eyes.

Beat ratios may not carry as much informational value this time around, but what will be particularly important is company guidance for Q4 and beyond. Guidance is always very important, but it has assumed added significance this time around given the elevated hopes that Q4 represents a material earnings growth ramp up after essentially flat growth over the last many quarters.

Evaluating Expectations for Q4 & Beyond

 

Let's take a look at how consensus earnings expectations for 2013 Q3 compare to what companies earned in the last few quarters and what they are expected to earn in the coming quarters.
The chart below shows the expected Q3 total earnings growth rate for the S&P 500 contrasted with the preceding two and following two quarters. (Please note that the Q3 growth rate is for the composite estimate for the S&P 500, combining the 109 that have reported with the 391 still to come)



The Finance sector has been a big earnings growth driver for some time. Outside of the Finance sector, total earnings growth for the S&P 500 was in the negative in 2013 Q2 and is expected to be no better in Q3. But the high hopes from Q4 and beyond reflect a strong turnaround in growth outside of Finance.
The chart below shows the same data as the one above, but excludes the Finance sector.



What this means is that quarterly earnings growth was +3.4% in the first two quarters of the year, is expected to be 2.1% in Q3, but accelerate to a +9.4% pace in Q4. And not all of the expected Q4 growth is coming from the Finance sector, as the rest of the corporate world is expected to reverse trend and start contributing nicely from Q4 onwards.

The chart below shows the same data, but this time on a trailing 4-quarter basis. The way to read this chart of steadily rising expectations is that total earnings for the S&P 500 are on track to be up +3.8% year over year in the four quarters through Q3, but accelerate to +4.5% in Q4 and +5.6% in 2014 Q1. Consensus expectations are for total earnings growth of +11.8% in calendar year 2014.



The two charts below show earnings for the S&P 500; not EPS, but total earnings. The first chart shows quarterly totals, while the second one presents the same data on a trailing 4-quarter basis. As you can see, the 'level' of total earnings is very high. In fact, quarterly earnings have never been this high - the 2013 Q2 total of $260.3 billion was an all-time quarterly record.




The data in this chart reflects current consensus estimates. This shows that consensus is looking for new all-time record quarterly totals in the coming two quarters. The high expected growth rates in Q4 and beyond are more than just easy comparisons, they represent material gains in total earnings.
The record level of current corporate profits is also borne by the very high level of corporate profits as a share of nominal GDP, which has never been this high ever. The chart below, using data from the BEA, of corporate profits as a share of nominal GDP clearly shows this.




Where Will the Growth Come From?


There is some truth to the claim that the current record level of corporate profits, whether in absolute dollar terms or as a share of the GDP, does not mean that earnings have to necessarily come down. But earnings don’t grow forever either as current consensus expectations of double-digit growth next year and beyond seem to imply.

After all, earnings in the aggregate can grow only through two avenues - revenue growth and/or margin expansion.

Revenue growth is strongly correlated with 'nominal' GDP growth. If the growth outlook for the global economy is positive or improving, then it’s reasonable to expect corporate revenues to do better as well. But the global economic growth outlook is at best stable, definitely not improving as the recent estimate cuts by the IMF shows.

The U.S. economic outlook has certainly stabilized and GDP growth in Q4 is expected to be modestly better than Q3’s growth pace. The expectation is for growth to materially improve in 2014, with consensus GDP growth estimates north of +3% for 2014 and even higher the following year. Europe isn’t expected to become an engine of global growth any time soon, but the region’s recession has ended and its vitals appear to be stabilizing. The magic of Abenomics is expected to revitalize Japan, but it’s nothing more than a hope at this stage. In the emerging world, sentiment on China has improved, but India, Brazil, Turkey and other former high flyers appear to be struggling.

All in all, this isn’t a picture to get overly excited about. But with almost 60% of the S&P 500 revenues coming from the domestic market, the expected GDP ramp up next year should have a positive effect on corporate revenues, which are expected to increase by +4.2% in 2004. But in order to reach the expected +11.8% total earnings growth in 2014, we need a fair amount of expansion in net margins to compliment the +4.2% revenue growth.

Can Margins Continue to Expand?

 

The two charts show net margins (total income/total revenues) for the S&P 500, on a quarterly and trailing 4-quarter basis. For both charts, the data through 2013 Q2 represents actual results, while the same for Q3 and beyond represent net margins implied by current consensus estimates for earnings and revenues.



The chart below shows net margins the same data for a longer time span on a calendar year basis – from 2003 through 2014.



As you can see margins have come a long way from the 2009 bottom and by some measures have already peaked out.

Margins follow a cyclical pattern. As the above chart shows, they expand as the economy comes out of a recession and companies use existing resources in labor and capital to drive business. But eventually capacity constraints kick in, forcing companies to spend more for incremental business. Input costs increase and they have hire more employees to produce more products and services. At that stage, margins start to contract again.

We may not be at the contraction stage yet, but given the current record level of margins and how far removed we are from the last cyclical bottom, we probably don’t have lot of room for expansion. The best-case outcome on the margins front will be for stabilization at current levels; meaning that companies are able to hold the line on expenses and keep margins steady. We will need to buy into fairly optimistic assumptions about productivity improvements for current consensus margin expansion expectations to pan out.

So What Gives?

 

What all of this boils down to is that current consensus earnings estimates are high and they need to come down - and come down quite a bit. I don't subscribe to the view held by some stock market bears that earnings growth will turn negative. But I don't buy into the perennial growth story either.

So what's the big deal if estimates for Q4 come down in the coming days and weeks? After all, estimates have been coming down consistently for more than a year and the stock market has not only ignored the earnings downtrend, but actually scaled new heights.

A big reason for investors' disregard of negative estimate revisions has been that they always looked forward to a growth ramp up down the road. In their drive to push stocks to all-time highs in the recent past, investors have been hoping for substantial growth to eventually resume. The starting point of this expected growth ramp-up kept getting delayed quarter after quarter. The hope currently is that Q4 will be the starting point of such growth.

Guidance has overwhelmingly been negative over the last few quarters. But if current Q4 expectations have to hold, then we will need to see a change on the guidance front; we need to see more companies either guide higher or reaffirm current consensus expectations. Anything short of that will result in a replay of the by-now familiar negative estimate revisions trend that we have been seeing in recent quarters.

Will investors delay the hoped for earnings growth recovery again this time or finally realize that the period of double digit earnings growth is perhaps behind us for good? Hard to tell at this stage, but we will find out soon enough. My sense is that markets can buck trends in aggregate earnings for some time, as they have been doing lately. But expecting the trend to continue indefinitely may not be realistic.

220 Stocks To Sell Now

 

No matter where the market is headed, one fact is obvious: You should not buy and hold stocks unless they offer good prospects for profit. I can help you weed out many of the ones that don't make the grade. That is because my company, Zacks Investment Research, is releasing to the public its list of 220 Stocks to Sell Now.

These Strong Sells are sinister portfolio killers because many have good fundamentals and seem like good buys.   But something important has happened to each of them that greatly lowers their odds of success. Historically, such stocks perform 6 times worse than the market.

I invite you to examine this list for free and make sure no stock you own or are considering is on it. Today you are welcome to see it and other time-sensitive Zacks information at no charge and with no obligation to purchase anything.

See Zacks’ “220 Stocks to Sell Now” list for Free.

Best,
Sheraz Mian
Sheraz Mian is the Director of Research for Zacks and manages its award-winning Focus List portfolio. 
 
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Riding U.S. Refinery Stock Recovery

Thinking about investing in U.S. refiners? I wouldn't do that without first following our trading partner Chris Damas who today has released some great calls on the refiners. How you paying attention?

My October 14 recommendation to buy U.S. oil refiners Marathon Petroleum, Valero, Alon USA Partners and CVR Refining is working out well. The story is intact. WCS/WTI spread for December is ($6.33) meaning the inland refiners are making money.

In particular, I think Alon is a buy and back to $15.09 this morning (we recommended it at $12.96) with the short selling squeeze sending the units up to $16.80 before falling back. Will the shorts get active again? I think once burned twice shy.

Note Alon’s EPU (Earnings per Unit) and hence CAD (Cash available for distribution) is expected to be only 4 cents for Q3 and a loss of 1 cent for Q4. Therefore I would be cautious around the Alon EPU and distribution release date and sell before the November 8 release date.

Similarly, CVR Refining is up to $26 versus $24 and change when recommended. Analysts expect 50 cents for Q3 and 41 cents for Q4. CVRR had an unexpected FCC outage at Coffeyville refinery which took about a month to fix. I would be cautious around the EPU date on November 1.

I also like CVI Energy the holding company that owns 71% of CVRR and 53% of CVR Partners (UAN). The stock yields 7.3% at $41.29 this morning. The three CVR companies and MLP’s brought their EPS release dates forward by four days at the behest of controlling shareholder Carl Icahn’s IEP group.

I think this was merely a matter of timing all the releases to coincide as IEP owns a big chunk of CVI (82%) and its results are material to IEP. Marathon and Valero have curtailed parts of the massive Garyville , LA and much smaller Three Rivers , TX refineries for maintenance. The shutterings will affect only Q4 and are small relatively to their overall refining capacities. They are buys.

These stocks are for more conservative investors and are rallying nicely. MPC up this morning $1.29 to $72.22 and VLO up 77 to $40.52. We recommended those in the $67 and $36 area respectively. How much higher can they go? The December WTI/Brent discount is $10.76 this morning. Combined with the WTS/WTI sour discount of $6.33, that’s a $16.33 crack spread and very healthy for inland producers.

The Gulf Coast producers bench mark off GOM Mars and Mexican Mayan sour versus Light Louisiana Sweet. I am not sure where that is trading, but it can’t be far off the WCS/Brent spread. Anyways, we are buying all of these due to the EPA’s proposed reduction in biofuels usage and RIN credits for 2014.

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Why Investors Must Be Cautious At These Prices

Last week on October 8th the financial market experienced a broad based sell off. Every sector was down with utilities being the only exception.

The individual leadership stocks, which are typically small to mid-cap companies (IWM – Russell 2K) that have a strong history and outlook of earnings growth, were hit hard as well.

Whenever the broad market experiences a price correction, one of the most important factors I analyze is how well leading stocks hold up and show relative strength to the broad market.

So, where does this leave us going forward?

When stocks that have been leading the market higher and only pausing during market corrections in the S&P500, Dow, and NASDAQ, it’s a positive sign. This tells us investors and big money continues to flow into the risk on assets (stocks).

Conversely, when these leading stocks/sectors begin succumbing to the selling pressure of the broad market, it quickly grabs my attention and tells us it’s time to be aware that a major top may be forming.

It looks as though the broad market rally is just barely hanging on. If the leading stocks and sectors begin breaking below their 50 day moving averages, my proprietary SP500 Market Timing & Trading System will shift to sell mode and things could get ugly for those who do not know how to trade a bear market.

Here's our chart work including videos for "Why Investors Must Be Cautious At These Prices"



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Busting Economic and Natural Resource Myths

By The Gold Report

The Gold Report: Why is the theory of tapering or turning quantitative easing (QE) off a myth, and who really benefits from QE?


Rick Rule: My view—as an investor, not an economist—is that QE is misnamed. I think it's another way of saying counterfeiting. It exists in large measure because we're running a trillion-dollar deficit and, while we can hoodwink investors into funding two-thirds of it, we need to print away the last third.

TGR: What are the consequences of turning off QE?

Louis James: Federal Reserve Chairman Ben Bernanke said himself that he had certain criteria he wanted to see before tapering—employment in particular. Those have not been met. Employment figures have improved, but only in—I guess the technical term would be "crappy" jobs. Long-term employment, the middle class' bread and butter, is not better.

TGR: Rick, you defy common sense and argue that bull markets are bad and bear markets are good, but it doesn't feel that way.

RR: JT, at the risk of being sexist, women are normally more rational shoppers than men. Think about the stock market as a mall.

In the mall, the store on the left-hand of the entrance has a big flashing sign that says, "Bear Market Merchants All Goods 70% Off, No Reasonable Offer Refused, Come Back Tomorrow—Prices May Be Lower." The store on the right-hand side has a tiny sign that says, "Bespoke Bear Market Merchants, No Deals Ever, High Margin for Merchants, Don't Even Think About Asking for a Deal, Prices May Be Higher Next Week."

If you're going to buy a pair of shoes, which store would you go to? This is a no-brainer. When people buy physical goods, they act rationally. When they buy financial goods, they want to overpay. It's totally irrational, and it's extraordinarily common. If you want to become wealthier, why wouldn't you buy financial assets when they're on sale?

TGR: Staying with the mall analogy, does that suggest that people are afraid stocks will be on even deeper sale tomorrow?

Marin Katusa: You have to look at the timeframe. This is a great market if you're an accredited investor and have an account with someone like Rick Rule or you subscribe to the International Speculator and follow the right management teams. Today, you can invest in deals with five-year full warrants that would not have been available three years ago. Rick and I have been in meetings where the venture teams laughed at me when I requested full warrants. Rick just said, "Bite your lip, smile, and wait." And he was right.
If you're buying stock today in hopes that the market will go up the next day, you'll be in a lot of pain. But if you have a two- to five-year timeframe, you can get guys like Bob Quartermain and Lukas Lundin on sale.

LJ: What would you give to go back in time and buy Apple just after the Apple II came out? Or to buy Microsoft when DOS was new?

Over the course of the last decade—what I think of as the first half of this great bull cycle—billions of dollars have gone into the ground and done good work.

Companies with 10 million ounces of high grade gold in a safe mining jurisdiction are on sale below IPO prices. Some companies with excellent management and assets in hand are selling for less than cash value. You can buy these companies now, instead of looking for the next Apple or Microsoft.

RR: Words like "want" and "hope" in speculation are truly four-letter words, profanities. Having a stock in your portfolio that cost $200,000 and has a current market valuation of $40,000 is unfortunate, but irrelevant. Investors need to take advantage of their education and do their best with the situation at hand. Right now, things are cheap. When things are cheap you're supposed to buy. In bull markets, when things are expensive, you're supposed to sell.

Right now, buying is easy because you have no competitors. In a bull market, selling is easy because everybody is a buyer. If the market is desperately looking for bids and you are scared to death because your stocks can't catch bids, you have to bid. They say the market was desperate for asks, but this market is desperate for bids.

TGR: Some have said this the end of the commodity supercycle. Is that a myth? And is it more or less of a myth in some sectors than others?

RR: The narrative that existed in 2009-2010, when the commodity supercycle was the currency of all financial thinking, is unchanged. The first part of that narrative was founded on the idea that world population growth was taking commodity consumption higher. World population growth is not over.

The second part of the narrative was that as poor people gained more freedom, they got richer and consumed more. Political liberalization in emerging frontier markets has continued, and people are wealthier and are consuming more.

A third part of the narrative was that Western consumers had lived beyond their means and as a consequence were debasing the denominators, the fiat currencies. If you debase the denominator, the nominal value of stuff would go up. We have not stopped debasing the denominator.

The entire narrative associated with the resource-industry bull market is intact. Nothing has changed except the price. A cyclical decline in a secular bull market is a different way of describing a spectacular sale, for people who understand that the narrative hasn't changed.

TGR: Are there some sectors that still feel as if it's a commodity supercycle?

MK: Definitely. Look at oil.

RR: But your readers don't want to look for hot sectors, because they are overpriced. They want to look for cold sectors. They want to find the sector, management team, or the company that's going to be hot.

TGR: If oil is hot right now, what is going to be hot?

MK: From the energy side, I think within three years uranium will be hot.

TGR: Why the three-year timeline?

MK: There are three major catalysts. First is the end of the US-Russia Highly Enriched Uranium Purchase Agreement (HEU). The last shipment will happen at the end of 2013.

Second is the transitional agreement, in which the Russians will provide up to 50% of the uranium on a new pricing metric than the HEU agreement. Only this time, the Russians have new dance partners: Saudi Arabia, China, India, Korea, even France. The reality is the Americans will have to pay more for uranium from the Russians.

Third, nuclear reactors are not all being taken down; they're being built. Japan plans to bring its reactors back online, just not on the timeframe the junior resource sector wants them to. The Japanese cannot afford to pay the most expensive electricity prices in the world and stay competitive. They have no choice but to move forward with nuclear power.

TGR: Is the end of HEU already priced in to uranium?

MK: Yes, both because the market is determining what it's worth today and because Japan shut down 40 nuclear reactors. That's a black-swan game-changer that shifted everything.

Yet, the long-term price is 50% higher than the spot price, and more than 90% of the uranium being consumed and traded is based on the long-term price. That's the equivalent of saying gold today is $1,300/ounce, but if you want to take delivery in three or four years—which is what nuclear utilities do for uranium—you have to pay $1,900/oz. Or copper at $4.50/pound if you want delivery in five years. That's the situation in uranium today.

TGR: Louis, which sector are you looking forward to?

LJ: There's talk on the streets about helium, although I'm not sure I want to move in that direction. I'm happier focusing on something right in front of me and that I understand. Finding a company that has a multimillion-ounce, high-grade deposit and is on sale at half price is similar to going into the supermarket and finding the thickest, most beautifully marbled T-bone steak, fresh cut today, on sale for half off. Why bother with hamburger of unknown quality?

TGR: We keep hearing that we've hit a bottom, which would imply that the market is moving up. However, Rick, you have described it as a bifurcated market in which the bad stocks will continue to sink, which would be a good thing. How do we know which companies will sink and which will revive?

RR: That's a critical question. Before your readers classify stocks, they need to classify themselves. Are they the type of person who will put enough time and attention into securities analysis to compete on their own? Or do they need other people to help them compete?

While securities analysis and stock selection in the junior market is imperfect, it can be done. It requires understanding the stock. If you're not willing to understand the stock, you need an advisor.

TGR: How many hours does that work take? What questions should investors be asking?

RR: Speculators running their own portfolios without advice should limit the number of stocks in the portfolio to the number that they can spend two or three hours a month working on. That means reading every press release, proxy, quarterly, and annual report. Read the president's message and measure it against what he said the company would accomplish over the year.

Speculators unwilling to do that need to hire somebody who will. That may mean subscribing to one of the trading services offered by Casey or hiring an organization like Sprott to be a broker or a manager.
Getting to bifurcation and stock selection, if 15% of the stocks are moving higher, 85% are moving lower. You won't be able to concentrate 100% in either camp, but if you get more right than wrong, you'll make so much money that the outliers will be irrelevant. If you get it wrong, you'll lose so much money that you ought to be in some other business.

TGR: Are there fewer brokers walking the streets of Vancouver these days?

MK: Definitely, also fewer analysts and fewer corporate development positions and many fewer investor relations people.

There are more BMWs, Mercedes, and Ferraris on sale, and now more offices becoming vacant.

TGR: Does that mean only the best are left?

MK: Not necessarily.

RR: But it does reduce the population. To be a responsible analyst, you once had to look in a cursory fashion at 4,000 companies. Today, having only 3,000 companies to look at is an advantage.

The three of us look at data in a summary fashion to try and dispose of a company. You look for something to kill your interest. The good news is that the population of timewasters is down by at least a third. That's unfortunate for their shareholders, but that's their problem, not ours. Our job is to look after our subscribers or clients.

TGR: Let's talk about regions. Is it true that the Yukon is remote?

LJ: It's no more remote now than it was last year. You can't write off the Yukon or anywhere without looking at and understanding the specifics of individual opportunities. Miners with remote projects that have high enough margins are able to barge or truck diesel fuel in and run gen-sets, etc. If Canadians can mine diamonds in the Arctic Circle, they can mine gold in the Yukon.

Remoteness by itself is not the issue. The issue is margin. If you're in the Yukon and you've got something low grade, with low recoveries and complex metallurgy—don't call us, we'll call you. If you have something high grade, open pit, that leaches, tell me more.

TGR: Rick, in your presentation, you talked about platinum and palladium. Is that an area where the supercycle needs to whip things up?

RR: I don't think it even requires a supercycle. With platinum and palladium, I can look empirically at simple supply and demand. On a global basis, the platinum and palladium industry doesn't earn its cost of capital. That means one of two things will happen: The price of platinum and palladium will increase, or there won't be enough platinum and palladium to supply current demand.

In the context of supply, you don't have to worry about investor inventories because there are almost none. The world supply of existing, finished platinum and palladium is less than one year's fabrication demand.
The consequence of the industry not earning its cost of capital is that production has fallen by 19% over six years. New mine supply is falling. South Africa itself accounts for 70% of world platinum production and 39% of world palladium production.

In South Africa, the industry has deferred $5 billion in sustaining capital investments; workers are dying and infrastructure is more and more decrepit.

A skilled worker crouching 7,000 feet underground in 105-degree heat in two inches of water makes $700 per month. An unskilled worker who mucks the material on his hands and knees 400 meters from the mine face to the adit makes $200 a month. A migratory worker sustaining a family in the homeland is probably sustaining another family at the mine face. Wages have to go up, but they can't because the companies don't earn their cost of capital.

According to the majority of South Africans, social take—taxes and royalties—has to go up, but can't because companies don't earn their cost of capital.

Prices have to go up. Platinum and palladium prices can go up because their utility to users is so high. It goes into high-carat jewelry. Platinum goes up a smokestack. Mostly, it goes out a tailpipe.

It costs $200—the cost of a catalytic converter in a new car—to give us the air quality we enjoy today. There's a social consensus in favor of stricter air-quality standards. If the price of platinum and palladium doubled, the catalytic converter would cost $400 in a $27,000 new car; the demand impact would be de minimus.

LJ: We all know the often-quoted phrase that most of the gold ever mined in the world is still sitting in purified form on the surface in one form or the other. Platinum and palladium are different; they are consumed. I agree with Rick.

I would go one step further regarding South Africa. It's not just the economics that don't work; it's the country itself. It's a balloon resting on pins. I see platinum and palladium as speculation on South Africa going up in flames, which is an easy bet to take now. I'm sorry for the South Africans, but it's a bad situation with no easy way out.

TGR: There's been a lot of talk about the dearth of young, qualified people coming up to take a place in management teams. Has the next generation of managers—and investors, for that matter—left the sector? If so, what will happen?

MK: There's a significant age gap in our industry. When I was taking geology courses at university, our professor would ask why we were taking this class. There were no jobs. He recommended we go into computers, and a lot of people did.

Unfortunately, good management teams are very difficult to come by. Only 1 in 3,000 projects ever becomes an economic mine, and I'd say investing in the right people is more important than any other factor.

LJ: This scarcity makes the investor's job a little easier. Just type the CEO's name in Google and look up his history. Has he done this before? Has he succeeded? Was he an accountant or a used car salesman? Google is one of our primary triage tools.

People is the first of Doug Casey's famous Eight Ps. If I hear about a story that fits our general criteria, the first thing I look at is management and directors. If I recognize the name of someone who has lied to me or whom I don't trust, I don't even look at the project.

TGR: New people coming up need to get experience by being in a successful project. Are there enough successful projects that they're learning how to do it?

LJ: I don't necessarily agree with that angle. All experience is good experience. A person can learn a lot from working for a company that does something wrong. It's having lots of experience, both good and bad, that is so important. The problem is that, unless you get very lucky, you need to have experience to really call shots well, and there are not enough people out there with the decades of experience needed.

On the bright side, because there is money in the field now, geology departments are no longer shutting down; enrollment is up. Supply is improving, but it will be another 5 to 10 years before the supply of highly experienced personnel really improves.

RR: Let's personalize it for your readers. There are three analysts in the room: an old one and two young ones. I guarantee you that, as a consequence of the bear market they just experienced, the two younger analysts will make their readers more money with less risk in the next bull market.

Youth isn't enough. You need to have a decade under your belt so that you have lived through the changes. Marin and Louis just lived through the kind of challenges I lived through in the 1980s. They now have the two things needed to survive in this racket: legs and scars.

MK: He's not joking about the scars.

RR: The transfer of the mantle from the Doug Caseys and Rick Rules of the world to the Marin Katusas and Louis Jameses is under way. The batons are being passed.

TGR: Is the bear market making a better generation of investors? Will they be more patient, have more perspective given what they've been through?

MK: If they stick with it. It's all about timeframe and perspective. The bear market will wash out a lot of investors; do not allow yourself to become a victim. But as Rick said, investors have to mitigate risk to stay alive until the next leg in the bull market.

RR: You're wrong there, Marin. You have to thrive. The year 2000, which was the market bottom, was one of the best investment years of my life. And 2001 was even better, as was 2002.

A bear market is when you make your money. You don't get to put it in your pocket until things turn, but you make your money by thriving in bear markets. You don't thrive in bull markets. You cash the checks. It's very different.

LJ: I expect this will be a painful experience for a lot of people. Some will learn a lesson, but it will be the wrong lesson. The lesson will be: Don't invest in commodities; they're too risky. That lesson will stick until the prices go bananas again, when they'll give it another try and get taken to the cleaners again.

To buy low and sell high, investors have to be able to sell high, which means they are expecting people to act irrationally when prices are very high—which means they didn't learn the lesson. It's unfortunate for our world that human nature is so, but it is so, and investors who ignore the opportunities this creates don't do anyone any favors.

TGR: Marin, going back to energy, there's been a lot in the media about the International Energy Agency (IEA) report about energy independence in North America. Will we be the Saudi Arabia of natural gas?

MK: North America is already the Saudi Arabia of natural gas. Unfortunately, so are the Russians.

The report said that if these eight assumptions happen the way we hope, America will become almost energy independent. The media forgot about the eight assumptions, and they got rid of the word "almost."
The US has done a great job of bringing North American innovation to the shale industry, but the industry has many other challenges to work through.

TGR: Is Saudi Arabia still the Saudi Arabia of oil? Its wells are getting long in the tooth, and the country is building nuclear plants for domestic use.

MK: We're all asking that question. The Ghawar oil field has been producing oil since before Elvis hit the scene and today produces about half of Saudi Arabia's oil. There is significant risk in relying on these old elephant deposits that have been producing for more than 50 years.

RR: I agree. What has happened in the US, and to a lesser degree Canada, is unique because our competitive markets still work. For example, 50 or 60 competitors at Eagle Ford tried and failed using various completion techniques, each time getting better and better. Ultimately, Eagle Ford was an extremely messy success.

In most of the world, there's one quasi-state oil company looking at a basin. There's no competition trying different solutions. Exporting American or Canadian technology doesn't work without exporting the messiness of the North American energy-exploration business.

Marin, would exporting technology from Eagle Ford work in Argentina's Vaca Muerta Shale?

MK: It would take billions of dollars to make it work at Vaca Muerta. A junior company with a $10 million market cap and $500,000 to make management's salary and payment on their BMWs will never be able to develop this billion-dollar shale potential. It will require a big company, like a Chevron.

TGR: We heard a lot about the potential for crowdfunding to save the resource sector by funding more companies. True?

MK: I'd like to make sure that all of your readers stay the hell away from crowdfunding for the resource sector. I've heard it works OK in the tech sector and among the let's-make-a-movie crowd, where all that is needed is to raise $150,000 for something that may or may not work.

In the resource sector, real exploration cannot be done for $2-3 million. If people want to invest in the sector, go to someone with a track record, someone who knows what he's doing. Subscribe to Louis' newsletter and educate yourself. Stay the hell away from crowdfunding for the resource sector.

RR: The last thing the sector needs is more companies. The idea that the crowd would invest $3 million in a de novo project when there are companies out there that have spent $80 million on an existing project, yet have a $6 million market cap is the most counterproductive activity that one could imagine. If there are 3,000 public companies doing exploration on a global basis, we don't need another 300. We need 2,000 fewer.

LJ: It's one thing to go directly to the masses with an art project that some snob at the National Endowment for the Arts turned down, but entirely another to do so for a mine project no knowledgeable investor will touch.

TGR: What myth would you want our readers to stop believing in?

LJ: I would like to dethrone the "grade is king" myth. It's not grade; it's margin. You can have an exceptionally high-grade deposit in an exceptionally expensive, difficult, or kleptocratic jurisdiction, and it won't work. You could have a water table that's so fluid that you spend more money pumping water than mining. There are so many things that can go wrong or add to costs. Too many people believe if a project is high grade, it has to make money. No, it doesn't. High margin is paramount, not grade.

MK: I think the myth that the commodity bull market is over is insane. We're nowhere near being over. This is the opportunity of a lifetime. This is when you start doing your homework and investing money.

RR: The idea that bear markets are bad and bull markets are good is bullshit. It's the other way around. Bear markets are good. Bull markets are bad.

LJ: Bullshit is a technical term.

TGR: I enjoyed talking with the three of you. Thanks.

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Weekly Futures Recap with Mike Seery

We’ve asked our trading partner Michael Seery to give our readers a weekly recap of the Futures market. He has been a commodity Analyst for close to 15 years and has extensive knowledge of all of the commodity and option markets. Michael frequently appears on multiple business networks including Bloomberg news, Fox Business, CNBC Worldwide, CNN Business, and Bloomberg TV. He is also a guest on First Business, which is a national and internationally syndicated business show.

Crude oil futures for the November contract are flirting with 4 month lows finishing lower by $1.10 at 101.90 this Friday afternoon in New York as global supplies are high while demand remains weak pressuring prices in recent months.

Crude oil is trading below its 20 day and right at its 100 day moving average and I’m still recommending traders to sell the futures contract and place a stop at the 10 day high which stands at 104.38 and I think there is a chance of crude oil dropping quickly possibly down to the $90 price level as the geo political news is bearish with Syria a distant memory.

I love trades that have a great risk/reward scenario and crude oil can pay you off big time if you are right on the trade while the risk at the 10 day high at the time of my recommendation earlier in the week was only $500.

The coffee market which I’ve talked about previously in many blogs continues to move sideways in a nonvolatile trading action up 200 points for the trading week trading at 116.60 a pound up 200 points in the December contract this Friday afternoon, however it is right at its 20 day but still below its 100 day moving average as the Vietnamese harvest is only a couple weeks away which could put harvest pressure on prices again with the possibility of going down to 100 in my opinion.

There is very little interest in coffee at this time and I’ve been trading for over 20 years and I can’t remember such a nonvolatile market as coffee generally is one of the most volatile markets in the world, however with huge supplies globally and excellent weather across the globe this market still looks weak hitting another 4 1/2 year low this week and a very bearish trade on Thursday when prices were up 300 points and then settled lower meaning traders are taking advantage of any higher prices to sell but keep an eye on this market I still think if you’re longer term trader buying coffee if prices reach 100 could pay you off in the long run.

Here is more of Mike's calls on commodities this week.

 

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Who Knows More: The S&P 500 Options or Financial Pundits?

By now the major media outlets have made sure to inform the public that the U.S. government is shut down, or partially shut down depending on your political perspective. Most financial pundits are looking to the recent past for clues about what to expect in the future.

While the situation appears to be similar to what we witnessed in 2011 with the debt ceiling debacle, the outcomes may be significantly different. I am a contrarian trader by nature, and as such I am constantly expecting for markets to react in the opposite way from what the majority of investors expect.

A significant number of financial pundits and writers all have a similar perspective about what is likely to occur. It seems most of the financial punditry believe that until there is a resolution in the ongoing government debacle, market participants should expect volatility to persist. Some of the talking heads are even calling for a sharp selloff if no decision on the debt ceiling is made by early next week.

The debt ceiling decision needs to be made by midnight on October 17th otherwise the first ever default on U.S. government debt could occur. Thus far, the volatility index (VIX) has moved higher as investors and money managers use the leverage in VIX options to hedge their long exposure.

As can be seen here, we are seeing the VIX trade at the second highest levels so far in 2013.....Read the entire article "Who Knows More: The S&P 500 Options or Financial Pundits?"



How to Avoid a Devastating Retirement Planning Mistake
 

COT Market Summary for Tuesday October 8th - Crude Oil, Natural Gas, SP 500, Gold and Coffee

November crude oil closed higher on Tuesday as it consolidates above the 10 day moving average crossing at 103.07. The mid range close sets the stage for a steady to higher opening when Wednesday's night session begins. Stochastics and the RSI are bullish signaling that sideways to higher prices are possible near term. Closes above the 20 day moving average crossing at 104.41 are needed to confirm that a low has been posted. If November renews the decline off August's high, the 50% retracement level of the April-August rally crossing at 98.71 is the next downside target. First resistance is the 20 day moving average crossing at 104.41. Second resistance is the reaction high crossing at 108.15. First support is the 38% retracement level of the April-August rally crossing at 102.43. Second support is the 50% retracement level of the April-August rally crossing at 98.71.

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November Henry natural gas closed higher on Tuesday and above the 20 day moving average crossing at 3.654 confirming that a short term low has been posted. The high range close sets the stage for a steady to higher opening on Wednesday. Stochastics and the RSI are turning bullish signaling that sideways to higher prices are possible near term. If November extends today's rally, September's high crossing at 3.892 is the next upside target. If November renews the decline off September's high, the 75% retracement level of the August-September rally crossing at 3.436 is the next downside target. First resistance is today's high crossing at 3.730. Second resistance is September's high crossing at 3.892. First support is the reaction low crossing at 3.450. Second support is the 75% retracement level of the August-September rally crossing at 3.436.

The December S&P 500 closed lower on Tuesday as it extended the decline off this month's high. Today's low range close sets the stage for a steady to lower opening when Wednesday's night session begins trading. Stochastics and the RSI remain neutral to bearish signaling that sideways to lower prices are possible near term. If December extends the decline off this month's high, August's low crossing at 1621.00 is the next downside target. Closes above the 20 day moving average crossing at 1687.11 would confirm that a short term low has been posted. First resistance is the 20 day moving average crossing at 1687.11. Second resistance is August's high crossing at 1726.50. First support is today's low crossing at 1651.00. Second support is August's low crossing at 1621.00.

December gold closed lower on Tuesday and the high-range close sets the stage for a steady to lower opening when Wednesday's night session begins trading. Stochastics and the RSI are neutral to bullish signaling that sideways to higher prices are possible near term. Closes above the 20 day moving average crossing at 1324.30 are needed to confirm that a short term low has been posted. If December renews the decline off August's high, August's low crossing at 1271.80 is the next downside target. First resistance is the 20 day moving average crossing at 1324.30. Second resistance is the reaction high crossing at 1353.80. First support is the reaction low crossing at 1276.90. Second resistance is August's low crossing at 1271.80.

December coffee closed higher on Tuesday. The high-range close set the stage for a steady to higher opening on Wednesday. Stochastics and the RSI are turning bullish signaling that a low might be in or is near. Closes above the reaction high crossing at 11.92 are needed to confirm that a low has been posted. If December extends this summer's decline, monthly support crossing at 10.21 is the next downside target.

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Weekly Commodities Recap with Mike Seery - Gold, Silver, Coffee, Sugar,

It's time for our weekly commodities market recap with our trading partner Mike Seery......

The gold market in the December contract sold off $30 dollars an ounce this week at 1,316 as the U.S dollar hit a fresh 10 month low not influencing gold prices just yet. Gold made a new 10 week low on the night session this week trading as low as 1,276 then rallied sharply as investors came rushing back into this market and I am still recommending to sick on the sidelines because of this choppy pattern where gold is down $40 dollars and the next day its up $30 but I still do think prices look weak and I think they still could re-test the summer lows around 1,200. If you are short the futures market in the December contract I would place my stop loss at 1,354 which was Mondays high minimizing your risk in case the trend changes. This market is very volatile with high risk so make sure you under trade meaning don’t lose more than 2% of your account balance on any given trade. TREND: LOWER –CHART STRUCTURE: EXCELLENT

Silver futures ended down 12 cents for the week in the December contract at 21.72 an ounce and in my opinion the panic selling on October 1st for no reason might have created a spike low on the daily charts as the U.S dollar broke 80 for the 1st time in 10 months. As I’ve stated in many previous blogs I think investors should take advantage of big down days because silver has a lot of bullish fundamentals which in the long run could push prices higher, however gold still looks weak to me as money seems to be going into the stock market which was sharply higher today and out of gold lately which is also keeping a lid on silver prices here in the short term. The silver market is very sensitive to a strong or weak dollar and if you do some homework and look at some historical charts you will see a rising silver market when the U.S dollar declines. TREND: NEUTRAL–CHART STRUCTURE: EXCELLENT

Sugar futures settled last Friday at 17.74 a pound going out today at 18.45 continuing its bullish trend hitting a 5 1/2 month high still trading above its 20 and 100 day moving average. Prices tumbled about 60 points last Friday just missing the 10 day low but then on Monday prices rallied about 60 points so if you’re still in this market I would still keep my stop below the 10 day low as prices have come alive to the upside as volatility has come back into this market. Sugar prices went up 4 straight days before profit taking took place finishing down 5 points at 18.48 and I think the next major resistance is around 19/19.50 as the U.S dollar is hitting 10 month lows which is starting to spur some commodity prices higher especially sugar. TREND: HIGHER –CHART STRUCTURE: EXCELLENT

Coffee futures this week continued their sideways trading action settling last Friday at 113.70 basically unchanged for the trading week settling at 114.15 a pound in the December contract and at this time there is very little interest in this market at this point as volatility is as low as I can ever remember historically. Coffee prices are right at 4 ½ year lows as huge crops around the world including Vietnam have put ample supplies onto the market which is why prices are so depressed at this time. If you are interested in getting long the coffee market I would look at call options at least 6 months out and buy them at the money limiting your risk to what the premium costs because premiums are historically cheap due to low volatility. The volatility in coffee at the present time is very small and I have been following coffee for 20 years and I believe volatility is going to come back into this sleeping giant and that usually means prices rise as interest comes back into the market. If you’re a longer term investor I would take advantage of coffee if prices dropped down into the 110 area remembering that coffee was trading at 300 just 3 years ago when supplies were much lower. TREND: LOWER –CHART STRUCTURE: EXCELLENT

Just click here to get more of Mike's calls in wheat, corn, cotton and more!



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Citigroup Picks Winners and Losers Among U.S. Refiners

It may not be the gospel but we should pay attention as Citigroup picks winners and losers among U.S. refiners. Here is Citigroup's take on oil refiners. The firm expects to see a bottoming of earnings in Q4 for most names, but companies overweight the Midcontinent and/or Midwest could experience a difficult earnings environment through Q1 2014.

The diverging earnings performance will result in positive price appreciation for some refiners - such as Valero (VLO) and Tesoro (TSO), which earn upgrades to Buy - but underperformance for others, such as on Alon USA (ALDW), CVR Refining (CVRR), Holly Frontier (HFC) and PBF Energy (PBF), which will remain pressured by narrowing price differences between WTI and Brent crude.

TSO will benefit next year from a tighter gasoline market in California, and VLO will benefit from wider heavy light differentials in H2 2014 as increased Canadian heavy crude flows to the U.S. Gulf coast, Citi says.

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The Renminbi.....Soon to Be a Reserve Currency?

By John Mauldin

I get the question all the time: when will the Chinese renminbi (RMB) replace the US dollar as the major world reserve currency? The assumption behind such questions is almost always that the coming crisis in US entitlement programs will force the Fed to monetize even more debt, thereby killing the dollar. Or some derivative line of that thought. Contrary to the thinking of fretful dollar skeptics, my firm belief is that the US dollar is going to become even stronger and will at some point actually deserve to be the reserve currency of choice rather than merely the prettiest girl in the ugly contest – the last currency standing, so to speak.

But whether the Chinese RMB will become a reserve currency is an entirely different question. Of course it will, over time, but the question has always been when. There are some preconditions required for reserve currency status. Quietly, apart from anything that might happen to the US dollar, China is working to meet those conditions. Rather than wallowing in concerns about China's actions, we might opt for a more thoughtful and constructive response: to welcome the RMB to the reserve currency club and hope that it gets here soon. The world will be a better place when that happens. And off the radar screen, it may be happening right now. Today we look at global trade flows and international balances and try to imagine a world in which much "common wisdom" gets stood on its head. It should make for an interesting thought experiment, to say the least. (This letter will print a little longer than usual, as there are numerous charts and graphs.)

One of the prerequisites for a true reserve currency is that there must be a steady and ready supply of the currency to facilitate global trade. The United States has done its part in providing an ample supply of US dollars by running massive trade deficits with the rest of the world, primarily with oil-producing nations and with Asia (most notably China and Japan), for all manner of manufactured products. The US consumer has been the buyer of last resort for several decades (I say, somewhat tongue in cheek). Those dollars typically end up in the reserve balances of various producing nations and find their way back to the US, primarily invested in US government bonds. In an odd sense, the rest of the world has been providing vendor financing to the US, the richest nation in the world.



The US Trade Deficit Turns Positive

The US trade deficit (a key component of the current account deficit – see chart on next page) fell to an unprecedented percentage of GDP during the last decade, a development that normally heralds a significant drop in a currency. Fortunately, the "exorbitant privilege" of controlling the world's dominant currency in reserve holdings, international trade, and financial transactions has helped shield the US dollar from a hard correction; but that status quo is in danger. After flooding the world with US dollars for more than twenty years, the US has reduced its current account deficit by 58% since the 2007-2008 financial crisis began. Looking ahead, I and many other observers believe this measure can continue to improve, due two surprisingly positive factors:

1. The US energy boom in shale oil and gas. The US has caught an incredibly well-timed "lucky break" made possible by the combination of new exploration, production, and processing technologies (such as horizontal drilling and fracking) and by the serendipitous discovery of massive supplies of oil and gas, often in areas that already have significant infrastructure and/or are accessible at reasonable costs. This energy renaissance is part of the reality that has made Houston, Texas, the number one port in the United States, with even more growth coming in the near future when the Panama Canal expansion is completed in 2014. US manufacturers are turning less-expensive oil and gas into value-added fossil fuel products and exporting them to the world. This trend will become ever more important. Indeed, when the first LNG export terminal is opened in a few years, the additional exports will approach $80 billion a year, I am told. From one terminal! There are four in the process of being approved and more on the planning boards. The math is there for anyone to do. Spot prices in the US natural gas-producing areas are under $4. The Japanese are paying more than $14. Even I can do that arbitrage. Just for fun, the next graph, from the Energy Information Administration, shows the rise in spot gas prices over the last six months, from a level that had been far too low. It also shows the arbitrage potential that exists right here in the US.

2. The consequent renaissance in US manufacturing. With cheaper energy and new technologies like advanced robotics and 3D printing, the US is producing more than we ever have – we're just doing it with fewer people.

These two trends are bullish for the US in general. But that's another story for another letter. The point today is that the US current account deficit is collapsing. A positive trade balance is not an unthinkable prospect today. It is quite possible that the US will be more or less energy self-sufficient by the end of the decade and could have a positive trade balance not long after that. I should note that exporting value-added chemicals made from less expensive energy will contribute even more to the positive balance than simply selling the raw natural gas.

To continue reading this article from Thoughts from the Frontline – a free weekly publication by John Mauldin, renowned financial expert, best-selling author, and Chairman of Mauldin Economics – Please Click Here.