Jim Rogers On “Buying Panic” And Investments Nobody Is Talking About

By Nick Giambruno, Senior Editor, International Man

I am very pleased to have had the chance to speak with Jim Rogers, a legendary investor and true international man. Jim and I spoke about some of the most exciting investments and stock markets around the world that pretty much nobody else is talking about. You won't want to miss this fascinating discussion, which you'll find below.

Nick Giambruno: Tell us what you think it means to be a successful contrarian and how that relates to investing in crisis markets throughout the world.

Jim Rogers: Well, there are two aspects of it. One is being a trader, being able to buy panic, and nearly always if you are a trader or an investor, if you buy panic, you are going to do okay.

Sometimes it is better for the traders, because when there is a panic, a war breaks out or something like that, everything collapses, and some people are very good at jumping in and buying. Then, when the rally comes, the next day or the next month, they sell out.

Now, the people who are investors can also do that, but it usually takes longer for there to be a permanent rally. In other words, if there's a war and stocks go from 100 to 30 and everybody jumps in, it may rally up to 50, and then the traders will get out, it may go back to 30 again. I'm trying to make the differentiation between investors and traders buying panic.

As an investor, nearly always if you buy panic and you know what you are doing, and then hold on for a number of years, you are going to make a lot of money. You also have to be sure that your crisis or panic is not the end of the world, though. If war breaks out, you have got to make sure it's a temporary war.

I used to work with Roy Neuberger, who was one of the great traders of all time, and whenever stocks would panic down, he was usually one of the few buyers, because he knew he could get a rally—if not that day, at least maybe that week or that month. And he nearly always did. No matter how bad the news, especially if there's a huge drop, it's probably a good time to buy if you've got the staying power and your wits, because you will likely get a rally. In terms of panic buying or crisis situations, that's normally the way to play.

Now, it's not always easy, because you are having everybody you know, or everybody in the media shrieking what a fool you are to even try something like that. But if you have your wits about you and you know what you are doing, and you know enough about yourself, then chances are you will make a lot of money.

Nick Giambruno: What is the story behind your most successful investment in a crisis market or a blood-in-the-streets kind of situation?

Jim Rogers: Certainly commodities at the end of the '90s were everybody's favorite disaster, and yet for whatever reason, I had decided that it was not a disaster. In fact, it was a great opportunity and there were plenty of things to buy. In 1998, for instance, Merrill Lynch, which at the time was the largest broker, certainly in America and maybe the world, decided to close their commodity business, which they had had for a long time. I bought. That's when I started in the commodity business in a fairly big way. So that's the kind of example I am talking about. Everybody had more or less abandoned or were in the process of abandoning commodities, and yet, that's when I decided to go into commodities in a big way, because of what I considered fundamental reasons for doing it, but the fact that Merrill Lynch was getting out buttressed in my own mind anyway that I must be right, because, you know, everybody was out. Who was left to sell? There was nobody left to sell at that point.

Nick Giambruno: What about a particular country?

Jim Rogers: I first invested in China back in 1999 and then again in 2005. The market at those times was very, very bad. I invested again in November of 2008, when all markets around the world were collapsing, including in China. So I have certainly made investments in countries with crisis markets, and I'm getting a little better at it than I used to be, because I have had more experience now. That's why I keep emphasizing that you have to know what you're doing. And by that I mean paying attention to and doing your homework on a stock or a commodity or a country. If you do that with a crisis market, then chances are you can move in and make some money.

Nick Giambruno: In your opinion, which countries today do you think offer the best crisis or "blood in the streets" type opportunities?

Jim Rogers: I think Russia is probably one of the most hated markets in the world. I don't think many people have a nice thing to say about Russia or Putin. I was pessimistic on Russia from 1966 to 2012, that's 46 years. But I've come to the conclusion that since it is so hated, and you should always look at markets that are hated, that there are probably good opportunities in Russia right now.

Nick Giambruno: Doug Casey and I were recently in the crisis-stricken country of Cyprus, which is also a pretty hated market, for obvious reasons. While we were there, we found some pretty remarkable bargains on the Cyprus Stock Exchange which we detailed in a new report called Crisis Investing in Cyprus. Companies that are still producing earnings, paying dividends, have plenty of cash (in most cases outside of the country), little to no debt, and trading for literally pennies on the dollar. What are your thoughts on Cyprus?

Jim Rogers: When I saw what you guys did, I thought, "That's brilliant, I wish I had thought of it, and I'll claim that I thought of it" (laughs). But it was really one of those things where I said, "Oh gosh, why didn't I think of that," because it was so obvious that you are going to find something.

It's also obvious, after what happened in Cyprus, that it's a place where one should investigate. Whether it is right to buy now or not, you are certainly right to look into it. If you stay with it and you know what you are doing, you do your homework, you are probably going to find some astonishing opportunities in Cyprus. It's the kind of thing that I'm talking about and that you are talking about.

(Editor's Note: You can find more info on Crisis Investing in Cyprus here.)

Nick Giambruno: Speaking of hated markets that literally nobody is getting into, I heard that you managed to find a way to get some sort of exposure to North Korea through bullion coins. Could you tell us about that?

Jim Rogers: Yeah, you know, it's illegal for Americans to invest in North Korea. It's probably illegal for us to even say the word "North Korea" (laughs). I look around to see which countries are hated. In North Korea there is no stock market, and there is no way to invest, especially if you are an American, but sometimes you can find something in a secondary market.

Stamps and coins were the only ways I knew of that one could get some sort of exposure. This is because you are not investing in the country, obviously, because you are buying them in a secondary or tertiary market. That said, I think the US government is going to make owning stamps illegal too.

There were people once upon a time—and maybe even now—who invested in North Korean debt. I have not done that, but it may be another way that people can invest in North Korea. I don't even know if North Korean debt still trades, but it was defaulted on at some point.

Nick Giambruno: Another hated market that actually does have a pretty vibrant and dynamic stock market is the Tehran Stock Exchange in Iran. Have you ever taken a look at this market?

Jim Rogers: Yes, at one point I did invest in Iran, back in the 1990s and made something like 40 times on my money. I didn't put millions in because there was a limit on how much a person could invest. But this was over 20 years ago. I would like to invest in Iran again, but I don't know the precise details on the sanctions and the current status of Americans being able to invest there. But Iran is certainly on my list. And so are Libya and Syria. I'm not doing anything at the moment in these countries, but they are places that are on my list.

Nick Giambruno: Switching gears a little, do you have any final words for people who are thinking about internationalizing some aspect of their lives or their savings?

Jim Rogers: Most people have a health insurance policy, a life insurance policy, fire insurance, and car insurance. You hope that you never have to use these insurance policies, but you have them anyway. I feel the same way about what you call internationalizing, but I call it insurance. Everybody should have some of their money invested outside of their own country, outside of their own currency. No matter how positive things are in your home country, something could go wrong.

I obviously do it for many other reasons than that. I do it because I think I can make some money finding opportunities outside your own country. Many people are a little reluctant, you know. It's tough to leave your safe haven. So I try to explain to them, "Well, you have fire insurance, why don't you look on investing abroad as another kind of insurance?" and usually what happens is people get more accustomed to it. And they often invest more and more abroad because they say, "Oh, my gosh, look at these opportunities. Why didn't somebody tell us there are all these things out there?"

Nick Giambruno: Jim, would you like to tell us about your most recent book, Street Smarts: Adventures on the Road and in the Markets? I'd strongly encourage our readers to check it out by clicking here.

Jim Rogers: I've done a few books before, and then my publisher and agent said, "Look, it sounds like it must be quite a story to have come from the back woods of Alabama to living in Asia with a couple of blue-eyed girls who speak perfect Mandarin. How did this happen? Why don't you pull this all together and it might be an interesting story?" So I did, somewhat reluctantly at first, and then, lo and behold, people tell me it's my best book. Whether it is or not, I will have to let other people decide, but that's how it happened, and that's what it is.

Nick Giambruno: Jim, thank you for your time and unique insight into these fascinating topics.
Jim Rogers: You're welcome. Let's do it again sometime.


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Kinder Morgan Announces Acquisition of Jones Act Shipping Tankers

Kinder Morgan Energy Partners, (NYSE: KMP) today announced it has entered into a definitive agreement to acquire American Petroleum Tankers (APT) and State Class Tankers (SCT) from affiliates of The Blackstone Group and Cerberus Capital Management for $962 million in cash. APT and SCT are engaged in the marine transportation of crude oil, condensate and refined products in the United States domestic trade, commonly referred to as the Jones Act trade.

APT’s fleet consists of five medium range Jones Act qualified product tankers, each with 330,000 barrels of cargo capacity. With an average vessel age of approximately four years, the APT fleet is one of the youngest in the industry. Each of APT’s vessels is operating pursuant to long term time charters with high quality counterparties, including major integrated oil companies, major refiners and the U.S. Navy. These time charters have an average remaining term of approximately four years, with renewal options to extend the initial terms by an average of two years. APT’s vessels are operated by Crowley Maritime Corporation, which was founded in 1892 and is a leading operator and technical manager in the U.S. product tanker industry.

SCT has commissioned the construction of four medium range Jones Act qualified product tankers, each with 330,000 barrels of cargo capacity. The vessels are scheduled to be delivered in 2015 and 2016 and are being constructed by General Dynamics’ NASSCO shipyard. Upon delivery, the SCT vessels will be operated pursuant to long-term time charters with a major integrated oil company. Each of the time charters has an initial term of five years, with renewal options to extend the initial term by up to three years. Kinder Morgan will invest approximately $214 million to complete the construction of the SCT vessels.

“This is a strategic and complementary extension of our existing crude oil and refined products transportation business,” said John Schlosser, president of KMP’s Terminals segment. “Product demand is growing and sources of supply continue to change, in part due to the increased shale activity. As a result, there is more demand for waterborne transportation to move these products. We are purchasing tankers that provide stable fee based cash flow through multi-year contracts with major credit worthy oil producers.”

“Blackstone and Cerberus are pleased to have founded and built American Petroleum Tankers into a market leading Jones Act tanker company,” said Sean Klimczak, Senior Managing Director at Blackstone. “We have enjoyed our partnership with APT’s management team and wish them continued success with Kinder Morgan in this next phase of APT’s growth.”

The transaction, which is subject to standard regulatory approvals, is expected to close in the first quarter of 2014, at which time it will be immediately accretive to cash available to KMP unitholders. APT currently generates about $55 million of annual EBITDA. After completion of construction of the four SCT vessels, KMP expects combined annual EBITDA of approximately $140 million, which is an EBITDA multiple of 8.4 times. The general partner of KMP, Kinder Morgan, Inc. (NYSE: KMI), has agreed to waive its incentive distribution amounts of $16 million in 2014 and $19 million in 2015 and $6 million in 2016 to facilitate the transaction.

Kinder Morgan Energy Partners, L.P. (NYSE: KMP) is a leading pipeline transportation and energy storage company and one of the largest publicly traded pipeline limited partnerships in America. It owns an interest in or operates more than 54,000 miles of pipelines and 180 terminals. The general partner of KMP is owned by Kinder Morgan, Inc. (NYSE: KMI). Kinder Morgan is the largest midstream and the fourth largest energy company in North America with a combined enterprise value of approximately $105 billion. It owns an interest in or operates more than 82,000 miles of pipelines and 180 terminals. Its pipelines transport natural gas, gasoline, crude oil, CO2 and other products, and its terminals store petroleum products and chemicals and handle such products as ethanol, coal, petroleum coke and steel. KMI owns the general partner interests of KMP and El Paso Pipeline Partners, L.P. (NYSE: EPB), along with limited partner interests in KMP and EPB and shares in Kinder Morgan Management, LLC (NYSE: KMR). For more information please visit www.kindermorgan.com.

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The Energy Report: Where to Drill for Portfolio Outperformance

The Energy Report: Chad, you recently released an early look at 2014 titled, Drilling Down for Outperformance. You noted that you saw an average 3540% upside on your Buy rated names. What are your criteria for picking companies?

Chad Mabry: To start, we use a discounted cash flow based net asset value (NAV) approach to valuing exploration and production (EP) stocks. While cash flow is an important metric, NAV does a better job of comparing companies with different asset profiles, specifically within the small and midcap EP space. NAV does a better job of accounting for a company's upside potential than cash flow metrics. We use a bottom-up approach to drill down into a company's asset base, its average type curve, estimated ultimate recoveries (EURs), well costs and so on. In this way we find out about the economics of those plays and what the sensitivities are to our commodity price deck. We then try to sort out companies that aren't being valued appropriately and identify strong risk reward opportunities.

TER: There has been a lot of commodity price volatility this last year. How do you determine what prices to use when you're estimating NAV?

CM: That's a good question. Given the volatility inherent in oil and gas commodity price movements, forecasting prices is somewhat of a losing proposition. We try to set a long term price deck based on the industry cost structure, which is based on the marginal cost of new production. Over the long term, laws of supply and demand will win out and commodity prices should normalize toward equilibrium levels, which are currently about $90 per barrel ($90/bbl) for oil and $4.50 per thousand cubic feet ($4.50/Mcf) for natural gas.

TER: The Energy Information Administration (EIA) is forecasting U.S. oil production to increase by about 1 million barrels/day in 2014 with year-over-year growth in the 1015% range. What impact could that have on the price of oil going forward?

CM: There is an oil production renaissance in the U.S. We expect that to continue, driven by the independent EPs. We're forecasting production growth in 2014 of about 5055% in our coverage universe. That is going to be driven by oil growth as companies continue to allocate the vast majority of their capex budgets next year to oil and liquids-weighted projects.

TER: Are there certain sectors of the oil market that you like better than others?

CM: We feel the outperformers into 2014 are the companies that have established core positions in some of the more economically attractive oil and liquids resource plays in North America. It won't come to anyone's surprise that some of the best-in-class resource plays include the Eagle Ford, the Bakken and the Niobrara, to name a few. But we also feel like there are some pretty intriguing, earlier-stage plays that offer exposure to oil and liquids that we're going to be keeping an eye on into next year, specifically the Utica, the Tuscaloosa Marine Shale and the Woodbine.

TER: What do you like about developed areas, like the Eagle Ford?

CM: Eagle Ford has become the standard bearer for the oil and liquids resource plays in the U.S. The geography is best in class and it is a repeatable play with very compelling economics. As we move into development mode in the play, we continue to see the potential for additional catalysts, which should continue to lead to outperformance for our names that have exposure there.

As well costs continue to reduce and recoveries and completion designs improve, we expect rates of return to drift higher. As various operators focus on additional zones, there is additional upside potential to companies' drilling inventories in the form of additional pay zones.

The best exposure to the Eagle Ford and one of our top picks is Carrizo Oil Gas Inc. (CRZO:NASDAQ), which has established a very nice sweet spot in La Salle County.

We also like Sanchez Energy Corp. (SN:NYSE), which has become somewhat of an Eagle Ford pure play with a very robust inventory across the play.

TER: Carrizo is in the Utica, the Marcellus and the Niobrara. In November, it announced record oil production, and the stock price is up pretty dramatically, although it's off its all-time highs. Is there still upside?

CM: We believe so. We see roughly 50% upside to our NAV from current levels. One of the reasons that it is a top pick of ours is that it has core positions in very attractive plays. You mentioned its position in the Utica, the Niobrara and the Marcellus. It has some best in class exposure to these plays.

We expect the company to have some downspacing results in the Eagle Ford as it continues to test 500 foot (500 ft) spacing versus 750 ft, where it is today. We don't have that in our numbers right now. We estimate that could add about $10/share to our NAV from current levels.

"Given the volatility inherent in oil and gas commodity price movements, forecasting prices is somewhat of a losing proposition."

In the Utica, the company's acreage is in a very delineated, core spot of the play. While it is still early on in its activity in the play, we expect it to have initial well results in the near term. We think that could be another catalyst for the name.

Then, like other operators in the Niobrara, Carrizo is also testing downspacing, which, if successful, could yield incremental upside to what we're giving it credit for right nownot only core positions in core plays, but also the catalysts that we expect to drive the stock up toward our NAV over the next 12 months.

TER: You have a Buy rating on Sanchez. It also has a secondary in the Tuscaloosa Marine Shale. What impact could the Tuscaloosa have on its share price?

CM: We have just $1/share of Tuscaloosa Marine Shale value in our NAV right now. It's very minimal at this point. At current levels, investors are getting a free option on Sanchez' Tuscaloosa Marine Shale potential, which could be very meaningful.

One of the reasons that we like these more emerging areas is that you're not really paying as much for some of these positions. Contango Oil Gas Co. (MCF:NYSE.MKT), which is more of a legacy name, also has exposure. I'd even classify it as a Tuscaloosa Marine Shale sleeper because it doesn't register on a lot of people's radars as having a significant position in that play following its merger with Crimson Exploration Inc. (CXPO:NASDAQ).

If you're a believer in the long-term commerciality of the play, which we are, then a name that you need to own is Goodrich Petroleum Corp. (GDP:NYSE), which has by far the most leverage to that play with around 300,000 net acres. As that company accelerates to a five rig-operated program in the Tuscaloosa Marine Shale next year and gets away from the well watch nature that's made for a volatile 2013, its position in that play delivers outperformance for the stock. If you're a believer in the play, then Goodrich is a must own name. As the play advances further along the development curve, Goodrich becomes a takeout candidate for any larger company looking to gain exposure in a material way.

TER: What else is intriguing in the Niobrara?

CM: A lot of these names with exposure to the Niobrara have been some of 2013's outperformers.

But when we look at who has exposure to the play and who maybe isn't getting as much credit as the next guy, an attractive name to us is PDC Energy Inc. (PDCE:NASDAQ). It's the third-largest producer and leaseholder in the Wattenberg. In addition, it has a pretty significant position in one of the emerging areas of the Utica. At these levels, it's a pretty compelling investment.

TER: The price is down from earlier in the year. Is this a buying opportunity?

CM: The stock did correct a bit after a Q3/13 earnings miss and its initial results in the southern part of its Utica position, which didn't meet Street expectations. This did present a nice buying opportunity. It does have a number of upcoming catalysts, not only in the Utica, but also from additional downspacing and testing of other formations in the Wattenberg/Niobrara. At current levels, investors are getting a free option on its position in the Utica.

TER: Are there any neighbors you like?

"As we look into 2014, we're more focused than ever on company-specific fundamentals and relative performance indicators that should help pick the outperformers into next year."

CM: Yes, as a matter of fact. Bonanza Creek Energy Inc. (BCEI:NYSE) has a very quality position in the Niobrara; it's essentially a Niobrara pure play. But at current levels, it is receiving closer to full valuation for that position, and we see better risk-reward in other names, specifically Carrizo and PDC.

TER: Bonanza Creek is both in Colorado and the Cotton Valley sands in Arkansas. What are the next steps?

CM: Its focus will be on its Wattenberg/Niobrara position. It has a four-rig program in the play, which should drive 2014 production growth of 4550%. But at the same time, the Wattenberg valuation is more than $50,000/acre, which just seems closer to full value at these levels.

TER: Did you also initiate coverage on Gulfport Energy Corp. (GPOR:NASDAQ)?

CM: Yes. We have a Hold rating on Gulfport for similar reasons. Whereas Bonanza Creek has a quality position in the Wattenberg/Niobrara, Gulfport has a fantastic position in the core of the Utica. The valuation is a bit stretched at these levels, however.

TER: You have a Buy on Midstates Petroleum Co. Inc. (MPO:NYSE). Is that based on its exposure to the Anadarko Basin?

CM: The Buy on Midstates is based on the fact that its portfolio is misunderstood and undervalued. It also has a leading position and is one of the biggest operators in the Mississippi Lime play in Northern Oklahoma. Then it has the third leg of the stool, if you willthe Wilcox play in Louisiana, which is an earlier-stage play that it is not receiving any credit for. As we move into 2014 and the company executes and delivers what we feel like will be above-average production growth, that value gap is likely to narrow.

TER: Do you still like the Gulf of Mexico?

CM: It's all about relative valuation. The Gulf of Mexico players had a nice tailwind earlier this year with Light Louisiana Sweet oil prices enjoying a healthy premium to West Texas Intermediateclose to $20-plus/bbl earlier this year. That premium has since eroded. It's not something that will likely come back in a meaningful way in the near term. As a result, you lose that benefit looking into 2014. But, like I said, it's all about relative valuation.

We do think there are some nice opportunities in the Gulf, specifically Stone Energy Corporation (SGY:NYSE). It has several impactful catalysts in the form of deepwater exploration wells that should have results starting in early 2014, which could drive outperformance for the stock. Investors aren't paying for any of that upside at these levels, so that's really why we have the Buy rating on Stone at this time.

TER: Its stock is up to $40 from $32 last month. Is that mainly because of the new spudding in early 2014?

CM: Fortunately for Stone Energy, there are a number of wells, operated and non-operated, that should provide a steady flow of catalysts throughout 2014 and 2015 in the deepwater Gulf of Mexico. We expect several catalysts over the course of the next couple of years.

TER: Are there other relative outperformers in the Gulf of Mexico?

CM: Right now, our two names that operate exclusively on the Gulf of Mexico shelf are Energy XXI (Bermuda) Ltd. (EXXI:NASDAQ) and Energy Partners, Ltd. (EPL:NYSE). We have a Buy rating on Energy XXI and a Hold rating on Energy Partners. Shares of Energy XXI, on a relative basis, are more attractive because they are trading below their proved-only valuation and the company is pursuing a number of exploration objectives, which could cause the stock to outperform. Energy Partners has had some issues in some of its core fields recently, which could provide a headwind for shares in the near term.

TER: Energy XXI also has been doing quite a bit of consolidating of other smaller players. It is pursuing some deeper salt plays. When could those start to pay off?

CM: It's the third largest oil producer on the shelf. It is taking advantage of its footprint in the area and its expertise of the geology in the basin to pursue some deeper exploration targets, not necessarily the ultra deep. We should get some results into 2014 from the company.

You mentioned it being a consolidator. Both Energy Partners and Energy XXI have become consolidators on the shelf. Looking into 2014, we wouldn't be surprised to see Energy XXI target some larger objectives internationally, specifically in Malaysia, which offers a nice analog field to what we've seen in the Gulf of Mexico, but with larger scale.

TER: Energy XXI also just initiated a share buyback program and raised the dividend. Is that part of a trend?

CM: It's a representation of its confidence in the stock and in its performance, its belief that shares are undervalued and its willingness to buy back shares at levels it feels are too low.

TER: Smart capital allocation has been a differentiator for some of these companies in 2013. How are successful companies better using their resources?

CM: Since we've seen commodity prices somewhat range-bound with a lot of the land grab more or less over, investors will be even more willing to reward companies that demonstrate effective and efficient operations in 2014.

TER: Companies have been trying to create some new catalysts and value, and derisk their new projects. Is that paying off?

CM: Yes. We've seen that across the board in terms of drilling efficiencies. As companies have migrated away from acreage capture to development mode in their core resource plays, we've seen rig productivity increase fairly dramatically. That's been an area where companies have been able to deliver meaningful cost savings while, at the same time, enhancing their drilling and completion techniques, essentially making bigger wells and increasing their IRRs in these plays. Downspacing has also been a catalyst in a lot of these plays and, looking into 2014 in some of the more developed plays, whether it's the Bakken, the Eagle Ford or the Niobrara, additional downspacing results will be a major catalyst for a number of companies.

TER: Can you leave us with some advice for investors in the space as they prepare for 2014?

CM: Stock selection will be more important than ever looking into 2014. While this is a group that historically has a high correlation to oil and gas prices, it's becoming more of a stock picker's market. As we look into 2014, we're more focused than ever on company specific fundamentals and relative performance indicators that should help pick the outperformers into next year.

TER: Thanks for joining us today.

CM: Thanks for having me.

Chad Mabry is an analyst in MLV's Energy and Natural Resources Research Department. Bringing over 10 years of experience in the oil and gas industry, he primarily focuses on small- and mid-cap companies in the Exploration Production sector. Prior to joining MLV, Mr. Mabry was a senior analyst with KLR Group and Rodman Renshaw, and an associate analyst with Pritchard Capital Partners. Mr. Mabry holds an M.A. in Accounting and a B.A. in Philosophy from the University of Texas at Austin.

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Commodity Markets Summary for Thursday December 19th

Crude oil closed higher on Thursday renewing the rally off November's low. The high range close sets the stage for a steady to higher opening when Friday's night session begins. Stochastics and the RSI are diverging but are turning neutral to bullish signaling that sideways to higher prices are possible near term. If January renews the rally off November's low, the 50% retracement level of the August-November decline crossing at 99.87 is the next upside target. Closes below the 20 day moving average crossing at 96.19 are needed to confirm that a short term top has been posted. First resistance is today's high crossing at 99.17. Second resistance is the 50% retracement level of the August-November decline crossing at 99.87. First support is the 20 day moving average crossing at 96.19. Second support is November's low crossing at 91.77.

Natural gas closed sharply higher on Thursday renewing the rally off November's low. The high range close sets the stage for a steady to higher opening on Friday. Stochastics and the RSI are diverging but are turning neutral signaling that sideways to higher prices are possible near term. If January extends the rally off November's low, the 75% retracement level of this year's decline crossing at 4.487 is the next upside target. Closes below the 20 day moving average crossing at 4.104 would confirm that a short term top has been posted. First resistance is today's high crossing at 4.471. Second resistance is the 75% retracement level of this year's decline crossing at 4.487. First support is the reaction low crossing at 4.172. Second support is the 20 day moving average crossing at 4.104.

The March S&P 500 closed lower due to light profit taking on Thursday as it consolidated some of this week's rally. The high range close sets the stage for a steady to higher opening when Friday's night session begins trading. Stochastics and the RSI are bullish signaling that sideways to higher prices are possible near term. If March extends this year's rally into uncharted territory, upside targets will be hard to project. If March renews the decline off November's high, the reaction low crossing at 1738.70 is the next downside target. First resistance is today's high crossing at 1806.10. Second resistance is unknown. First support is Monday's low crossing at 1755.00. Second support is the reaction low crossing at 1738.70.

Gold closed lower on Thursday renewing the decline off August's high. The low range close sets the stage for a steady to lower opening when Friday's night session begins trading. Stochastics and the RSI are diverging but bearish signaling that sideways to lower prices are possible near term. If February renews the decline off August high, June's low crossing at 1187.90 is the next downside target. Closes above last Tuesday's high crossing at 1267.50 are needed to confirm that a low has been posted. First resistance is last Tuesday's high crossing at 1267.50. Second resistance is the reaction high crossing at 1294.70. First support is today's low crossing at 1190.00. Second support is June's low crossing at 1187.90.

COT Fund fav coffee closed lower on Thursday as it consolidates some of the rally off November's low. The low range close set the stage for a steady to lower opening on Friday. Stochastics and the RSI are neutral to bullish signaling that sideways to higher prices are possible near term. If March extends this month's rally, the reaction high crossing at 12.10 is the next upside target. Closes below the 20 day moving average crossing at 11.04 would confirm that a short term top has been posted.

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Cabot Oil & Gas raises 2013 production growth guidance view to 50%-55%

Cabot Oil & Gas (COG) says it recently achieved a new gross production record in the Marcellus shale of 1.5B cf/day, prompting it to raise its 2013 production growth guidance range to 50%-55% from 44%-54%; 2014 production growth guidance remains unchanged at 30%-50%.

COG also agrees to provide 350M btu/day of natural gas to the Dominion Cove Point LNG Terminal for 20 years commencing on the project's in-service date scheduled for 2017.

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Potential Takeover Target Anadarko [APC] is Now $9 Billion Cheaper

Anadarko Petroleum's (APC) legal troubles likely haven't tarnished its allure for investors - instead, it has helped make APC $9 billion cheaper, and more appealing for a buyout, Bloomberg reports.

APC may be at the top of the list for multinational oil companies seeking purchases to turn around declining production, analysts say; a buyer willing to shell out $40B plus a premium would get a presence in fields where few big energy companies have exposure: the Niobrara formation in Colorado, Texas’ Eagle Ford shale basin, and offshore Africa.

APC would be an especially good fit for Exxon (XOM) or Chevron (CVX), Oppenheimer's Fadel Gheit says, although it's hard to see how a deal could be serious without a resolution to the Tronox lawsuit, which could leave APC on the hook for as much as $14B in environmental cleanup and health claims.

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A Fed Policy Change That Will Increase the Gold Price

By Doug French, Contributing Editor

For investors having a rooting interest in the price of gold, the catalyst for a recovery may be in sight. "Buy gold if you believe in math," Brent Johnson, CEO of Santiago Capital, recently told CNBC viewers.

Johnson says central banks are printing money faster than gold is being pulled from the ground, so the gold price must go up. Johnson is on the right track, but central banks have partners in the money creation business—commercial banks. And while the Fed has been huffing and puffing and blowing up its balance sheet, banks have been licking their wounds and laying low. Money has been cheap on Wall Street the last five years, but hard to find on Main Street.

Professor Steve Hanke, professor of Applied Economics at Johns Hopkins University, explains that the Fed creates roughly 15% of the money supply (what he calls "state money"), while the banks create "bank money," which is the remaining 85% of the money supply. Higher interest rates actually provide banks the incentive to lend. So while investors worry about a Fed taper and higher rates, it is exactly what is needed to spur lending, employment, and money creation.

The Fed has pumped itself up, but not much has happened outside of Wall Street. However, the Federal Open Market Committee (FOMC), during their October meeting, talked of making a significant policy change that might unleash a torrent of liquidity through the commercial banking system. Alan Blinder pointed out in a Wall Street Journal op-ed that the meeting minutes included a discussion of excess reserves and "[M]ost participants thought that a reduction by the Board of Governors in the interest rate paid on excess reserves could be worth considering at some stage."

Blinder was once the vice chairman at the Fed, so when he interprets the minutes' tea leaves to mean the voting members "love the idea," he's probably right. Of course "at some stage" could mean anytime, and there's plenty of room in the word "reduction"—25 basis points worth anyway. Maybe more if you subscribe to Blinder's idea of banks paying a fee to keep excess reserves at the central bank. Commercial banks are required a keep a certain amount of money on deposit at the Fed based upon how much they hold in customer deposits. Banking being a leveraged business, bankers don't normally keep any more money than they have to at the Fed so they can use the money to make loans or buy securities and earn interest. Anything extra they keep at the Fed is called excess reserves.

Up until when Lehman Brothers failed in September of 2008, excess reserves were essentially zero. A month later, the central bank began paying banks 25 basis points on these reserves  and five years later banks, mostly the huge mega banks, have $2.5 trillion parked in excess reserves. I heard a bank stock analyst tell an investment crowd this past summer the banks don't really benefit from the 25 basis points, but we're talking $6.25 billion a year in income the banks have been receiving courtesy of a change made during the panicked heart of bailout season 2008. This has been a pure government subsidy to the banking industry, and one the public has been blissfully ignorant of.

But now everything looks rosy in Bankland again. The banks collectively made $36 billion in the third quarter after earning over $42 billion the previous quarter, showing big profits by reserving a fraction of what they had previously for loan losses. The primary regulator for many banks, the FDIC, is even cutting its operating budget 11%, citing the recovery of the industry. The deposit insurer will have one short of 7,200 employees on the job in 2014.

That's a third of the number it had in 1991 after the S&L crisis, but almost 3,000 more than it had in 2007 just before the financial crisis. So with all of this good news, the Fed may indeed be thinking they can pull out the 25bp lifeline and the banks will be just fine. What Blinder thinks and hopes is the banks will use that $2.5 trillion to make loans. After all, one-year Treasury notes yield just 13 basis points, while the two-year only kicks off 31bps. Institutional money market rates are even lower.

Up until recently, banks haven't been active lenders. The industry loan to deposit ratio reflects a tepid loan environment. During the boom, this ratio was over 100%. Now it hovers near 75%. It turns out that what the Fed has been paying, 25 basis points, has been the best source of income for that $2.5 trillion. However, banks won't be able to cut their loan loss reserves to significant profits for much longer. Loan balances have grown at the nation's banks the last two quarters and this will have to continue. If the Fed stopped paying interest on excess reserves and bank lending continues to increase, those $2.5 trillion in excess reserves could turn into multiples of that in money creation.

Banks create money when they lend. As Blinder explains, Fed injected reserves are lent "creating multiple expansions of the money supply and credit. Bank reserves were called 'high powered money' because each new dollar of reserves led to several additional dollars of money and credit." Fans of the yellow metal, like Mr. Johnson who sees the price going to $5,000 per ounce, have likely been too focused on the Fed's balance sheet when it's the banks that create most of the money.

When the Fed announces it won't pay any more interest on excess reserves, and banks start lending in earnest again, the price of gold will be very interesting to watch.

And when that happens, you'll want to be prepared. 

Find out all you need to know about the best ways to invest in gold—in the FREE 2014 Gold Investor's Guide. Click here to read it now.

The Fed Taper Explained by SPX Options

From our trading partner options guru J.W. Jones......

With the last major news item for 2013 less than 48 hours away, I thought I would share some insights as to what the S&P 500 Cash Index (SPX) options were pricing into the Federal Reserve’s monetary policy announcement due out Wednesday.

After the news is released and the week ends, it will be time for Santa Claus to come to Wall Street. While most people believe in the Santa Claus rally, what few understand is the bullish undertones that traditionally accompany a triple witching event.

This coming Friday, is a triple expiration. Equity options, index options, and futures contracts will be expiring this Friday. This event is traditionally known as “triple witching” and historically the quarterly expiration event ushers in serious bullishness.

According to Bank of America Merrill Lynch, “In the 31 years since the creation of equity index futures, the S&P500 has risen 74% of the time during this week. More recently, it has risen in ten of the past 12 years.” The chart shown below was posted on zerohedge.com and was provided by Bank of America Merrill Lynch......Read "The Fed Taper Explained by SPX Options"



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The Monster That Is Europe

By: John Mauldin

This week, Geert Wilders and his Party for Freedom in the Netherlands and Marine Le Pen of the Front National (FN) of France held a press conference in The Hague to announce that they will be cooperating in the elections for the European Parliament next spring and hope to form a new eurosceptic bloc. Their aim, as Mr. Wilders put it, is to "fight this monster called Europe," while Ms. Le Pen spoke of a system that "has enslaved our various peoples." They want to end the common currency, remove the authority of Brussels over national budgets, and undo the project of integration driven with so much idealism by two generations of European politicians. (My thought about Marine Le Pen after looking at her policies is that if Marine Le Pen is the answer for France, they are asking the wrong question.)

For now, Le Pen and Wilders are in a decided, if growing, minority (think Beppe Grillo, who got 25% in Italy in the last election). But as the graphic below suggests, the stitching that is holding the Frankenstein of Europe together seems to be getting a little frayed. And my new worry is that the real monster, one likely to pop many more of the tenuous stitches that hold things together, could be lurking in German banks. This week's letter explores a problem as "hidden" as subprime was back in 2006. Not as big, to be sure, but it might not need to be big to tug too hard the frayed threads that hold Europe together. (Note: this week's letter will print out longer than usual due to the large number of graphs and pictures.)



But first and quickly, we have finalized the dates for next year's Strategic Investment Conference. Mark your calendar for May 13-16. We are adding half a day so we can bring you a few more must-hear speakers. In addition to our always killer lineup of investment and economics thought leaders, I want to add some technology and politics. The significant difference about this conference is that there are no "B list" speakers. Everyone is a headliner. No one pays to get to speak or promote their deal. When we started the conference 11 years ago, my one rule was that we would invite speakers that I wanted to hear and create a conference that I would want to go to.

With my co-hosts Altegris Investments, we have done that and more. Attendees typically rate this conference as the best they attend. This year we have moved to San Diego, where we can have more space. We will still keep it small enough so that you can meet the speakers, as well as a room full of extremely interesting fellow attendees. You can sign up now and book your rooms by going to http://www.altegris.com/sic. Don't procrastinate. Mark down the dates and plan your time accordingly.

The Complacency of Consensus

"But where are you out of consensus?" came the question. I had just spent a few minutes outlining my view of the world to a group of serious money managers here in Geneva, highlighting some of the risks and opportunities I see. The gentleman's question made me realize that for the short-term, at least, I am all too sanguine for my personal taste. I have never thought of myself as one of those consensus guys. But when you consider that Japan is continuing down its path to starting a global currency war, with a currency that will drop at least in half from where it is now (plunging Japan into Abe-geddon); that China is launching its most serious economic overhaul in 20-30 years; that the US is still careening toward its day of reckoning with entitlement spending while dealing with the fall-out from taper tantrums in emerging markets; and that Europe is steering a course straight into deflation – the lot leaving us with Disaster A, Disaster B, or Disaster C as the consensus choice; then yes, I suppose I am a consensus guy, of sorts. But those are all worries that will come to a head later next year or the year after, not in the next few months or weeks, which is where most traders live. The trader who quizzed me wanted to know what was going to affect his book this week!

We seem to occupy a world where we are all somewhat uncomfortable. The problems are all so apparent; but somehow we are compelled to take risks anyway, hoping that the risks we take are properly managed or that we can exit at the propitious moment. The game seems to be moving along, absent another major shock to the system. It's not quite party like it's 2006, because the level of complacency is nowhere near the same; but we do seem headed down the same risk path, even though it scares us. Which means that it might take somewhat less than a subprime debacle and banking shock to trigger a crisis, since no one wants to be exposed when the next crisis happens. The majority of market players appear to believe that another crisis might materialize, but in the meantime you have to dance while the music is playing. Fifty Shades of Chuck Prince.

So, as investors and money managers, we must be on shock alert. Where will the next one come from? By definition, a shock is a surprise to the markets, something that few people recognize until it becomes too big to ignore. Ben Bernanke achieved a degree of infamy for saying that the subprime crisis would be contained, even as some of us were shouting that losses would be in the hundreds of billions (what optimists we were!). And then came the shock that created the biggest global economic crisis since the Great Depression.
But an almost desperate reach for yield and shouldering of risk are clearly in evidence. Junk bond issuance is over 2.5 times what it was in 2006 and twice as high as a percentage of total corporate bond issuance. Leveraged loans are back to all-time highs, even as credit spreads continue to fall (see graph).



Collateralized loan obligations (CLOs) are close to all-time highs after almost disappearing in 2009. And subprime auto-asset-backed paper is projected to set a new record in 2014. Party on, Garth!
But if you ask the participants in those very markets, and I do, if there is any sign that the reach for yield is easing, the answer is generally "Not yet." After 2008, everyone remains nervous; but when the analysis is done, enough buyers conclude that the future will be somewhat like the recent past. Although no one I talk to believes that in 2014 we will see another year in the stock market like the current one, still, the consensus outlook is rather sanguine. But I talk to more bulls than you might think. Last night in Geneva David Zervos was arguing (till rather late in the night, for me at least) his familiar spoos and blues with me (long S&P 500, long eurodollar). He is ready to double down on QE. Our hosts bought an excellent if outrageously expensive dinner (for the record, there is no other kind of meal in Geneva – can you believe $12 Diet Cokes?), and it was only polite to listen. And the trade has been right.

But for how long? Central banks are still going to be easy. But markets can be characterized as fully valued, at best, especially since there have been more earnings warnings this last quarter than at any time in the recent past. While the conditions are not quite the same as in 2006-07, we are getting a little frothy. So is it 2005, so that we can enjoy the ride into late 2006 and then look for an exit strategy? I would argue that the markets actually need a "shock" of some kind. And in addition to the "consensus-view" shocks mentioned above, I see one especially big, nasty lion lurking in the grass. In the form of German banks.

The Sick (German) Banks of Europe

Quick: I say "German banks," and what's the first thing that comes to your mind? The Bundesbank? Staid, no-nonsense central banking? The Bundesbank is all about maintaining the price of money – forget QE. Deutschebank? Big, German – must be stable and low-risk. The fact that southern Europeans are opening accounts left and right in DB must mean that DB is lower-risk than the local wild guys. Except that they have the largest derivatives portfolio, at $70 trillion (but don't worry because it all nets out, sort of, and of course there is no counter-party risk!), and they are the most highly leveraged bank in Europe (at 60:1 in the last tests – not a misprint), which might give you pause. Although their CEO argues that their leverage doesn't matter. And keeps a straight face. Just saying…

If something happens to DB, they are, in all likelihood, Too Big To Save, even for Germany. But Deutschebank is not my focus here today. It is their much smaller brethren, Too small to be called siblings, actually. More like first cousins twice removed. But there are a lot of them, and they all piled into some very interesting and, as it turns out, very questionable trades. And the story begins with the American consumer.
This Christmas, we will all engage, as will much of the world, in an orgy of gift giving. (I helpfully offer a few ideas of my own at the end of the letter.) The iPads and Xbox Ones and GI Joes with the Kung-Fu Grip (gratuitous esoteric movie reference) will be flying off the shelves. But the one thing that ties all those gifts together is The Box, the humble container unit, the TEU, which allows the world to transport all those items ever more cheaply. That story is resoundingly told in a book that Bill Gates featured in his Best Reads for 2013, simply entitled The Box.

You can read a great review here. It turns out that the shipping container was created in the '50s by a force-of-nature entrepreneur who fought governments and regulators (who typically tried to protect unions rather than help consumers) to bring the idea to market. It finally took off when the military decided it was the best way to ship material to the troops in Vietnam. It is one of those things that make sense and would have happened anyway, but as often happens, military spending drove the ramp-up.

The container was not without controversy. Longshoreman unions fought it aggressively, as containers meant fewer high-paying jobs. But The Box also meant far cheaper transportation of goods, and so it helped boost international trade. Now it is hard to imagine a world without containers. And even though the container business started in the US, there is not one US firm in the top 18 container shipping companies. The business is dominated by European and Asian firms.

And container ships were profitable. Oh my, fortunes were built. And they were so successful that a few German bankers looked at the easy money made by US bankers securitizing and packaging mortgages and decided they could do the same with ship financing. I know it is hard to believe, but the German government decided to create pass-through tax vehicles that gave serious tax preference to high-tax-rate investors for all sorts of things, including movies (such cinematic monuments as Terminator 3, I Robot, and the forgettable Stallone flick Get Carter were financed with German "tax shelters"); but my research has so far unearthed nothing to equal the German passion for financing ships. Seriously, would any US government entity give tax breaks to a favored industry? Would a Canadian or Australian or [insert your favorite country here] government? Such things are done by many governements, of course. Here we may apply Mauldin's Rule (stolen from someone else, I am sure): Any seriously out-of-whack financial transaction requires government involvement (generally in the form of some market-distorting law).

Cargo ships, especially container ships, were serious cash machines for long-term money. Buy the ship with some leverage, put it to work, and watch the cash roll in. The Greeks were especially good at this, but the Germans and Scandinavians caught on quick. The Germans went everyone one better and allowed small high-net-worth investors to put their money into funds that financed these ships. At one point, I am told, German banks might have been financing 50% of the world's cargo ships. (They control at least 40% of the world's container ship market today.) Anyone familiar with limited partnerships in the US in the late '70s and early '80s knows how this story ends for the investors.

I came across this story from the inside, as a business partner of mine is in the shipping business; but he owns and operates a special type of ship: massive tugboats that move ocean drilling-rig platforms, and those are still in healthy demand. But his original financing many years ago was from Germany.

It turns out that if a little leverage makes a deal look good, then a lot makes it look even better. In 2007, ships were financed at 75% leverage (on average). It looks like 2008 vintages were financed in the 90% range! (Data is from a presentation I was sent, done by Dr. Klaus Stoltenberg of NordLB.)

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Growing Oil and Natural Gas Production Continues to Reshape the U.S. Energy Economy

The Annual Energy Outlook 2014 reference case was released today by the U.S. Energy Information Administration (EIA) presents updated projections for U.S. energy markets through 2040.

"EIA's updated Reference case shows that advanced technologies for crude oil and natural gas production are continuing to increase domestic supply and reshape the U.S. energy economy as well as expand the potential for U.S. natural gas exports," said EIA Administrator Adam Sieminski. "Growing domestic hydrocarbon production is also reducing our net dependence on imported oil and benefiting the U.S. economy as natural-gas-intensive industries boost their output," said Mr. Sieminski.

Some key findings:

Domestic production of oil and natural gas continues to grow. Domestic crude oil production increases sharply in the AEO2014 Reference case, with annual growth averaging 0.8 million barrels per day (MMbbl/d) through 2016, when domestic production comes close to the historical high of 9.6 MMbbl/d achieved in 1970 (Figure 1). While domestic crude oil production is projected to level off and then slowly decline after 2020 in the Reference case, natural gas production grows steadily, with a 56% increase between 2012 and 2040, when production reaches 37.6 trillion cubic feet (Tcf). The full AEO2014 report, to be released this spring, will also consider alternative resource and technology scenarios, some with significantly higher long-term oil production than the Reference case.

Low natural gas prices boost natural gas-intensive industries. Industrial shipments grow at a 3.0% annual rate over the first 10 years of the projection and then slow to a 1.6% annual growth over the balance of the projection. Bulk chemicals and metals-based durables account for much of the increased growth in industrial shipments. Industrial shipments of bulk chemicals, which benefit from an increased supply of natural gas liquids, grow by 3.4% per year from 2012 to 2025, although the competitive advantage in bulk chemicals diminishes in the long term. Industrial natural gas consumption is projected to grow by 22% between 2012 and 2025.

Higher natural gas production also supports increased exports of both pipeline and liquefied natural gas (LNG). In addition to increases in domestic consumption in the industrial and electric power sectors, U.S. exports of natural gas also increase in the AEO2014 Reference case (Figure 2). U.S. exports of LNG increase to 3.5 Tcf before 2030 and remain at that level through 2040. Pipeline exports of U.S. natural gas to Mexico grow by 6% per year, from 0.6 Tcf in 2012 to 3.1 Tcf in 2040, and pipeline exports to Canada grow by 1.2% per year, from 1.0 Tcf in 2012 to 1.4 Tcf in 2040. Over the same period, U.S. pipeline imports from Canada fall by 30%, from 3.0 Tcf in 2012 to 2.1 Tcf in 2040, as more U.S. demand is met by domestic production.

Car and light trucks energy use declines sharply, reflecting slow growth in travel and accelerated vehicle efficiency improvements. AEO2014 includes a new, detailed demographic profile of driving behavior by age and gender as well as new lower population growth rates based on updated Census projections. As a result, annual increases in vehicles miles traveled (VMT) in light-duty vehicles (LDV) average 0.9% from 2012 to 2040, compared to 1.2% per year over the same period in AEO2013. The rising fuel economy of LDVs more than offsets the modest growth in VMT, resulting in a 25% decline in LDV energy consumption decline between 2012 and 2040 in the AEO2014 Reference case.

Natural gas overtakes coal to provide the largest share of U.S. electric power generation. Projected low prices for natural gas make it a very attractive fuel for new generating capacity. In some areas, natural-gas-fired generation replaces power formerly supplied by coal and nuclear plants. In 2040, natural gas accounts for 35% of total electricity generation, while coal accounts for 32% (Figure 3). Generation from renewable fuels, unlike coal and nuclear power, is higher in the AEO2014 Reference case than in AEO2013. Electric power generation from renewables is bolstered by legislation enacted at the beginning of 2013 extending tax credits for generation from wind and other renewable technologies.

Other AEO2014 Reference case highlights:

• The Brent crude oil spot price declines from $112 per barrel (bbl) (in 2012 dollars) in 2012 to $92/bbl in 2017. After 2017, the Brent spot oil price increases, reaching $141/bbl in 2040 due to growing demand that requires the development of more costly resources. World liquids consumption grows from 89 MMbbl/d in 2012 to 117 MMbbl/d in 2040, driven by growing demand in China, India, Brazil, and other developing economies.

• Total U.S. primary energy consumption grows by just 12% between 2012 and 2040. The fossil fuel share of total primary energy demand falls from 82% of total U.S. energy consumption in 2012 to 80% in 2040 as consumption of petroleum-based liquid fuels falls, largely as a result of slower growth in LDV VMT and increased vehicle efficiency.

• Energy use per 2005 dollar of gross domestic product (GDP) declines by 43% from 2012 to 2040 in AEO2014 as a result of continued growth in services as a share of the overall economy, rising energy prices, and existing policies that promote energy efficiency. Energy use per capita declines by 8% from 2012 through 2040 as a result of improving energy efficiency and changes in the way energy is used in the U.S. economy.

• With domestic crude oil production rising to 9.5 MMbbl/d in 2016, the net import share of U.S. petroleum and other liquids supply will fall to about 25%. With a decline in domestic crude oil production after 2019 in the AEO2014 Reference case, the import share of total petroleum and other liquids supply will grow to 32% in 2040, still lower than the 2040 level of 37% in the AEO2013 Reference case.

• Total U.S. energy-related CO2 emissions remain below their 2005 level (6 billion metric tons) through 2040, when they reach 5.6 billion metric tons. CO2 emissions per 2005 dollar of GDP decline more rapidly than energy use per dollar, to 56% below their 2005 level in 2040, as lower-carbon fuels account for a growing share of total energy use.

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