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Don Coxe Weekly Call
Always a good listen. Go Canadian, go commodities, go precious metals ehhyy!
http://events.startcast.com/events/199/B0003/#
Reserves in the ground are key. Safe countries are preferrable.
Good Luck!
Kipp
cl001 - BMO Capital Markets
Here is the info:
03:55pm EDT 3-Aug-07 BMO Capital Markets-US (Deacon, Raymond 303-436-1113) TXC TXCO --Raising Target Price to $24; Maintaining 2007 Volume Target - Part 1/2
TXC TXCO --Raising Target Price to $24; Maintaining 2007 Volume Target - Part 1/2
PLEASE SEE END OF NOTE FOR IMPORTANT DISCLOSURES.
TXCO Resources Inc. Analyst: Raymond J. Deacon, CFA
(TXCO - NASDAQ) (303) 436-1113
August 3, 2007 Denver, Colorado
Raising Target Price to $24; Maintaining 2007 Volume Target of 9 Bcfe
TKR/ Price 52-wk EPS (FY-Dec) P/E MCap Target
RTG (8/2) Range 2006A 2007E 2008E 2007E 2008E (mn) Yld Price
------------------------------------------------------------------------------
TXCO / 9.92 15-9 0.21 0.01 0.50 nm 19.8 334 0.0% 24
Outperform
Event
2Q EPS reflect the inclusion of the Output purchase, which brought higher costs
per unit to the income statement. EPS were below our estimates (loss of $0.04
versus our estimated $0.12 profit) principally because of higher-than-expected
DD&A rates and LOE expenses. Absent any guidance, we are carrying the per-unit
costs forward for the remainder of the year. Our EBITDA estimate declines by
roughly 10% for this year although the 2008 estimate rises given higher
expected oil prices and slightly higher volume projections (assumes tar sands
production begins to ramp in December given announced plans to drill more than
a dozen wells by year-end).
Impact
Neutral. Given delay in first Pearsall horizontal well becoming a 4Q story.
Forecasts
2007 EBITDA declines 9% while 2008 EBITDA is increasing 21%, principally due to
an assumed increase in oil revenues to $102 million versus $79 million
previously. We maintain our 2007 and 2008 production forecast of 9.0 bcfe and
11.7 bcfe.
Valuation
Our new $24 a share target price reflects the NAV impact from a higher mid-
cycle price case (2009 and beyond) of $55/bbl for benchmark NYMEX pricing and
$7.50/Mmbtu for natural gas.
Recommendation
We rate the shares OUTPERFORM and believe they offer a highly attractive
risk/reward proposition.
Details & Analysis
Our thesis on TXCO remains that the proven reserves and the Glen Rose Porosity
inventory is worth somewhere between $9 and $10 a share and that investors gain
exposure to the San Miguel tarsands play, the Pearsall Shale play, and the
horizontal Glenrose shoal play on the Output properties essentially for free.
The following table shows our estimate for the value of the company's 300
locations in the Glenrose Porosity play, typical IRRs, and the NPV per well
assuming a $55/bbl oil price.
Exhibit 1: Glenrose Porosity Economics & Inventory
*** Graphic object removed from ascii version of document. ***
Source: BMO Capital Markets Estimates and Company Reports.
Additional conference call and recent Boston/Chicago roadshow highlights:
" Schlumberger has been hired to do a reservoir study on the company's Glen
Rose Porosity play to determine oil in place, and recoverable reserves as well
as to suggest a secondary recovery program for the future. This may result in
play being classified as one reservoir and allow the company to book PUDs
(positive F&D impact). The company is working diligently on ways to lower the
reservoir pressure to allow the oil to escape from the porosity matrix.
" Deep Bossier. Peers are drilling wells in excess of 65 mmcfpd on the same
"shelf" of the Bossier as TXCO in the vicinity of the Fort Trinidad field. We
look for a well to be drilled in 2008.
" Tar Sands. We expected news on pricing of tar sands product from Corpus
Refinery at this point and it looks like that news is further away than we had
thought. By year end we hope to see commercial production from a pilot that may
consist of as many as 32 wells.
" Pearsall. Because of the completion technique equipment that will be
required it is likely two months until results from fracture stimulation are
known. Anadarko recently permitted its first horizontal well to test the
potential of the Eagleford and Pearsall shales in the Maverick basin, having
drilled five vertical wells. The lateral in the well extended 1,560' versus
2,500-4,000' planned lateral since Encana, the operator, had difficulties
handling pressures encountered. TXCO intends to drill its next well
underbalanced to avoid formation damage in, it hopes, to improve deliverability
from the well.
" 3-D defined Glenrose Shoals on Fort Trinidad field have significant
potential. The first of seven planned wells targeting the Glen Rose B is slated
for September. The Glen Rose C shoal had been the primary target given that it
had oil while the Glen Rose B was never targeted for development.
" Capex. We believe that in order to fund expected drilling in the San
Miguel tar sands play the cap-ex will go up.
Company Description
TXCO Resources is a small-cap ($365 million) independent oil and gas E&P
company. The company's core area is the Maverick Basin (85% average working
interest) in Southwest Texas, with more than 600,000 acres in the basin. TXCO
also has interests in the Marfa Basin in West Texas. The company reported year-
end 2006 reserves of 41.4 Bcfe, 48% of which are proved developed. On a pro
forma basis for the merger, the company has 81.4 bcfe, and production of
roughly 21.4 mmcfepd and net acreage of more than 723,000 acres. With the
acquisition now closed, the company has in excess of $90 million available for
development capital expenditures on its credit lines. The company also owns a
91-mile pipeline system in the Maverick basin with current capacity of 35
mmcfpd (33% utilized) with expansion potential to 100 mmcfpd.
Exhibit 1: TXCO Actuals and Estimates
*** Graphic object removed from ascii version of document. ***
Source: BMO Capital Markets Estimates and Company Reports.
Exhibit 2: TXCO Summary Balance Sheet and Reserve Table
*** Graphic object removed from ascii version of document. ***
Source: BMO Capital Markets Estimates and Company Reports.
Exhibit 3: TXCO NAV Model
*** Graphic object removed from ascii version of document. ***
Source: BMO Capital Markets Estimates and Company Reports.
Important Disclosures
Analyst's Certification
I, Raymond J. Deacon, CFA, hereby certify that the views expressed in this
report accurately reflect my personal views about the subject securities or
issuers. I also certify that no part of my compensation was, is, or will be,
directly or indirectly, related to the specific recommendations or views
expressed in this report.
Analysts who prepared this report are compensated based upon (among other
factors) the overall profitability of BMO Capital Markets Corp, BMO Nesbitt
Burns, and their affiliates, which includes the overall profitability of
investment banking services. Compensation for research is based on
effectiveness in generating new ideas and convincing clients to act on them,
performance of recommendations, accuracy of earnings estimates, and service to
clients.
Company Specific Disclosure
BMO Capital Markets Corp. has provided advice for a fee with respect to this
company within the past 12 months: Yes
BMO Capital Markets Corp. has undertaken an underwriting liability with respect
to this company within the past 12 months: Yes
BMO Capital Markets Corp. has provided investment banking services with respect
to the company within the past 12 months: Yes
BMO Capital Markets Corp. or its affiliates owns 1% or more of any class of
common equity securities of the company: No
BMO Capital Markets Corp. or its affiliates makes a market in the security:
Yes
BMO Capital Markets Corp. or its affiliates managed or co-managed a public
offering of securities of the company in the past 12 months: No
BMO Capital Markets Corp. or its affiliates received compensation for
investment banking services from the company in the past 12 months: No
BMO Capital Markets Corp. or its affiliates or its officers own warrants or
options: No
Company is a client (or was a client) of BMO Capital Markets Corp. or an
affiliate within the past 12 months: Yes, for investment banking services
Employee, officer, or director of BMO Capital Markets Corp. is a member of the
Board of Directors or an advisor or officer of this company: No
A member of the Board of Directors of Bank of Montreal is also a member of the
Board of Directors or is an officer of this company: No
Analyst and/or associate who prepared this report is a member of the Board of
Directors of this company or an advisor or officer of this company: No
A household member of the research analyst and/or associate who prepared this
report is a member of the Board of Directors of this company or an advisor or
officer of this company: No
Analyst or associate who prepared this report or member of household of analyst
or associate owns shares: No
Analyst or associate who prepared this report or member of household of analyst
or associate owns warrants/options: No
BMO Capital Markets Corp. or its affiliates expects to receive or intends to
seek compensation for investment banking services from the company in the next
three months: No
Analyst received compensation from the company in the past year: No
BMO Capital Markets Corp. or its affiliates received compensation for products
or services other than Investment Banking Services from the company in the past
12 months: No
Methodology and Risks to Our Price Target
Methodology: Price target is based on our NAV, which assumes mid-cycle
commodity prices of $7/MMBtu and $50/Bbl.
Risks: Commodity prices, ability to create predictable growth from the Glen
Rose.
Breakdown of Rating Distribution and Banking Clients
(Continued in Part 2 ...)
Thomson Financial
All rights reserved. 800.347.7822
B/GT C/CNA C/CUS I/NOI S/SEO TXCO TXCO.O
2morrow - Thanks for reposting. AEZ is another stock that I think people are over looking the potential. I am swampped at work and have not had time to go through the October IR presentation I posted the link to earlier. At the bottom of the slides it gave the theoretical # of wells they could drill in the 4 different fields. It was a number over a thousand wells. If you get time look AEZ over and see what you think. I am glad you are in TXCO and hope it treats us all very well. They will have news out soon on flow rates from the tar sands wells!
Good luck!
Kipp
Bobwins - G7 and USD
Bob,
What can be done to support the US Dollar and how will it relate to the markets?
I can't see any scenario that strengthens the dollar without totally killing the US stock and housing markets.
What do you see?
Thanks!
Kipp
Nuts - AEZ - We need to see how these first wells flow. I looked at the bottom of the slides and there are theoretical #'s of wells that could be drilled. Let's say they drill 600 wells, if each adds an average of $.10/shr, that takes the stock price up $60. The reserve #'s could be big enough to attract a big cap producer and they may get taken out well before they get to that stage. Look at the chart of ARD.
Kipp
Blue Note Ships Zinc Concentrate
Thursday October 18, 9:00 am ET
Shares outstanding: 287 Million Symbol & Exchange: BN-TSXV
MONTREAL, Oct. 18 /CNW Telbec/ - Blue Note Mining reports that its first shipment of zinc concentrate has been shipped from the port of Belledune, New Brunswick on October 17, 2007. This first shipment of approximately 5,600 metric tonnes of concentrate is enroute to Antwerp, Belgium.
"We are pleased to be able to report delivery of this quantity of zinc concentrate this early in our ramp-up phase," said John Martin, Chief Operating Officer of Blue Note, "We have now successfully delivered both lead and zinc concentrates to our customers. Mine and mill operations are stabilizing and metallurgical performance is continuously improving. We expect to be meeting our planned production and metallurgical performance targets by year end"
Blue Note recently announced that it had customers for all of its lead concentrate and 85% of its zinc concentrate. "We are benefiting handsomely from record lead prices as lead accounts for roughly half of our total production," said Michael Judson, Blue Note's President and Chief Executive Officer.
Blue Note Mining is a Canadian mining company headquartered in Montreal with operations in Bathurst, New Brunswick. The company's shares trade on the TSX Venture Exchange under the symbol BN.
Dollar just made new low this morning. The index is at 77.40 as I type. CNBC is talking about a rate cut on the weak jobs #s, 75% chance of .25% cut. Oil is up around $88 and gold up as much as $9 this morning.
Looks like a train wreck no matter what the FED does.
Kipp
AEZ - Updated October Presentation
I mentioned this stock in mid June at $5.50ish, now $6.50ish.
Please take a few minutes to look over the new October presentation at this link:
http://aez.investorpass.com/profiles/investor/fullpage.asp?f=1&BzID=992&to=cp&Nav=0&...
Once the results of currently drilled wells come in I can see huge potential for the stock price. They have completed the drilling of some super complex wells, some tapping 5 pay zones and nearly 3 miles deep.
I think this has multi-bagger potential.
Kipp
EXN could find the Mother Lode!
"We are very pleased to see the Rodilla Manto grow into a major sulphide body so quickly and hope these intercepts can be incorporated into our pending Mineral Resource update," said Richard W. Brissenden, Excellon's CEO and president. "Eventually we expect to link Rodilla to the Guadalupe Manto, but the way Rodilla rises from the northeast suggests the presence of a parallel feeder structure that we have not previously encountered. We look forward to pursuing it with one of the two drill rigs we have dedicated to expanding the known sulphide bodies in and around our current operation."
Exciting!
Kipp
EXN - New Intercepts HIGH GRADES!
http://biz.yahoo.com/ccn/071016/200710160419114001.html?.v=1
Kipp
Look at this chart, Gartman has a huge following!
http://bigcharts.marketwatch.com/quickchart/quickchart.asp?symb=gmo&sid=0&o_symb=gmo&fre...
Kipp
Gartman Letter Last Wednesday:
Finally, we wish to bring to our
clients' collective attention our
growing interest in molybdenum.
"Moly" was brought to our attention
by our old friend, Dr. Mike Berry,
whose interests in the metals has
been long standing and intense.
"Moly" seems to us to have been
left behind the other metals, but
appears to us also to be as critically
essential to global economic growth
as is copper, or zinc, or aluminium.
As the "pie chart" this page
(courtesy of the International
Molybdenum Association" notes,
just over 1/3rd of the demand for
"moly" comes from steel alloys.
Stainless steel demands another
1/4 of the demand for "moly" generally, with another 9%
used in "tool and high speed" steel alloys. What is more
essential to world economic growth than is steel? We
have gotten our feet wet in "moly" in recent weeks, and
have owned a position in one of the few "pure plays"
there, Idaho General Mines, for some while. We have
learned that we don't pay attention to things until we take
a position, forcing us to begin to learn about what it is that
has caught our trading/investing fancy. GMO's chart is
beginning to show signs of strengthening. Nothing our
interests and remaining as utterly transparent as we can,
we bring "moly" generally and "Idaho" specifically to our
clients' collective attention this morning, knowing that we'll
become keener in this regard as we move along.
Dennis Gartman is bullish MOLY!
This was in his news letter today.
WE'RE BULLISH OF
"MOLY:"
Molybdenum is the last of
the metals that hasn't
moved powerfully higher, but
now it is, and GMO is one of
the "purer bets" on it.
gilead23 - HLXH is going to pay my way to Vegas. I got 10k at $.09 yesterday!
Thanks!
Kipp
Thanks all for broker opinions.
Anyone Using Interactive Brokers Care to tell me how you like them so far. I have an Ameritrade account and an account with a firm in Iowa (long story) and I am going to consolidate them. I am trading heavily in Canadian stocks and need live Canadian quotes. Please let me know what you think.
Thanks!
Kipp
Anyone Using Interactive Brokers Care to tell me how you like them so far. I have an Ameritrade account and an account with a firm in Iowa (long story) and I am going to consolidate them. I am trading heavily in Canadian stocks and need live Canadian quotes. Please let me know what you think.
Thanks!
Kipp
I am waiting for FED minutes. If they say it is one and done for a whil on the rate cuts and they are worried about inflation, dollar spikes, gold pulls back. If they say they are worried about the banking system failing and will pump more $ in the system with more rate cuts, gold to and over the moon. Silver is the laggard that deserves attention today. Oil sands are hated too, I still hold AOS. 10 minutes and we will know.
Kipp
Not me in SAM today. I need someone to want NGG.V, it is due for a little action!
Kipp
MNG being taken out by NEM @ $6.25
This is no doubt the beginning of a trend.
http://biz.yahoo.com/prnews/071009/latu092.html?.v=101
Kipp
I will fly in Saturday morning and fly out Sunday afternoon. I will be solo and plan to attend all VMC activities.
Thanks,
Kipp
Metalheads - I need advice/help
Guys,
I have observed the Canadian Dollar (CAD) gain 15% on the USD in a very short time. I have also noticed the Mexican Peso (MXP) follow the USD decline nearly lock step.
If I invest in Canadian listed companies, operating mines in Mexico, am I not getting a triple benefit?
1. I am insulated from further USD weakness by being invested in the Canadian market.
2. The Canadian miner has lower operating costs in Mexico than he would operating in Canada or Europe. (This number could be big)
3. I will not only be protected from USD weakness but also recognize appreciation of the CAD.
One thing I don't understand is what happens to Canadian debt. If I was a Canadian company that took out a loan a few years ago, won't I have a lot more to pay back now(in real terms)?
Don Coxe is calling for CAD to go to $1.10 USD.
I am working on a list of Canadian companies that I think will do well operating mines in Mexico. I like SAM.V, EXN.V, SPM.TO as a start.
Anyone else thinking about this? Just think of how many Canadians will be on the beaches of Mexico this winter EY!
Kipp
2morrow - Even a blind squirrel finds an acorn every now and then!
Thanks!
Kipp
TXCO - Bobwins has me laughing!
I went back and looked at this old VMC post from 2006 on TXCO. I rode my shares up to $14 and never sold. When I looked at my average cost I am in TXCO at $9.45...Bobwins is in yesterday at $9.44!!!!
Check this out: http://investorshub.advfn.com/boards/read_msg.asp?Message_id=15574304&txt2find=txco
Petrobank of the South!
Kipp
MNG - Strange Activity
I have a few shares of MNG that I got at $1.35 a long time ago. It is on my gold watch list and was the only stock on the list of over 20 that was up today. I can find no news but some chatter on yahoo message board about "something in the wind". It would be a way for a big cap miner to add reserves. Anyone got any hunches???
Kipp
Bobwins, Nuts: LIHIR GOLD - LIHR(NAS)
I looked all of this over this morning. I am thinking of owning some larger cap gold miners and using them to margin some of the smaller, non-marginable microcappers.
Here is a link to recent presentations, look at mine life, expansions, safe countries, geothermal power, etc.
http://www.lihir.com.pg/asp/index.asp?pgid=10658
I also like AEM as a large cap.
The big question is will we get any pull back to fill gaps in LIHR chart?????
cl001 - Bobwins and I are each going to grab one of your legs in Las Vegas, turn you upside down, shake really hard, and grab some of those cheap shares! Wow, you are stealthy! I am going to hold out for $2.00 on my NGG.V.
Good Luck!
Kipp
I have made lots of $ following Sprott around. This time we beat him to it. I doubled up on NGG and have $.42 average on 100k shares. I am holding this one longer term, so many possible projects oin a part of the world that has produced some "Mother Load" mines. I "hope" this one works out!
Kipp
Astrology Fund Sees a Selloff in the Stars
This is a fun read. Go for the gold!
http://www.thestreet.com/_yahoo/funds/mutualfundmonday/10380922.html
Kipp
Here Is Link To Donald Coxe Call Today
http://events.startcast.com/events/199/B0003/#
Manditory listen for me every Friday at 10:30 CST
If anyone here doesn't get Coxe's monthly "Basic Points" newsletter just send me your email in a PM and I will put you on the list.
TGIF!
Kipp
MAM.V - Canadian Explorer
Has anyone looked at this one? Manicouagan Minerals website:
http://www.manicouaganminerals.com/s/Home.asp
It spiked up 100% on volume and then pulled right back. This move was on drilling results at one of it's 4 properties showing high % of several base metals.
I am adding it to the watch list.
Kipp
TRGL making some headway.
Anyone know anything other than upcoming presentation. I am stuck with a few @ $15. Hope the shorts exit in a hurry and move on.
Kipp
Market Sell Off - Buying Op.
I deployed some cash in junior gold stocks on the mid-August sell-off. So far so good. What I am hoping for now is another sell off after a re-test of the 14,000 DOW. (Notice I am using the word "hope"). What I really would like to see is a tanking of the indexes and an upthrust in commodities. I have stuck with my oil and gold and have been more reserved on the basemetals. If the dollar gets below $.78 on the dollar index we should see more strength in "stuff". An initial sell off in the commodity stocks should be expected again in a big downdraft, however they should recover and ralley based on dollar weakness and general demand for stuff.
I am putting together a shopping list:
NGG.V
GORO.OB
SGR.V
YNG.TO
RBY
SPM.TO
CS.TO
EXN.V
NRDS.PK
Anyone have any more table pounders we should look at?
Kipp
Bobwins, NRDS
Do you know how many shares are outstanding?
Kipp
GORO PP price may be leaking out.
I see GORO selling off here. Could this be the reaction to upcoming PP???
Kipp
"Why China Won't Save the World Economy"
I found this story on China and it will give you something to think about!
Kipp
China—the Other Growth Engine—was supposed to save the world from U.S. financial woes. It won't.
By George Wehrfritz
Newsweek International
Updated: 6:00 p.m. MT Sept 30, 2007
Oct. 1, 2007 issue - You've probably heard of the butterfly effect—inspired by legendary sci-fi writer Ray Bradbury back in 1952—which posits that minute changes in one place can lead to massive impacts elsewhere, as when a fluttering insect triggers atmospheric disturbance that causes a distant tempest. The past few weeks of global market turbulence are a perfect illustration of the effect, as American mortgage troubles have led to Continental bank collapses, emerging-market stock plummets and, most recently, a Great Depression-like run on a British bank. In Hong Kong last week, CLSA's chief economist Jim Walker issued a new warning, predicting that "butterfly wings in America's unfolding subprime-debt debacle ... will blow like a hurricane through China's rust belt." Walker is a well-known China bear, but his thesis is no work of dismal science fiction. Until quite recently, economists worldwide had hoped that America's subprime-induced slowdown would be offset by robust growth elsewhere in the world. After all, Europe had a stellar 2006, and Japan was recovering. Most important, there was China, a new global engine expected to contribute more to world GDP growth this year than any other economy.
Unfortunately, recent weeks have proved that the global economy hasn't decoupled from the American consumer nearly as much as many theorized it would. Mirroring the U.S. slowdown earlier this year, both Euroland and Japan are seeing their own expansions wind down—suggesting more synchronization, not less. Five months ago, a Merrill Lynch report on Japan was titled "Smiles and Enthusiasm." Earlier this month, the header from the same Merrill economist was "Nightmare," as the country slipped into negative growth. Europe, which was poised to challenge the United States with 3 percent GDP growth, is slipping back to its usual lethargic 2 percent.
Could China be next? Walker predicts that growth may shrink from 12 to 5 percent by the end of next year, as the downturn in developed countries takes its toll on the Chinese rust belt. It wasn't supposed to happen that way. In a newly "rebalanced" global economy, the emergence of a new Chinese consumer class was going to make up for weaker Western spending. But despite Beijing's efforts to boost consumer spending, domestic consumption as a share of GDP is actually decreasing, making the Middle Kingdom more dependent on exports than ever before. In Walker's forecast, demand for all the goods churned out by China will slacken just as thousands of new factories come online next year, collapsing profits inside China Inc. and exposing mountains of problem loans at state banks. The ultimate result will almost surely be a global slowdown. "This is the biggest credit crunch we've ever seen," says Walker.
Already Chinese stocks have rallied into uncharted territory, housing prices in major cities hang in the stratosphere and glittery developments are rising everywhere. If that scenario has a familiar feel, it should. Even as it encapsulates China's ongoing boom, it also aptly describes an earlier pre-bust frenzy some two decades ago in Japan. "It's shockingly similar," says Richard Katz, whose seminal 1998 book "Japan: The System That Soured" dissects the stagnation that crippled the world's second largest economy in the 1990s, following a late-'80s bubble. "Looking at these numbers [from China], I was stunned by how much they resembled some of the imbalances we saw in Japan in the 1980s, except that they're more severe."
The passage of time and globalization's sweeping impact make any comparisons with the Japan of two decades past inexact, to be sure. Yet there's no denying that Beijing is now struggling to engineer the same transition from an export- and investment-led growth model to one in which domestic consumption is the key driver—precisely the shift Tokyo botched so miserably. The difference is that while Japan's adjustment problems were mostly an internal affair, Asia's future prosperity, and possibly even the world's, hangs on China's ability to rejigger its economy.
The quantitative similarities between the two countries are alarming. Fixed- asset investment (construction of ports, factories, condos, etc.) now accounts for about 45 percent of China's GDP. Its trade surplus has grown from almost nothing in the late 1990s to 9 percent of GDP today. Meanwhile, private consumption has shrunk from half of total economic activity in the late 1990s to just 35 percent this year. By comparison, Japan's investment component averaged 30 percent of GDP during its peak growth years, its trade surplus topped out at 4.5 percent of GDP and its consumption levels never dipped below 58 percent of GDP. Conclusion: China's economy is currently more out of kilter than Japan's ever was.
Katz has coined a term for the problem: economic anorexia. He defines it as a nation's chronic inability to consume all that it produces—a malady that leads to bloated trade surpluses, asset bubbles and ultimately collapse. In China today, "you have a pace of investment that is not sustainable and [export growth] that comes at the expense of other countries," he argues. "Really smart people in China know this is a very risky course, but the problem is how to get off the tiger's back." The first casualties of any downturn in China would likely appear at brokerages and on trading floors across the country. Last week David Webb, a shareholder-rights advocate and nonexecutive director of Hong Kong's main stock exchange, called China's stock market "a giant Ponzi scheme" and warned that a correction to reasonable valuations would entail a fall of 78 percent.
Events now playing out in Europe and the United States may soon force a resolution. Since early August, banking woes have prompted central banks to inject in the neighborhood of $400 billion into the financial system to prevent a total freeze-up. U.S. Federal Reserve chairman Ben Bernanke lowered interest rates by 0.5 percent, sparking a stock rally but raising questions as to whether more liquidity is a cure or merely a painkiller. The core problem is no longer subprime, but rather the resultant crimping of the credit pipeline that now undermines the increasingly complex "structured finance" on which much of the modern economy runs. According to Fed data, the current credit downturn has been the sharpest since the Great Depression.
One disturbing result has been a massive falloff in interbank lending. Case in point: Northern Rock, the U.K.'s fifth largest mortgage lender, found itself unable to finance mortgages by borrowing from other banks last week, which led to whispers of impending insolvency, then a 1930s-style bank run that prompted the British government to guarantee the savings at not only Northern Rock but all other banks.
Why has interbank lending fallen? The generic answer—heightened risk aversion—is correct but incomplete. The specific terror that grips bankers in New York, London and Tokyo today is based on what they know but outsiders as of yet merely suspect: that billions in subprime debt remain still untallied, parked off the balance sheets in collateralized debt obligations (CDOs) and structured investment vehicles (SIVs). "There's very little difference between what these banks have been doing and Enron," says CLSA equity strategist Christopher Wood, referring to the American energy giant that collapsed under the weight of its hidden debt. Given this, it's no surprise that banks aren't keen to lend to their peers that might be holding equally explosive bags of highly complex debt products.
The sanguine view maintains that today's financial woes can be overcome by deft central-bank interventions. Others say the real limits are on what the Fed and its counterparts can do. Indeed, last week's rate cut further widened the already large spread between what the government charges banks for money and the interbank rate, at which they lend to each other. To be effective, liquidity injections must reach the real economy. But they won't so long as "banks don't want to lend to anyone," says Wood, adding that the result of the drama now playing out in Europe could be "an unwinding of [risk] securitization" globally.
And that brings us back to Asia, and China's case of anorexia.
In today's China, the government's weak yuan policy and myriad subsidies make its export sector hypercompetitive, yet government efforts to awaken a domestic consumption habit have yet to take hold. As in Japan two decades ago, China's export bias has led to overinvestment, asset bubbles in stocks and real estate, and a politically explosive trade imbalance. The key actors are the same, too, including out-of-their-depths government planners, wobbly state banks, myopic business groups and political leaders who have come to believe their own good press. Dong Tao, chief regional economist for Credit Suisse in Hong Kong, warns that all this "could intensify resource misallocation and cause long-term damage to China's competitiveness."
Just like Japan in the 1970s, China is overbuilding heavy industry with export subsidies, cheap energy and easy credit. The result in steel, for example, is that smelting capacity tripled between 2001 and 2005, making China the world's leading producer, but also driving down domestic steel prices to 30 percent below the international average. The same is true of many Chinese industries, making the country ever more dependent on exports for growth, and therefore vulnerable to an export shock of the sort that could now be coming.
The problems, of course, are compounded by China's size. A slowdown in Chinese exports would have a huge impact on players ranging from resource providers in Africa, to East Asian components makers, to German heavy-machinery manufacturers. Meanwhile, the country's shaky banking system is likely the next global financial bubble to burst. China's banks—all of them state-owned behemoths—are products of a command economy. The yuan is undervalued and not convertible. The mountains of savings amassed over a 27-year economic boom remain locked inside the country, where negative real interest rates push ever larger portions into speculative asset markets.
Policymakers in Beijing have been cautious in their efforts to cool Shanghai's sizzling bourse, stabilize real-estate prices (up thirteen-fold in some cities since 2000) or change the growth equation to de-emphasize exports. With an eye on next year's Olympics, Beijing's top priority has been to keep the party going.
That slow and steady approach is good—to a point. But Beijing should avoid "the false impression that China has time on its side," argue Jahangir Aziz and Steven Dunaway in a study published by the International Monetary Fund this month. "Unchecked, the imbalances [in China] will continue to grow and, with them, the rising probability of a large correction." CLSA's Walker says leaders in Beijing are now powerless to avert a major shock. "What you do to avoid a Japan situation is take actions before things get to this stage," he says. "They've already failed."
Does that mean China is in for a bigger version of Japan's "lost decade"? Not necessarily, says Katz. Even at half of today's growth rate, China would have more forward momentum than Japan did in the 1990s. The Chinese are also far less likely to experience a long denial phase prior to enacting reforms. That said, change won't be easy. Millions could lose manufacturing jobs, and curing the bad-loan problem will cost taxpayers dearly. Such fixes are always best made before—not during—a crisis. Says Katz, "The longer they wait, the harder it gets."
Until that waiting game ends, however, China will remain geared to ship ever more product to increasingly beleaguered Western markets, but unable to consume what the rest of the world makes with the appetite its economic girth would suggest. Whether China's rust-belt crisis will trigger a full-blown global recession remains to be seen, of course. What's clear is that butterflies in the United States still have the power to stir up global tempests from which no country is sheltered.
YEN carry trade?
The yen weakened to 117.40 overnight, the futures spiked overnight and the markets opened higher. Now the yen is trading at 115.84 and the markets are down. It sure looks like we are trading on the yen. I also see the base metal prices following the same trend. Does anyone have any theory on where the YEN is headed?
Kipp
Thanks cl001. Order in at .55 CAN.
I will buy a few here, getting board and hard to sit on the sidelines knowing FED may cut rates and send gold up.
What is your take on CMM.V?
Kipp
What is holding me back.
The Yen carry trade unwinding is what worries me about entering any new positions. I am watching the Yen closely and everytime it strengthens gold and stocks go down. I think we could see another huge panic sell off if the Yen gets stronger. The kind of sell off that sees the high quality stocks get hammered in order for margin calls to be met. It is hard to sit on my hands but I am going to wait and see if my hunch is correct.
Kipp