JP Morgan Says Not To Worry About Surging Bond Prices

   JP Morgan is out with a report telling investors not to worry about surging bond prices and that they do not necessarily mean we are entering a deflationary spiral as some have postulated. Looking back at prior economic cycles, JP Morgan notes that bond yields often bottom out approximately 2.5 years after the end of a recession. So the current rise in price of the 10-year Treasury is not completely unexpected and is simply following the pattern from previous recoveries. The firm also says that the two primary catalysts for the recent rise in bond prices are a decrease in inflation expectations and record buying of US bonds by US households. The current 5-year break-even rate on bonds is 1.3%, down from around 2% reached backed in June. Furthermore, US household purchases of treasuries has surged 46% year over year in Q1 2010. In fact, households are the second largest holder of US treasuries, ahead of Japan and only $100 billion behind China. If that was not enough to arrest deflationary concerns, JP Morgan goes on to mention that the strong resiliency of commodity prices indicates that deflation is a remote possibility at this point. I agree, oil at 75, copper at 3.30, and gold at 1238 hardly make sense if we are entering a deflationary period. The deflation scare mongering is just a ploy by central bankers to print more money. Below is a chart which shows the 10-year Treasury over the last 35 years.

Here is the full report from JP Morgan:

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JP Morgan Says Not To Worry About Surging Bond Prices

Weekend Reads and Audio

1. We are running out of helium--only 25 year supply left--maybe helium is the next great investment

2.  The Death of Quant Funds

3. Stock Market is Still for Suckers

4. King World News Interview-- John Williams of ShadowStats

5. Goldseek Radio--Ron Paul and Harry Dent

6. Peak Oil Theory Has Peaked

7. The Stealth Debt Restructuring: Inflation

8. Emerging Markets are Still Looking Good--Deutsche Bank



Posting will be lite over the weekend. I am recovering from food poisoning courtesy of the Getty Villa Restaurant. Don't get the triple cheese pizza and cheese platter!!!

Black Swan Insights

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Weekend Reads and Audio

Weekend Reads

If you have time this weekend you may want to check out these articles.

1. Yuan As A Reserve Currency--Deutsche Bank

2. Latin America-Not just a commodity play---JP Morgan

3. Telling Swiss secrets: A banker's betrayal--Global Post

4. No Wheat Shortage--Global Stocks Adequate---Tell that to the speculators bidding up wheat

5. Goldman Sachs Estimates Derivatives May Provide 35% of Revenue--BusinessWeek



Have a good weekend.

Black Swan Insights

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Weekend Reads

Thoughts From Marc Faber--- Aug 1

Legendary investor Marc Faber is out with his monthly report which discusses the US economy, QE 2, equity markets, China's property sector, and the EU debt crisis. Here are a few highlights:

1. Stock market outlook is uncertain. Faber is less confident that markets will fall to 850-900 because of the inevitable money printing (aka QE 2), which will boost asset prices. Possible trading range developing with 1040 as the bottom and 1170 as the top for the S&P 500. Even so he would be reducing equity exposure on any stock market strength.

2. Euro is likely to bounce around erratically between 1.25 and 1.35. Faber hates the dollar and euro but likes undervalued Asian currencies.

3. If you have to buy stocks make it Asian equities and REIT's in Thailand, Singapore, and Malaysia. They have high yields and are attractive compared to 3% 10 year treasuries. Asian economies will continue to grow at a healthy clip even with weakness in the US and Europe, which makes them good investments.

4. China's economy will continue to do grow even if the property market declines sharply. The growing Chinese middle class will support increased domestic consumption. Wages in China have gone up giving hundreds of millions of people increased purchasing power.

5. US municipal debt will likely become a major problem in the future. As of the 1st quarter of 2010 there is an estimated $2.8 trillion in outstanding municipal debt, which can never be repaid and will require a federal bailout. Another issue is state and local government pension plans, which are severely underfunded.

6. Gold is a buy after its seasonal bottom usually in September. Long term trend is up and as long as Bernanke is Fed Chairman, gold will do well.

7. Likes agricultural commodities and related stocks (but says avoid commodity ETF's because of the roll). In particular Faber likes wheat, rice, and soybeans. He also likes the fertilizer and seed stocks.

8. Faber expects rising agricultural prices will lead to civil unrest and violence in some countries.


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Thoughts From Marc Faber--- Aug 1

China Reduces rare earth export quotas for second half 2010

   China announced that it will reduce export quotas for rare earth's by 72% for the second half of 2010, indicating that Beijing wants to keep its production for domestic consumption. According to the Department of Commerce, shipments will be capped at 7,976 tons, down from 28,417 tons for the same period a year ago. 

    The only reason I bring this up is because it bodes well for one of my investments Stans Energy, which is bringing back a previously operated soviet era mine in Kyrgyzstan. If China were to completely restrict supply (which it is expected to do in the next few years) this would cause the price of rare earths to increase quite dramatically. This is because China accounts for 90% of rare earth production globally. The outlook for rare earths is looking up.

Black Swan Insights

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China Reduces rare earth export quotas for second half 2010

Don't bet the Farm on the Baltic Dry Index

    You will often hear the talking heads on TV and blogs refer to the Baltic Dry as a leading economic indicator worth following. It has become a sexy indicator that people use to predict movements in the stock market. They constantly analyze what the Baltic Dry is "telling" investors. I disagree, the Baltic dry is not a good indicator of world economic growth. It is however a good indicator when it comes to the Chinese economy. You see China controls all commodity markets these days and so the Baltic dry will tell you whether China is buying commodities. It will not help you trade the market (outside of China). The Baltic Dry is also influenced by the supply/demand relationship of global shipping. This has pressured it recently due to the large number of new ships entering the market. Lets go the charts. The first one is of the Baltic Dry, the second is of the Chinese stock market, and the third is the S&P 500. You will see that the Baltic Dry has been consolidating for the past 13 months along with the Chinese stock market. If you had followed the Baltic Dry's signal you would have missed out on a large rally in world markets over the past year. So while the index is skewed more to the Chinese economy it is always worth paying attention to.

Black Swan Insights

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Don't bet the Farm on the Baltic Dry Index

My investment in Stans Energy

UPDATE: Position Sold 2/5/2011

Click Link for Update On Stans Energy Oct. 25, 2010

About Stans Energy

Stans Energy Corp is a Toronto based company focused on developing properties containing Rare Earth Elements (REEs), Uranium, and Associated Metals. Stans owns five mineral properties in Kyrgyzstan, of which Kutessay II is most advanced.

Company Website: StansEnergy.com

Symbol: RUU.V on the Toronto Exchange and STZYF.PK on the american pinksheets.

Investment Thesis

Before I go into the investment reasons for Stans I think I should first discuss the rare earths industry in general. Overall the rare earths industry is in somewhat of a mania thanks to James Dines (major investment newsletter) who pumped the stocks in May 2009. This had the effect of propelling many of these nothing companies 8-10 fold in under 9 months , leaving many of them egregiously overvalued. However, Stans Energy has escaped this mania because the company only acquired their rare earth property in Dec 2009 which benefits investors looking for exposure to rare earths.

With that said lets get to why Stans Energy makes a compelling investment. Instead of going out and exploring for rare earths Stans simply bought an existing mine in Kyrgyzstan called Kutessay II for $855,000 (pretty good deal). This previously producing mine was operated by the Soviet Union between 1960-1991 and made up 80% of total rare earth output. After the fall of the Soviet Union the mine was placed on care and maintenance. It is estimated that the mine was only 1/3rd mined and has potential for expansion through further drilling. The mine produced all 15 rare earth elements (at 65% recovery rate-good for rare earths) and included a good mix of 50% Heavy rare earths (HREE) which are the most economically profitable. Because this was a previously producing mine, there is excellent infrastructure which minimizes the cost to Stans Energy. All necessary roads are there along with a power source and a railway. More importantly Stans has purchased an option to buy the processing mill which was previously used for Kutessay II. This is a major plus for Stans because processing mills are extremely expensive to build from scratch. Stans management has indicated that 3 of the 4 required processing plants are there and in adequate condition. Obviously they will have to spend money to upgrade and enhance some of the facilities but this gives Stans a real advantage over its rare earth competitors.

One major concern regarding Stans Energy is the political turmoil and violence in Kyrgyzstan which does not seem to be going away any time soon. However I do not think this is a major problem for Stans considering the current government is supportive of opening the mine and has not shown any interest in expropriating privately owned assets. Also the violence you hear about on TV is not located anywhere near the mine so the reduces the chances of the mine or processing facility being vandalized. Finally, many members of Stans board and management have important political ties and contacts in Kyrgyzstan which should help them get this mine back into production.

Timeline

For a company which only acquired their property 6 months ago I must say management has been very quick to get the ball moving. The company recently outlined the plan for the next few months which includes completing a JORC resource estimate, underground drift resampling, complete a comprehensive study to discern what it will take to get the mill processing plant up and running, and identify future drilling sites to potentially expand the official resource estimate. Once this is completed the company will go ahead with a feasibility study. Stans goal is to become the first rare earths producer outside of China and because they are only redeveloping an existing mine I think they have a good chance of accomplishing this. As to when the mine will be back into production I do not for sure as the company has not disclosed this fact. However, I would estimate that we could see this mine back into production by the end of 2012.

Management

From what I have observed so far the management team under CEO Robert Mackay is pretty business savvy. After all they were able to get a proven rare earth mine for $855,000.  No doubt the boards extensive Kyrgyzstan political contacts helped the process but it was a great move for shareholders. Furthermore, the company has done an excellent job of recruiting knowledgeable experts in the rare earths sector which should help provide the technical know-how to get this mine back into production. My only complaint is the high share count which is always a problem for junior resource companies (currently 141 million).

Financial Position

There is no question that Stans will need to raise more money which of course means future dilution to shareholders. However this is what happens with junior resource companies and is necessary in order to get the mine into production. The company should not have a problem raising the money the only question is on what terms. The company has approx. 23 million warrants outstanding which should also be a potential source of funding assuming there in the money. My hope when it comes to future capital raising is that the company waits until they complete the JORC estimate in October 2010, which should provide a nice bounce for the stock.

Because of the strategic nature of the deposit I believe the company will be able to arrange an off-take/financing agreement with a user of rare earths. This will dramatically reduce dilution to shareholders and raise the company's profile within the investment community.

Major Investors

For some reason I have not been able to find an ownership list for Stans Energy. However, management has a strong interest in the stock and owns 23% fully diluted. Also, Pinetree Capital owns aprox. 9% of the company.


Summary

Overall Stans Energy represents an attractive investment for investors interested in the rare earths sector but do not want to buy into the high flying stocks. Stans is in my opinion a much lower risk than the other companies because they are not blindly exploring for rare earths but already have a proven mine which requires much less capital to put into production than building a mine from scratch. There is also an upcoming catalyst (approx Sept 2010) when the company will announce their JORC estimate which should confirm historical estimates. While Stans has a lot in its favor there are always potential risks and in small junior resource companies there are in more risks to evaluate. Most people will point to the political problems in Kyrgyzstan but my greatest are of concern is with future dilution and how the company is going to raise all of the money necessary to get the mine into production. However I believe in this case the potential reward greatly out ways the risks and provides investors with an excellent opportunity.

If you want some more information on the company you can check out a presentation by the CEO at an investment conference by clicking here.

Black Swan Insights

Disclosure: 2% of my portfolio is invested in Stans Energy. My basis in the stock is .30 cents.

Legal Disclaimer: I am not an investment advisor and nothing on this site should be interpreted as investment advice. Please consult with your own financial advisor before investing in the stock market or any financial asset. (I know this is a stupid statement but for legal purposes I have to say it. Thanks)

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My investment in Stans Energy

My Investment in Africa Oil

Postion Sold Sept. 3, 2010 at $1.34

Click Here for an Update to Africa Oil Investment--June 20, 2010

I first heard about Africa Oil after Rick Rule of Global Resource Investments presented the idea at a Casey's Research Conference. He had just taken a major stake through a recent capital raise.

About Africa Oil

Africa Oil is an oil exploration company focused in Ethiopia, Kenya, and the Puntland region (Somalia). The company has a large acreage position totaling 200,000 km in the largely unexplored regions of East Africa.

Company's Website: Click Here

Investment Analysis

Africa Oil represents a compelling opportunity to participate in the oil exploration business in geographical regions which could produce multi-billion barrel finds. The company has obtained a sufficiently large land position in under-explored regions where few wells have been drilled.

Somalia is the company's hidden gem. Because of numerous civil wars, Somalia has been largely untouched by major oil companies in the past, even though it shows excellent potential. There have been numerous oil seeps over the years indicating that there is some oil there, but it remains to be seen if any of it is commerically viable. The basins of Somalia and Yemen used to be contiguous millions of years ago before they separated. The two major areas of interest are the Dharoor and Nogal basins, which were connected to the Masila, and Shabwa basins in Yemen. These same basins in Yemen have produced large oil finds in the past.


While Somalia is a political morass, the Puntland is a self governing, stable  region in the north of the country. Africa Oil has exclusive drilling rights to the region (with their partner Range Resources) and will begin drilling in mid 2010 and early 2011. The only potential problem with this site is that the Somalian government has challenged the agreement, claiming that a self governing region cannot grant drilling concessions to a company without the approval of the central government. I am not particularly concerned about this as the President of the Puntland Region recently noted that the central government has no practical authority in Somalia outside the capital. The Puntland region has its own elected government and military. For more on Oil in Somalia Click Here

The company also has exploration licences in Ethiopia located around the Adigala and Ogaden basins. The Ogaden basin in particular looks to be the best prospect because oil and natural gas deposits have already been discovered by other companies. The only problem in this area is the Ogaden National Liberation Front, which is a separatist militia group which has committed acts of violence against companies in the past. The NLF opposes oil exploration and has threatened to attack any company who tries to drill in the area. Most of the western oil majors are unwilling to accept this type of risk.




Kenya is another place of interest for Africa Oil ,which has interests in three major blocks in the northern section of the Anza basin. This basin is thought to be a continuation of the hugely successful Muglad basin in Sudan that has produced large oil finds. While hopes are high in Kenya, it has a poor track record when it comes to actually finding commerically viable oil and natural gas deposits (drilling has found large concentrations of gas though). One of the main reasons for this could be that the majority of wells only reached a depth of 3000-3500km. Another reason is that only 37 exploratory wells have been drilled in the country. For a comparable example, it took over 90 exploratory wells to find oil in Sudan. Africa Oil and its partner CNOOC are currently in the process of drilling the deepest well ever in Kenya (5,500km) in Block 9.




Timeline

One of the best aspects of Africa Oil is their timeline for drilling. Unlike other explorers who promise drilling in the future, Africa Oil is commencing all of its drilling within the next two years. Their first well in Kenya was spud on Oct. 2009 with their partner CNOOC (Chinese oil company). In May, 2010, they completed drilling and announced that they had hit natural gas in four pay zones. Testing is currently underway to test the commercial viability of the find. The Company is expected to begin drilling in the Puntland in Q4 of 2010. In 2011 they should be drilling in Ethiopia and Kenya.

Management

The team at Africa Oil is experienced in the exploration business and has a strong record of bringing value to shareholders. CEO Keith Hill was the founder of Valkyries Petroleum which was successfully sold to Lundin Petroleum for $700 million. Management has hinted through interviews that their goal with Africa Oil is to find and prove oil resources and then sell the company rather than spending 5-7 years and hundreds of millionsof dollars to bring the resources to production.

Financing

One of the more frustrating aspects of the exploration business is the large amount of capital required. To finance exploration, companies seem to issue shares almost on a quarterly basis, which results in severe dilution to existing shareholders. While Africa Oil has has had to do this as well, they are now in a position  to  finance fully their drilling program for the next year. They will be able to accomplish this through farm out agreements that reduce their interest in the well but help pay for the large exploration costs (up to $26 million per well). So, in my opinion, shareholders do not have to worry about any more dilution for the foreseeable future. Furthermore, the company has 44 million warrants outstanding which expire in 2012. This gives the company access to more capital if the warrants are exercised without having to go the capital markets again.

Major Investors

I like to see respected resource investors invest alongside me. In the case of Africa Oil, there are two major investors who have significant stakes in the company. Rick Rule has an approximately 9% interest through common shares and warrants. Another major investor is the Lundin family of Sweden, well known for their oil company Lundin Petroleum. There are certainly smart people investors in this endeavor.

Summary

I consider Africa Oil a valuable call option on oil exploration in East Africa. It is a high-risk high-reward situation where you have to be willing to lose your entire investment. If the company hits oil in any of their blocks, the stock will do incredibly well for shareholders. Conversely, if they fail, the stock will most likely go to zero. There are no guarantees in the resource exploration business no matter how good the prospects look on paper. The company is also exposed to major political risks in Ethiopia and Somalia, which could result in the company losing their exploration licenses. Overall, I think the potential far exceeds the risk and am willing to invest in the company.

Disclosure: 3% of my portfolio is invested in Africa Oil. I may bring that number up to 5% if the opportunity presents itself. By basis in the stock is .91 cents.

Legal Disclaimer: I am not an investment advisor and nothing on this site should be interpreted as investment advice. Please consult with your own financial advisor before investing in the stock market or any financial asset.

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My Investment in Africa Oil