THE TRAILING EDGE - d1w116sruyx1mf.cloudfront.netd1w116sruyx1mf.cloudfront.net/.../channels/sr_pdf/TheTrailingEdge.pdf · It’s hard to overstate how much the petrodollar system

By NICK GIAMBRUNO

THE TRAILING EDGEFOUR BOLD MOVES THAT COULD “FLIP” CRISIS INTO FORTUNE

By NICK GIAMBRUNO

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THE TRAILING EDGECrisis Investing

The Number One Black Swan Event for This YearOn August 15, 1971, President Nixon killed the last remnants of the gold standard.

It was one of the most significant events in US history—on par with the 1929 stock market crash, JFK’s assassination, or the 9/11 attacks. Yet most people know nothing about it.

Here’s what happened…

After World War 2, the US had the largest gold reserves in the world, by far. Along with winning the war, this let the US reconstruct the global monetary system around the dollar.

The new system, created at the Bretton Woods Conference in 1944, tied the currencies of virtually every country in the world to the US dollar through a fixed exchange rate. It also tied the US dollar to gold at a fixed rate of $35 an ounce.

The Bretton Woods system made the US dollar the world’s premier reserve currency. It effectively forced other countries to store dollars for international trade, or to exchange with the US government for gold.

By the late 1960s, the number of dollars circulating had drastically increased relative to the amount of gold backing them. This encouraged foreign countries to exchange their dollars for gold, draining the US gold supply. It dropped from 574 million troy ounces at the end of World War 2 to around 261 million troy ounces in 1971.

To plug the drain, President Nixon “suspended” the dollar’s convertibility into gold on August 15, 1971. This ended the Bretton Woods system and severed the dollar’s last tie to gold.

Since then, the dollar has been a pure fiat currency, allowing the Fed to print as many dollars as it pleases.

Of course, Nixon said the suspension was only temporary. That was lie #1. It’s still in place decades later.

And he claimed the move was necessary to protect Americans from international speculators. That was lie #2. Money printing to finance out-of-control government spending was the real threat.

Nixon also said the suspension would stabilize the dollar. That was lie #3. Even by the government’s own rigged statistics, the US dollar has lost over 80% of its purchasing power since 1971.

Doug Casey: Inflation is one of the most misused words; few even think about its actual meaning. What is inflation? “Well, that’s prices going up.” No, it’s not. To say that is to confuse cause and effect. Inflation is an increase in the money supply. You inflate when the money supply is increased by more than real wealth increases.

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Prices go up as a result. People have forgotten about that. Today, inflation seems to come from out of nowhere, like a freak storm. No cause. Unless it’s blamed on the butcher, or the baker, or an evil oil company. Nobody ever thinks it’s a central bank—the Fed in the US—that actually creates more money and causes inflation.

You’ve heard that the Federal Reserve is trying to create a little bit of inflation because, they say, “A little bit of inflation is good.” No, even a little bit of inflation is deadly poisonous. For two reasons: It creates the business cycle. And it destroys the value of savings. Saving is the basis of capital creation. People who say that a little inflation is a good thing are dangerous fools.

The death of the Bretton Woods system—which was really the US government defaulting on its promise to back the dollar with gold—had profound geopolitical consequences.

Most critically, it eliminated the main motivation for foreign countries to store large US dollar reserves and to use the US dollar for international trade.

At this point, demand for dollars was set to fall… along with the dollar’s purchasing power. So the US government concocted a new arrangement to give foreign countries another compelling reason to hold and use the dollar.

The new arrangement, called the petrodollar system, preserved the dollar’s special status as the world’s reserve currency. For President Nixon and Secretary of State Henry Kissinger, it was a geopolitical and financial masterstroke.

From Bretton Woods to the Petrodollar

From 1972 to 1974, the US government made a series of agreements with Saudi Arabia, which created the petrodollar system.

The US handpicked Saudi Arabia because of the kingdom’s vast petroleum reserves and its dominant position in OPEC—and because the Saudi royal family was (and is) easily corruptible.

The US also picked Saudi Arabia for geopolitical reasons. During the Yom Kippur War of 1973, OPEC’s Arab members started an oil embargo to punish the US for supporting Israel. Oil prices quadrupled, inflation soared, and the stock market crashed.

The US was in a vulnerable position. It needed to neutralize the Arab’s potent Oil Weapon. Turning a hostile Saudi Arabia into an ally was the key. The alliance would also help check Soviet influence in the region.

In essence, the petrodollar system was an agreement that the US would guarantee the House of Saud’s survival. In exchange, Saudi Arabia would:

1. Take the Oil Weapon off the table.

2. Use its dominant position in OPEC to ensure that all oil transactions would only happen in US dollars.

3. Invest billions of US dollars from oil revenue in US Treasuries. This let the US issue more debt and finance previously unimaginable budget deficits. By 1977, at least 20% of all Treasuries held abroad were in Saudi hands.

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Oil is the world’s most traded and strategic commodity. If foreign countries need US dollars to trade oil, it creates a very compelling reason to hold large dollar reserves.

For example, if Italy wants to buy oil from Kuwait, it has to purchase US dollars on the foreign exchange market to pay for the oil first.

This creates an artificial market for US dollars. The dollar is just a middleman in countless transactions that have nothing to do with US products or services.

Ultimately, the arrangement boosts the US dollar’s purchasing power. It also creates a deeper, more liquid market for the dollar and US Treasuries.

Plus, the US has the unique privilege of buying imports, including oil, with its own currency… which it can print.

It’s hard to overstate how much the petrodollar system benefits the US dollar. It’s allowed the US government and many Americans to live beyond their means for decades. And it’s the reason the media and political elite give the Saudis special treatment.

In short, the petrodollar is the glue that holds the US–Saudi relationship together. But its bind is not permanent.

Bretton Woods lasted 27 years. So far, the petrodollar has lasted over 40 years. However, the glue is already starting to lose its stick.

I think we’re on the cusp of another paradigm shift in the international financial system, a change at least as fundamental as the end of Bretton Woods in 1971.

As I’ll explain, the relationship between Saudi Arabia and the US is at historic lows. I only expect it to get worse.

The death of the petrodollar system is the number one black swan event for this year.

During the 1974 negotiations that created the petrodollar system, the Saudis demanded strict secrecy about their Treasury holdings.

For decades, analysts wondered how much US debt Saudi Arabia actually owned. Now, after decades, we finally know.

Recently—for the first time ever—the US Treasury revealed the full extent of Saudi Arabia’s Treasury holdings and acknowledged the kingdom as one of America’s largest foreign creditors.

The US government’s willingness to lift the veil of secrecy is a major sign that the petrodollar system is breaking down.

Additionally, the US government has released 28 previously classified pages of the 9/11 Commission Report, which show Saudi government involvement in the attacks. And earlier this year, Congress passed a law allowing 9/11 victims to sue the Saudi government.

These are major, unprecedented, irreparable blows to the petrodollar arrangement.

Even without these radical changes, the petrodollar could still bite the dust…

The Saudis could decide to sell their oil in Chinese renminbi, euros, IMF SDRs, gold, or many other non-dollar currencies. And they could influence most of OPEC to follow suit.

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Or the House of Saud could implode. I think that’s inevitable anyway, given the colossal economic and military mistakes it’s made recently.

The geopolitical sands of the Middle East are rapidly shifting.

Saudi Arabia’s regional position is weakening. Iran, which is notably not part of the petrodollar system, is on the rise. US military interventions are failing. And the emerging BRICS countries are creating potential alternatives to US-dominated economic/security arrangements. This all affects the stability of the petrodollar system.

Right now, the stars are aligning against the Saudi kingdom. This is its most vulnerable moment since its 1932 founding.

And, of course, I’ll share how to profit from the monumental changes I anticipate in the international monetary system.

I expect the dollar price of gold and oil to soar when the petrodollar system crumbles in the not-so-distant future. You don’t want to find yourself on the wrong side of history when that happens.

Ron Paul called for the end of the petrodollar system in his 2006 speech “The End of Dollar Hegemony”:

The chaos that one day will ensue from our 35-year experiment with worldwide fiat money will require a return to money of real value. We will know that day is approaching when oil-producing countries demand gold, or its equivalent, for their oil rather than dollars or euros. The sooner the better.

Essentially, Paul said that understanding the petrodollar system and the forces affecting it is the best way to predict when the US dollar will collapse.

Paul and I discussed this extensively at a Casey Research conference. He told me he stands by his assessment.

Nick Giambruno and Ron Paul

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Investment Recommendation: EOG ResourcesEOG Resources is the “best of breed” U.S. shale oil company.

In recent years, technologies like fracking have unlocked billions of barrels of oil that were once impossible to extract from shale regions.

As you may know, EOG was at the forefront of the shale-drilling revolution. It’s been the leading shale oil producer, and it has a reputation as an excellent operator and cost-cutting innovator.

EOG has trophy assets in the major U.S. shale basins. It has a solid balance sheet. And, unlike many of its peers, it didn’t overleverage itself during the last boom.

EOG is a cost leader and an efficient operator. Its profit margins are among the best in the industry. It has first-mover advantages. It is an innovator. And it has an exceptional management team that wisely allocates capital.

In short, EOG is a great business.

EOG is engaged in the exploration, development, and marketing of mainly crude oil (but also natural gas) in the U.S. It also operates in Canada, Trinidad, and the U.K. Its primary focus is in U.S. shale plays. Foreign operations only account for around 10% of revenue.

Trophy Assets

Large oil and natural gas deposits are some of the most valuable assets on the planet. EOG has proven reserves of 1.2 billion barrels of crude oil, 474 million barrels of natural gas liquids, and 5.3 billion cubic feet of natural gas.

Almost all of EOG’s proven reserves (97%) and production (90%) are located in the U.S., mostly concentrated in three major shale fields: the Eagle Ford, Bakken, and Permian basins.

Source: EIA

EOG has been a first mover in all the main U.S. shale basins. It was one of the first companies to drill in the Bakken and the Eagle Ford. This head start helped it acquire large acreage positions at a fraction of the cost latecomers paid.

Innovation and Efficiency Leader

EOG is an innovative, cost-conscious company. It’s developed in-house efficient drilling and completion techniques.

Proven Reserves

Proven reserves are petroleum quantities that companies can estimate with reasonable certainty (at least a 90% likelihood) to be commercially recoverable.

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Its technological ingenuity is a main reason why it’s one of the lowest-cost producers in the industry, at cash costs of around $35 per barrel in certain regions of the Eagle Ford and the Bakken. By comparison, most shale oil producers aren’t even profitable when oil trades at $50 per barrel.

EOG knows how to adapt and cut costs. This is essential for surviving the storm in the oil markets and leading the industry going forward.

EOG recently developed new well-completion designs that have boosted its reserve potential.

Solid Balance Sheet

Another factor that separates EOG from its peers is its conservative use of debt. The company didn’t go crazy with leverage during the last boom, so it has some of the most attractive debt ratios in the industry.

As you can see in the next chart, EOG is among the least-leveraged companies in the industry.

Debt isn’t a problem for EOG now, and I don’t expect it to be in the future.

EOG is still generating more than enough operating cash flow to cover its debt costs.

EOG is not a short-term trade on oil-price volatility. Instead, it’s a play on powerful geopolitical trends in the energy markets. It’s a chance to pick up the best company and some of the most valuable assets in the U.S. for bargain prices.

Buy shares of EOG at up to $120 per share. Use a 50% hard stop minus any dividends received.

Please keep track of stop losses on stocks you own. If a stock hits its stop, we’ll write about it in our next monthly issue. However, we will not send out alerts between issues. It’s your responsibility to monitor your portfolio and follow the stop losses we provide.

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A Second Chance at One of Doug Casey’s Most Lucrative Hits They call it “death by necklacing.”

It has nothing to do with jewelry. Necklacing is a torture technique that was common in South Africa during the violent 1980s.

A mob would place a rubber tire, the “necklace,” around the victim’s the neck, douse the tire in gasoline and light it on fire.

The victim would slowly burn alive.

Nelson Mandela’s wife, Winnie Mandela, widely publicized the practice when she said…

“Together, hand in hand, with our matches and our necklaces, we shall liberate this country.”

Winnie Mandela’s famous quote illustrates a nuance to the conflict most people overlook.

At the time, South Africa was still under apartheid (legalized racial segregation). Black rebels fighting against the government would frequently necklace other blacks, “traitors” they suspected of collaborating with South Africa’s white government. It was a nasty but powerful deterrent.

I’m not bringing this up to churn your stomach, but to highlight that, from time to time, South Africa goes through horrible crises. The country’s bloody history of racial division pretty much guarantees recurring turmoil.

In 1976, South Africa was in one of those crises. Massive riots erupted in the Johannesburg suburb of Soweto. There was literally blood in the streets as police killed hundreds of protestors. Everyone thought South Africa, and its gold-mining industry, would collapse.

As you may know, South Africa has been one of the world’s largest gold producers for over a century. In the mid-1970s, the price of gold was plunging. Gold hit a low of $103 in August 1976…nearly 50% off its $200 high two years earlier. Nearly everyone holding South African gold stocks sold them.

It was a classic crisis-investing situation…

The conventional wisdom turned out to be dead wrong. South Africa didn’t collapse. And gold rocketed to $800—a 700% gain.

Higher gold prices meant higher profits for South African gold miners. Higher profits meant higher dividend payments for investors.

Over the next few years, South African gold stocks rose an average of 600%. Most paid out more in dividends than it would have cost to buy the stock. This led to one of Doug Casey’s biggest investment hits ever.

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Doug Casey: One of the biggest percentage hits I ever made in the market was when I bought South African gold stocks in 1976, a time when many were yielding 30%–60% in dividends (this is not a misprint). Those dividends doubled and redoubled several times as gold rose to its 1980 highs. That shows how cheap stocks can get, and the experience spoiled me in some ways; it was a once- or twice-in-a-lifetime event.

Their earnings had collapsed, with gold falling from almost $200 in late 1974 to a low of $103 in August 1976, but their share prices fell much more (95% in some instances), resulting in outrageous yields. The collapse in share prices was partially due to the drop in gold, partially due to the fact they were bid up to manic levels in the 1971–74 bull market and partially due to the Soweto riots.

The critical element in profiting from these stocks has always been timing. That’s true of any stock, of course, but of these more than others because of the political element. Historically, the time to buy South African gold stocks has been when blood is running in the streets.

Today, South Africa is facing another crisis. This crisis is economic, not political. But it’s still very serious.

I’ll show you how South Africa’s economic crisis and low gold prices are creating a chance to make huge gains that are on par with Doug’s 1976 gains.

SOUTH AFRICA’S CURRENCY CRISIS IS OUR OPPORTUNITY

Since 2011, the collapses of the price of gold and the rand have crushed South African gold miners. The stocks of some quality companies are down more than 80% from their recent peaks.

However, it appears gold has bottomed (more on that in a bit). And this could be one of those “once- or twice-in-a-lifetime events” Doug described.

The rand has been in a free fall. It’s lost over half its value against the U.S. dollar since 2012. It recently hit its lowest value ever against the U.S. dollar.

In other words, for U.S. dollar–based investors, South Africa is one of the cheapest markets in the world right now.

The incompetence of South Africa’s government is surely part of the reason behind the rand’s collapse. But I think misplaced faith in the U.S. dollar and the Federal Reserve’s ability to raise interest rates is also at play.

If the Fed raises interest rates, the dollar will appreciate against the rand (all else being equal). The market thinks this is going to happen.

I think the market is wrong and the dollar is near its top. This makes now a good time to buy assets denominated in rand, like South African gold stocks.

I’m confident the Fed won’t raise rates in any meaningful way. It can’t. It’s trapped.

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The Fed is publicly pondering dropping rates into negative territory. So, it’s puzzling why anyone expects it to raise interest rates any more than a token amount.

As Janet Yellen, the chair of the Federal Reserve, recently said, “Potentially anything—including negative interest rates—would be on the table.”

The truth is, more than seven years of yields of near zero percent and successive rounds of money printing have warped the U.S. economy. At this point, the Fed doesn’t think it can handle even the tiniest increase in interest rates. A rate hike would be the pin that pricks the biggest stock and bond market bubble in all of human history.

The Fed doesn’t want that to happen. And it’s willing to take interest rates negative in a misguided effort to keep the bubble from bursting.

Doug Casey: It’s really, really serious. Zero, and especially negative, interest rates discourage saving. But saving is what builds capital. And without capital you wind up as an empty shell—Rome in 450 A.D., or Detroit today—lots of wonderful but empty buildings and no economic activity. Worse, it forces people to desperately put their money in all manner of idiotic speculations in an effort to stay ahead of inflation. It’s going to make The Greater Depression much worse.

The Fed can’t raise interest rates in any significant way. It would trigger a financial meltdown that would quickly force it to reverse course. The Fed might be able to get away with a token increase, but that’s all.

Doug Casey: True. Borrowers—not least the U.S. government—would not be able to service their debt. If rates rose a measly 2%, that would add about $400 billion to the government’s annual interest bill.

That means the Fed’s only option is to print more money. And that’s going to be a positive for gold and countries that produce it, like South Africa.

Now is the time to take advantage of South Africa’s currency woes and pick up a quality mining company at an extraordinary price. South African gold-mining companies have delivered triple- and quadruple-digit returns in the past. In the coming gold bull market, I think some will offer a 10-1 upside or even better, just as they have in previous bull markets.

That brings us to Gold Fields Limited (GFI), a South African gold-mining company that trades on the New York Stock Exchange. You can trade it just like a U.S. stock. And now is the perfect time to buy.

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Investment Recommendation: Gold Fields LimitedGold Fields is one of the largest gold miners in the world. And at current prices, it has huge upside potential.

It’s uncommon for a large, multibillion-dollar company to hold such enormous potential for investment return. But the opportunity is here. Low gold prices and the collapse of the rand have made this solid South African miner extraordinarily cheap.

The company is based in Johannesburg, South Africa, where over 70% of its gold reserves are located. It also has reserves and operations in Australia, Peru and Ghana.

The gold-mining industry is in one of its worst downturns in decades. Gold prices have dropped over 40% from their 2011 peak. This has put enormous pressure on mining companies. Most are in survival mode. They’re trying to cut costs to stay profitable.

But I think Gold Fields will do far more than just survive. When gold breaks out of its almost five-year bear market (I think it already has), the company will hand huge profits to its shareholders.

THE SAUDI ARABIA OF GOLD

The South Deep mine is Gold Fields’ “trophy asset.” With over 80 million ounces of gold, it’s the second-largest gold mine in the world.

South Deep is located near Johannesburg in the Witwatersrand Basin. It holds the world’s largest known gold reserves. Think of South Deep as the gold version of Saudi Arabia’s Ghawar oil field, the largest oil field in the world.

With its massive gold deposits, the mine could last well over 70 years, analysts estimate. Many think it’s one of the last great mines in South Africa.

After a massive dividend cut in 2012, Gold Fields’ stock is now yielding about 0.5%. Prior to the cut, it was yielding over 5%. If the company restores the dividend payout—which I fully expect it to as gold rises—Gold Fields’ stock will yield over 14% at today’s prices.

Doug Casey: You may recall that this mine used to be called Western Areas Gold Mine. In the ’60s, when gold was controlled at $35 an ounce, it generally yielded around 5%. Yields got up to the teens in the ’70s.

The company pays for its costs primarily in rand. But it sells the gold it produces for U.S. dollars.

The rand’s record lows have been an absolute boon for U.S. dollar–based investors. They’ve helped Gold Fields control costs and made its stock dirt cheap. The stock trades in New York in U.S. dollars, but its share price reflects the rand’s collapse.

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Doug Casey: Of course, a cheap currency is a disaster for people in South Africa. They can’t afford imported goods. Can’t afford imported technology to make their production more efficient. Local investors can’t buy good deals abroad. Local saving is discouraged, since people expect the rand to go the way of the Zimbabwe dollar. A devalued rand is only good for foreigners who can swoop in to buy things at a huge discount. Some people want a cheaper U.S. dollar because it will stimulate U.S. exports. A cheaper dollar will severely damage the whole country, while just helping a few export-oriented businesses. Most people seem unaware that the German mark (now essentially called the euro) quintupled from its value in 1971—to the great benefit of Germany. The same with the Japanese yen.

PRODUCTION

The South Deep mine produces nearly 200,000 ounces annually. But it has the potential to produce over 700,000 ounces per year. This year, the company is aiming for over 250,000 ounces. I think that’s a reasonable target.

Although most of Gold Fields’ production is in South Africa, the company is internationally diversified, with mines in Australia, Ghana and Peru, as the next chart shows.

Gold Fields has done a great job of bringing down costs.

Right now, Gold Fields is one of the few gold miners producing profits and free cash flow. With the price of gold rising and production increasing at the South Deep mine, I expect profits to continue to grow.

VALUATION

Gold Fields’ stock trades at a discount to book value. This is mainly because of the negative sentiment in the gold industry. For perspective, AngloGold Ashanti, Gold Fields’ South African peer, trades at double its price-to-book valuation.

As you can see in the next chart, Gold Fields has an attractive valuation compared to its South African peers and other, non-South African peers.

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RISKS

Gold Fields and other South African miners face real challenges. They have to navigate labor demands and burdensome government regulations while cutting costs. So far, Gold Fields’ management has done this successfully, and I think it will continue to do so.

Doug Casey: Another factor is that skilled white South Africans continue to make the chicken run from the country, if they can. The black government is terminally incompetent and corrupt, and unlikely to get better. They see the mines, in particular, as cash cows to be milked to the greatest degree possible. So, remember, gold mining in general is a crappy business. And especially in Africa, you have to treat these things as a speculation, not a long-term holding. That said, I agree with Nick.

There is also a risk that the gold market hasn’t bottomed yet. But this isn’t a major concern, given Gold Fields’ low leverage, cost efficiencies and 80 million ounces of gold in the South Deep mine.

THE TRADE

Buy shares of Gold Fields (GFI) at up to $8 per share. Use a 50% hard stop minus any dividends received.

https://www.caseyresearch.com/articles/making-chicken-run

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Investment Recommendation: Impala Platinum HoldingsPlatinum is “the other silver metal.”

Like silver, platinum has the qualities of a precious metal and an industrial metal.

Platinum is resistant to corrosion and has a high melting point, making it ideal for industrial uses.

The largest demand for platinum comes from the automotive industry. It’s used in diesel engines and in pollution-reducing components. Stricter emission standards around the world, especially in Asia and Europe, have increased demand for platinum. Demand has grown in these areas even as the global economy has sputtered.

I was just in China, and the air quality was awful. The pollution in Chinese cities is a huge health risk. Much of this pollution comes from auto emissions.

In 2008, the Chinese government considered its air quality a state secret. The conditions were so poor, they could have sparked social unrest.

Now, the problem is so bad the Chinese government can no longer deny it. Recently, the government issued its first pollution “red alert.” It closed schools and factories, and forced half of the private cars off of the road.

I expect China to continue tightening emission requirements for cars. And this will be good news for platinum.

Platinum’s next main use is in jewelry, particularly in Asia.

Physical platinum can also be an investment in the form of bullion bars and coins. But investment demand is insignificant. Platinum just doesn’t have a history of being money or a safe haven asset like gold and silver. Platinum is primarily an industrial metal.

South Africa has a large portion of the world’s platinum reserves.

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There honestly just hasn’t been anything in the platinum market that has ever piqued my interest…until now.

Right now, there is a historical anomaly in the platinum market.

People call platinum “the richer man’s gold.” That’s because platinum is almost always more expensive than gold. In fact, platinum prices have dipped below gold prices only a few times in the last hundred years.

Today is one of those times…

Priced in gold, platinum is at near it’s all-time low.

I think at the very least, we can count on a reversion to the mean in platinum prices. Now is a good time to go shopping.

That brings us to Impala Platinum Holdings (IMPUY), or Implats.

Implats is the best way to get in on the platinum market during this historical anomaly.

Implats is based in South Africa and trades in U.S. markets. The company has low debt (a 16% debt-to-equity ratio) and you can buy shares at a fraction of book value. It’s a bargain.

Implats has $400 million in cash and $20 million in net debt. Leverage is not a problem.

Even in this depressed market, Implats is still profitable, and generating free cash flow.

The bottom line is the world needs platinum. It will continue to need platinum. South Africa has it. Implats is how we get it…at historical bargains.

THE TRADE

Buy shares of Implats (IMPUY) today at up to $10 per share. Use a 50% hard stop minus any dividends received. Implats can be illiquid, so use limit orders near the market price.

A limit order is an order placed with a broker to buy at a specified price or better. The share price of illiquid companies like Implats can fluctuate easily. Using limit orders helps us get the best price.

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The Ultimate Crisis Investment“It was the single most important financial event of my career.”

That’s what my friend Rick Rule of Sprott Global recently told me of his experience in the uranium market.

Rick was referring to Paladin Energy, a uranium company that leaped from one penny to $10 per share during uranium’s last bull market. That’s a 1,000-fold increase.

In other words, a $10,000 investment could have exploded into $10 million.

Even the worst-performing companies in the uranium sector delivered 20-to-1 returns.

Uranium can deliver these almost unbelievable returns because of unique supply-and-demand quirks that create colossal bull and bear markets.

Doug Casey: These wild imbalances in supply and demand, accompanied by equally wild swings in price, often surprise people who aren’t familiar with the resource business, but it is the very nature of the beast. It’s really only possible to raise money to discover deposits and build mines when prices are high, because that’s when the typical investor thinks he’ll make a killing. Of course the industry takes advantage of that window, resulting in an immense amount of new capacity. Meanwhile, the same high prices that encourage new production also start to discourage new consumption.

Which means by the time the new production hits the market after a time lag of several years, both prices and physical demand have collapsed—as have share prices of surviving companies. That is when professionals who understand the way these things work open up their checkbooks, because the resource business—oil, precious metals, grains, you name it—is as cyclical as the seasons of the year. It’s just that each commodity has its own peculiarities.

1950s Uranium Bull Market

Uranium cycled through its first bull market in the 1950s. This bull was mainly driven by the nuclear arms race between the US and the Soviet Union. Back then, the only practical way an investor could get exposure was through uranium exploration companies trading on small regional stock exchanges, like the one in Salt Lake City (which closed in 1986). Those who did made a bundle.

Doug Casey: I recall having seen, when I was a kid in the 50’s, an installment of I Love Lucy that had Ricky buying uranium mining stocks and buying a Geiger counter to go prospecting. The show obviously had a subtle effect on my future… Anyway, the first uranium boom was all over by 1960, when it became apparent the world’s militaries already had enough bombs to destroy the planet several times over.

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The Late 1970s Uranium Bull Market

The uranium price increased more than tenfold during this bull market… from $3 to $43. Some uranium stocks shot up by a factor of 100. Greater nuclear power use was the main driver. It was a cheap alternative to high-priced oil.

Disastrous power plant failures ended this bull market—first Three Mile Island and then Chernobyl, the final nail in the coffin. New production also came online and flooded the market just as demand was decreasing. The resulting bear market lasted for 20 years.

The 2001–2010 Uranium Bull Market

This bull market originated with the preceding 20-year bear market, where the uranium price decreased over 70%. It bottomed at $8 per pound in 2001.

For many companies, the cost of producing uranium was higher than the spot price. Miners were producing uranium for around $18 per pound, but they could only sell it for about $9 per pound. So there was little incentive to increase or maintain production.

Miners simply stopped producing. Production capacity plummeted. This sowed the seeds for another uranium bull market.

The market didn’t just settle into equilibrium. The supply destruction and increasing demand were so great that, eventually, uranium overshot the price needed to balance the market. After bottoming at $8 per pound in 2001, it skyrocketed to $130 in 2007.

That alone is impressive. But uranium stocks had an even greater meteoric rise. This is when Paladin Energy, the company Rick Rule was talking about, soared from one penny to $10.

Doug Casey: I wrote a very long (16 pages) and thorough article on uranium and nuclear power in October 1998 for International Speculator, where I recommended several uranium stocks, including Paladin, that subsequently—about two years later—exploded upwards in value. When the market wants into gold stocks it’s like trying to force the contents of Hoover Dam through a garden hose. In the case of uranium stocks, it’s more like a soda straw.

A nuclear catastrophe ushered in a new bear market, just as it had with previous uranium runs.

In 2011, a tsunami caused a nuclear meltdown at the Fukushima power plant in Japan. It was the worst nuclear disaster since Chernobyl. Afterward, Japan took all 52 of its nuclear power plants offline and switched to importing liquefied natural gas (LNG).

A major source of demand in the global uranium market was gone. And a global supply glut followed.

The uranium price crashed from around $85 to under $30.

The current uranium supply/demand imbalance has a lot in common with the last market cycle. It’s setting the stage for the next uranium boom.

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Now is the time to get positioned for the same kind of explosive returns we’ve seen in previous uranium bull markets.

Doug Casey: When commodities sell below production costs for long enough, the producers go bust, supplies drop, prices rise and production goes back up. At the peak of the last uranium bull market, in 2007, there were about 300 uranium exploration companies. Now there might be a dozen, mostly dormant.

Higher uranium prices will predictably switch investor sentiment from bearish to bullish. Then, as Wall Street belatedly reacquaints itself with uranium, companies will get value for assets which nobody could care less about today.

It’s an eternal cycle, and quite predicable—except for its timing.

THE NEXT URANIUM BULL RUN

I can’t think of a commodity with more upside and less downside than uranium right now. While many commodities have bounced off their lows, uranium hasn’t. It’s still at or near the moment of maximum pessimism.

The situation is screaming, “Bargain!”

Psychology plays a big part here…

People don’t like uranium. It’s yucky. It’s politically incorrect. Some hear “uranium” and think “cancer.” Many get emotional because of its association with Hiroshima, Nagasaki, Chernobyl, Three Mile Island, and of course Fukushima.

Besides that, investors are terrified that uranium prices have fallen over 85% from previous highs. It’s hard to think of a market where the sentiment is worse.

This is why we’re excited. Crises and extreme sentiment don’t scare us. They attract our interest.

The whole point of investing in crisis markets is to take advantage of the aberrations of mass psychology and pick up elite companies and assets for pennies on the dollar.

This describes the current opportunity in the uranium market perfectly.

Simply put, nuclear power delivers immense value to its users, there’s no substitute for uranium, and production is falling while demand rises.

This situation has only two possible outcomes…

1. Uranium prices don’t go up. Miners have no incentive to produce. Nuclear power plants run out of uranium, and the lights go out for billions of people.

2. Uranium prices go up and incentivize enough production to meet the demand.

There are no other options. Which one do you think is more likely?

Doug Casey: I doubt, especially in view of the fundamentals, that this will be the first bear market in history that’s not followed by a bull market. As the price of the commodity rises, the shares of producers should rise disproportionately (by 10 times), and shares of exploration companies might increase exponentially.

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I’m of the opinion that solar is—after 40 years of development—finally becoming economical, and will finally have its day in the sun, as it were. Solar finally makes practical sense. That said, nuclear will remain the safest, cheapest, and cleanest form of mass power generation for a long time. Most people know nothing about the technology other than what they hear in a two-minute TV rant. Despite Einstein having been quite correct when he said, “After hydrogen, stupidity is the most common thing in the universe,” reality will win out in the end. Nuclear is the way to go.

Demand

Nuclear power plants account for most of the demand for uranium. They are inseparably linked to the future of its price. Nuclear energy generates about 11% of the world’s electricity. There are currently 31 countries that use it and 447 operable nuclear power reactors.

A nuclear power plant produces energy by splitting uranium atoms. The energy that’s released boils water, producing steam that drives turbine generators.

These plants use fuel made from uranium ore. Miners extract the ore from the ground. Then it’s enriched and made into fuel pellets.

Every year, the world’s nuclear plants need 68,000 tonnes of uranium to operate. This demand is inflexible… The power plants must buy uranium.

The cost of uranium is a sliver of a typical power plant’s operating cost, perhaps 2%. So the price of uranium could double, triple, or more and it wouldn’t significantly affect a plant’s total operating cost.

Worldwide, there are 61 nuclear power plants under construction. Another 160 are planned and more than 300 proposed. The demand from these new plants alone all but guarantees the price of uranium will go up.

Most of the new plants are in China. Others are in India, Taiwan, and South Korea. Some Persian Gulf countries also have plants in the works. They figure, why burn oil when nuclear power is so much cheaper?

China, which currently accounts for 8% of global uranium demand, is expected to overtake the US (29% of demand) as the world’s largest uranium consumer by 2030. The country sees nuclear power as the best way to reduce its huge air pollution problem. (Nuclear energy has essentially no carbon emissions.)

China should ensure that uranium prices rise, regardless of what Japan does.

Supply Crunch

Uranium is a naturally occurring element in the Earth’s crust. Though there are traces of it almost everywhere, the vast majority of uranium production happens in just a handful of countries.

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Uranium is mostly produced in countries friendly with Russia, like Kazakhstan. These are not exactly US allies.

I recently spoke with an industry expert about Kazakhstan, the world’s largest producer. He told me that Kazakhstan has major problems. Its mines have used environmental and regulatory shortcuts. He wouldn’t be surprised to see a large portion of Kazakh production come offline one day because of these problems—but the market certainly would be.

Others producers, like Niger, where France buys most of its uranium, are plagued by instability from Islamic insurgencies in neighboring countries.

This all adds up to a precarious supply situation in the face of growing demand. That’s bullish for uranium prices.

Inventory Depletion

Global production is around 50,000 tonnes and shrinking. With global demand at 68,000 tonnes, there’s an annual deficit of around 18,000 tonnes. In other words, current production only satisfies about 75% of current demand. Global inventories make up the rest.

It’s difficult to get accurate figures on global uranium inventories. Governments and companies keep it confidential. But they won’t allow inventories to get too low for energy security reasons. Most experts I’ve talked to say it’s a matter of months before reserves drop into the danger zone.

With supply shrinking and demand rising, uranium prices will inevitably go up. It’s simply a matter of when.

But, when the turnaround comes, I expect it to be as explosive as previous uranium bull markets. The price will likely overshoot, since it will take years for production to catch up to the increased demand.

We know the uranium price will go up. The key is to get positioned now in the companies best able to survive the rest of the downturn.

Doug Casey: The trick is to find companies that are cognizant of the opportunity and have the business plan, the knowledge, and the resources (both geological and financial) to exploit it. The type of company I want should now be buying marginal resources and have the ability to put them into production quickly, preferably using fixed price contracts. To do that, they must have knowledgeable, reputable uranium people in place now. Last, but not least, they must have the financial backing to allow them to survive until the inevitable becomes imminent.

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HOW TO PROFIT: CAMECO CORPORATION (CCJ)

Cameco Corporation is the “best of breed” uranium company. It’s the premier play on higher uranium prices.

Based in Canada, Cameco is the world’s largest and lowest-cost uranium producer. It’s responsible for 16% of the world’s production.

The company controls two of the world’s largest high-grade uranium mines (100 times the global average). That means Cameco can produce uranium at a much lower cost than anyone else.

I have no doubt the company will survive this downturn and deliver huge profits to investors in the coming uranium bull.

Cameco has the upside of a junior exploration company—think ten bagger or better. But it’s very low risk. This is the kind of trade we look for in crisis markets, with the risk/reward skewed in our favor.

Cameco traded for $1.35 per share at the beginning of the last bull market. Then shares shot all the way up to $50, an increase of 3,600%. That’s a ten bagger almost four times over.

I expect similar returns in the coming cycle.

Remember, this is not a junior exploration company. It’s a multibillion-dollar industry dominator.

This is a fantastic opportunity to pick up the premier uranium asset (and management team) in the world at an extreme discount from its previous high.

Despite the horrible uranium bear market we’re in now, Cameco isn’t only making a profit, it’s paying 3.5% in current divi¬dends.

Cameco’s trophy assets—its ultra-high-grade uranium mines—are located in Canada. The risk of operating a profitable uranium mine is much lower there than in, say, Africa or the former Soviet Union.

Cameco has the capacity to ramp up production when uranium prices rise to bring in more profits.

Doug Casey: I’ve been asked “What’s the secret of finding winning gold, silver, and other natural resource stocks?” more times than I can even begin to count. And for over 20 years, my answer has remained pretty much the same: the Nine Ps.

Let’s take a look at Cameco’s 9 Ps.

People

CEO Tim Gitzel was born and raised in Saskatchewan, where Cameco’s trophy assets are located. So he’s intimately familiar with the area. Gitzel is an industry veteran with over 25 years of experience and success overseeing the world’s most important uranium projects. I expect the same positive results from him going forward.

Property

Cameco controls two of the world’s largest high-grade uranium mines. They’re the company’s crown jewels. They allow it to produce uranium at a much lower cost than anyone else.

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Promotion

When institutional investors think “uranium,” they think of Cameco and its trophy assets. The company is well known and covered by dozens of institutional investment research analysts.

Politics

Cameco’s trophy assets are in Canada, one of the world’s top mining and relatively low-risk jurisdictions.

Paper

Institutions hold about 70% of the outstanding paper. About three million shares change hands each day, so liquidity is not a concern. If the company needed to raise money it would issue debt. There’s little dilution risk.

Phinancing

Cameco has over $100 million in cash, with a total debt to equity ratio of 27%. That’s well below most of its peers, which hover around 60%.

Push

Cameco’s Push will come from higher uranium prices. Institutional investors should flood into Cameco in the next bull market. It will be their go-to uranium play.

Price

Cameco is trading near lows for this cycle.

Pitfalls

Another Fukushima-like nuclear disaster would derail the coming uranium bull market. Short of that, I think an increase in uranium prices is inevitable. However, inevitable doesn’t mean imminent.

It may take up to two years, but maybe much less, for uranium to turn around. I have no doubt that Cameco can make it through the current downturn and deliver explosive returns to investors on the other side.

THE TRADE

Buy Cameco Corp. (CCJ) at current prices. Plan on holding it for two years for a potential ten bagger and possibly much higher returns.

We’re not using a stop loss here. We’d consider selling our shares if there’s another nuclear disaster or if something else alters the fundamental attractiveness of the long-term supply/demand dynamics of the uranium market.

Nick Giambruno Senior Analyst

P.S. I want to hear from you. If you have a question or anything to tell me about this month’s issue (or about a past issue), please send it to me at [email protected]. I read every email that comes in from subscribers. I can’t respond personally to your emails. That’s company policy. But I will address common questions in upcoming issues.

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