Diamonds: The Less Known Commodity: Olivut Resources

Everyone is talking about gold and silver these days, but nobody talks about diamonds. Let's have a little peek inside this sector.

There are many sorts of diamonds in different colors and different grades. The higher the grade, the more precious the gem is. Aside from being pretty, diamonds can also be used in industrial applications (Figure 1).

Figure 1: Diamonds in Industrial Applications

We live in the year 2012, and what is very important about 2012 is that we are at an inflection point. The diamond market is to be found in the developed world as Asian/emerging markets only have a 10%-30% stake in this market (Figure 2). This means that demand is going to keep growing in countries like China and India, while we won't have any new and significant discoveries. In fact, we haven't had any Tier 1 discoveries in over 17 years now. Tier 1 discoveries are very large and very high grade discoveries by the way.

Figure 2: Diamond Demand

As a result, we will get a huge supply and demand gap in the near future, starting from 2015 (Chart 1).

Chart 1: Production - Demand Curve Diamonds

This supply-demand gap will spark diamond prices and we can already see a recovery in diamond prices on chart 2. Consulting firms forecast a 3% to 10% price growth per annum in rough diamonds for the coming years due to China and India.

Chart 2: Diamond Price

So how do we play the positive fundamentals in the diamond market? We go after the biggest resource in the world and that can be found in Olivut Resources.

Find out more here.

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Copper turns back to backwardation

It seems that copper is going back into backwardation, so that's good for equities, oil and commodities.

Chart 1: Copper Contango

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Oil Price Dip is a Buying Opportunity

On 17 September 2012, talk about a possible release of oil from the U.S. strategic petroleum reserve was put on the table. Since that announcement, the oil price has dropped 10% from $100/barrel to $90/barrel. These strategic petroleum reserves are only to be used during emergencies defined as follows:

1. an emergency situation exists and there is a significant reduction in supply which is of significant scope and duration;
2. a severe increase in the price of petroleum products has resulted from such emergency situation; and
3. such price increase is likely to cause a major adverse impact on the national economy.

The biggest reason for this release of the SPR is obviously the turmoil in the Middle-East of which I talked about here. Other reasons are said to be because of the presidential election. The question is, how long can this release of the SPR put a lid on rising oil prices?

The strategic petroleum reserves are currently standing at 695 million barrels, while the U.S. uses 20 million barrels a day according to the Department of Energy. This means that when all of the reserves were to be released, we will have 695/20 = 35 days of extra emergency supply. So basically, oil prices would only drop for a month and then quickly rise again afterwards. Moreover, the U.S. wouldn't release all of its SPR at once, but is likely to release a small part of it. The U.S. has only released its SPR a few times in history, the first time it released its SPR was on January 1991 and the last time was on 23 June 2011. All of these releases were on average in the amount of 30 million barrels. Which is about 1.5 days of supply, too few to have any significant long-term effect on the oil price.

Figure 1: Releases of SPR (Source: Bianco Research)

The first release of SPR was on January 1991 under the Bush administration due to the war in Iraq. The U.S. released 17.3 billion barrels from its oil reserves. Oil prices had spiked from an average of $25/barrel to $50/barrel due to the Gulf War. After the release of SPR, the oil price returned to its average of $25/barrel. Last year on 23 June 2011, due to the Libyan crisis, the International Energy Agency (IEA) once again released 60 million barrels of oil, of which the U.S. contributed half of it. The effect was a 10% drop in oil prices. But the oil price quickly recovered a few months later.

Chart 1: Light Crude to Gold Ratio

Conclusion:
I believe the recent 10% drop in oil prices is overdone and should be a buying opportunity for investors, especially in terms of gold (Chart 1). The reason behind this logic is found in the amount of supply of the SPR, which is only 35 days maximum and probably 1.5 days if we look at history. Additionally QE3 was announced a few weeks ago and it should be very beneficial to the price of oil going forward. Investors can bet on a rebound in the price of oil by buying iPath Crude Oil ETN (OIL) or United States Oil Fund (USO).

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Long Idea: Platinum!

In an interview from Peter Schiff on 25-September-2012 with the CEO of Sandstorm Gold, Nolan Watson, I noticed that platinum production costs are now almost the same as the platinum price. This is very significant as every price drop in platinum will render platinum mines nonviable for business.

Figure 1: Price versus Operating Cost (Gold, Silver, Platinum, Palladium)

Several articles like these have popped up recently and it's almost certain that the platinum price will go up due to supply concerns. South African miners are very inefficient and their costs are rising rapidly due to inflation.

Nolan Watson told us that the price of gold hasn't kept pace with rising inflation. This means that the gold price should already be at $2000/ounce just to be on par with the inflation as compared to 4 years ago. Basically this means that gold is now cheaper than 4 years ago if we count in inflation.

And platinum will be even better!

Just look at the platinum gold ratio (Chart 1). It is forming a bottom and should go higher, meaning higher prices of platinum versus gold.

I will be long platinum for the time being.

Chart 1: Platinum Gold Ratio

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Stock Alert: St. Augustine Gold & Copper Ltd

A very interesting development has been spotted in a gold-copper mine I talked about before here. I noted that the Philippines' gold and copper resources were ranked in the top 5 in the world. At the time of that article, St. Augustine Gold & Copper Ltd. (SAU) was at CAD 0.3/share. Just recently, the share price of the company jumped up to CAD 0.4/share on news that Australia based CGA Mining Ltd. (CGA) is going to be bought out by B2Gold Corp. for $1.1 billion. Read more about this news here.

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China Construction Bank to Buy European Bank: RBS or Commerzbank?

On 16 September 2012, China Construction Bank (CCB) announced that it would use up to $15 billion dollars to buy a stake (30%-50% stake or full acquisition) in a European bank. CCB chairman Wang Hongzhang said he would target banks in France, Germany and the United Kingdom. He indicated that some of the European banks are "on sale". The most interesting candidates are to be found in the partly nationalised banks, because it allows the government to reprivatise the banks. This way, the treasury is allowed to recoup its investment after having bailed out the banks during the economic crisis. The likely candidates are Royal Bank of Scotland (RBS), Lloyds (LYG) and Commerzbank (CRZBY.PK). Today the U.K. government controls a 82% stake in the Royal Bank of Scotland (RBS) and a 41% stake in Lloyds. The German government holds a 25% stake in Commerzbank. If this deal were to go through, it would shatter the $5.5 billion record held by Industrial and Commercial Bank of China (ICBC) for its purchase of a 20% stake in South Africa's Standard Bank in 2007.

We will go through the numbers, the earnings and choose which bank will be the likely target.

Find out here.

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The correlation between M1 and Gold: Quantifying how much the USD will devalue due to QE3

Ben Bernanke recently announced QE3 and it is estimated by Bank of America that the federal reserve balance sheet will go to $5 trillion in two years from now (end of 2014). If we know that the federal reserve balance sheet will go to $5 trillion in two years from now, I want to point out what this means to the U.S. dollar denominated in gold (GLD). How much depreciation in U.S. dollars can investors expect due to QE3? For the answer we need to take a look at the money supply measures of M0 and M1.

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Chart 1: Federal Reserve Balance Sheet

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Chart 2: Currency in Circulation

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Chart 3: Base Money (M0)

On Chart 1 we see the current Federal Reserve Balance Sheet and this balance sheet correlates to base money M0 (Chart 3). M0 (or monetary base) is basically the U.S. dollars and coins in your wallet (Chart 2) (biggest part of M0 namely "currency in circulation") (not in the bank) + deposits held by depository institutions at Federal Reserve Banks.

As you can see, currency in circulation was going up very steadily together with the federal reserve balance sheet during the period 1985 till 2008. We went from around $200 billion in 1985 to $800 billion in 2008. Then suddenly the federal reserve balance sheet exploded by $2 trillion, while the currency in circulation (your money in your wallet) only went up $300 billion. That means the federal reserve's increase in balance sheet (printing of money) hasn't adequately increased currency in circulation.

The extra $2 trillion in QE3 recently announced by Ben Bernanke (expansion of the federal reserve balance sheet) is expected to have the same effects. This is because all of the expansion in the federal reserve balance sheet is going to the excess reserves of depository institutions (Chart 4). You can find these excess reserves by simply subtracting Chart 2 (Currency in Circulation) from Chart 3 (M0: Base Money).

This will give Chart 4: Excess Reserves of Depository Institutions. This increase in excess reserves is seen by many to be a sign that inflationary pressure will come to the U.S. economy and the U.S. dollar.

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Chart 4: Excess Reserves of Depository Institutions

One simple model for determining the long-run equilibrium exchange rate is based on the quantity theory of money: MV=PT. Money x Velocity = Price x Transaction. A one-time increase in the money supply is soon reflected as a proportionate increase in the domestic price level (everything becomes more expensive). The increase in the money supply is also reflected as a proportionate depreciation of the currency against other foreign currencies.

The question is, how much depreciation will we see in the U.S. dollar against the real currency: Gold?

You can find the answer here.

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