Friday, August 31, 2007

Long Live the Credit Bubble!

Today Bush announced plans to essentially bail out irresponsible lenders, developers, borrowers, brokers, basically anyone involved with the subprime mortgage mess, as this news release outlines.

There are a number of responses, critical as in Mish's post, and I do think Mish is right on with his analysis.

I am not sure what to make of "Parting the Bankrupt Sea." He points out that those hurt by this move are those who correctly assessed that these were bad investments and there would be a crash. I simply don't get the part of this post that says:

This is a good move by our government (unless Bush does something really odd during his speech later today or Bernanke usurps President Moses Bush with comments that are at less than positive and supportive)

I don't see at all how it can be a good move to bail out highly irresponsible activities. Governments role is to regulate highly irresponsible activities, not dip into taxpayer's pockets to make irresponsible activities ok. At best, it is a short term solution that allows the wealth to cut their losses.

Another post, just a graph, shows the degree to which US debt has risen relative to that which makes a nation strong. The graph screams to me the degree to which today's promise is short term, unsustainable and further cannibalizes the future.

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Tuesday, August 28, 2007

"Panic First..."

I'm not sure where I read it, but on one of the blogs I read today it said that if you must sell under panic, be the first to do so...

I found the post, on Mich's Global Economic Trend Analysis, a blog that I highly recommend be added to all investor's daily reading list. If you look at my reading list on the side tab, I often add these posts to be displayed as what I've been reading lately.

End of post

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Checking broker ratings...

I was looking at a write-up on a few of Meryll Lynch's buy rating at Bespoken.

Anyone with any common sense was rating these as sell at that time so you do have to wonder about the hidden agenda.

The research shows that investors are consistently better off managing their money themselves and anyone saying that you need an expert is ill informed. You are the only one that puts your best interests first.

End of post.

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Saturday, August 25, 2007

Declining grade of Gold – Are the cost disadvantages linear?

This is an analysis that I have been meaning to do for a while that simply looks at how mining a declining ore grade affects costs. This is a particularly important analysis for investors of gold stocks as my sense of the market is that the grades of gold being mined are declining faster than any other commodity, and additionally, replacement reserves for gold companies are grossly lower quality than reserves that are currently being mined.

The markets were awful while I was away on vacation, and some of the market fears from the subprime mortgage market spilled over into commodities. These fears as well as fears of stagflation or hyper-inflation are part of what is driving gold prices and gold stocks. The idea is that gold will hold wealth better than paper currency that is simply printed at will.

Figuring out what gold bullion is “worth” is very easy, just go to If you think the price of gold will double, well, just buy the bullion and your investment will double.

Figuring out what a gold stock is “worth” is a very complicated thing and nothing about how a company is run is in your control. Proper evaluation of a gold stock requires an enormous amount of time. A simple linear extrapolation that if they double production they double earnings is proving to be false due to increases in costs that would be best described as a hyperinflation of costs, as in the Goldcorp 2004 project of costs for 2006 of $70/oz that ended up 179% higher at $195/oz. Gold stocks also have a propensity to issue equity at will, highly diluting wealth as well.

My suspicions are that gold producers are mining off their higher grades at a rate that leaves drastically reduced grades left to be mined and they have drastically lower grades in replacement properties so new mines do not have any chance of coming close to the profitability of historical mines despite higher gold prices.

The question I want to answer is how does the declining grade affect costs. I suspect that costs do not increase linearly with declining grade, but exponentially and if I am correct, many investors are going to find themselves in serious trouble with their gold stock investments, even if the price of gold doubles.

As the purpose of this investigation is to simply understand what happens to costs when all things are equal except the grade declining, I will make some very simple assumptions. First, assume there is a part of the processing linked to the cost of grinding the ore and extracting the gold. For this analysis assume the cost is fixed per ton of ore. I will assume a cost of $25/ton of ore, as you might have for an open pit operation. At the end of this will be a gold concentrate that requires more processing to extract the pure gold. The second part of the process assumes a fixed cost per ounce of gold. I will assume a fixed cost of $10/oz of gold.

Further, I will look at how a 0.5 g/ton decline affects costs from 100 g/ton down to 1 g/ton. The last assumption will be that 32 grams of gold must be extracted to get one ounce of gold. Recovery is never 100% and using this number works out to 97% recovery. My educated guess as a chemist is that the overall percent recovery would also decline with declining grade, so more than likely this analysis will understate the increasing costs with grade.

I set up a simple spread sheet at It shows that with the costs used a half-gram decline in grade when the grade is over 30g/ton is utterly marginal to costs. The follow graph is the percent increase in cost as the grade increases.

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This graph demonstrates beyond my wildest expectations that costs hyper-inflate for low grades of ore. The prices I used would be for a low cost open pit operation. The graph does not explain how Goldcorp’s projected costs ended up being 179% higher over a two-year period.

When I put a cost of $175/ton of ore for processing for underground mining my model gives costs of $80/oz when the grade is 79.5g/ton, reasonably close to Goldcorp’s $80/oz when they were mining a grade of 77g/ton. At 30g/ton the model gives a cost of $187/oz, very close to the $195/oz they had around that grade. Interestingly, the model shows that it would cost $5,600/oz to mine underground grades of 1g/ton, and double that, $11,200, for a grade 0.5g/ton.

This is a very simple model, but the lesson it shows is something that every gold investor ought to understand. Below is the graph reproduced for grades 6 grams and less, showing the increased percentage cost for a grade decline of 0.5g/ton, and I reversed the director of the x-axis so you can see the out of control, concave up, shape of the curve.

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This graph should have investors of companies with low-grade reserves feeling utterly ill. I would suggest that what it means is that anyone signing their name saying that a low-grade reserve is economically viable is either incompetent, unethical or they think investors are truly gullible and stupid.

I have worked as a chemist in a lab and the entire economic viability of the feasibility study rests on the accuracy and extrapolation of the assay results. The lab I worked in we used to regularly send out samples to other labs as a crosscheck on our results and there would typically be up to a 30% variation in results. To test where the problem in results lay, I sent out duplicate samples labelled differently and carefully prepared and tested standards and the results returned were out by 30%.

This graph is showing that when grade declines from 6g/ton to 5.5g/ton, costs increase by almost 10%. A half-gram decline at 3g/ton has cost increases of about 20%. At 2g/ton the same decline results in a 30% increase in costs, and at 1g/ton the decline results in about a 100% increase in costs. When you consider the potential error in assay results, the margin of error in these feasibility studies on low-grade deposits is potentially so enormous; these kinds of investments simply are not investments, but truly a form of gambling.


The cost increases in low-grade deposits are not linear, but exponential and imitate a hyperinflation of costs as grade declines. In high-grade deposits errors in feasibility studies due to errors in grade or small declines in grade are relatively small and have a minor effect on investment decisions. Feasibility studies on low-grade deposits are highly suspected for huge errors due to the grossly different economics of low-grade deposits from small errors in assumptions and data. Using these studies for investment decisions resembles gambling more than investing.

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Friday, August 24, 2007

Currency devaluation, social policy - Reflections from vacations

I just got back from a three week vacation in Costa Rica, where one US dollar gets you about 520 Costa Rican colones.

I know little of Costa Rica's economy, except that their main export is from agriculture and their main "industry" is tourism. Currently there is negotiations for a free-trade deal with the United States and every where you go graffiti shows opposition to a free-trade deal with the US. Their taxes are low with universal health care and education being the two most important items taking up the majority of the taxes.

I went to Costa Rica to explore the idea of learning Spanish, so I went for a two week introductory course and I stayed with a home stay family. The family consisted of grandparents and young adult grandchildren. What was strikingly different from Canada is this family with "retirement" age adults did not have entitlement attitudes towards pension, but continued working. They were a hard working family.

I would have to say our Canadian attitude towards entitlement and social programs leaves a foul taste in my mouth. First, not a senior currently collecting a pension paid for it. I so clearly remember my amazement as a very young adult with a job in the bank and seeing this pittance of a tax for pension and then also seeing how much seniors were getting in pension and I brought it up with my employer about how little the pension tax was compared to the pension payout and I was told that over the long term the money put in would pay for the pension and I was shown a bit of compounding, which still made no sense to me, but I simply assumed those older and wiser understood these things better.

I now know that our pension system was set up based on a pyramid scheme that would be illegal under today's law. The relative amount -- meaning correcting for wage increases -- we pay for pension today is much, much, much higher than what was paid in my youth, but it is still utterly unsustainable in terms of the pension entitlement expectations, and political leaders saying anything otherwise are either ignorant or lying. One day I will post more on the topic as I believe that I live in one of the greatest countries, but the unraveling of this pyramid scheme has the potential to destroy us, and could ultimately pit youth against age when age is defenseless. Certainly our currency and savings are at extreme risk from unsustainable debt and entitlement expectations and we are at risk of seeing it unravel as Mexico, Costa Rica and Zimbabwe have all experienced, unless we change our attitude and work together to make something sustainable and fair.

But, the Costa Rican people do not burden their children with their entitlement expectations, but instead continue to take responsibility for their economic future.

I wondered about the huge numbers for the currency in Costa Rica and I remembered traveling in Mexico in the 90s after their currency was grossly devalued and they were in the process of switching from old pesos to new pesos at a rate of 1000 old pesos is one new peso. They had periods of inflation of 30-40% per year, perhaps more. My Mexican friend in university in the 80s had talked about Mexican inflation and how her family had worked to move their money to more stable currencies as they saw the buying power of their savings rapidly decline. My last vacation in Mexico in the 1990s a Canadian dollar traded for about 3 Mexican pesos. Today it trades for 10.5 Mexican pesos so Mexico has continued to have a rate of inflation that grossly destroys the buying power of savings.

The young man at the school I attended talked about how over the previous few years if you had a US account you saw the number of colones increase pretty much daily as their currency deflated relative to the US currency. It made me wonder what had happened with government management of Costa Rica's economic resources. The young man in my homestay was highly interested and informed on political issues and he talked about the many social programs Costa Rica had at one time and their glory years of spending beyond their means and increased wealth. He mentioned the huge consequences to Costa Rica when one of their Presidents failed to yield to demands to cut social spending when their debt load to other nations was high. I do not know Costa Rica's full story, but it appears they faced a hyper-inflation due to high debt, an inflation that is not yet under control. I saw price increases of up to 25% at retail establishments in the mere 3 weeks that I was there.

There is something in place to control the currency exchange rate for the past year or so. The young man at the school said that you could no longer see your colones increase dramatically by holding a US account. What is this control? Currently in Zimbabwe there is an "official" exchange rate mandated by law. They have hyperinflation running at 4500%. At black market rates the exchange rate for 44,000 Zimbabwean dollars, the price of a loaf of bread, is about 18 cents. At the official rate mandated by law that loaf of bread costs $176.

Costa Rica is an inexpensive country for travel, but the tourist areas have become grossly expensive for the local people. The average price of meal in the tourist areas that I visited seemed about twice the price that I paid in San Jose in close proximity to the school, and other students said they visited tourist areas on the Pacific side where the price was double again to what we were paying in the Caribbean coast. A policeman`s monthly wage in Costa Rica is about $350 per month and with the prices I saw, inexpensive by Canadian standards, I can not imagine how they make ends meet. It seemed to me that the prices were anywhere from 20 to 75% less. Bottled water was about $1 as was pop. A lunch you`d spend $6-12 here was $2.50-5 in town, but as much as $7 in the Caribbean coast.

I discovered it is wise to always ask the price first because if you say what you want and then it is packaged, they will take you to the cleaners in terms of what they expect you to pay. I paid $2.65 for a coffee in a very small cup with two refills, whereas when I cautiously shopped for my coffee the next day I paid 70c for a coffee that was twice the size of the cup of the previous day.

In another example, the going price for the locals for a bag of cut mango fruit, the fruit of two very small mangoes or one large mango was 40c. I paid 60c, but my last day at the beach this other vendor, after I had confirmed the 60c price in the morning, had halved the amount in the bag and made it look the same by loading the bag with pits, which I only discovered after I returned to my friends, who had given me 60c for a bag each. He tried to charge $1.20 in the afternoon and I settled at 70c. I did not ask the price again before I just asked for it. So even asking the price earlier you still have to confirm the price again before you order. I found in many places Costa Ricans do not think twice about changing prices and the terms of what you think you`ve agreed to simply because they figure you can pay more.

Anyway, Costa Rica is a great country to visit right now, and depending on where -- ie Atlantic versus Pacific coast -- it is inexpensive by Canadian/American standards. The tours arranged for tourists are perhaps a little less expensive than a tour in Las Vegas or Disney World, but overall they are not cheap. They wanted $50-60 for a 3-4 hour jungle tour, and $70-80 for a river rafting tour, whereas you can find a room with a private bathroom for two people for as little as $35 per night close to the waterfront. Shop around and your meals will be less than $10 per day, but even going for the finest dining you would be hard pressed to exceed $25 per day.

I do wonder about how the currency is being set and about the rate of inflation as to whether Costa Rica will remain highly attractive for tourism.

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