Hope for a debt solution fades

The chase by Marty Cej:

Turning to the European debt crisis and the meeting of European leaders this weekend, the market's expectations have been bludgeoned lower by German government spokesmen and images of European bureaucrats scrambling the private jets for urgent emergency last minute 11th-hour crisis summit talks in Berlin. Optimism for a plan has been downgraded to prayers for a blueprint for a plan to come up with a solution.

France wants the ECB to use its balance sheet to boost the bailout mechanism's – the EFSF – funds and for the EFSF to have a banking license. Germany would like the EFSF to provide first loss guarantees to boost the funds. The French approach would increase the EFSF's available funds, a good thing, but then it also increases the exposure of the guarantors and could lead to credit-rating downgrades.

The German approach limits members' liabilities to those already agreed under the recently enhanced EFSF, but it's questionable how much value investors will give to a partial guarantee which would undermine confidence. But it's only Thursday. There's plenty of time left.
Plenty of time left for a European solution, that is. Time appears to have run out for Moammar Gadhafi (nee Qadhaffi nee Gaddafi) however.

Reuters reports that the former Libyan despot and disco king was captured and wounded in both legs near his hometown of Sirte. There are also unconfirmed reports that he has died of his wounds. We'll continue to report developments as and when they can be confirmed.

The Canadian Pension Plan Investment Board is partnering with Microsoft to take a run at Yahoo, according to unnamed sources in the Wall Street Journal. What would the CPPIB want with Yahoo? How much would the pension plan throw into the kitty? What is Yahoo worth? The CPPIB has told us that it won't comment on the WSJ story so we'll have to look under the rocks for answers ourselves.

Earnings will dominate much of our coverage this morning with EnCana reporting a drop in earnings that still appears to have topped expectations. Paul Bagnell has the file in the early going but will hand off to Brett Harris. We're watching for Shaw Communications this morning and Celestica after the close. Out of the U.S., Union Pacific, AT&T and Eli Lilly will help set the tone ahead of Microsoft after the close of trading tonight.

A parade of economic data will either be cheered or jeered (not everyone loves a parade) this morning: Initial jobless claims at 8:30 will be followed by leading economic indicators at 10 as well as the market-moving Philadelphia Fed survey out at the same time. Existing home sales, also at 10, are expected to confirm that things are tough and just getting tougher.

Viewers are listening to the news and reading the headlines and wondering what to do. In our coverage of the daily breaking news, we occasionally miss the opportunity to talk strategy and financial planning.

How do investors prepare their portfolios for a lengthy period of subpar growth? How do they position their finances for a rebound in inflation? A rally in stocks? A slowdown in earnings? There are as many plans as there are hypotheses about the next several quarters.

Ivan Lo Equedia Weekly Says...

September, which is generally a down month, is over. October thus far, despite volatility, has been performing well. On Friday, U.S. stocks advanced, giving the Standard & Poor's 500 its biggest weekly gain since July 2009, as retail sales beat economists' estimates and the G20 began discussions on Europe's debt crisis.

Regardless of politics and worldwide economic conundrums, historical trading patterns show us that the sell in May theory still works. Over the last 40 years, selling in May and buying back in October would net you a profitable return - even with the dramatic swings in prices over the last 40 years.The only down month during this time (October - May) would be February, as profit taking from past months come into play.

The rating agencies haven't stopped their downgrades. Fitch has just downgraded UBS and has now put Morgan Stanley, Bank of America, Goldman, BNP, Deutsche Bank, and SocGen on watch negative. As more negative news emerges, investors continue to hold onto their cash. But is this smart?

The answer lies in whether you believe the dollar will continue its dominance in the market. While it remains the world's reserve currency, it also belongs to the world's largest debtor nation.

Countries around the world have been dumping US treasuries with reckless abandon. In the last six weeks, foreigners have dumped $74 billion in treasuries - the biggest sequential outflow in history. Even Bill Gross, founder and managing director of the world's largest bond fund, is having a bad year. In his October 2011 investment outlook report:

"There is no "quit" in me or anyone else on the PIMCO premises. The early morning and even midnight hours have gone up, not down, to match the increasing complexity of the global financial markets. The competitive fire burns even hotter. I/ we respect our competition but we want to squash them each and every day. You the client have 100% of our attention as always, as do your portfolios. I am just having a bad year. My fabulous rock of a wife, Sue, always tells me that by December 31st, the alpha is always green, not red, but this year will be a long shot. This year is a stinker. PIMCO's centerfielder has lost a few fly balls in the sun." - Bill Gross

When the world's largest bond manager is having a bad year, you know things aren't good.

As a matter of fact, Jim Rogers, the former Quantum Fund co-founder said he would quit if he was a bond portfolio manager. In a recent interview with CNBC, Jim Rogers said the U.S. economy is likely to experience a period of stagflation worse than the 1970s, which would cause bond yields to spike. Rogers said governments were lying about the inflation problem and the recent rally in Treasurys was a bubble:

"As the inflation numbers get worse and as governments print more money and as governments have to issue many, many more bonds - somewhere along the line we get to the point when (bond prices) go down."

Between 1974 and 1978 average inflation in the U.S. was at 8 percent, while unemployment hit a peak of 9 percent in May 1975. Currently, unemployment is at 9.1 percent while CPI is at 3.8 percent.

Rogers believes inflation will get much worse this time because in the 1970s only the Fed was printing money, whereas now many global central banks have been easing monetary policy:

"Bernanke is obviously backing the market again and the Federal Reserve has more money than most of us - so they can drive interest rates down again. As I say they are making the bubble worse...I wouldn't advise anybody to buy bonds, I would advise you to sell bonds. If I were a bond portfolio manager, I would get another job...In the 70s you didn't make much money in stocks, you made fortunes owning commodities."

Rogers' view is at odds with others such as economist Nouriel Roubini who have been talking about a depression. Other economists have said the U.S. is experiencing a "balance sheet recession", just as Japan did in the 1990s, and that means the U.S. risks a long period of falling prices and asset values. Regardless of which viewpoint you take on, let's take a look at commodities.

Base Metals

I continue to believe that commodity price expectations will remain the primary driver of base metal and bulk commodity equity valuations. Despite the recent commodity price declines, which reflect fears of global recession, I don't think commodity prices will fall back to recessionary levels - which means there remains an opportunity to participate in undervalued commodity equities.

For now, the world's major economies are either unable or unwilling to provide the sort of liquidity injections we saw in 2008 and 2009. But given the circumstances, I still expect a strong infusion of liquidity in the near future.

As such, I believe commodity prices should be fine as I expect continued strong economic growth in China and much of the developing world - while this may be for the short term, we have to look at things on a near-term basis now given the volatility of the markets.

China alone now accounts for about 40% of global consumption of most of the industrial commodities. Of the base metals, the fundamentals for copper are the best - as they always have been used as a gauge for worldwide growth.

Over the last few years, I have had numerous Chinese businessmen come from abroad and ask me for shipments of both iron ore and coking coal - the primary drivers for steel production. They are willing to buy whatever they can get their hands on. While this in no way represents the overall market, it shows me that the demand for these basic materials from China remains strong - as it does in other developing countries. If you have coal or iron ore, someone will buy it.

For the rest of 2011, I expect base metal prices and coal to remain at, or higher, than current levels - based on both short term fundamentals and the possibility of liquidity injections by world governments.

Copper

The free fall in the copper price over the last quarter has made it one of the worst performers amongst commodities. From interim highs at the end of July to the end of September, copper dropped 32% from highs of US$4.50/lb to lows of US$3.07/lb.

During any sort of commodity sell off, copper generally leads the way and this was no different given the sell off last month. The weakness driving copper lower has been driven on speculation that demand would decline in a slowdown in global economies, particularly China.

However, I expect copper to rebound back up between $3.75 - $3.90 before the year is over but trend lower early 2012. Of course, this forecast could easily change given any major liquidity injections by the world governments. This is a short term price target and over the next few years, copper prices will remain subdued to reflect my view that worldwide economies will slow (see The Dangerous Unknown). As this happens, copper production will decrease which will eventually force a shortage in copper by 2015 - at which point, I expect copper prices to surge once again.

Uranium

While the ongoing nuclear crisis in Japan has shaken the world's confidence in nuclear energy and placed a significant overhang on the uranium market, this remains temporary.

Short term, we may see more weakness in the uranium market. But in the medium to long term, the nuclear renaissance will continue with China and other emerging economies leading the way. (see Back to Reality)

Gold

Again, my view remains unchanged.

On September 26, 2011, the CME Group raised initial margin requirements on COMEX gold futures by another 21% - the fifth raise this year. This once again forced speculators out, forcing the price of gold down. We have seen this over the past year as gold sells off, only to rise higher.

This, along with other contributing factors - such as the redemptions of gold holdings where investors sold positive positions in gold to cover losses in other asset classes - has caused gold to decline back to the $1600 range. Given fundamentals and the strong possibility of another liquidity injection, gold at these prices should be viewed as a buying opportunity. This includes gold equities, which should recover from current historical low trading multiples to much higher levels.

Final Thoughts

The world is coming close to finalizing a plan to bailout Europe. I fully expect a major infusion of liquidity, which should bolster both stocks and precious metals. Look for buying opportunities in the market ahead of any major announcements. While the market has moving up based on this premise, there remains room for more upside short term.

Ride the momentum.



Until next week,

Ivan Lo
Equedia Weekly

Bankers Pet operational update:

Current production rate 14,250 bopd


CALGARY, Oct. 3, 2011 /PRNewswire/ - Bankers Petroleum Ltd. ("Bankers" or the
"Company") (TSX: BNK) (AIM: BNK) is pleased to announce the following
operational update:


Production and Oil Prices


Oil sales from the Patos-Marinza oilfield in Albania during the third
quarter averaged 13,667 bopd compared to second quarter sales of 12,152
bopd, an increase of 12%. Oil inventory on September 30th was 201,000 barrels, a decrease of 38,000 barrels from June 30th.


Average production for the third quarter was 13,232 bopd representing a
2% increase from 12,973 bopd in the second quarter. Current production
is 14,250 bopd, 8% higher than the second quarter's exit rate.


The Patos-Marinza third quarter average oil price was approximately
US$74.55 per barrel (representing 66% of the Brent oil price of
US$113.46 per barrel), a decrease of 4% compared to the second
quarter's average oil price of US$77.03 per barrel (66% of Brent oil).
With the current differential between Brent and West Texas
International oil (WTI), Patos-Marinza crude is presently priced at
approximately 86% of WTI.


For the nine months ended September 30, 2011 oil sales were 12,578 bopd
($73.30 per barrel) as compared to 9,318 bopd ($46.95 per barrel) for
the comparable 2010 period.


2012 Crude Sales Agreements


The Company is also pleased to report several Patos-Marinza crude oil
sales agreements for 2012. Three new export market agreements have been
priced at an average of 72.5% of the Dated Brent oil benchmark. ARMO,
the Albanian refinery, agreed to purchase Patos-Marinza crude in 2012
for an average price of 66% of Brent, which is approximately the same
netback value as the export market due to lower transport and port fee
costs. The 2012 pricing agreements represent an average 7% increase
over the 2011 Patos-Marinza oil price.


Drilling Update and Well Reactivations


Twenty-one (21) wells have been drilled during the third quarter,
sixteen (16) horizontal production wells, a vertical cored delineation
well, two (2) thermal horizontal wells, and two (2) water disposal
wells. Fourteen (14) of the horizontal production wells have been
completed and are on production with two (2) awaiting completion.
Average production from eighty-eight (88) producing horizontal wells in
the field is 100 bopd per well at the end of the third quarter. This
includes the early period decline and operations change to limit the
peak rate of the horizontal wells to achieve stabilized production as
well as the low rate producing wells that were previously excluded due
to water intrusion and poor mechanical drill concerns.


The first Driza 1 (D1) horizontal step-out well in the western extension
(Area 3) of the field has been drilled, and is currently on production
at a rate in excess of 200 bopd. Several follow-up locations are
planned for this area in the fourth quarter of this year where limited
D1 reserves have been booked to-date. Production from five (5) Lower
Gorani horizontal wells continues at an average of 120 bopd per well.
Follow-up locations are planned in the Upper and Middle Gorani
formations in the last quarter of this year which will contribute to
additional recoverable reserves from this formation.


The fifth drilling rig is expected to arrive in Albania in November 2011
and spud its first well before the end of the month.


Reactivation and recompletion work continued in the third quarter with
nineteen (19) wells reactivated, ten (10) of which are on production
and averaging 30 bopd per well. Well reactivation success north of the
Seman river in the Kalmi area confirms good high productivity from
vertical wells in this area where the Company is planning to commence
drilling numerous horizontal wells later this year and beyond after
completion of the new bridge across the river.


Thermal Program & Exploration Block "F"


Drilling of a cored vertical delineation well and two thermal cyclic
steam horizontal wells of the thermal pilot program have been completed
during the quarter. Completion and equipping of the thermal wells will
occur in late October and construction of the steam generation and
thermal production facilities are in progress with completion targeted
by early November. The first steam injection cycle is estimated to
start in mid November 2011.


Drilling the first of several gas exploration wells on Block F is
scheduled for December 2011. This multi well program will test several
discrete structural and stratigraphic targets over the next 12 to 16
months.


Infrastructure Development


Construction on the first phase of the crude oil sales pipeline, which
connects the Patos-Marinza oilfield to Bankers' storage and loading hub
facility at Fier, is complete. Operations at the storage and truck
loading terminal at the Fier Hub is scheduled to commence in November.
Social and environmental impact assessments for the second phase of the
pipeline, from Fier to the export terminal at Vlore, are underway for
2013 construction.


Construction of the Central Treatment Facility (CTF) expansion is
progressing and on schedule for completion in December 2011. The Seman
River Bridge, in the northern area of the Patos-Marinza oilfield, is
progressing with completion expected in December 2011.


Kucova


Water injection, pressure and fluid level observations are being
monitored at the Kucova oil field. Water injection into well F-38 commenced in May; current
injection is exceeding forecast and two offset wells are exhibiting
rising fluid level and pressure in the wellbores indicating positive
initial water flood pressure response. The two wells will be equipped
to commence production operations by year-end.


Environmental Initiatives


The pilot remediation project in Sector 3 is now complete with surface
clean-up of old infrastructure and removal of legacy oil spills. This
area can now showcase the results and the impact of remediation efforts
in portions of the field and the surrounding communities.


Analysts and Investors Field Visit


Bankers is organizing a field visit on October 31, 2011 for analysts and
institutional investors to view the completion and progress of all of
its capital projects at the Patos-Marinza oilfield.


For additional information on this operational update, please see the
October 2011 version of the Company's corporate presentation at www.bankerspetroleum.com.


Conference Call


The Management of Bankers will host a conference call on October 4, 2011
at 6:45am MDT to discuss this Operations Update. Following Management's
presentation, there will be a question and answer session for analysts
and investors.


To participate in the conference call, please contact the conference
operator ten minutes prior to the call at 1-888-231-8191 or
1-647-427-7450. A live audio web cast of the conference call will also
be available on Bankers website at www.bankerspetroleum.com or by entering the following URL into your web browser http://www.newswire.ca/en/webcast/viewEvent.cgi?eventID=3685880. The web cast will be archived two hours after the presentation on the
website, and posted on the website for 90 days. A replay of the call
will be available until October 18, 2011 by dialing 1-800-642-1687 or
1-416-849-0833 and entering access code 15629656.

Ivan lo Equedia says...

Every day, it seems we're heading back closer to 2008.
 
A quick recap of last week will tell you the tale. Bear with me.
 
Crude oil capped the largest quarterly drop since the 2008 financial crisis by tumbling to a one-year low. Despite the rally on Tuesday, stocks eventually fell and the MSCI All- Country World Index took its biggest quarterly loss since 2008.
 
Big banks across the board also dropped - with Morgan Stanley down 10 percent, Goldman Sachs Group Inc. down 5.4 percent and Deutsche Bank AG down 4.9 percent.
 
Last week, the four-day rout erased $1 trillion from U.S. equities - this left the S&P 500 trading at 12.4 times earnings in the past 12 months. According to Bloomberg data, this is 4.4 percent below its average valuation at the lowest point during the last nine bear markets.
 
Even gold, silver, and other commodities took a major tumble. On Monday, gold plunged to its biggest 3-day loss in 28 years. Silver traded below $30 for the first time since February.
 
A few weeks ago, I wrote in a past letter (see Mark Your Calendar) that if Bernanke didn't announce or make a hint of QE3 at the September 20-21 FOMC meeting, the markets will crumble. Since then, the market has taken a nose dive. No surprise here.  
 
The world economies are obviously at risk. In terms of growth, there is more downside than upside in the near future as the world works to solve its fiscal issues. Europe is on the verge of some major changes and China is looking more like a bubble every day.
 
On Sept. 13, the Census Bureau released their annual report on income, poverty, and health insurance in the United States. The report said that the number of people below the official poverty line rose from 14.3% in 2009 to 15.1% in 2010. This meant that 2.6 million more people fell into poverty last year, and the total of 46.2 million poor was the largest number in more than 50 years of records.
 
At the same time, corporate profits after taxes soared to a record high in 2010. Corporate profits grew 36.8% in 2010, the biggest gain since 1950. Total business profits totalled almost $3.5 trillion, or about one-quarter of the entire economy.
 
So why is it that even with continued high unemployment levels and more people falling into poverty, US corporate profits are at record levels?
 
The Secret Behind Corporate Profits  
 
While profits are high, that doesn't mean business is strong.  
 
Corporate profits are now being generated through a bunch of economic anomalies that are not the normal course or factors that generate profits.
 
Since 2008, we have had record low interest rates, less borrowing by companies and a surge in productivity that has allowed companies to do more with the same number of workers or fewer. Corporations have been getting away with paying less and expecting more. Either take the job, or don't - because with the employment crisis, someone else will . Furthermore, there has been a big push by these corporations to cut their bottom line costs.
 
There is a huge difference between corporate profitability based on top line revenue growth and bottom line cost cutting. Even with declining revenues in certain quarters, profit margins continue to rise - leading to stronger corporate earnings.
 
That is how US corporations have been able to generate record profits on very, very low volume and very weak economic growth.
 
But there's a problem with this scenario.
 
The Hidden Tale 
 
Profit margins have surged over the last few years due to massive cost cutting, layoffs and benefit reductions - that means profitability came at the bottom line of the income statement. In a normal environment, this would spell short term success for corporations. However, in no way does that signal a bright outlook for the US economy.
 
Corporations will hire instead of cut workers if they expect a bright and growing future. When economic conditions worsen, corporations will cut back - they'll work to trim the excess fat.  
 
Shareholders are looking for profit margins and with dismal growth and a bleak economic outlook, that is how corporations give shareholders what they want. Cut costs and trim the fat.
 
There is nothing wrong with this in the short term. As a matter of fact, that is exactly what a corporation should be doing in times of uncertainty. As such, stocks should rise to catch up with earnings if the European mess is contained.  
 
However, this method of profit growth cannot be sustained in the long term because many of these corporations have already taken their diet pills through layoffs and benefit reductions.
 
Even with record earnings, analysts continue to slash earnings growth as year-over-year profit growth of companies is on the verge of going negative. That means asset prices will have to adjust to meet the decline in profitability.
 
Since companies have already trimmed the fat by cutting workers, inventories, and reduced borrowing - it will be exceptionally difficult in the future to cover up declining profits with further cost cutting. In other words, when profit margins can no longer grow through cost cutting, corporations will have to rely on top line growth - which, given the economic outlook, doesn't appear to be very optimistic.
 
With an already weak economy, it is only a matter of time before the markets begin to adjust for lower profit growth.

So while the short term outlook for stocks may be strong, don't expect extreme growth for overall equities in the next few years. Unless you can buy stocks now and put them away for five years, as Warren Buffett does, don't expect any miracles in the short term.   
  
The Exception  
 
Go into Gold. Go into Silver. Go into related stocks.   
 
We've seen the S&P rise 2%, while gold rose 4%. This is the type of correlation that signals gold is in a league of its own - it's the type of signal that shows gold's prowess in the market despite what happens to the dollar. I have mentioned this before (see The Big Signal).
 
While the selloff in gold and silver has investors nervous, don't be. The selloff was due to many factors such as profit taking and margin requirements. When people lose money on stocks, they sell their strongest investments that have been making money to cover their loses. Gold was merely an innocent bystander.   
 
With the recent pullback in precious metals, the buying opportunity looks strong. While it may not be the exact bottom, gold and silver at these levels look very promising. Within a year's time, I fully expect gold to hit $2500 and would not be surprised to see it hit $2000 by the end of this year.      
 
In an article published by Bloomberg a few weeks ago, Dylan Grice of Société Générale calculated the "fair value" for gold based on the price at which each dollar in the U.S. monetary base would have been if backed by an ounce of the precious metal.  As of June, this price would have exceeded $10,000/oz.   
 
While gold and silver sit at these levels, investors will have the opportunity to pick up these precious metal and related stocks at rock bottom prices.  
 
That's because sooner or later, certain events will make these precious metals climb higher and faster than they have before...  
  
The Next Leg Up 
 
The U.S. and Europe face about a 40 percent likelihood of a prolonged period of economic stagnation should policy makers fail to restore confidence, according to analyst Jose Ursua of Goldman Sachs: 
 
"The prospect of a long period of stagnant growth is a plausible risk and a legitimate concern for the major developed economies. Whether these countries manage to avoid a 'Great Stagnation' by a pick-up in the recovery is likely to depend on policy being able to restore confidence and putting in place reforms that can decisively jolt growth."
 
After analyzing 93 episodes of the conditions in the past 150 years, Ursa concluded that the U.S. and Europe are already exhibiting signs that would be typical of stagnations, characterized by "high and sticky" unemployment, an average 0.5 percent growth rate in per capita gross domestic product and stock markets that underperform historical averages.  
 
When this happens, policy makers must begin new rounds of stimulus to stimulate the economy - they know that the damage wrought by prolonged stagnation will be much worse than printing more dollars.  
 
Most Bank of England policy makers have already said it's "increasingly probable" more asset purchases will be needed to support growth, while European Central Bank officials are likely to debate restarting their covered-bond purchases and further measures to ease monetary conditions.
 
Fed Chairman Ben S. Bernanke said this week the U.S. is facing "a national crisis" with the jobless rate at around 9 percent since April 2009:     
 
"We've had close to 10% unemployment now for a number of years, and of the people who are unemployed, about 45% have been unemployed for six months or more. This is unheard of." - Bernanke, September 28, 2011
 
With the economy and markets shattered and prices of commodities coming down, it now means that the threat of inflation is becoming subdued. Without the short term threat of inflation, the Fed will soon have the firepower to implement (you guessed it) QE3:   
   
 "If inflation falls too low or inflation expectations fall too low, that would be something we have to respond to because we do not want deflation" - Bernanke, September 28, 2011
 
St. Louis Federal Reserve President James Bullard said the Fed is prepared to ease policy should the U.S. economy weaken, while keeping an eye on inflation risks:
 
"The Fed has potent tools at its disposal and is not now, or ever, out of ammunition. Should further weakness develop, monetary policy will need to respond appropriately." - Bullard 
 
While no one is talking about QE3 anymore, the lagging economy and poor stock market performance gives way to a new round of talks in the near future.  
 
Regardless, gold and silver will rise over time but will shoot even higher if QE3 becomes a reality - which I still believe it will.    
   
That is my prediction. Of course, this prediction involves politics based on fundamentals, so take it with a grain of salt.  
 
Here's what I am looking to do:
 
I continue to hold cash but will be buying gold and silver on dips. I will also be looking at both the Market Vectors Gold Miners ETF (NYSE: GDX) and Market Vectors Junior Gold Miners ETF (NYSE: GDXJ), as well as other individual gold and silver explorers and miners -  including the more speculative plays. The GDXJ has a basket of gold stocks that are very well positioned and should be able to take advantage of the run up in gold prices as more investors move into gold stocks.
  
I will also be looking at the extremely beat up energy sector - especially if politics show any bigger signs of QE3. I will be looking to buy through individual large cap stocks, as well as ETF`s such as the SPDR S&P Oil & Gas Exploration & Production ETF (NYSE: XOP) and the Claymore Oil Sands ETF (TSX: CLO).
   
There are lots of bargains out there if you can stomach the volatility. Happy hunting.  
 
   
 
Until next week,
 
Ivan Lo
Equedia Weekly