Financial markets are at the whim of how events will unfold in Ukraine. Equity markets looked poised to breakout off of Friday’s job numbers, but pared back their early gains. Given gold’s failed attempts to breakout past key resistance levels, it previously looked under pressure; however, the metal ended up maintaining a positive finish to the week as its geopolitical safe haven bid ensued. As well, Friday’s sell off in US treasuries sent yields on the 10 year bond to its highest level since January, despite the dollar seeing regained strength as it is geopolitical tensions that are keeping the markets at bay.

The uncertainty with the situation in Ukraine is clearly what is restraining markets this week and potentially in days ahead. US jobs data ultimately guaranteed the US Federal Reserve’s tapering path of 10 billion a month in purchases of treasuries and mortgage backed securities by their next meeting (March 18-19). Implications of this lead to both a strong US dollar and strong equity markets. But the threat of economic sanctions on Russia is what has market participants questioning the potential impact on Western economies.

Questioning the impact on Western Economies is about all we can do, because trying to determine whether or not economic sanctions are imposed on Russia or Russian oligarchs doesn’t address the severity of how long a situation like this can play out and what will actually amount. Some well documented statistics have highlighted the European Union’s reliance on Russian energy, and also Russia’s mutual benefit of having the EU as a trading partner. By some estimates, Europe imported 30 percent of their gas from Russia in 2013, and the reason Ukraine is so important is because approximately half of the EU imports came through pipelines via Ukraine. It’s the conundrum that Western Europe and Ukraine face should Russia do what they did in 2009 cutting off supplies to Ukraine, which affected gas en route to Europe. There is breathing room given European inventories are 11 percent higher than average this time of year. 

Over the last week, a number of American politicians and commentators over the last week have made calls on Washington to export American Natural Gas to the European Union. Although that sounds like a solution, it takes an overly simplistic view of the US energy sector and how they export the commodity. To be brief, just because the US has come into a glut of the natural resource doesn’t mean that it’s on a tanker ship headed across the Atlantic. The simplicity of the argument is highlighted by the fact that the US and EU do not have a free trade agreement in place. Only one export terminal has been approved on the Eastern seaboard and is not scheduled to complete until late 2015. Any further projects require regulatory, safety, and environmental approval from a multitude of government agencies. Let’s not the forget the fact that North American natural gas is more interested in an Asian market where it can attract a higher premium. And the very reason the US government limits free trade of their natural resources is to supress domestic prices from the global market price.

Energy prices are the concern of the global economy. A shock to global prices at this point is not expected. However, a sustained increase in oil prices always leads to a recession, and that is the reason financial markets are wavering. Given a response from the Obama administration to this crisis that led one Congressman to suggest, “Putin is playing chess while Obama is playing marbles,” the global economy can still be thankful for one thing. Europe is facing a mild winter.   

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Dow down 35 (on March 5th). Gold up slightly. A dull day on Wall Street, with investors holding onto most of Tuesday’s gains.

Here’s another record that was broken recently…

In the late 1970s, Michael Milken persuaded his boss at Drexel Burnham to let him start a high-yield bond trading department. (High-yield bonds are non-investment grade bonds that carry high default risk. Hence their nickname: “junk bonds.”) Soon, Milken’s trading department started earning a 100% return on investment.

The junk-bond market was tiny – with total issuance only rising to about $30 billion in the mid-1980s. Milken was right about junk bonds being hugely profitable. But that didn’t stop the feds from putting him in jail in 1990 on six counts of securities and tax fraud. (Milken didn’t just stop at legitimate means of making money in the high-risk world of junk bonds.)

Nevertheless, the junk-bond market continued to grow. At the end of the 1990s, issuance was hitting new records – at about $150 billion. Then junk-bond issuance collapsed with the tech bubble.

But unlike tech stocks, junk bonds were soon flying higher than ever. In the middle of the 2000-07 period, annual junk-bond issuance rose above the $150 billion mark. But in 2013, the junk really topped the charts – with about $330 billion of new bonds issued.

Dumpster Diving for Yield

Why so much junk?

Ah, for that… as for so much else… we have a central bank to thank. Lower yields on Treasury bonds and investment grade corporate bonds, as a result of Alan Greenspan’s driving down the federal funds rate in the wake of the tech-wreck and the 9/11 attacks, encouraged investors to stretch beyond their comfort zone for higher rates of return in lower quality issues.

By 2007, they were driving into bad neighborhoods to get what they needed. And by 2013, they were dumpster diving for a measly 5%.

Can you blame them, dear reader?

With the Fed holding down interest rates, there was less and less reason for anyone to default. A mismanaged zombie business didn’t need to stop paying its coupons; it just had to rollover its debt. Borrowers and lenders were deceived. The former found lenders unusually motivated; the latter believed borrowers were uncharacteristically solvent.

All of which just serves to highlight our latest dictum: The Fed’s $4.1 trillion balance sheet is a standing invitation to trouble.

Hello, Trouble

Mr. Trouble walks through the door every morning and into a party every night. But he is a master of disguise.

One day, he comes with the healthy mien of a robust high-yield debt market. The next day he is crumpled over, as if depressed by unusually low consumer price inflation. And on the weekend here he is again – a big shot from Wall Street with the highest profit margins in 60 years.

Yes, dear reader, trouble comes in many guises and disguises. An honest, properly functioning economy spots him immediately and promptly shows him the door. But a trumped-up, highly manipulated and mountebank economy is like a carnival hoedown. You can find anything you want… but nothing is exactly what it appears to be.

Economists refer to this as the problem of “distortion.” The real cost of real capital is usually set by the prevailing interest rates. When the Fed permits Mr. Market to function normally investors can take the facts at face value. When the Fed intervenes the effect is to distort the economy and the markets.

Artificially sending interest rates lower makes capital too cheap. It is borrowed too easily and spent too readily. The result is over-speculation… and over-investment.

That is why we have a record issuance of junk bonds in 2014. It is just one more of the many drag queens and carnival kings that have been corrupted by the Fed’s heavy-handed meddling in the markets.

On display, too, is the US “recovery” – the weakest ever in postwar history! Never before has such a strong recession been followed by such a weak bounce back. Quarter after quarter, job growth, GDP growth and consumer price growth substantially underperform every other recovery since World War II.

Another record! And just one of the many jolly revelers who opens the door for Mr. Trouble when he shows up.

Regards,

Bill

P.S. If you’re worried about the worst US economic recovery on record… and the effects on the dollar of rampant Fed money printing, maybe it’s time to get out of Dodge. Our colleagues at International Living magazine have just published a book on retiring overseas on a budget. Here are details of how to pick up a copy at special pre-order price.

Market Insight:

Five Years of Bull
From the desk of Chris Hunter, Editor-in-Chief, Bonner & Partners

Today, we doff our cap to the wizards of central banking at the Federal Reserve.

As you can see from the chart below, the remarkable 181% rally in the S&P 500 that started this day five years ago, has moved more or less in lockstep with the expansion of the Fed’s balance sheet from about $1.5 trillion to $4 trillion.

Source: Financial Times

Although correlation and causation are two different things, this chart raises an interesting question: If the correlation between the size of the Fed’s balance sheet and gains on the S&P 500 holds… and the Fed’s commitment to shrink its balance sheet stays firm… where will this leave the S&P 500?

We don’t know the answer…

But we’re reminded of Rule No. 2 of former Merrill Lynch technical analyst Bob Farrell’s 10 “Market Rules to Remember”:

Excesses in one direction will lead to an opposite excess in the other direction.

What Farrell meant was markets that shoot higher on the upside will also shoot lower on the downside. Think of a pendulum: The farther it swings in one direction, the farther it swings in the other direction. [par break] The fate of the US stock market relies on breaking its five-year correlation with the size of the Fed’s balance sheet. If it can, then US stocks could continue to rally.

If not, look out below…

Given that medical technology is an easy target for payers looking to cut reimbursements, it’s important for investors to find device and diagnostic companies with the greatest efficiencies. Accuracy, speed and economy command a premium multiple because these features ultimately relieve pressure on margins, improve quality and reduce patient risk and institutional liability. In this interview with The Life Sciences Report, Senior Research Analyst Ben Haynor of Feltl & Co. shares his top two medtech names, which he expects will achieve outsized gains this year. He also delivers a couple of bonus names that investors could parlay into a profitable small- and micro-cap portfolio.

The Life Sciences Report: Ben, you currently follow micro- and small-cap companies in the medtech space, but previously you were the founder of two tech startups. How does one know when an idea can be marketable?

Ben Haynor: One of my startups was more of a hobby that I hoped would turn into a company, and what I learned from that experience came more from the mistakes that I made. A lot of people think that if you build a better mousetrap—if you’re slightly more clever than your competition—that will be enough. You find yourself thinking you’ve got greatest idea, you’ve thought through every aspect of what the user might want, all the features are great. . .and you wind up drinking your own Kool-Aid. Your product might have features that go well beyond what the competition has, but if the customer doesn’t care about those features, or they are just incremental changes, you can only compete on price or the level of service. Your product might not be something that commands premium pricing. I fell victim to that.

TLSR: Are you saying it’s not reasonable to think in terms of competing on price and service?

BH: No—competing on price or level of service is a completely reasonable business strategy. But when it comes to investing in a startup or starting a business, outsized returns are going to come from innovations that massively reduce the time it takes to accomplish something, hopefully by orders of magnitude.

For instance, one company I have under coverage (and also one of my two best ideas) is TearLab Corp. (TEAR:NASDAQ), with its TearLab Osmolarity System for detection of dry eye disease. What clinicians did prior to the TearLab test was stick a piece of litmus paper under a person’s eyelid, pull it out and measure how many millimeters of moisture had collected. This older diagnostic method is called the Schirmer’s test: It could take up to 10 minutes to complete and could be irritating to the eye. However, the American Academy of Ophthalmology has considered osmolarity testing the gold standard for diagnosing dry eye for a couple of decades plus. Prior to TearLab, there were no point-of-care tests available to do osmolarity testing. Additionally, the TearLab test has taken testing time down to 30 seconds or less, which is a couple of orders of magnitude in improvement. This is important because clinicians value their time.

The other thing I think helps—and would be something of a corollary—is developing a product that results in an immense improvement in accuracy or performance, such as coming up with a test that could improve predictive value. In this case, the Schirmer’s test had a 30–40% predictive value; the TearLab system takes that up to 80–90% predictive value. It’s innovative, and certainly good enough to take to market. I think TearLab is a good example of these ideas on the diagnostic device side.

TLSR: Your research focus is solidly in medtech—both diagnostics and medical devices. Is it preferable to improve on an idea by creating a technology platform that is more user-friendly, or cheaper, or broader in its application?

BH: I think in terms of the iron triangle, an old engineering adage that states if you’re trying to build something, the tradeoffs are such that you’re only going to be able to pick two of the three desired attributes—better, faster, cheaper—but never all three. This holds true in software development, an area where I have some experience.

But in other areas, you may be able to have all three. For instance, Novadaq Technologies Inc. (NVDQ:NASDAQ), which I follow and have a Buy rating on, has a better solution for visualizing blood flow and perfusion. It’s also faster than traditional methods, be it Doppler or some of the oximetry methods. The Novadaq system is also cheaper, as evidenced by published studies that suggest that hospitals can save a great deal of money by utilizing it in complex procedures where there are high complication rates and hospitals are ultimately on the hook. The Novadaq system is better, it’s faster and it’s cheaper for hospitals.

In my universe, I equate “better” to unique performance characteristics, and cheaper to a higher level of reimbursement, or less risk of creating complications that aren’t reimbursed. If a company can fit these into its offering, it has a product that can become standard of care and part of a real business. I think Novadaq and TearLab can ultimately accomplish this, given enough time.

TLSR: Your firm recently released its 2014 Top Idea List, and you have two names from your universe of coverage on that list—TearLab, which we’ve already discussed, and Cancer Genetics Inc. (CGIX:NASDAQ). What thought processes go into each name on that list? Is it about which company has a sure thing in its pipeline or product portfolio? Or is it about which company can be the top gainer for the year? Or is it about relative safety of investor capital?

BH: Each analyst gets to make two picks. Most of us have chosen stocks that we think will be the biggest gainers in a given year. Last year, my picks happened to be the two companies that I have mentioned—Novadaq and TearLab—both of which did quite well. This year, I’ve gone back to the well on TearLab. I think it’s still an underappreciated story, and there are only a handful of analysts who cover it.

My other top idea for this year is Cancer Genetics. I prefer underappreciated and underfollowed picks that I believe will demonstrate something in the coming year that will cause the Street to reevaluate, garner more interest from investors and ultimately drive the stocks higher.

TLSR: You initiated on this company back on May 21, 2013, when it was just under $12/share, with a target of $17.50/share. You presently have a $24/share price target. It was recently at about $19/share. Could you go ahead and talk about this company?

BH: Cancer Genetics is an oncology diagnostics company that had just a handful of salespeople one and one-half years ago. Over the past year or so it has gone public, raised a decent war chest of capital and has been able to hire more than a dozen experienced salespeople. Fewer than 1,000 people are selling into the oncology diagnostics space, so the fact that Cancer Genetics was able to get a practiced sales force to take its products to market is a very big deal. It’s also something that will bear fruit this year.

The company also continues to roll out new proprietary tests. Last year it launched a few new tests and updated some that were on the market already. The company’s initial focus is hematological cancers, and it has four different proprietary microarrays that are able to give clinicians not only a diagnosis, but also a prognosis and assistance in treatment decisions. To be able to subtype the disease and determine that the oncologist should use a specific receptor tyrosine kinase inhibitor—or whatever the appropriate drug may be—is a very powerful service. That’s particularly true in blood cancers, where you can get a recurring revenue stream because these cancers can mutate quite often. Every year—or even every three or six months, depending on how aggressive the malignancy might be—the oncologist might run a Cancer Genetics test to make sure that a treatment decision is correct at any given point in time.

The company also recently launched a proprietary florescence in situ hybridization (FISH)-based HPV-associated cancer test (FHACT). It’s a DNA probe enabling determination of whether cervical cancer has progressed beyond cervical intraepithelial neoplasia (CIN) grade 2, which is considered the cutoff for determining whether the cancer is likely to progress further. The beauty of this test is that the conventional Pap smear sample is used, instead of doing a colposcopy, which costs $700–800 per procedure and may require the patient to be on pain medication and perhaps out of work for a few days. Now a clinician may forego the invasive procedure by using the Pap smear sample and running the Cancer Genetics FHACT test for $400–500. This saves the payer money, is also convenient and pain-free for the patient, and gives the clinician a good diagnosis.

TLSR: I note that you have Cancer Genetics doing $20.3 million ($20.3M) in revenue in 2014. For 2015, you forecast revenue of $48.9M, while growing gross margins from 37.2% in 2014 to 54.4% in 2015. I understand this company is a top pick because of its proprietary tests, but you really have to get out and show these services to pathologists—to oncologists, to OB/GYNs and to hospitals. How do you get that kind of growth?

BH: It is stunning growth. But if you look at the historical revenue ramps of some other companies that have had proprietary tests, they’re not all that dissimilar. In fact, a number of them have grown more quickly than I project Cancer Genetics to grow.

I think Cancer Genetics’ growth potential is really due to a combination of factors. You have the proprietary tests, as you mentioned, but the company also has relationships with a couple of biopharma companies—Gilead Sciences Inc. (GILD:NASDAQ) and Roche Holding AG (RHHBY:OTCQX)—that seem to be ramping up its backlog. A year ago, there may have been $1M or $2M in biopharma backlog. Now, it’s more like $13M, and I believe that will continue to grow over the next 12–18 months. Plus, the company always has the opportunity to deliver another of these tests—or several—to help drive growth. It is a matter of driving the adoption of the proprietary tests that the company has already developed, and layering on new ones.

Cancer Genetics does have a joint venture with the Mayo Clinic, which is using next-generation sequencing (NGS) to go after lung cancer, multiple myeloma and follicular lymphoma. You should start to see some new and improved panels in the next year or year and a half. The company is going to continue to add new panels and proprietary tests; that activity and exposure will bring along some nonproprietary work as well, which will help drive the company’s revenue growth to the levels that I’ve estimated, hopefully.

TLSR: Is there another growth possibility for Cancer Genetics? Its business is primarily on the East Coast and in the Midwest currently. Is the company thinking about the West Coast?

BH: Yes, I think the company is definitely thinking about that. A West Coast lab would certainly help. I would expect Cancer Genetics would probably acquire a small lab that already has its certifications in place. It’s easy enough to do, and quicker than setting up a brand new lab, which means having all the inspections and the certifications before you can open it. If Cancer Genetics can buy one that’s already in place, that’s a pretty good expenditure of some of its cash.

TLSR: I’m noting that you follow diaDexus Inc. (DDXS:OTCMKTS). You have it rated Buy, which is interesting because the company seems to have lost a potential revenue stream with the failure ofGlaxoSmithKline’s (GSK:NYSE) phase 3 STABILITY trial testing darapladib, an Lp-PLA2 (lipoprotein-associated phospholipase A2) inhibitor, to prevent major adverse cardiovascular events. The idea was that if this enzyme, Lp-LPA2, was elevated, you could give this drug to reduce a patient’s risk of heart attack. Would you discuss why this company is Buy-rated after the failure of that GSK trial?

BH: Sure. DiaDexus’ PLAC Test basically gives a patient an idea of how likely it may be that plaque within the coronary arteries might rupture. That, of course, causes heart attacks and strokes.

TLSR: You’re talking about vulnerable plaque exfoliation, a deadly event.

BH: Yes. I think this is a great test to offer to people. One of the ways that diaDexus has been successful over the past few years is that some specialty cardiovascular labs have bundled the PLAC Test with a number of other tests to give a more in-depth picture of a patient’s cardiovascular health and risk. These bundled tests are then sold to doctors. DiaDexus only has a 13- or 14-person sales force selling directly to doctors, but the salespeople also sell to these cardiovascular specialty labs, which then take the product out to many more physician practices. Collectively, diaDexus may benefit from as many as 500 salespeople who work with the big-eight nationwide cardiovascular specialty labs—none of which is public—taking its tests out to primary-care doctors. During 2014, diaDexus will probably sell a couple million PLAC Tests.

The PLAC Test looks at the Lp-PLA2 enzyme, which is the subject of two GSK trials, one of which was the STABILITY study (NCT00799903) that you mentioned. It did indeed miss its primary endpoint. However, the primary endpoint was a composite of time-to-first-occurrence of death due to a cardiovascular event, nonfatal myocardial infarction and nonfatal stroke. It showed some improvement in these patients, but it wasn’t statistically significant. One thing that could have skewed the data is that stroke isn’t caused by plaque rupture in up to half the instances, and therefore does not have the same etiology as a heart attack. My point is that this was a very broad primary endpoint. The STABILITY study did meet at least two of the five secondary endpoints. I speculate one of these was heart attack by itself.

On his most recent conference call, the GSK CEO talked about how he’s seen more data from the STABILITY study than the Street has. He characterized the signals they were seeing as encouraging, and briefly talked about how the company now has a whole development program around Lp-PLA2. So GSK clearly remains encouraged by the trial. We’ll see a second phase 3 study in the next couple months on darapladib, called the SOLID-TIMI 52 (NCT01000727) trial. This trial is in sicker patients, and it’s probably more likely that the drug will show effectiveness with the same primary endpoint. It will be interesting to see how that plays out.

TLSR: Ben, clearly the Lp-PLA2 test renders important information. It sounds like GSK is now evaluating subgroups from its darapladib STABILITY study, but subset studies never seem to turn out very well. I’m wondering: If the cardiologist, the internist or the family physician doesn’t have a good Lp-PLA2 inhibitor, why would he or she feel justified in doing the PLAC Test on a patient? The physician could say, “I’m doing everything I can by giving this patient statins and trying to modify his diet. If I don’t have a good inhibitor of Lp-PLA2, why should I run this test?”

BH: That’s a fair question. I can certainly see both sides. Maybe it comes down to adding value at the margins. I suspect that not everyone who has high cholesterol and is on statins treats their body as a temple. Physicians might want to scare them straight by running the PLAC Test, which is relatively inexpensive. The physician can then say, “Look, you have double the risk of heart attack and stroke based upon this test. Do you want to do something about it?”

Not every clinician is going to adopt this test overnight. But it’s an interesting test and is going to give both the doctor and the patient better information so that both can make better decisions about whether that patient should eat his oatmeal.

TLSR: You have a $2.90 target price on diaDexus, which is a 150%+ implied return from current levels. Is that a one-year target price?

BH: Yes. We do 12-month targets here at Feltl.

TLSR: The reason this diaDexus story is interesting is that other analysts seemed to be hanging their hats on the darapladib study. But not you.

BH: I treated darapladib as a call option. Yes, if it works, it will be a massive benefit to the company. Who knows? Maybe it turns out that the subgroup analysis of the STABILITY study uncovers something that makes the drug very useful in a subpopulation. Maybe that leads to approval of darapladib down the road. I think having more data for diaDexus is certainly a good thing.

Just one thought I’d leave you with. Back in October 2013, the Journal of the American Heart Association published a substudy of 6,500 patients—the Long-Term Intervention with Pravastatin in Ischemic Disease (LIPID) study, which showed a reduction in Lp-PLA2 levels while on statin therapy could reduce the risk of coronary heart disease. It’s one of the largest studies in the cardiovascular arena. The findings were that Lp-PLA2 is as good as, or is better, a marker than LDL cholesterol, which is a pretty big statement. Now that there is an appeals mechanism to the guideline decisions made by the American Heart Association (AHA), I would expect to see diaDexus take the data from the LIPID, STABILITY, and SOLID-TIMI studies to the AHA for elevation of the PLAC Test in their clinical guidelines, assuming the AHA does not choose to take it up on their own.

TLSR: Thank you, Ben.

BH: Nice speaking with you. I appreciate it.

Ben Haynor joined the Feltl & Co. research department in October 2010. Prior to joining Feltl, Haynor founded two technology startups—Taggart Communications and Spigot Games. Before launching those firms, Haynor spent five years in equity trading at RBC Capital Markets, with the last several years spent as a NASDAQ market maker. He is a CFA charterholder and a member of CFA Institute and CFA Society of Minnesota. In the most recent Wall Street Journal “Best on the Street” publication, Haynor took second in the Medical Equipment & Supplies category, and was also ranked the No. 1 stock picker by StarMine in the U.S. Health Care Equipment and Supplies sector as part of the 2013 StarMine Analyst awards. He earned a bachelor’s degree in finance with a minor in management information systems, from Pennsylvania State University.

Read what other experts are saying about:

• Cancer Genetics Inc.

Briefly: In our opinion short speculative positions (half) in silver and mining stocks are justified from the risk/reward perspective. We are closing half of the long-term investment position in gold.

As you know, we had been expecting the tensions in Ukraine to cause a significant rally in gold (not necessarily in the rest of the precious metals sector). Not only wasn’t that the case on Monday – the rally indeed took place, but it was rather average, but gold managed to decline on Tuesday while there was no visible improvement in the situation in Ukraine and on the Crimea peninsula.

Gold is not performing as strongly as it should. That is a major bearish factor. Let’s examine the situation more closely (charts courtesy of http://stockcharts.com):

(Click on Chart for larger image)

The move above the 61.8% Fibonacci retracement level was invalidated yesterday. The move lower took place on low volume, which doesn’t confirm the rally. However, that’s not the most important thing to focus on – gold’s performance in light of the most recent events is. As mentioned earlier, it didn’t rally. In fact it’s more or less where it was a week ago. The implications are bearish.

From the gold to bonds perspective, the downtrend simply remains in place. There has been no breakout above the declining resistance line (marked in red), so the precious metals market is still likely to decline once again.

(Click on chart for larger image)

Silver’s performance has been weak, if not very weak. Not only did it not really rally on Monday, but it declined more on Tuesday than it had rallied on Monday and it’s now 0.42% lower than it was last week. 

Some might say that the white metal is almost flat, and that is correct, but the point is that it’s almost flat (on the south side of being flat) when the geopolitical tensions are rising significantly. This is a significant underperformance relative to what’s going on in the world.

What we wrote yesterday remains up-to-date:

Meanwhile, silver invalidated the breakout above the 50-week moving average, the 2008 high and the 61.8% retracement level based on the entire bull market. The weekly volume is highest in months, which confirms the significance of the invalidation. Actually, the last time we saw volume that was similar was at the beginning of the previous decline in mid-2013.

Silver is still above the declining red support line, but drawing an analogous line in mid-2013 would also have given us a breakout that turned out to be a fake one.

The situation in silver was bearish based on Friday’s closing prices and it has further deteriorated based on the lack of rally this week despite reasons to make a move higher.

Not too long ago we wrote that the juniors to stocks ratio could indicate local tops in the precious metals market if one looked at it correctly. The things that we were focusing on were spikes in volume (we have seen a major one) and sell signals from the ROC indicator (a decline after being above the 10 level) and the Stochastic indicator. We have seen both recently. Consequently, it seems that the precious metals market will move lower sooner rather than later.

The USD Index moved a bit higher and mining stocks declined, both of which confirm the above bearish indications.

All in all, it doesn’t seem that keeping the full long position in the investment category is justified at this point in our view. Based on this weekend’s events it was likely that gold would move much higher – but its reaction has been very weak. It looks like there will be no rally in gold before a bigger decline. We are keeping half of the funds in gold, though, just in case the next days bring improvement. If not – things will become even more bearish and we will likely adjust the position once again.

We might suggest changing the short-term speculative position and / or the long-term investment one shortly, based on how the markets react and what happens in Ukraine.

To summarize: Trading capital (our opinion): Short position (half): silver and mining stocks.

Stop-loss details:

• Silver: $22.60
• GDX ETF: $28.9

Long-term capital (our opinion): Half position in gold, no positions in silver, platinum and mining stocks.

Insurance capital (our opinion): Full position

You will find details on our thoughts on gold portfolio structuring in the Key Insights section on our website.

Disclaimer

All essays, research and information found above represent analyses and opinions of Przemyslaw Radomski, CFA and Sunshine Profits’ associates only. As such, it may prove wrong and be a subject to change without notice. Opinions and analyses were based on data available to authors of respective essays at the time of writing. Although the information provided above is based on careful research and sources that are believed to be accurate, Przemyslaw Radomski, CFA and his associates do not guarantee the accuracy or thoroughness of the data or information reported. The opinions published above are neither an offer nor a recommendation to purchase or sell any securities. Mr. Radomski is not a Registered Securities Advisor. By reading Przemyslaw Radomski’s, CFA reports you fully agree that he will not be held responsible or liable for any decisions you make regarding any information provided in these reports. Investing, trading and speculation in any financial markets may involve high risk of loss. Przemyslaw Radomski, CFA, Sunshine Profits’ employees and affiliates as well as members of their families may have a short or long position in any securities, including those mentioned in any of the reports or essays, and may make additional purchases and/or sales of those securities without notice.

PDAC 2014: Don’t Rely on Elon Musk or Vladimir Putin to Boost Metal Prices

• We have just returned from our annual pilgrimage to PDAC 
• This year the tone of the conference “felt” different– not necessarily in a good way 
• There are several significant questions looming that the industry must consider 
• Differentiation and diversification are key to survival and prosperity 

Through last weekend and into this week, we attended the annual Prospectors and Developers Association of Canada (PDAC) Conference in freezing cold Toronto. PDAC is the largest mining conference in the world. It attracts just about everyone involved in the mining industry. More than anything, it represents a fantastic networking opportunity. 

It has been most interesting to watch how sentiment has changed in recent years given the fall in metals prices and resulting struggles faced by ALL mining companies. This includes major producers Mid caps and across the value chain to Greenfield exploration companies.

 I have to say, that despite the “buzz” which results from 30,000 people together, the tone of the conference this year was flat. That prevailing sense of optimism we have typically felt at a conference of this magnitude just didn’t appear to be there this year. 

And so the question is why? Why, after three years of generally down markets for mining companies, did this year’s PDAC in particular feel different from others? 2014 has started off on a positive note with the TSX up 4.96% and the TSXV up 10.35% year-to-date. This has helped erase memories of a most challenging 2013. 

The uncertainty I mention above can be boiled down to several questions – many of which we have discussed and debated in past Morning Notes. Paradoxically, this uncertainty and feeling of capitulation may be a good sign, that of a behavioural bottom. 

I am on record early this year stating that the commodity super cycle is not dead, but has changed its complexion. I still believe that and think that profits can be made in mining equities as long as selectivity and patience are the hallmarks of an investment strategy. 

The mining boom in the first decade of the 21st Century added a significant mineral capacity in the mining infrastructure, and reserves and resources across the entire commodity spectrum.

The two year decline in metals prices, from gold, rare earths, silver, and graphite has rendered much of this investment worthless at current prices. This has caused massive write offs in the gold industry for example. Many commodity prices have settled at levels above their historic averages, but costs have increased also. 

While there are a number of questions we in the industry must face, I see six specific questions to consider at this point in the cycle: 

1. How quickly can excesses be worked off? – It is clear that the days of the “wind at the back” of the mining industry (with China’s increasing appetite for a host of commodities) is over or at least paused. Mining companies of all market capitalizations have written down the value of assets, sold properties at a discount, or instituted strict cost discipline. Can this newfound focus help the market “turn” up as many of us are hoping for? 

2. How quickly can China change its growth paradigm from investment and export-led to internal consumption? – I don’t believe China is headed for a hard landing, but give China’s leadership credit for acknowledging the necessity for a slower, more sustainable growth paradigm. Can this change, which is really a change in the average citizen’s mindset, occur fast enough to breathe life into a junior mining sector desperate for signs of increasing global demand? 

3. How quickly can the rest of the Emerging Markets and Frontier Markets sop up this lack of demand from a slowing China? – China has size and scale, which is why so many of us focus on the country. Careful study of the growth dynamics of countries such as Indonesia, Poland, and Colombia is a wise. It is these countries and others that will fill a demand void left by China. 

4. If not fast enough, what does this mean for the junior sector? – I think this question answers itself. In this scenario the Junior sector shrinks laying the seeds for the next metals cycle. 

5. Is Geopolitics set to play an increasingly important role in the typical mining portfolio? The crises in Ukraine and Venezuela bring this question to the fore. Additionally, issues like slowing growth and inflationary pressures in emerging markets and resource nationalism appear set to provide investment opportunities elsewhere, but also may wipe out unsuspecting or careless resource investors. 

6. What is a realistic investment strategy in the face of slow growth and excess capacity? – I explore this below. 

Despite the dour tone of this Note, I am still optimistic over the medium to long term vis-à-vis commodity demand. Population dynamics and the ubiquity of technology dictate that many more individuals in the future are poised to live more commodity-intensive lifestyles. 

A key takeaway from PDAC this year was that all commodities are not created equal. Uranium is clearly the “belle of the ball” right now. Differentiation and diversification amongst metals and across the value chain are keys to success going forward if you’re investing at this stage of the cycle. 

It is increasingly clear that large projects, either in terms of tonnage or capital expenditure, are being re-evaluated in favor of smaller sized projects better able to fit into current and future demand forecasts. This is a good development. 

On an additional positive note, there does seem to be a flurry of significant financings taking place, with NexGen Energy (NXE:TSXV) announcing a $10MM bought deal most recently. This is good news, specifically for the sustainability of junior uranium companies. If more financings of this type can be completed across various commodities, some of the questions I listed above will have a favorable outcome. 

It was also abundantly clear at PDAC that money is pooling and consolidating assets across a host of metals in the precious and base categories. Private equity money has moved into the mining sector and is intent on consolidating properties, recapitalizing companies, and eventually spinning them out. Again, this is a longer-term positive sign for the industry as a whole, but differs from one metal to the next. 

I wrote above that you can’t rely on Elon Musk or Vladimir Putin to boost metals prices. This may sound silly, but it’s true. With the recent announcement of Tesla’s (TSLA:NASDAQ) “Gigafactory”, share prices of US and Canada-based lithium exploration and development plays exploded. Similarly, Russian President Vladimir Putin’s movement of Russian troops into Ukraine sent gold and silver much higher. 

I’ll be writing a note shortly on the TSLA Gigafactory and its implications for the junior sector. My point is that these isolated events tell us nothing about true supply and demand dynamics of commodities but do tell us everything about speculation and the fear and greed paradigm in financial markets. 

Only organic growth, technological breakthroughs, and sound fiscal and monetary policies will provide the basis for increasing and sustainable demand. The travails in the mining markets today are setting the stage for the next move higher, but I continue to believe that a mixed global growth picture and excess capacity have delayed this move into the future. Patience and selectivity are still the most prudent way forward and can be rewarding in the interim as we’ve seen with select uranium plays.

Note on a portfolio sale: I will be taking profits in half of my position in URZ (5,000 shares) within 24 hours of receipt of this note. I still like the story and believe that near-term production plays in uranium are the most appealing, but want to lock in a portion of my gains. 

Note on a portfolio sale: I will be taking profits in half of my position in URZ (5,000 shares) within 24 hours of receipt of this note. I still like the story and believe that near-term production plays in uranium are the most appealing, but want to lock in a portion of my gains. 

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