Monday, October 10, 2011

Wealth and GDP

"Political Economy is defined as the science of wealth" wrote Francis Wayland in 1870 (Wayland was Yale University's first professor of Political Economy). Adam Smith wrote "An Inquiry into the Nature and Causes of Wealth of Nations" in 1776 inspired by a group of mainly French economists called the Physiocrats. The Physiocrats (who could probably be considered the first economists) proposed that all material wealth came from the development of land.

A question is: does the classical view of wealth production provide any insight into the modern conception of GDP and economic activity?

Wealth Defined by Classical Economists

Wealth from a Classical sense (classical economists are economists from the 1700's before the mid 20th century) was defined on a national level as, according to the classical economist Jean Baptiste Say (1821) in his Letters to Malthus on Political Economy. Say asked and answered a series of questions in these letters concerning wealth. Say defined Wealth as "Whatever has a value; gold, silver, land, merchandise..." and then defined Value as "[A product] having utility." Value was conceived of as mainly a product with "utility," and utility was viewed as having a both subjective and a non-subjective element in so far that, according to Say, utility drives value as "persons are then to be found who are in want of this thing (with utility); they desire to have it from those who produce it."

The subjective element of wealth -- wealth as defined that is deemed useful by potential customers in the classical economic tradition, to the extent that they will pay for that item -- is interesting in so far that wealth has to be something not already extremely abundant and/or provided by nature (classical economists asked "if I hold a glass of water, is this wealth? The accepted answer, after much debate was no, in so far that water is already in abundance).

Further wealth could hold significant value, but if this value was not recognized by consumers or if the necessary infrastructure was not in place to realize this value, then perhaps the item would not have value. One could think of, for example, petroleum oil in the 1800's, at first was considered a nuisance for agriculture and therefore did not represent wealth.

Alfred Marshall, John Maynard Keynes' mentor at Cambridge University, in the late 19th century proposed the concept of supply and demand curves for products summing up the idea of price (value) as the intersection between supply and demand for the product.

On a national scale, Jean Baptiste Say defined the "wealth of nations" as: "(A wealthy nation) in which many things of value, or more briefly, many values are to be found." But Jean Baptiste Say did not formalize a measurement system for quantifying a country's wealth -- this was not to be performed until the 1930's under the economist Simon Kuznets (to be examined below).

One last interesting point is that classical economists stated that wealth could only cocur with the legal right of private property: Jean Batiste Say asked in his Letters: "Can Riches Exist without property?" and answered "No, as richest represent property."

Classical Economists on How Wealth is Produced:

The next question is, according to classical economics, how is wealth produced? The production of items of value (note Say did not cover services in detail, or even conceive of services as a major portion of the economy) was split by Say into three separate activities in his Letters (1821):

1. "Cultivation," by which Say meant the production of resources and commodities, agriculture and mining and resource extraction -- Say began with this activity in so far Say was influenced by the Physiocrats, who stated that all value came from land.

2. Manufacturing -- the conversion of resources to a usable end product -- Say expanded and improved upon that all value came from land only by expanding value added to manufacturing.

3. Commerce -- the distribution of manufactured and processed products to the end customer. One can think of modern retail chains, grocery stores and online as falling under this designation of commerce.

Say noted that each of these three steps in the economy was necessary for the completion of the next step, in so far that manufacturing could not occur without cultivation or resource extraction and commerce could not occur without manufacturing or processing. Say did not discuss trade in detail -- whether one step could be outsourced to another country sustainably.

Two questions come to mind: first, would all new industries (from technological advances) since 1821 fit into these three steps in terms of producing value? And second, how would services fit into Say's 3 step framework?

Major advanced such as the cotton gin and steel industry, the Bessemer Steel Process, the steam engine would all fit in very well within Say's Framework. The textile industry, revolutionized by the cotton gin and the spinning jenny -- told resources in the form of raw cotton and manufactured these into clothes, then distributed these clothes to the end customer.

Industries invented in the 20th century such as the computer industry would also fit in, albeit with a more substantially available raw material (semiconductors are made from silicon -- sand, and also energy - from coal and natural gas) and an interesting "manufacturing" process, if one can view production of software or the "soul" of a computer as "manufacturing." (taking prewritten logic commands and constructing them to give instructions, on a silicon base). Technology consulting companies such as EDS could be viewed as providing both manufacturing (programming of local data processing for banks, for example) and commerce -- directly providing a service to the end customer.

One can see that much of our "service based" economy can be viewed as really either processing and/or commerce. Currently retail is classified as services and IT work is also classified as services in modern GDP accounting.

The modern finance industry, one could say is meant to assist the other segments of society. Warren Buffet has stated that the "raw material" of banks is "capital" by which they make loans (end product) in which the capital would not be dependent on physical raw materials (even software depends on silicon, but in modern banking money can be created by the central bank). I am not sure how to classify finance according to Say's three part system, but would lean towards finance supporting other industries, not as an industry in and of itself (one could also make this case with legal services).

The modern health care industry -- which accounts for upwards of 15% of US GDP -- does not exactly follow Say's threefold method -- more thought on this by the author is needed.

To sum up, classical economics was the study of wealth by which a country produced and distributed items of perceived utility, by a three step process of gathering resources by the land, processing these resources and then delivering these products to the end customer. We will next see how this view fits with modern GDP theory. Note that classical economics did not focus in any significant way on debt -- Say did mention national debts, but only in passing, and also did not focus on income distribution -- what would occur if a small percentage of the population owned most of the wealth? Say did not address this in detail, nor did Wayland or John Stuart Mill. ONe would have to wait for economists in the early 290th century such as John Maynard Keynes and Mickal Kaleci to discuss the distribution of wealth.

Modern Gross Domestic Product Defined

Classical economics did not provide a substaniative calculation procedure to determine the size of the overall economy -- before the invention of the gross domestic product methodology in the 1930's economic activity was roughly gauged by production of key outputs such as steel and/or by the unemployment rate. Modern conceptions of gross domestic product are generally based on theories of the early 20th century economist Simon Kuznets: consumption is calculated by utilizing the formula Consumption = income - savings (income both salaried and capital gains and profits can be obtained by tax records). GDP is then calculated by the formula GDP = net domestic consumption = C + I + G + (X-M), which theoretically equals net domestic income (aggregate salaries plus capital gains and profits) which also theoretically equals net domestic product (aggregate hours worked times productivity). The fact that the three equations for GDP must equal each other is the reason, according to Kuznets, that GDP account is refered to as the "National Accounts" (similar to the accounts, balance sheet, cash flow and income statement of a business).

Gross Domestic Product calculations do not focus on the conception of wealth as utility per say. One could conceive of an economy mainly driven by the production and sale of tulips at a very high price, which would result in high sale prices and therefore high salaries and therefore high GDP. However this economy would soon collapse -- once consumers realized tulips are plentiful and don't have much intrinsic utility (cannot be eaten, made clothes out of, etc).

GDP calculations do not give too much indication as to the utility of GDP -- not to say that classical economics provided significant insight into the economy as utility, but at least classical economics would indicate the citizen to consider the functionality of goods produced. Modern economics reports one number, GDP, without much discussion of its underlying "value." An economy producing very high amounts of "intrinsic utility" items, such as food in a period of food, energy, clothing and transport, in a period of surplus of these items (meaning the items sell at a low price) mean that the GDP calculation for this economy would be low, despite the high "real" living standards and relatively high sustainability.

There is a sense Modern GDP accounting has well known shortcomings -- it does not typically (except for certain countries like Norway) account for resource base depletion, GDP only accounts for economic activity in constant currency (so if the currency depreciates by a significant margin it is unclear if GDP is really declining), related to resources the sustainability of GDP is not indicated, nor is the overall debt level of the economy. GDP also does not measure the distribution of wealth in the overall economy -- it seems a country would be "richer" overall if more of its citizens enjoyed a wider range of its products.

It seems that the production of goods and services in Say's three economic productivity dimensions that have higher "utility" that satisfies "needs" -- clothing, shelter, nutrition,

Friday, October 7, 2011

What Will Happen When Greece Defaults?

Greece will likely not be able to pay back the full value of its debt, due to the fact that Greek debt to GDP is 140%. Many market commentators are stating that a Greece default will not cause a significant move in the markets ("Greece is only 3% of EU GDP" or "A full meltdown is very unlikely but the market must price in this very unlikely event")

These commentaries do not perform a cause and effect analysis -- meaning, what would occur in the case of a Greek default, if one takes into account the impact on banking institutions, and national economic activity, in a step by step, sequential analysis? Such an analysis shows that significant problems occur with a Greek default for the EU and world economy and markets.

If Greece defaults, then the value of its bonds will drop by 50-80%. Note that the average sovereign default since 1980 according to Moody's has seen net losses of between 50-60%, but Greece is has significantly more debt than the average default, so losses would likely be higher.

Greek Banks would be insolvent:

This default in turn would cause the major banks of Greece (which in turn hold Greek sovereign debt) to go bankrupt. As the Greek government cannot guarantee the deposits of the Greek banks, the deposits of these institutions would be wiped out.

Significant Declines in Greek GDP:

What would happen to Greece's gdp? Many large banks go bankrupt in Russia in 1998 (although not in Argentina to the same extent in 2002-2003, as Argentina limited the amount of funds deposit holders could withdraw) as Russia defaulted on its debt in that year. Russia's GDP fell approximately 50% from 1992 to 1996, then recovered somewhat from 1996 to 1998 but then declined a further 15% fro 1998 to 2000. Argentina's gdp declined approximately 15% from 2002 to 2004. Both countries began to recover when their currency declined significantly and the export market (as both Russia and Argentina are major commodity exporters) picked up.

Greece's GDP would likely fall more than 15%. The world economy is more fragile currently, so a recovery in two years may not occur, through an export led recovery, so the slump would likely last for several years. The issue of leaving the Euro would have to be addressed -- instituting a new currency in a very difficult economic environment would be problematic.

Other Southern EU Banks at Risk:

Deposits in other southern European Union countries would be at risk, in so far that account holders in Italy, Portugal, Spain and Ireland would see Greek banks default, then attempt to transfer their deposits to safe havens, whether northern European banks. Italian, Portuguese, Irish and Spanish banks would be at risk from direct losses from holdings of Greek bonds (total outstanding Greek debt is over $400Bn, held mainly by European banks). As the southern EU governments are already highly levered, it is not likely that they would have the ability to raise funds to bank stop losses in their banking systems.

Southern EU Countries GDP at risk of significant decline:

Southern EU banking insolvency would be a significant risk, which could drive declines in Southern EU gdp.

French and German banks with exposure to Greek debt would be at risk:

Deutsche Bank and the major French banks have significant exposure to Greek debt, which would mean significant losses at these banks, and likely a need for government assistance. As both France and Germany have debt to GDP ratios in the 80% range, further payments to their banks would likely move their respective debt to GDP levels to close to 90%, which is the cut-off range (according to Harvard economics professors Kenneth Rogoff and Carmen Reinhart) for markets funding debt to GDP without significant issues (although this 90% cut off grade has received some criticism as being too arbitrary, however 90% likely does not leave too much room for further debt financed growth or assistance).

Certain Hedge funds will likely go insolvent and will likely have to liquidate, driving stock values down:

In the October 2008 crash, according to the book "The Quants" many large quantitative and macro hedge funds which were levered had to panic sell in order to meet investor redemptions. With the unprecedented volatility in the markets from a Greek debt, some larger hedge funds would have to liquidate, driving asset prices down.

Mutual Funds would see higher redemptions, causing selling to drive the market down:

Most mutual funds have been bullish through this crisis and have encouraged their investors to hold through the long term. Mutual funds had record low levels of cash in July and many have seen significant declines in equity values since that time. Further the average mutual fund investor is likely an aging baby boomer who is nearing retirement. All these factors point to higher redemptions.

Pension Fund Values would decline, leading to unrest:

Pension funds as a whole are more heavily invested in equities, due to the fact that they can assume a higher rate of return on equities (more in the range of 8-9%) verses bonds (in the range of 4-6%). The projected value of the pension plan is highly dependent on the projected return on plan assets. With panicked selling, pension plans would see the value of their assets decline significantly.

Safe Haven Assets would increase in value:

Safe haven assets are likely the US dollar, the Swiss Franc, potentially precious metals (however precious metals are held by hedge funds, which would likely liquidate in the short term).

Government Bailouts of Banking Institutions would be even more unpopular with the public, worsening the banking crisis.

The public of many countries is already upset with the banking bailouts of 2008 and 2009, and would not be in any mood for continued bailouts. This would complicate efforts to shore up bank balance sheets, making the banking crisis worse than otherwise would be. As banking crises have a "cumulative" character - the farther they are allowed to fester, the more the public panics and withdraws funds, potentially causing and worsening a bank run -- the unpopularity of bailouts can only worsen events for the banking system.

Recovery for Southern Europe would be more protracted, due to a weaker than normal world economy and therefore export market:

Both the United States and China are currently slowing -- China is attempting (successfully) to slow housing and infrastructure spending, however this means that commodity demand from China is slowing. This, in turn, impacts the major regions more dependent on commodity export: Latin America, the Middle East, Russia, Australia. This means that the EU will have a more difficult time utilizing exports to dig itself out of crisis.

What can be done to avoid a Greek Default?

As this analysis shows that a Greek default would be extremely problematic for the EU and world economy as well as stock markets, the question is, what can be done to avoid a Greek Default?

Either the EU, or another institution such as the IMF, should come in and guarantee Greek debt so that banks are assured of receiving 90%+ of their full value of their bonds. If the full value of Greek bonds are more or less assured, the chain of events described above will not occur.

However, likely the sovereign debt of the other Southern EU states, Italy, Spain, Portugal as well as Ireland needs to be backstopped as well in order to stop potential defaults of these countries, which in turn would cause banking crises moving to economic to market crises.

What would be the amount of funds needed to guarantee Greek and Southern EU debt?

Something in the range of 50-80% of Greek Debt would be needed to fully backstop this debt, meaning funding in the range of $200Bn to $360Bn. This is likely at the highest range for France and Germany combined to fund. Germany's debt to GDP is 80%, and German GDP is $3.33 Trillion, meaning that Germany can afford $333Bn before it moves to 90% debt to GDP (the danger zone, according to Rogoff and Reinhart). France's debt to GDP is also approximately 80%, and France's GDP is approximately $2.65 Trillion, meaning France could contribute $265Bn before reaching 90% debt to gdp.

Both France and Germany would therefore be seriously strained to provide a backstop to Greek debt, and the UK (also at 80% debt to GDP) is not in the Eurozone, and would likely significantly resist paying for Greek debt. Other countries with relatively low debt to gdp such as Finland (48% debt to GDP) only have smaller GDP levels (Finland's GDP is approximately $222Bn). Of course, Southern EU countries such as Spain and Italy cannot provide funding to Greece, in so far that their debt to GDP levels are already too high and the markets would likely not support these countries issuing more debt.

The problem is that not only Greek debt needs to be guaranteed, but also Italy, Spanish, Portuguese and Irish debt needs to be guaranteed. Italy currently has a debt to gdp of 119% with total debt outstanding in the $2.5Trillion range. In order to get this debt down to a manageable 80%, total funds would be needed of approximately $700Bn. All in all, the total backstop for Europe to guarantee all its "in danger" countries would likely be over $1Trillion.

Overall, it appears unlikely that France and Germany or a combination of other European countries can backstop $1trillion.

Can the IMF provide funding to Europe?

The current lending capacity of the IMF is approximately $400Bn -- so the lending capacity of the IMF would have to be increased. To get to $1Trillion, the United States (which contributes 17% to the overall IMF funding capacity) would have to increase $106Bn, which is possible, but politically unlikely. Other countries, such as Japan (which contributes 6% to the IMF budget) would have a difficult time raising funds to contribute to a vastly increased IMF lending capacity. Overall it appears the IMF will have a very difficult time guaranteeing EU debt alone.

Can a combination of IMF and the EU Guarantee Southern EU Soveriegn Debt?

This is possible, but would require the IMF taking the lead, as it is difficult to see how the northern EU states and France could guarantee more than $400Bn, while over $1 Trillion would likely be needed. An increased funding capacity to $500-$700Bn for the IMF is more possible -- meaning additional funding by $200 to $300Bn. This would require close cooperation between the IMF and the EU, which appears very difficult currently, politically. But financially, it is possible although difficult.

Conclusion: Greek Default and Southern EU Sovereign Defaults Very Possible -- if not likely -- without joint EU -IMF Bailouts

Currently as of the beginning of October, it does not look as if there is the political will to get the EU and IMF coordinating on a combined, increased bailout package, which would require significant additional funding (read: additional taxes) for the EU from France and Germany and increased funding for the IMF (read additional taxes for IMF member countries). The likelihood of this occurring is very difficult to say, but cannot be considered "the most likely outcome" meaning that the probability is higher for less than a needed guarantee for southern EU debt materializing in the future.

Thursday, October 6, 2011

Valuing Corning in an Extended Period of Lower Revenue Growth

Corning (NYSE: GLW), founded in 1851, has historically been at the forefront of glass production technology. Corning invented the glass process to produce light bulbs in the late 19th century, fiber optic cable in the 1970's, and liquid crystal displays (LCD's) in the 1990's to early 2000's.

Glass, which is produced from silicon (which in turn is made from sand) will likely be utilized in society far into the future, in so far that glass has certain suprior optic characteristics vis-a-vis plastics, a chief competitor material. Further, plastics are produced from more expensive hydrocarbons.

Corning, along with many downtrodden stocks in the current environment, is currently selling at a multi-year lows, at approximately $13, down from $22 in July and only moderately above the depths of the near $8 valuation at the bottom of the financial crisis. Corning's valuation represents 1x book value and approximately 6x historical earnings, with a net cash position of over $4.1Bn on Corning's balance sheet.

The question most relevant for investors is: at this current valuation is Corning significantly undervalued?

The answer to this question mainly lies with the direction of the High Definition television market. Corning's current profitability is highly dependent on its patented Fusion Process for liquid crystal display (LCD), which are used for high definition televisions and displays for computers and hand held devices. Corning, along with its 50% owned equity company Samsung Corning, has an estimated 83% market share in the manufacture of LCDs.

In the last quarter ended 6/30/11, Corning's LCD segment, along with equity earnings from Samsung Corning, comprised 90+% of operating income.

Corning's Profitability is Likely Significantly Higher in LCD's Produced for HD Televisions Verses for Computers and Hand Held Devices:

Corning in its 2010 Investor's Day estimated that approximately 60% of the volume (square feet) of this LCD glass was produced for HD televisions, and 40% by sq footage was produced for computers and hand held devices. Corning does not split out the relative profitability for computer and hand held display glass, however it is likely that Corning derives a higher percentage of its display earnings from HD Television glass, in so far that this glass is significantly thicker and represents a higher valued added product, in which screen resolution is significant competitive differentiator.

The Fusion Process Invention for LCD Marked an Incredible Turnaround for Corning in 2004:

Corning in the 1990's derived the majority of its income from the production of Fiber Optic fiber, where GLW had a market leading market share. In 1998, Corning derived 65% of its operating income from its telecommunications division, which mainly sold fiber optics. Interestingly, in 1998, Corning derived only 11.5% of its operating income from its information display segment, which at that time produced glass mainly for cathode ray tube televisions and computer monitors (this segment would by 2005 comprise the vast majority of Corning's profits through LCD technology).

Optic fiber sales collapsed in 2000 following the popping of the Internet bubble. Corning reported losses of $5.2Bn, $1.2Bn and a slight gain of approximately $200M in 2002, 2001 and 2000 respectively. In retrospect, it could be said that fiber optics worked TOO well, in so far that, according the publication The City of Light: The History of Fiber Optics by a medium sized, single fiber optic cable had enough capacity to carry ALL the phone calls in the United States simultaneously. One could say, Fiber Optics would be built once, then would not need to be rebuilt for 10 years or more -- a difficult market to build a sustainable business.

Are there Parallels Between Fiber Optics and LCD Technology in terms of the technology "working too well?" LCD's interestingly do not wear out at any sort of moderate pace -- most technological publications estimate that LCD screens will last decades -- 30,000 to 60,000 hours for the LCD screen to lose 50% of its display brightness, which, at a rate of 8 hours of use a day means a minimum of 10.6 years before the LCD needs to be replaced.

One could envision a scenario in which consumers buy one LCD television and do not replace this television for 15 or more years. Corning, in its 2010 annual investor meeting, estimated that 50% consumers would replaced their HD televisions every 6 years on average, but this data is speculative in so far that HD televisions have been introduced only since 2006 and therefore not many consumers have replaced their televisions for functional deterioration or any other reason.

HD televisions were introduced in 2006, and experienced rapid growth as consumers replaced their traditional cathode ray tube (CRT) sets with LCD and plasma televisions. In North America, Europe and Australia and New Zealand, initially the sales of HD televisions was likely buoyed by a strong housing market -- as one buys a new house, part of the improvements process likely involved buying a HD television for the living room (which could be viewed as an "investment" along with new floors, landscaping, furniture etc). All in all, HD televisions increased at an annual rate of over 30% from 2006 to 2008, driving HD televisions to a respectable 44% of all televisions in the United States (or slightly more than 1 HD television set per household in the US) by 2010. HD televisions represent 37% of all televisions in the EU-27 and 45% of all televisions in Japan. Even China reports HD television market share of total television units of 21% across all approximately 400 million households, even as according to the China's People Daily, the Chinese middle class (defined as households with income of at least 60,000 rmb or approximately $10,000 per annum) comprises 23% of the total population -- in other words nearly all of China's middle class as of the end of 2010 already owns an HD television set.

Will HD Televisions Units Sales Grow Significantly Going Forward?

At first glace, this question would be ridiculed by Corning and industry consultancies, which would reply of course! Corning has estimated that the total sq footage of HD televisions will increase at an annual rate of 21% in China and other emerging markets, with a total increase in HD television sales to 2014 across all areas of 12% (with only 4% growth in North America and Europe on an annual basis).

It is argued here that 1) HD television penetration in China likely will only grow at the rate of the overall Chinese middle class growth and 2) economic weakness in the US and Europe will mean flat to declining HD television unit sales in the near term.

The Chinese publication estimated at in July 2010 that the middle class would reach 48% of the total population from the current 23% by 2020, or a near doubling in 10 years. However, this implies that HD television sales will increase at only an approximate 7.2% per year -- and this under more optimistic economic growth forecasts for China of last year (in which growth rates of 8-10% were considered attainable for the next 10 years, currently China is more likely to achieve lower economic growth).

HD televisions do not appear to be any cheaper within China than in the US or Europe, with starting costs at around $US300 -- a newly minted middle class member of China with approximately $10,000 of annual income can afford this purchase but those with lower incomes likely will keep their old CRT televisions (currently China already has on average 1.1 televisions per household).

In the 4th quarter of 2008 and the first quarter of 2009, Corning's display segment reported significantly lower sales, total year on year sales declines of 50-58%, as North American and European consumers cut back on discretionary purchases. As Goldman Sachs has recently updated the forecast for a recession in the US to a 40% probability in 2012, and likely the odds of a recession in Europe are significantly higher (given the banking crises there) unit sales growth of HD televisions appears to be on a declining trend in the US and Europe for 2012 and the intermediate term.

Overall, Corning's 2010 investor day forecasts of 12% industry growth in HD television sales growth should be averaged to a rate that is significantly slower, and potentially (probably) slightly negative (mid single digit sales growth in China, declining sales growth in North America and Europe). The question is, can Corning remain profitable in these conditions?

Estimating Cornings' Display Segment Profitability with Mid-Single Digit HD Television Sales Declines:

In the 1st quarter of 2009, Corning's display segment actually reported a small profit (excluding Samsung Corning) of $38M despite 57% lower sales year on year -- however $37 of this profit was due to favorable exchange rates. Some of this moderate result was due to Corning idling LCD plants. Impressively, Samsung Corning only reported 13% lower year on year profit declines to $180M in the 1Q 09 -- mainly (appears, as Samsung Corning does not publish separate financial figures) due to continued growth in HD sales in China during 2008 and 2009 as the Chinese middle class bought new HD televisions.

With lower than expected growth over the near to intermediate term, it can be inferred (very roughly, based on Corning's historical ability to idle plant capacity) that Corning will eek out approximately low profits, in the $100M range per quarter. It does not appear that Samsung Corning will get the same boost from Chinese demand going forward into 2012 as it did in 2008 and 2009, but on the flip side, other region's declines of 50-58% in revenues is quite severe and not likely to be repeated. Total yearly profits therefore appear around $400M to $800M in the LCD division for intermediate term.

What Annual Earnings in a Slow Growth Environment would Corning's Other Division's Yield?

Corning's fiber optics group has reported relatively break even profits (with growth mainly dependent on infrastructure spending in China) and three interesting, but smaller groups -- specialty materials which includes Corning's Gorilla Glass and Biologic Glass, which includes high-tech glass for biotech laboratories (cells, test tubes, etc -- glass is non-reactive so has an advantage in these applications verses plastic). Corning's environmental technol0gies group produces glass for catalytic converters, and reported profits of $42 in 2010. Earnings were $60M for life sciences in 2010, and Gorilla Glass reported impressive sales growth but no profits in 2010. All in all, in appears Corning's other divisions can be counted on for around $100M in annual earnings in a slow economic growth environment in 2012.

Dow Corning Earnings:

Corning owns 50% of Dow Corning, which is a major producer of silicon and silicon based materials. Dow Corning is a large company in a period of world economic growth, with earnings approaching $800M for 2010. In a recessionary environment, Dow Corning broke even in 2008. With recessions more likely than not in 2012, Dow Corning appears to be set for low profits in 2012, barring significant governmental action.

Likely Earnings for Corning in a low Growth Environment:

Corning appears to be set for $600M in annual earnings without significant new product introductions ($400M approximately in their Display Segment and $100M per year in their other segments combined, and $100M for the 50% stake in Owens Corning). With a 14x multiple, $600M would command a market cap of $8400M (plus $4.1Bn of net cash) would be valued at $12.5Bn -- current entreprise value is $15.71Bn.

Corning would likely significantly disagree with this analysis, but such an analysis assumes significantly lower HD television sales growth and significantly lower replacement rates for HD televisions, based on a more challenged global economic enviornment. To the extent that Corning is accurate in forecasting close to double digit HD television sales growth going forward, Corning's long term value would be significantly higher.

Thursday, July 14, 2011

Very Low Cost Electricity -- Impacts on Commodity Prices

What impact would very low cost electricity have on commodity markets? First let's consider on commodity prices that are used for electricity generation -- mainly coal and natural gas. This is to say, if, the great scientist John Von Neumann was correct in the previous post, nuclear energy had become extremely abundant to the extent that natural gas and coal were mainly used for chemical feedstocks, then the expenditure that was used for natural gas and coal for electricity would be diverted to (costless) nuclear fuel -- or another costless source of electrical power.

However note, that the previous post calculated the savings from electricity, which should include the expenditures for coal and natural gas. This is to say, as almost all of the coal and natural gas in the United States is purchased by power utilities as inputs, and then sold to consumers through electricity as kilowatt hours, savings in electricity costs would include the savings in costs spent on natural gas and coal (interestingly, this calcualtion makes sense, the entire natural gas market in the United States in 2010 was 24.1 billion cubic feet, which at a price of $5 per cubic foot is approximately $120Bn. The price of all electricity sold in the US in 2009 was $383Bn (about 4.5 Billion megawatt/hours at 9.7 cents per megawatt -- the total expenditure on electricity includes the expenditure on natural gas and coal).

Further we will assume that electric power has become so abundant that natural gas is not even used for heating, but for chemical feedstock purposes only. This usage represents actual cost savings however (not included in electricity), so in 2010, the US according to the EIA supplied 8.2 Billion cubic feet to residential and office and commercial buildings, which at a price of $5 per cubic foot would be cost savings of $41Bn.

Natural gas in particular is used as a feedstock for chemical synthesis, as is oil -- approximately 20% of the oil consumed by the United States is used as a feedstock for petrochemicals. According to the EIA, the US supplied Industry with 6.6B cubic feet. Let's assume without the recent rise in natural gas prices over the last decade, with very low cost energy, natural gas would average long term prices from 1980-1999, of approximately $1.50 per cubic foot (much natural gas is produced along with oil, and producers of oil could supply natural gas as a side business to chemical producers). This would mean savings of ($5-$1.50)*6.6Bn = $23.1Bn

According to the EIA, only approximately 2% of coal was used for non-electricity generation purposes in 2010, so the vast majority of cost savings that are not already calculated by savings in electricity costs.

How would the price of Oil be affected by very low cost electricity?

Oil prices are determined by supply and demand. Demand: Oil on the demand side is mainly used for transportation (80% in the US) and petrochemicals (20%) in the US. As oil is a world market, the world demand for oil determines world prices, and world demand is a higher percentage for transportation (as the United States is the world's largest producer of petrochemicals).

It is not clear if a large number of cars would be converted to electrical (battery-operated if electricity was very low cost, and whether this would encourage more public transport dependent on electricity (trains, trams, etc). Currently the firm "A Better Place" is undertaking projects to convert a large percentage of cars in several countries (Israel, Denmark, Australia) to battery powered -- in light of high oil prices. With extremely low electricity costs, more battery powered vehicles is more feasible.

On the supply side, low cost electricity would assist exploration and production through lower cost drilling as well as refining and marketing, through lower electricity costs.

How much would oil prices be lowered in a world of very low electricity costs, stemming from these factors? It is very difficult to tell. Supply would be incentivitzed to increase by a small amount, while demand would likely decline, by what amount is very difficult to tell. One could say that China would be more likely to build a transportation infrastructure highly dependent on electricity, in light of its relatively low domestic reserves of petroleum, which would likely have reduced demand by a great deal throughout the decade of the 2000's. China has been cited as one of the main drivers of higher oil prices, by several commentators.

For the purposes of this analysis, oil prices with very low electricity costs are assumed to decline to levels averaging in the 1990's, of approximately $20 per barrel (this is a large assumption! But also shows how much oil prices have risen over the last decade). With prices of $20 per barrel, the US would save ($90 per barrel approximately currently - $20 per barrel)*19.5M barrels consumed per day*365 = approximately $498Bn per year.

Would the prices of non-energy related commodities such as food (grains) and metals decline with very low cost energy?

As the prices of all commodities are determined by supply and demand, one would go through the sources of supply and demand for each commodity to determine what direction the prices would move. It would be very difficult to argue that prices would actually go up with very low cost and abundant electricity. For the purposes of this analysis, I will leave out the cost savings as an impact on GDP (as this post is getting very lengthy:).

Environmental Impacts from Low Cost, Clean Energy:

An additional benefit to GDP would be from environmental impacts. Carbon production would be significantly lower, as most carbon in the atmosphere is due to coal production and oil production (coal consumption would be much lower, oil consumption would be debatable, how much it would decline, as argued above).

Oddly, GDP impacts from lower carbon would not be dramatic as of 2011, as very few companies engage in carbon trading/credits, however if some publications and scientists are to be believed -- such as the late Steven Schneider of Stanford University, a lower amount of carbon in the atmosphere is an extremely -- extraordinarily -- serious matter.

Some countries' GDP such as Norway includes environmental degradation, but the US' GDP to a large extent does not, so this would not be directly added to GDP. I will look for environmental estimates of the impact on GDP from other published sources.

Additional Technological Breakthroughs from Very Low Cost Electricity:

Very low cost electricity would likely lead to more scientific breakthroughs (besides the knowledge of low cost nuclear energy in itself) with more funds being available for scientific research grants, and lower costs to research labs (which depend on electricity as a cost and an input to experiments). This is likely a critical outcome of lower cost electricity, but I won't go into detail on this as this time as this post is getting quite lengthy.

Conclusion: Calculation of Additional Savings from Lower Oil and Natural Gas Prices:

In addition, to the GDP benefit calculated from lower electricity costs in the previous post, the additional lower oil and natural gas prices are assumed to add an additional (pre-multiplier) $498Bn + $41Bn + $23Bn = $592.1Bn. At different multiplier effects (see previous post for a discussion):

At a MPC of 0.94, additional $9368 Bn of GDP
At a MPC of 0.5, additional 1242Bn of GDP

Combined with the previous gain in GDP from lower electricity costs:

At a MPC of 0.94, total GDP gain of 122.7% (more than twice as large of a GDP with zero cost electricity)
At a MPC of 0.5, a total GDP gain of 58.53%

What Does of This Discussion of low cost electricity have to do with stocks?

Well, this discussion is somewhat removed from stocks but has been inspired by a thought experiment of why the economy is not performing as expected currently with lower consumer expenditures on the horizon, and a shaky recovery (the recent Federal Reserve minutes demonstrated significant concern on the economy, and employment is disappointing). If electricity was available at a very low cost, likely the economy would be doing significantly better now and the stock market (as an index, with perhaps different/additional firms in it) would be much higher. As many economists have stated, GDP over the long term is determined by productivity, and productivity would be enhanced by low cost electricity -- and a higher GDP means that we would all be wealthier.

Wednesday, July 13, 2011

What impact would very low cost electricity have on the economy?

An interesting question to ask is what effect low cost electric power would have on the modern economy. In the United States, electricity rates are climbing upward, averaging 9.7 cents per kilowatt hour in the year ended February 2011, up from approximately 5.5 cents per kilowatt hour in 2000. (non-inflation adjusted, however) This is approximately a growth rate of 5.2% per year, a growth rate significantly higher than the average real GDP growth rate of the US of 1.5% per year over the same period.

Electric power is of course a prerequisite of almost every aspect of modern life, from the production and shipping of commodities (crushing reservoir rock, drilling into rock, pulverizing grains, etc) to manufacturing, to the operation of consumer products that rely on computing, lighting and/or moving parts or chemicals of any type.

The increasing cost of electric power in the United States is been driven to a large degree by higher coal and natural gas prices, which, combined, accounted for approximately 70% of electricity generation. One can certainly say that supply is failing to keep up with demand -- the reasons for the decline in supply relative to demand of coal in particular is not fully understood to my knowledge, as the supply of coal appears, on the surface, to be abundant. (I will address this topic of supply and demand in more detail below).

Alvin M. Weinberg's The First Nuclear Era: The Life and Times of a Technological Fixer captured the optimism of future low cost power -- nuclear power -- in the early 1950's until the early 1970's. Alvin Weinberg, along with the Nobel Laureate Eugene Wigner, were two scientists at the forefront of the development of nuclear power, and both theorized that fission and later fusion power would become exponentially more efficient (an electricity production version of Moore's Law) over the next few decades. As such, Weinberg describes (somewhat infamously) that nuclear power had the potential to be "too cheap to meter" which earned him and the nuclear community a significant dose of ridicule with the higher build costs experienced in the US in the 1970's.

Interestingly the potential of nuclear power was shared by other members of the scientific community in the 1950's and 1960's. One of the greatest scientists of the 20th century, John Von Neumann, wrote in 1955 that nuclear power was likely to be the source of vast amounts of energy by the late 20th century: "A few decades hence (nuclear) energy may well be free -- just like the unmetered air -- with coal and oil used mainly as raw materials for chemical synthesis, to which, experience has shown, their properties are best suited." Science Fiction movies such as "The Day the Earth Stood Still" (1951)implied that rapid technological progress in nuclear energy production was imminent (the movie showed Aliens coming to Earth due to the potential technological breakthrough from nuclear energy).

In 2011 however we are still stuck with a significant reliance on oil and coal for energy while nuclear is fading as an energy source, and energy is anything but free as the cost of energy is rising.

Estimating the Impact of Higher Energy Prices on GDP:

The most direct way to estimate higher energy prices is through treating higher energy costs as a "tax" on consumption on the residential electricity usage side and as a cost to business on the industrial and commercial usage side. Utilizing the GDP formula: GDP = Consumption + G + (X-M) + I, consumption should be reduced by the amount of the additional electricity costs on residential customers. Note that residential customers comprise approximately one third of US electricity demand, while industry comprises one-third of electrical demand and commercial (office buildings, retail, grocery, non-industrial) comprises one-third of demand.

Higher electricity costs on industrial and commercial sources will be treated as a direct tax to income in the income measure of GNI -- as GNI must approximately equal GDP then a simplifying assumption is that the higher rates pass through to consumption as well on the consumption measure of GDP. (actually I am not sure if this assumption holds, but will go with this anyway :)

The Keynesian Multiplier!

I've been informed that a higher amount of consumption would ripple through the economy through Keynes' multiplier. This is to say, that as a typical consumer has more income, they spent a percentage of this income, then the recipient of this income spends the income, etc, leading to a "ripple" effect through the economy. Keynes termed this effect "the multiplier" which actually (I believe) wasn't Keynes' original idea but one of his student's ideas (the Polish economist Michal Kalecki had a similar idea of revolving around additional stimulus impacting the economy, but did not come up with the idea of the multiplier).

With additional income that is present over all time periods -- and not during a recession (when consumers are more likely to save income to reduce debts and plan for an uncertain future) the marginal propensity to consume should be higher, towards the normal spending range for Americans, which is currently around 0.94. In times of recession, tax cuts tend to have a lower MPC, this paper argues that the MPC in the 2001 tax cuts was somewhere between 0.6 and 0.4.

The impact will be calculated according to the simplified MPC impact on GDP formula: Change in GDP = 1/(1-MPC)

So, a calculating the increase in GDP from electricity costs at a variety of rates per KWh verses the average rate of 9.7 cents in 2011:

Total Electricity Usage (thousand MegaWh) (2009): 3950331

Cost per KWh (cents) 9.7 8 7 6 5 4 3 2 1 0
Total Cost $383,182,107,000.00 $316,026,480,000.00 $276,523,170,000.00 $237,019,860,000.00 $197,516,550,000.00 $158,013,240,000.00 $118,509,930,000.00 $79,006,620,000.00 $39,503,310,000.00 $0.00
$ Savings (verses $0.097) $0.00 $67,155,627,000.00 $106,658,937,000.00 $146,162,247,000.00 $185,665,557,000.00 $225,168,867,000.00 $264,672,177,000.00 $304,175,487,000.00 $343,678,797,000.00 $383,182,107,000.00
GDP 2009 $12,832,600,000,000.00

Percentage Increase in GDP 0.52% 0.83% 1.14% 1.45% 1.75% 2.06% 2.37% 2.68% 2.99%

With a Marginal Propensity to Consumer of 0.94 for additional consumption from additional income, increase in GDP:8.72% 13.85% 18.98% 24.11% 29.24% 34.37% 39.51% 44.64% 49.77%

With a Marginal Propensity to Consumer of 0.5: 1.05% 1.66% 2.28% 2.89% 3.51% 4.12% 4.74% 5.36% 5.97%

Results: At first glance, with electricity at ZERO cost, the increase in GDP is appears to be only 2.99% from current levels, as a total, not in growth terms. (meaning that the savings from electricity are equivalent to about one year of additional GDP growth, as the US economy can easily grow about 3% in real terms during a good year).

However this result does not take into account the effects of the multiplier. With a normal multiplier of 0.94 -- meaning that consumers spend 94% and save 6% of their income -- the increase in GDP with free energy is nearly 50%. With a multiplier more in line with stimulus/tax break spending of 0.5, the increase in GDP from zero cost energy is only about 6%.

The 50% increase in GDP sounds more in line with what one should expect from zero cost energy, in a very unscientific way, mainly by being be more in line with the optimistic comments from the great scientists of the 1950's, referenced above:). Nevertheless, it is likely that the increase in GDP from very low cost energy would be even higher, for several reasons.

Reasons for likely higher GDP from Low electricity costs than implied by the multiplier:

First of all, low cost energy would likely translate to lower cost commodity prices across all sectors, in so far that cheap and abundant energy can be used to produce and extract commodities at a lower cost, leading to higher returns for oil, mining and agricultural firms. For oil refining, for example, electricity costs are approximately 10% of total costs. Lower costs would encourage higher supply, lowering prices relative to demand.

Low Cost Electrical Power as a Signal to the Market That an Energy Shortage is Not Foreseeable:

One aspect of very low electricity costs is that it would signal that a shortage in other energy commodities -- oil, natural gas and coal -- is not imminent over the medium term. There has been a lot of speculation on why the prices of commodities have risen over the past decade, for example this discussion forum at the Economist Magazine presents a wide variety of reasons for rising commodity prices, from Federal Reserve monetary policies, to demand from China. Financial speculation has also been blamed in some circles. One reason for higher prices is that an impending shortage may be anticipated relative to supply.

Adam Smith once asked, "Why is it that diamonds, although frivolous, are expensive, while water, while necessary for life, is free?" This question led decades later to the concept of supply and demand (invented by the economist Alfred Marshall, in (incredibly for such a core concept) the late 1800's. One can say, if water was in shortage, it certainly would be expensive -- the last remaining volume of water would be "bid" upon by millions of individuals (one can think of the movie "Mad Max" -- absolute chaos if water was in shortage relative to demand (although in that movie it was gasoline that was in shortage)(perhaps this mental picture is a bit silly but does illustrate the basic concept :). There is a lot of evidence that many key commodities, from oil to copper to even grains, have been getting close to shortage levels (the subject of this is lengthy, and for another post). For example, the additional supply of iron ore in late 2009 were bid upon by the European Union and China, with the only additional supply coming from three companies (BHP, Rio Tinto and Vale), causing the price to increase from around $80 per tonne to over $200 per ton. China, in particular, in late 2009 was desperate for iron ore as a key input into in construction-heavy stimulus program passed in 2008 -- the economic livelihood of China was at stake in obtaining iron ore as as such demand outstripped supply, causing prices to skyrocket.

Figure 1: The Historical Price of Iron Ore:

I would argue that a proper calculation of GDP savings would calculate additional price declines across energy as well as metal and food related commodities, stemming from low cost electricity. As this post is getting lengthy, I will calculate this GDP increase in the next post.

Tuesday, June 7, 2011

Ratings History and Credit Risk for Southern EU Sovereign Debt

Contagion in 2008 was driven by credit losses, and so it follows that the main risk for a new round of contagion is also credit risk. This is to say that the EU banks potentially could lose a lot on the default/restructuring of Greek and/or Irish debt, and/or other Southern EU debt.

Credit losses depends in part on the previous ratings of, in particular, Greek and Irish debt -- anything above A would mean that the European banks could hold the government debt without much in the way of reserves. (I believe under Basel, a bank can buy with AAA rated debt with no reserves, AA with 10% or so and A with 20% or so -- need to check this)

This is what got the banking system into such a tangle with the subprime mortgages -- they were rated AAA, and so the banks bought them without almost any reserves. The losses flowed down straight into equity.

So rating history of Greece: (Moody's)
currently as of 6/11 Caa
A1 --> A2 12/09
A2 --> A1 11/02
Baa3 (oldest I can find) 1996

So Greece has never been above A2, which means the European banks likely have some reserves for this debt. (this is to say, the writedowns won't be the same as write downs on AAA debt)

Raing History of Ireland (Moody's):
Baa1 --> Baa3 4/11
Aa2 --> Baa3 12/10 (ouch!)
Aaa --> Aa2 7/10 (Ireland was rated triple A??)

Note that from 2000 to 2007 Irish debt/gdp was below 38%, reason for the AAA rating, now it's at 93.6%. However, the main problem in Ireland is the banking system not necessarily the governmental debt. If the governmental debt became an issue, this could be a problem (only slightly mitigated by the fact that overall Irish governmental debt is not overwhelmingly large at around $US165Bn approximately -- in so far that the EU banks tend to be highly levered and any losses will put capital ratios at risk).

Other countries:
Aa1 --> Aa2 3/11
Aaa -> Aa1 10/10 (Spain was also triple A!)

Note however Spain has debt to GDP of 63% so isn't a huge default risk currently.

Aa2 (current)
Aa2 (2007)
Aa2 (2004)
Aa3 --> Aa2 5/2002

Appears Italy has been rated Aa2 for a long time, before in 2002 it was Aa3 (thank goodness it hasn't been AAA).

Overall, the main risk again appears to be Italy -- due to its relatively high rating and above 100% debt, so far the market isn't worried about Italy, rather Greece, which was never rated higher than A2 -- EU banks likely have reserved (in part) for holdling Greek debt.

Still there is risk due to the fact that the European banks tend to be more levered than American banks. I´ll research to see if the major EU banks publicly disclose their EU sovereign debt holdings.

Sunday, June 5, 2011

Some Thoughts on the Current Market Volatility

I spent the weekend reviewing the economic situation and the most concerning situation to my mind is Greece and Ireland, in the EU. Northern Europe -- mainly Germany - is effectively transferring capital to Ireland (through Central Bank transfers) and Greece, direct monetary transfers to the government. Losses in the banking system in Ireland, and a lack of tax revenue in Greece to cover governmental debt interest costs are driving the need for capital transfers.

Greece is interesting because it is mainly a governmental problem, not a banking problem -- Greece has serious societal problems. Most other countries with problems in this last downturn saw banks sort of drive the economic problems, (one can think of the US, Ireland, Iceland, Britain) but Greece mainly has problems because of governmental corruption, lack of work ethic and lack of transparency with regards to taxes.

It seems these problems are fixable (if the problems are only isolated to Greece and Ireland), in so far that Ireland isn't that large -- Germany can cover Ireland's banking debts (Germany is the fourth largest economy in the world, Ireland has only 4.4M people, although Ireland's banking debts are quite large, as shown in Figure 1 below) while Greece,seems to be coming back every year for funds. Greece, it seems, eventually they have to start paying taxes and working a bit longer -- in any case Greece's sovereign debt is not that large as a total sum.

Contagion can happen if there are additional large writedowns of sovereign debt in other EU countries -- one can think of Portugal -- but especially Spain and Italy. So far Spain looks ok -- the debt to GDP is in the 60-65% of GDP range (the US is now getting up to over 90% of GDP). Greece is up at 142% of gdp --this is why there are problems. I don't think there will be problems with Spanish governmental debt too soon, due to the relatively moderate debt/GDP level.

However, Italy does not look strong with debt/GDP of 114% -- but they do not seem to be a major concern for the markets now. Italian debt is yielding around 4.5% -- not in danger territory. Actually also Belgium looks not so great, with debt/GDP at 100%. The other EU countries look ok (with the exception of Portugal but they are getting IMF assistance).

So the main problem is that problems in Greece and Ireland can trigger problems in Italy and Belgium. Here is a nice chart showing the interrelations --


So far it appears problems in Greece (and note, Greece is much smaller than Ireland, in terms of debt owed) are more impacting Germany and the UK. If there are problems in Italy, in particular, there will really be problems in Europe - in so far that Italy owes significant total amounts of debt to countries outside of its borders.

The other issues, slower growth in China-- so far my impression is that China is following growth at all costs so is still going to register 9% growth this year (even with the slowdown) according the the IMF. The US is shaky -- I am not sure what to make of the stimulus and the Quantitative easing coming to an end.

So overall things look shaky out there but so far not nearly as bad as the subprime problems going into late 2008, when major institutions were failing every month (but it would be this bad if Italy was having serious economic and debt problems).

In terms of holdings, I think oil should be ok -- interest rates will have to be kept low in the EU, leaving commodity inflation -- but copper may be a bit more unpredictable -- copper is being driven by China,(and mainly construction in China) -- I'll look to pare down a bit of exposure here).

Sunday, May 15, 2011

World Copper Supply is Being Gobbled up by Residential and Office Construction in China

China consumes approximately 40% of the world's copper, making it by far the most important end market for the yellow metal. Copper prices are at near record highs currently (in mid-2011) a large part due to the strong demand from China, as well as flattening mine production of copper.

What exactly, is driving the massive consumption of copper in China? Copper is by far the best electrical conductor of the base metals - copper is approximately twice as conductive as its closest base metal substitute, aluminum -- making copper essential in any structure or product that utilizes electricity. It follows that as China industrializes, it will be a massive consumer of copper. According to BGRIMM, a copper research agency in China, construction and infrastructure accounted for 56% of total copper usage in China in 2007, and the broad category "general consumer goods" accounted for an additional 27% of consumption, as shown by figure 1:

According to, Copper has its largest use in residential and office construction as building wire -- electrically conductive wire built in the structure in order to allow electricity to be used in the structure through electrical outlets, air conditioners, computers, and other devices. The relative percentage useage of copper in a multi-family unit according to the is as follows:

It is useful to calculate the actual consumption numbers to give more detail on these overall categories. What is the percentage of copper in China consumed by laptop computer production (a laptop is approximately 6.9% copper by weight)? Office building construction? Mobile phone manufacturing -- note that the average mobile phone is approximately 13% copper by weight.

The author has calculated the expected copper consumption in China by residential and office construction, mobile phone, television set, computer (both desktop and laptop), power and telephone line, and automotive production. These results are presented in figure 3 and 4 below. Interestingly, even as China is, in the World Bank's words, the "world's manufacturing center," accounting for the manufacture of approximately 90% of the world's laptops, 50% of the world's mobile phones, and 30% of the world's television sets (among many other products that use copper) it appears that the overwhelming majority of copper in China is used in residential and office construction. The author's calcuations puts office and residential consumption of copper at 82.4% of the total consumption, presented in figure 3.

Figure 3: Calculated Chinese Copper Consumption by End Use:

The numbers of residential and office construction are estimated by the Economist Intelligence Unit for 2010, then the copper usage of these structures are estimated by applying similar per unit copper useages from US residential and office consumption. The sources for the numbers of products and km of infrastructure are including in figure 4 below.

The author's estimate of copper consumption by end use is different than the BGRIMM figures in chart 1 above, this is due to two factors: first, the BGRIMM numbers are for 2007, in which total infrastructure spending was lower than in 2010 (the year for which the author has estimated copper usage in China). Total residential construction totalled an incredible 2.4 Billion square meters in China in 2010, and office construction totaled an incredible 1.8 Billion square meters (more than a square meter of office space for every man, woman and child in China in 2010) according to the Economist Intelligence Unit. Second, there is likely significant error in the author's estimates of total copper consumption, as estimates are based on average copper usage per application, times total estimated application numbers (both variables are likely to have high errors in estimation, depending on the source of the numbers). BGRIMM, to the author's knowledge, does not disclose their methodology for estimating copper consumption by end use, so thye author was not able to determine sources of difference between this estimate and BGRIMM's estimate further.

It appears that copper usage in technological devices including PC's, netbooks, and mobile phones do not comprise a major component of overall copper usage for China. The author's calculations have these computing categories at only 2.1% of copper usage in 2010. This is due to the fact that as computing power increases, the size and weight of computing devices declines which means despite very large production numbers, the overall usage of copper is relatively small.

Even power cable appears to not be a massive driver of copper consumption in China. Power cable is typically a smaller copper core surrounded by aluminum insulation -- perhaps this is part of the reason why so the overall copper usage is not massive.

Copper consumption for residential and office appears to be the main source of demand in China, which makes residential and office building forecasts for China -- such as ones done by the Economist Intelligence Unit -- to be paramount in the forecast for the price of copper going forward.

A couple of notes on the supply side for copper: Approximately 38% of the world's supply of copper comes from Chile. Geologically, 75% of world's copper reserves exist in the form of copper porphyrys -- porphyrys are igneous rock (this is to say, rock relatively recently formed by volcanic lavas) and most copper sulphides are in the "Ring of Fire" -- a geological term for newly formed rock around the Pacific Ocean. Chile has the highest geological deposits of copper but is having difficulty increasing production significantly. The state owned Codelco -- which produces, along with BHP and Rio Tinto, the majority of Chile's copper -- warned in 2010 that without high levels of investment, its production of copper would fall by 50% over the next decade, due to declining copper grades. This, in turn, has led to some analysts warning of "Peak Copper" -- the inability of particularly Chile to increase copper production. Currently, Chile has projected that will expects to increase copper production levels modestly to 2020 based on an intensive capex program. However, uncertainties exist as to whether Chile can achieve this forecast in the light of the geological limitations presented by continuing declines in copper grade at the major Chilean mines.

In addition, it is interesting to note that according to geological estimates, almost all porphyry copper despoits were formed 500 million to 200 million years ago. This is to say, if humans had evolved 200-500 million years sooner, we would not have access to copper in any meaningful quantity on the surface of the Earth, and widespread usage of electricity would have likely not developed in industrial society.

Figure 4: Geological Date of Origin of Porphyry Copper Deposits:

Source: Source: Ore Metals Through History. Science, Vol 227, March 22, 1985 p 1421-1428

Figure 5: Calculations of Copper Usage by End Production/Infrastructure in China 2010
(numbers in millions of KGs of copper consumed)(bold indicates totals for each catagory)

Office 280 2800M sq m of office space added
Total office 2800
Residential Apartments 36.00 million, per year average 50 sq m
per apartment 80
Total Apartments 2,880.00 1.8B Sq M residential space added
Power Cable per km 70
Power Cable Total 511 7.3M km of cable capacity
Telecom Cable per km 80
Telecom Cable Total 0.8 10,000 km of copper telecomm cable added per year
High speed train 0.01 per km
Total High Speed Rail 20 about 2000 km per year
per PC 1.725
Total PCs 93.15 377M PCs + laptops worldwide
per laptop 0.207 6.9% copper, 3 kg av weight
Total laptops 39.33 approx 90% of all laptops made in China - 190M units
per mobile phone 0.01469 kg
mobile phone total 5.22 355.5M mobile phones produced China 2009
0.069 per netbook
Total Netbooks 1.10 32.8M total
Per Automobile 17
Total Automotive 238
per television 5
Televison 300 est 60 M tvs Produced China
Total: 6,887.50

Actual Consumption China 2011 Est 7300

Total World Production 16,400.00

Tuesday, April 26, 2011

Comparing Net Present Values to Market Values of Alberta Conventional and Oil Shale Plays

Several Canadian Royalty trusts have converted to corporate status over the past two to three years, including Equal Energy (EQU), Penn West (PWE) and Pengrowth (PGH). Many newly converted Canadian Royalty Trust have significant unexplored and undeveloped land holdings, which they did not develop due to capital restraints -- in so far that the royalty trust legal structure required that most net income earned to be paid as dividends.

How can these firms be analyzed for potential value? Canadian firms are required to publish after tax, forecasted discounted net revenue from proven and probable oil and natural gas reserves with SEDAR (the Canadian equivalent of the SEC).

The oil and gas companies selling below future net discounted oil revenues will be undervalued, all other factors equal. The forecasted value is listed as the "PV-10" value below (Present Value of oil and gas reserves, discounted at 10% per year, minus income taxes, development and transport cots, not taking out corporate costs and interest expense).

Table 1: Disclosed Future Value of Proven and Probable Oil and Natural Gas Reserves, year end 2010 Reserves Data, Selected Canadian Oil Firms (and Exco, US based Oil Shale Development Company):
PV-10 Value (proved)($C1000's) PV-10 (Proved + Probable)($C1,000's) Enterprise Value EV/PV-10 (proved) EV/PV-10 (prov+prob)
Equal Energy (EQU.TO) 318.7 374.7 375 1.18 1.00
Pace Oil & Gas (PCE.TO) 515.9 681.9 574 1.11 0.84
Penn West (PWE) 7401 9205 14580 1.97 1.58
Pengrowth (PGH) 3218 4028 5670 1.76 1.41
Enerplus (ERF) 2914 3683 6340 2.18 1.72
Baytex (BTE.TO) 2478 3327 7410 2.99 2.23
Bonavista (BNP.TO) 3012 3780 5316 1.76 1.41
Can Natural Res (CNQ) 38892 54302 59140 1.52 1.09
Encana (ECA) 18083 23566 30940 1.71 1.31
Exco Resources (XCO) 1223 na 5940 4.86 na
Legacy Oil&Gas (LEG.TO) 815.2 1192 2230 2.74 1.87
Imperial Oil (IMO) 21295 na 44950 2.11 na

Note in Table 1, the ratio of the PV-10 values for both proven and probable reserves are placed in bold font, and the lower, the more potentially undervalued, all other factors equal.

From table 1, it appears that most of the Albertan oil and gas corporations are trading a bit above their PV-10 values. PV-10 to market capitalization plus debt is between 1 to 2x for most of the firms listed. Pace Oil and Gas is the sole exception, while Equal Energy and Canadian Natural Resources are trading very close to their PV-10 values, on a combined proven and probable basis.

Most US based Oil and Gas Firms trade well above their PV-10 values, as the market assumes (probably correctly) that these firms will discover significant new reserves going forward -- and also possibly on the assumption that energy prices will rise going forward. An example of this is Exco Resources, which is US-based (included in Table 1), which is typical of US firms in so far that it sells at 4.86x its PV-10 value.

Summing up, overall the Albertan energy industry appears to be selling at a discount compared to its US based counterpart for PV-10 values, and may have good expansion potential. This means that the newly converted Albertan Royalty trusts may be undervalued. Future questions include the relative land holdings of the firms compared to the current market valuation, and the ability of these firms to execute on expansion plans, now that they are organized as corporate entities.

Thursday, April 21, 2011

Imperial Metals, Duluth Metals and Amerigo Resources

In Canada mining companies are required to publish their best estimates of the net present value of their mines. In the US, only oil companies are required to do this. The value of a mining company should equal the future net discounted profits from mining operations, so this is really a great resource.

So I've been spending some serious time going through the filings. I found 3 very interesting firms. First:

Imperial Metals:

Imperial Metals is listed in Canada ticker: III.TO but also has a US OTC listing. III mines copper and gold -- have two main mines now that generate around $C40M at $3.40 copper and $1000 gold -- stock is at a market value of $781M -- the net present value of a new project, Red Chris, is $C2.5Bn, at $3 copper (current copper is at $4.10 per pound) and $1000 gold (currently gold is at $1500 ou). Revenues will be about 70-30% copper gold. Red Chris is starting up at Dec 2013.

Present value of the current projects are around the current market value, so once the market anticipates the Red Chris, the market value should appreciate to around $C2.5Bn. This is a gain of 210% by the end of 2013, so in 2 and a half years (we'll see if we get this, but do expect Imperial to sell close to net present value). I've checked many other mining firms and they sell close to the market value of the mines. This one is unusual since they don't highlight the Red Chris project very much in their investor presentations, I had to dig to find it.

The Red Chris project in British Columbia is really large -- has about 2 M tons of copper at a cutoff of 0.3% grade and 5.5M ou gold at a cut off rate of 0.55 g ton. To put this in perspective, the largest copper co in the world is Codelco (Chile) which has 77 M tons of copper (albeit at a cut-off grade of 1%), and Barrick is the world's largest gold producer, with 130 M ou gold -- Red Chris is smaller, but still isn't too small.

Environmental issues have been settled at the supreme court of British Columbia so the mine is moving forward with high probability.

Duluth Metals:

Duluth (DM.TO) has a 50% concession of the Nokomis reserve in Northern Minnesota, which is 48% Nickel, 36% copper and approx 8% palladium. The future value of this reserve is $800M (for Duluth's share) albeit starting in 2017, while Duluth's current market value is $269M, so a gain of 200% by 2017. The present value of the income is calculated based on $7 nickel (currently nickel is at $11) and $1.75 copper (Copper is currently $4.10) -- so really the net present value should be significantly higher.

Duluth has a major mining partner, Antofagasta, so the project is likely going through. The main issue is the 6 year wait to production, but note Duluth has a net cash position of $26M so won't go bankrupt and Antofagasta will pick up the majority of the development costs. In anticipation of the production, the share price should rise -- or the co can sell itself.

Last firm: Amerigo Resources:

Interesting company, Amerigo (ARG.TO) treats the tailings (the waste rock and sludge) from Codelco's largest mine, El Teniente -- which is the world's largest underground copper mine and also a major producer of Molybdenum. Interestingly, the tailings have an average grade of 0.125% copper -- probably due to the fact that the El Teniente mine has very high grade reserves, in excess of 2.0% copper. Many new mines are coming online with around 0.3% copper, since new high grade copper deposits are very, very rare -- Amerigo has all the infrastructure set up and electricity etc, so margins are ok.

Amerigo produces a lot of copper, in excess of 1M pounds per year -- also produces a lot of Molybdenum by treating the tailings (I don't know the split between copper and Moly revenues -- need to research). They have forecast production of over 1 M tons of copper to 2021, which is a lot.

The co was selling at around $C2-$C3 before the financial crisis, now it's at $C1.20 , market cap of $C200M -- back in 2007 they earned $30M, in 2007 they earned $40M (but with a $8M one time gain). They paid dividends of $7M in 2006 and $11.2M in 2007 so should have record earnings this year, as copper prices are at an all time high.

I found a research report here: Fair value is estimated at $2.00 per share, approximately, according to this report.

NPV is not given in the technical reports since the mine isn't fully owned by them but projections are given, production is expected to remain steady to at least 2025.

One issue, is that they have the contract with Codelco until 2021. They have renewed it twice in the past so shouldn't be a problem but there is still risk.

The El Teniente mine is set to produce for several more decades.

Sunday, April 17, 2011

Which Country is the World's Largest Food Producer?

In 1890, the United States' 'non-farm' GDP surpassed 'farm' GDP for the first time. Currently in most industrialized countries GDP from agriculture accounts for less than 5% of GDP (according to the CIA World Factbook the US derives less than 2% of its GDP from agriculture). Despite its low 'ranking' in GDP methodology, agriculture forms the base of an economy on which other economic activities stand, in so far that workers cannot work if they don't have food.

It is interesting to ask which country is the world's largest food producer. There are overall two main methods to show which country is the world's largest producer of food. First, by food production by total calorie content (one could say this is a way to judge if the country has sufficient resources to feed its population) and second, by monetary value of the food categories produced. Interestingly, the monetary value appears to get more attention from statisticians and economists -- actually the author is unaware of calculations showing total calorie production by country by food category.

Below in Figure 1 this information is presented -- utilizing USDA production numbers across grain, protein, dairy and selected fruit categories and then taking the average calorie content per ton per food item.

Source: author's calculations, USDA for production, NutritionData for calorie Content, total calories in 1000's Note a limitation of the above chart is that it does not account for all food categories, such as marine food, nuts, oats and other grains and vegetables.

According to calculations presented in Figure 1, China is clearly the world's largest producer of food by calories. The largest percentage of calories produced in China came from rice at 34% of the total (China accounts for approximately 26% of world production of rice), and wheat at 32% of the total. India, in second place, narrowly beating the total calorie production of the US, derives 37% of its total from rice. The United States is slightly behind India, but ahead of the EU-27 -- the US is unusual due to its relatively large production of corn -- 39% of total calories are produced from corn across the major grain, meat, dairy and fruit categories in the US.

One would expect countries which comparative advantages in land, sun and water to be the food's largest agricultural producers, according to economic theory from Ricardo and Heckscher-Ohlin's theories. However, necessity appears to play an equally important (if not more important role). China and India with the world's two largest populations of citizens, requires high food production for domestic food self-sufficiency. Further, labor also may play a high role in certain crops, such as rice and fruit, which are highly labor intensive.

Taking into account the value in monetary terms, China also appears to be the world's largest agricultural producer, although more narrowly beating out the US. India falls to the bottom of the 5 countries surveyed by monetary value of food produced. The US is a relatively larger producer of protein -- beef, pork and poultry account for 9% of all calories produced in the US (although note that China is a much larger producer of pork than the US, with more than 4x the production of pork in 2010). Meat tends to sell for a significantly higher price than grains. India produces a relatively low level of meat, with poultry, beef and pork only accounting for approximately 2% of the total calories consumed in India in 2010.

Source: author's calculations, USDA, Moneycnn for commodity price data

Monday, April 11, 2011

BRIC Banks, verses EU and US Banks, by Assets, Market Capitalization and Asset Growth Rates

As economies grow, their banking assets by institution also grow in lock step. The following charts show banking assets at the largest of the banks in the BRIC countries (Brazil, Russia, India and China) compared to assets and growth rates in the largest banks in the US and the EU (plus Switzerland).

Note that all of the US and EU banking institutions have seen very low asset growth over the past three years -- due to a large degree to the Global Financial Crisis in Oct 2008 which forced these countries to cut bank on problem assets and shore up financial ratios.

It is interesting to note that asset growth all the selected BRIC banking institutions was relatively unaffected by the GFC -- BRIC banks on average saw annual average total asset growth in the mid to high teens.

From a total asset level, the largest US and EU based banks still hold the lead in overall assets. Interestingly, Industrial and Commerical Bank of China is the largest bank in China by total assets and market capitalization, and has been growing at an average annual rate of 13.9% per annum over the past three years. This means it will be as large as the largest EU and US bank by assets -- Deutsche Bank -- within the next three years (if growth rates continue).

From the perspective of market capitalization to net tangible assets, it appears the market has more than priced in growth at the BRIC banks, with market capitalization/tangible book value averaging 2.5x for the BRIC banks on average, compared to 1.3x for the EU & US banks, on average.

Monday, March 14, 2011

Is Chaoda Modern Dropping Because of an Unfounded Rumor that it Changed Auditors?

Chaoda Modern, the 3rd largest agicultural firm in China has dropped from a price of near HK$10 in the past year to somewhere near $HK4 currently. I suspect the current drop is due to an inaccurate rumor that Choada changed auditors -- but the last auditor Grant Thornton was acquired by the current auditor, BDO Seidman, which is the 5th largest auditor in the worldwide.

An article stating that Chaoda changed auditors appeared on Dec 31, 2010 on a blog -- Since that time the stock has dropped from $HK6 to $HK4ish, with the only other news a moderately positive 6 months ended Dec 31, 2010 earnings release (more on this earnings release below).

Chaoda is audited by BDO Seidman,which is the largest US based accounting firm outside the Big 4. The previous auditor Grant Thornton merged with BDO (reference: but no change in auditors. BDO actually is probably a stronger accounting firm than Grant Thornton, but Grant had a good reputation as well.

Grant Thornton gave an unqualified opinion in the last Annual Report:
source: p. 41-42

It should also be noted that Chaoda is ranked by Forbes as the 3rd largest agricultural co in China. It is very difficult to fake being one of the largest agricultural firms in the world's largest country in terms of agricultural production.

The results announcement was moderately strong. Chaoda reported good top line for the six month period ended Dec 31, 2010 (+18%) but flat in net profit, the main item was an increase in general and admin expenses to 6% of revenues from 2% the previous period, plus they issued shares to pay for mainly an acquisition of more land.

Shares increased as they issued equity instead of dipping into cash to fund expansion (don't really know why they won't utilize their very large cash and investment position). Chaoda has RMB3.8Bn of cash and no debt -- all assets are in RMB and look solid, buildings (RMB8Bn), vegetables in inventory (RMB2Bn) and they have very low liabilities RMB218M total. They also have RMB1.3Bn of equity assets - mainly I believe their share of HK listed Asian Critus. One asset is "prepaid premium for land leases" at RMB5.8Bn -- I believe this is tangible (prepaid leases, so expenses won't appear in future periods, as long as the firm is a going concern). With prepaid land leases, net tangible book value is RMB 24.9Bn while market cap is HK15Bn (RMB12.5Bn) so market cap is around 50% of book. PE is below 4 (interim 6 mo net profit is RMB1.54Bn).

Operating cash flow looks strong, equal to EBITDA of RMB1.8Bn for the interim period, but the co raised RMB2.3BN of financing (mainly equity) to fund expansion. Almost RMB1Bn from new shares issued over the past half year (this seems to me, not a huge dilution).

Note, the major reason for the increase in SG&A was an increase in options exercised, from only RMB6M in 2010 to 160M in 2011 - also note salaries were up about RMB100M (this is likely due to wage inflation in China, surprisingly workers are somewhat in short supply for farming). So this hopefully won't be repeated. -- they are approx 192M share options outstanding but the majority have excercise prices between $HK6.75 and HK$8.10 per share. The exception is the ceo who has 66M options with an excercise price of HK1.50 (but at least he'll be motivated to get the stock price up).

They are paying a dividend this year of RMB84M -- didn't pay a dividend last year. So at least will get some income, also shows they care about the stock price a bit.

Overall to me the company looks strong I don't know why it's dropping for sure -- the first drop, issuance of equity at HK$7.50 when the stock was trading at HK$9 -this made sense to drop, but the second drop, if it has anything to do with the rumor that they've changed auditors, is just plain wrong (the news of the previous auditor, Grant Thornton, being acquired by BDO maybe is not well known, and it may be thought that Chaoda really did want to change auditors, but BDO is a well respected accounting firm). So this one really has me scratching my head. It looks very strong, with the exception of the issuance of equity to fund expansion, that has made net profit growth relatively flat.

Thursday, March 10, 2011

Follow Up on Frontier Resources

As posted in a previous note, the main question for Frontier Resources (ASX: FNT.AX) is whether the deposit on New Britain has a reasonable chance of proving to be a large scale, economically producing, high grade mine. This is significant because the initial exploratory data was reported to be very positive (could this be a major deposit of Gold in a new territory, relatively unexplored New Britain of Papua New Guinea? -- similar to Lihir of Newcrest Gold (the 7th largest gold deposit in the world, discovered in the past 5 years?)

We won't answer this out with 100% certainty, but it seems we can be able at least shed some light on this main question, by asking few sub-questions first: 1. Does the management team have the connections and experience to at least get the ball rolling on development, if reserves are economic?

Second, are there high grade deposits nearby (in Papua New Guinea?). Mineral deposits are formed by geological processes, and these processes can be similar in nearby locations.

Third, what are the (known) geological processes for forming gold? This might sound too esoteric, but really this helps a lot, at least in the case of oil, in looking for new reserves (really many analysts won't even speculate on this, but for example, I know a bit about oil formation theory, and so for example, took a look at Petrobras of Brazil, looked at their producing wells, and saw huge territories unexplored plus offshore areas next to rivers -- good signs of future oil discoveries and Petrobras subsequently has announced very large

First question -- actually this is probably the best question -- management experience. The Chairman and CEO Peter McNeil is also CEO of another PNG based gold mining firm in addition to Frontier -- New Guinea Gold Corporation. Frontier Resources has only 2 full time employees in management, it appears, the CEO and a co secretary. (this data is really hard to find, is not in the Annual Report -- have to infer since they don't state how many employees).

New Guinea Gold is also mainly on New Britain, same management structure, just McNeil and a secretary and non-exec directors (so essentially it is a twin of Frontier except drills different prospects) has drilled 12 projects, got good exploration results (grades of over 2 g/ton, but hasn't been able to develop these projects, one problem was that crushing the ore turned out to be a problem, so gold production has been disappointing. The stock has been down a lot -- stock price on the Venture Exchange of Canada of New Guinea Gold has gone from .6 in 2007 to 0.1 currently -- the market has lost confidence that management will bring any projects into production and/or sell deposits.

Frontier Resources is also a vehicle to explore New Britain, is up a lot with the recent report of grades but -- really reading the reports from New Guinea Gold Corporation they sound sort of similar in terms of grade (some reports of very high grade 30-60 g/ton then most of above 2 g/ton) -- but New Guinea Gold hasn't been able to bring these online.

I've seen a small management team be CEO's of more than one mining co before --example New Gold and Silver Bear Resources -- both headed by the same management team -- note New Gold is doing great while Silver Bear isn't. So this isn't a bad sign necessarily -- what you do want to see is proven experience getting mines to production and building value. New Guinea Gold isn't this, Frontier so far isn't proven (wondering actually why two co's in the same region for the same type of deposit -- Silver Bear is at least for silver while New Gold is for gold, makes sense -- wondering if Frontier is another vehicle to make investors forget about lack of success at New Guinea Gold).

Anyway -- on the first question overall summary is "iffy."

Second question, yes there are good, relatively recent discoveries is Papua New Guinea. The most publicized is the LIhir Gold discovery on tiny Lihir Island in PNG: Amazingly, this deposit has 28.8M ou of gold reserves at an average grading of 3.5 g/ton (which is extremely high, most grades are 1 g/ton or lower) and ranks #7 on the world's largest gold deposits. In other words, huge! Lihir was bought out by Australia's Newcrest Gold in 2009, and Newcrest states that it wants to produce about half of its production from Lihir going forward (Newcrest is an amazing stock, Australia's largest Gold producer, has rocketed up to a $A30Bn market cap (3rd largest gold mining co in the world). Note that Newcrest's other major producing mine, Cadia East in Western Australia, produces over 1M ou per year of gold but from an average
grade of about 0.5 g/ton (so Lihir is about 7x more concentrated). Cadia East
has reserves of gold of about 18.7M ou, so Lihir has about 50% more gold. (in
other words, Lihir is a world class deposit)

Two other PNG projects appear in the top 200 largest gold deposits. Allied Gold owns Simbiri which is located also on a tiny PNG island (called Simbiri) about 30 km north of Lihir -- average grade is between 1.0-1.5 g/ton with total reserves of 2M ou (so much lower and smaller than Lihir, but LIhir is unusually large and high grade). Harmony Gold and Newcrest co-own Hidden Valley on the main lsland of PNG, with an average grade of 1.7 g/ton and total proven resource of 1.2M ou.

For gold mines in Indonesia, there are three in the top 200 (Indonesia could have similar geology to PNG, both are island countries and actually the main island of PNG is split evenly between Indonesia and PNG). Interestingly, Indonesia's gold deposits are all relatively low grade, below 0.5 g/ton, including the massive Grassberg mine, owned by Freeport (FCX), which has approx 35M ou of gold at an average grade of 0.4 -- note this mine is ranked #3 in terms of reserves of gold, and has already been in production since 1975 so could be depleted in terms of its higher grade ore.

In summary to question 1, there are high grade deposits in PNG and it doesn't appear that PNG has been a major destination of mineral exploration budgets (only a few firms, Newcrest, Harmony, Allied and some minors including Frontier searching so it is possible. Actually the next question is, what did the exploratory mineral info look for Lihir and the other major deposits? Were these close to info coming about concerning Andewa? Will try to find this.

Third question, (this is getting lengthy) gold appears to be formed by three main geological processes. First process, the Witwatersrand deposit in South Africa (largest in the world, produced approx 40% of the world's gold, but now is largely depleted except for underground mining, was in production since the 1910's) was formed approx 3 bn years ago -- the earth is 4.5 bn years old so South Africa is one of the few areas with surface areas formed during this time. Almost all other areas (with the exception of parts of Australia) have been reformed by more recent geological processes. The best theory is that during this period of the earth's history (3 bn years ago) heavier metals were flowing from the magma to the surface (gold, platinum) and the earth was in a different phase of history -- the gold is left over from this period, but not covered in vast amounts of overbuden unlike almost all other areas. This process is probably unique to S. Africa, won't explain Papua New Guinea gold.

Second process Carlin type deposits, found in Nevada -- gold is completely dissolved in minerals -- unique (I thnk) to mainly North America -- won't go into detail.

The journal Science explains a process of gold formation unique to Pacific Islands
-- water flow accumilates gold over relatively short periods (couple 100,000 years). Will reference for this (getting tired) -- anyway, need a lot of flowing water and a trap, can be a good source for PNG, for New Britain -- was how Lihir gold was formed.

Anyway so the summary would be management -- medium to negative, close-by deposits -- moderately positive, gold formation -- positive. Overall however probably question 1 is the most indicative and so overall I would say "iffy."