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US Government Has its Way with S&P

By
Rafi Farber
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S&P

The credit raters at S&P just got beat by the US Government to the tune of $1.5 billion. What happened here is a case of extortion, dishonesty, and revenge.

In August 2011, S&P downgraded US Government credit for the first time, down from AAA to AA+. For accumulating the largest debt in world history, you’d think it’s about time. Then, in February 2013, the Federal Government sued S&P for allegedly overrating certain mortgage backed securities, or MBSes, that it alleges caused the financial crisis of 2008.

Mortgage backed securities can be a bit difficult to understand, so before we get into the specifics of this settlement, here are the basics of MBSes. If you take a loan from a bank to buy a house, the right to your monthly payments is now worth something. Whoever owns the mortgage, owns your monthly payments. The bank you got the loan from, assuming you got it before 2008, inevitably sold the loan to Fannie Mae or Freddie Mac, so when you pay your mortgage, the money ultimately went there.

Fannie Mae and Freddie Mac were government sponsored enterprises, or GSE’s. They ended up owning most of the mortgages in the end because the banks always sold to them and they bought it all. A lot of these loans all bundled together from different mortgages constitutes an MBS. An MBS only has value if the people that took the loans that make up the MBS can pay them back. Otherwise the MBS is worthless.

So, after the S&P downgrade of the US credit rating, the US government sued S&P, and only S&P, for giving these MBSes a AAA rating just before everyone figured out they were worthless, sincethose taking out mortgages couldn’t repay them. Other rating agencies gave these same MBSes a AAA rating, but they weren’t sued. The US Government claims this is a coincidence.

Looking at it from the inside out though, the whole thing is convoluted. All these MBSes became the property of the Federal Government, more or less, through Fannie and Freddie, the two government sponsored enterprises which bought them. So in order to take revenge on S&P for downgrading US Government credit, the US sues S&P for overrating the MBSes that the US Government itself was sponsoring through Fannie and Freddie? If the Feds are unhappy that S&P overrated MBSes, why are they upset that S&P downgraded the US debt?

There is no consistency here. And now S&P has settled with the Feds to the tune of $1.5B in what was originally a $5B lawsuit.

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Capstone Could Succeed with AEM-28 where Aegerion and Sanofi Failed

By
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capstone

Cholesterol-reducing statins like Pfizer’s (NYSE:PFE) Lipitor may be the best selling prescription drug class in history, but for one kind of cholesterol disease, statins are just a pharmacological drop in the bucket.

 

Homozygous familial hypercholesterolemia (HoFH), though an ultrarare genetic disease at only 1 in 1,000,000 births, makes the liver completely incapable of metabolizing cholesterol. Lipids build up in the blood at levels so high that the blood is actually cream colored, and in order to survive, patients need to physically filter cholesterol out of the blood by a process similar to dialysis, or else get a liver transplant.

 

Only recently have two prescription drugs been approved to treat HoFH, but neither of them are grad slams, as they say. The first to be approved was Aegerion’s (NASDAQ:AEGR) Juxtapid in December 2012. It works by blocking a protein called MTP, which prevents very low density lipoproteins (VLDLs) from being secreted by the liver. Though the blocking mechanism is slightly different from run-of-the-mill statins, this is the same medical mechanism as Lipitor, in that it blocks cholesterol from being synthesized by interfering with liver function.

 

Juxtapid was approved after data on only 23 patients indicated a 50% median drop in LDL. 23 may sound like a small number but when the patient base is 1 in 1,000,000, it’s about 8% of the entire US HoFH population. Juxtapid sells decently, having totaled $155.2M in sales since its commercial launch, or roughly $89M a year so far.

 

The main problem with Juxtapid though is the side effect profile. Not all HoFH patients can even tolerate it (29 patients were enrolled in the trial and only 23 tolerated the drug at all) and for those that can, according to the FDA:

 

Juxtapid carries a Boxed Warning regarding a serious risk of liver toxicity because it is associated with liver enzyme abnormalities and accumulation of fat in the liver, which could potentially lead to progressive liver disease with chronic use. Juxtapid also reduces the absorption of fat-soluble nutrients and interacts with several other medications.

 

From an investment perspective, the financial numbers are important to take note of. Juxtapid was incredibly expensive to develop. To give a rough idea of how expensive, Aegerion had accumulated losses of $193M by the time Juxtapid was approved. When it finally was, the stock eventually rose from $20 to a high of $97.83 in October 2013. But sales have not been enough to keep the company net positive yet, and the stock has since crashed down to pre-approval levels. The drug is also ludicrously expensive at $300,000 a year. It would have to be if it cost hundreds of millions to develop and there are only around 300 people in the country that even have the disease.

 

The second drug approved for HoFH is Sanofi’s (NYSE:SNY) and Isis’ (NASDAQ:ISIS) Kynamro. If one can even call Juxtapid a sort-of success, maybe, Kynamro is so far a failure. Approved just one month after Juxtapid, Kynamro works similarly, except it blocks a different protein crucial for cholesterol synthesis in the liver. It was approved based on a trial of 51 patients with an average LDL-C reduction of 25% over 26 weeks of treatment. The placebo arm of the trial, however, saw a reduction of 21%. So really not much of an improvement over sugar pills, if any.

 

Couple that with the same scary-sounding FDA warning of serious side effects and the fact that Juxtapid had better trial results, and you can see why sales were so abysmal that they were not even publicly reported by either Sanofi or Isis. (Sugar pills at least don’t have any side effects, and they work almost as well according to the data. They also don’t cost $176,000 a year like Kynamro.)

 

Clearly then, the HoFH population is still in serious need of a drug that works well and does not have any serious side effects, and with any luck does not cost $176,000 – $300,000 a year. Enter Capstone Therapeutics (OTCMKTS:CAPS) and its lead HoFH candidate AEM-28. AEM-28 stands for Apolipoprotein-E Mimetic 28. Apolipoprotein-E, or apo-E is the protein that malfunctions in the livers of HoFH patients, which makes them unable to metabolize cholesterol. AEM-28 is a simple chain of 28 amino acids that act as a mimetic of apo-E, meaning it mimics its function, though is not the same molecule. It basically completes the missing link in the livers of HoFH patients, enabling them to actually metabolize cholesterol.

 

Think of it as insulin for diabetics, except AEM-28 metabolizes fat instead of sugar. Diabetics can’t produce their own insulin to metabolize sugar, so they inject an analog, and it works well enough. Same here with AEM-28 and fat.

 

The crucial difference between AEM-28 and either Juxtapid or Kynamro is that AEM-28 does not interfere with or block liver function. It simply enables it. Instead of blocking cholesterol from being produced, it enables cholesterol to be metabolized. And since it is a mimetic of a naturally occurring protein only 28 amino acids long, it is cheap to produce and manufacture, and there are no known systemic side effects. Capstone estimates that a registrational trial will cost around $10M.

 

A phase 1/2 study reported positive safety and efficacy data just last month: Specifically a 56% drop in VLDL versus placebo, and a 55% drop in triglycerides over placebo within 12 hours of treatment.

 

The next step is a phase 2/3 registrational trial, but first Capstone needs the money to get it started. It currently has $3M on its balance sheet but will need to raise more, or get a partner, to go to the next step.

 

If AEM-28 can do better than Juxtapid for HoFH, with little to no systemic side effects and at a fraction of the cost, then gains could be similar to Aegerion from trough to peak, except sustainable. From there, the big question is can AEM-28 also be applied to the heterozygous form of the disease as well, which affects 1:500 instead of 1:1,000,000?

 

Answering these questions will take time and money, but so far, so good for Capstone, and encouraging news for HoFH sufferers in particular.

 

Market Exclusive Is a financial portal geared to engaging discussion on current financial topics. Market Exclusive is not an investment advisor. Please read our full disclaimer at http://marketexclusive.com/about-us/disclaimer/

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Syriza May have Won, But Greece Still Has No Money

By
Rafi Farber
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syriza-3

The debate around Syriza’s victory today is centering around the end of so-called “austerity”. The assumption seems to be that Syriza will end this policy as promised, and Greece’s national budget will no longer be “austere”. Logically, then, this means that the budget will be expanded, i.e., Greek government spending will increase because Syriza says so.

The question is how will that be possible? Greece has no money, and the European Central Bank (ECB) will not give it any money on Alexis Tsipras’s – Syriza’s leader’s – terms. While Syriza may have won – possibly even enough for an outright ruling majority without any coalition partners, the European Central Bank still holds the printing press.

The will of the people cannot overcome reality, no matter how united that will is. An appropriate analogy might be a new CEO voted in to lead a bankrupt company on promises that he will give every company employee a raise. How, exactly? Well, what he can do is default on the company’s current debt, and then print his own “money” and give it out to his employees. How much would that new money be worth though? Chances are, not much.

Defaulting on current debt and handing out new money to appease voters would be the equivalent of a Grexit. No more Euros, the Greeks would begin printing their own money on the off chance that it will buy something without hyperinflating within weeks or days. The other option is to stay in the Euro, which would mean either toeing the line with the ECB in order to keep Greek debt from falling to zero. This would spell the end of Syriza’s election promises.

 

The other option, which seems to be that of Syriza’s probable candidate for Finance Minster Yanis Varoufakis, is to default on all bonds but stay in the Euro. In that case, “austerity” would become real bona fide austerity, because nobody would buy Greek bonds any longer, and the Greek government would have to operate on tax revenues alone. The budget would have to be slashed by much more than it has been since “austerity” began.

greece-government-spending

The chart above plots Greek government spending from 2005 until the present. While there is a downtrend beginning in 2010 from the time austerity began, it is only slight. From peak to trough, it decreased €11137.7M to €7116.6 per quarter, a maximum decrease of 36%. If Greece defaults but stays in the Euro, it will have to be cut by much more, because without access to bond markets, budget deficits will not only be undesirable – they will be impossible, as no one will lend any money to finance them.

Greece, Syriza especially, is between a rock and a hard place. If they go through with their plan to end “austerity”, the ECB will cut them off. At that point, they will either have to print drachmas and risk hyperinflation, or else stay in the Euro and rely solely on tax revenue to finance themselves.

Those are the options. There aren’t any others.

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Russia Increases Gold Holdings to 13% of Foreign Reserves

By
Rafi Farber
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Nabiullina

As the Ruble began crashing last October due to falling oil prices, Russia had to defend its currency from complete collapse. A unit of currency, if unbacked by any commodity, is a claim on the economic output of a State. Russia being the largest exporter of oil in the world, it is understandable that a collapse in the price of oil would lead to the collapse of the currency of the largest oil exporter. From the chart below, it is clear that oil and the ruble/dollar exchange rate generally move inversely.

Oil Ruble

In order to defend the currency, Russia’s central bank head Elvira Nabiullina raised interest rates to the current level of 17%. In addition to that, Russia began selling its foreign exchange reserves for Rubles, retiring the Rubles in an attempt to prop up the exchange rate still further. Russian foreign reserves are now down to $385B, the smallest amount since 2008, but still substantially higher than they were at the turn of the century.

Russia Forex

The only thing that Russia did not do is sell its gold reserves to defend the Ruble. In fact, the Bank of Russia actually added 600,000 ounces to its holdings, upping its total reserves to 13% of foreign exchange reserves. The fact that the Bank of Russia added to its gold hoard in December in itself is not unique. But the fact that it added to its gold hoard at the expense of defending the Ruble while it was in total free fall, certainly is.

In order to increase its gold reserves, Russia had to sell some of its foreign currency in order to obtain it – forex it could have used to further defend the Ruble, but chose not to. What this says is that increasing its gold reserves was for some reason more important to Russia, under the administration of Nabiullina at least, than defending the Ruble itself.

The real question is why. If Nabiullina is loathe to sell the Bank of Russia’s gold reserves even in a full-fledged currency crisis, when would she think it is a good idea to do so?

Nobody knows for sure, but the real answer might be never. In that case, what Russia is doing, for all intents and purposes, is to back the Ruble with gold. While buying gold does not provide any short term boost to the Ruble on international exchange, it would provide stability in the long term to the Russian currency, especially if made directly convertible at a fixed rate.

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China’s Meteoric Drop Today – Fluke or Omen?

By
Rafi Farber
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China Stocks

The Chinese stock market, the Shanghai Composite, tradable under the iShares FTSE/Xinhua China 25 Index ETF (NYSEARCA:FXI) fell by nearly 8% today on news that would otherwise seem rather vapid. Regulators put the clamps on three Chinese brokerages for lending more money for longer than margin trading rules allow.

The news itself should not really be that worrying. Preventing a few brokerages from loaning on margin temporarily is in not nearly earth-shattering news. Rather, it is the reaction to the news that is more worrisome. If Shanghai can trade down 8% in one day off a few brokerages being grounded for a few months, that means the recent rally is being driven by weak credit-addicted hands.

That rally is about 6 months old now. The Shanghai composite has risen 64% since June. However, putting it in perspective, this is only the third most powerful short term rally for the index going back to the early 90’s. Chinese stocks rose nearly 100% from October 2008 until July 2009, and 445% in the two year period from November 2005 until October 2007.

Shanghai Composite

Compared to those two, this rally is a pipsqueak. And still it gets sopped into the biggest decline in 6 years due to a few brokers who got slaps on the hand.

There are two possibilities here. Either this was an overreaction and Shanghai will quickly recover and resume trading higher, or the sudden extreme weakness is a sign of underlying fundamental weakness in the Chinese capital markets, as signaled by the broader economy.

To answer that question, we need to turn to the real economy, which isn’t doing so well. Housing prices registered a 4th straight monthly decline, raising questions as to whether there will be a true housing bust like in the US in 2007-2008, and whether this will trigger a chain of bankruptcies and credit defaults.

The fact that slamming the credit breaks on three brokers for only a few months had such a large impact on its stock market, indicates that any significant credit crunch in the broader Chinese economy could have an even stronger negative effect on Chinese stock prices.

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JP Morgan’s Fortress Balance Sheet is also a Debt Fortress

By
Rafi Farber
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Revance
Revance

Rumors were circulating last week that JP Morgan Chase (NYSE:JPM), currently the largest bank in the US with over $2.5T in assets, may be splitting. JP Morgan CEO Jaime Dimon begs to differ, and with the force of his leadership he may soon put the rumors to rest, for now. In any case, Wall Street is now discussing the bank’s earnings with interest, pun intended, concerned over signs of lack of growth. Revenue is down 1% from last quarter. Net income is down 17%.

These are the numbers that the main stream media is focusing on, but they are not really the most worrisome numbers. The ominous numbers are in fact JP Morgan’s debt numbers. The nation’s largest megabank now has $723.6B in debt on its “fortress balance sheet” as Jamie Dimon likes to call it. He even labels it that name on the bank’s official SEC filings.

Scarier than the number itself, which is more than half-way to $1T in debt, is that the number has gone up 187% since 2008. This is to be expected, because exceedingly low interest rates pretty much force banks to take on debt in order to stay ahead of competing banks. JP Morgan’s interest expense as of the middle of 2013 was just over $2B. If interest rates were to reach 3% or 4%, that interest expense would eat into its entire net income. If they got any higher sustainably, the entire bank would be in serious danger in a relatively short time, fortress and all.

Defenders would say that the bank is almost indestructible because if interest rates do go higher, JP Morgan would wind up making even more money on its loans on the creditor side, which would compensate for its higher interest expense on the debtor side. While that sounds good on paper, in reality, the megabank would have a hard time staying “fully loaned up” if interest rates do go up, and even if it did, it would have an even harder time collecting its money from delinquent borrowers. It would probably end up having to pay the higher interest expense from the huge debt on its fortress balance sheet, while not being able to fully compensate on for that increase with higher interest income.

In one sentence, if interest rates rise and JP Morgan’s debtors begin defaulting on their bank loans, the bank will be in serious trouble.

On top of that, the foundation stone of any bank’s business is to borrow short and lend long, profiting on the difference between long term and short term interest rates. This is the famous yield curve. The yield curve usually slopes positive, meaning that long term rates are usually higher than short term rates, enabling the bank to profit on the difference. But on the rare occasions that the yield curve inverts and long term rates are actually lower than short term rates, the bank can no longer borrow short and lend long without losing money.

Below is the yield curve plotted from 1977 until today – the 10-year yield minus the 2-year yield plotted continuously. Above zero means positive, and the higher above zero, the bigger the gap between short and long term rates, meaning the higher the profit for banks like JP Morgan. The last three times that the yield curve sloped negative were in 1989, 1999, and 2007, preceding the 1990, 2000, and 2008 recessions. Those recessions happened, in part, because the banks – the credit machines of the economy – could not profit on providing credit anymore, and that puts them in danger, starting a chain reaction of bankruptcies.

Yield Curve

The yield curve is still positive, but it has been heading lower since early 2013.

More important than any talk about JP Morgan being split or having not-so-stellar earnings now for whatever happenstance reason (in this case it is higher legal fees), is what happens to JP Morgan, given its exploding debt since 2008, if the yield curve continues trekking downward and goes negative?

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Swiss National Bank Scraps Euro Cap, Gold Skyrockets

By
Rafi Farber
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SNB

In a stunning move this morning, the Swiss National Bank has decided to scrap its cap of 1.20 Swiss Francs (CHF) per Euro and let the Franc free float against the Eurozone currency. While this move was unexpected to say the least, it is especially surprising given the rejection of the Swiss Gold Initiative at the end of November last year, and the insistence of SNB staff that it be rejected precisely because it could cause the Swiss Franc to skyrocket, as it just did today.

At its peak this morning, the Swiss Franc was up as much as 30% against the Euro.

The Swiss Gold Initiative, which would have forced the SNB to hold a 20% gold reserve, would have essentially stopped the bank from unlimited printing of CHF in order to buy Euros and thereby peg the exchange rate at 1.20. Now that this is exactly what the SNB has just done, investors are scratching their heads. It has basically announced a “cease and desist” order from printing, at least for the purpose of supporting the Euro.

The fact that this move is nearly equivalent to what the Swiss Gold Initiative was trying to accomplish is evident in the fact that on the announcement, gold shot up 2.5%.

Short of a candid interview with SNB decision makers, one can only guess why, and why now. It is possible that the SNB, seeing the recent tumbling of the Euro against the USD to 9 year lows and to an exchange rate below its founding, did not want to tether itself to a sinking ship any longer. The prospects of a SYRIZA win, the Greek anti-bailout party, in Greek elections in 10 days magnify the possibility that Greece will soon be leaving the Eurozone, which is not dangerous for the currency block on its own, but could cause bond runs in other weak Eurozone countries, especially Italy. Italy leaving would be existentially dangerous for the Eurozone and the Euro itself.

It is likely that the SNB is simply fearing a currency crash in the Euro in the event that a chain reaction ensues if and when SYRIZA takes power, and does not want to be tethered to such an event on the off chance that it occurs.

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Biotechs to Follow in 2015 off Fresh Insider Moves

By
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cdilogo_tnsp

Biotechs to Follow in 2015 off Fresh Insider Moves

Insider moves are always interesting to equity traders no matter where they occur, but more than any other sector, insider buys tend to inspire the most chatter around biotech. This is mostly due to the esoteric science and trial statistics that often determine the fate of a firm, which company and other biotech insiders tend to know more about than even premium hedge fund operators.

Over December, several significant moves have been made at different biotech firms that warrant at least a raised eyebrow. In some cases, the moves themselves have caused significant increases in either share prices or trading volume, and in other cases not. Whatever the situation, these stocks should be watched carefully for developments in 2015 in light of these transactions.

Cocrystal Pharma (OTCBB:COCP)

In chronological order, we begin with Cocrystal Pharma, an early-stage biotech specializing in antivirals with sporadic press but an all-star board and staff. On December 5, a Form 13D was filed indicating a 14.3% holding by Dr. Phillip Frost, a Cocrystal board member, as well as Chairman of both Opko Health (NYSE:OPK) and Israeli generics giant Teva (NYSE:TEVA). Opko has been on a 1500% tear since market bottom in March 2009, going up from 61 cents to now just under $10 a share. Opko was at $2 when Frost was first named Chairman. Teva has had a good year as well, up 43% in 2014, outpacing the larger Nasdaq biotechnology index ETF (NASDAQ:IBB).

Opko itself has a 7.8% holding in Cocrystal, which brings Frost’s total interest in the company to over 22%.

If that weren’t enough, the November 25th merger between Cocrystal and private firm RFS Pharma saw RFS owner Dr. Raymond Schinazi take a 38.9% stake in the company. Schinazi has his own impressive record in biotech, founding Pharmasset, which was acquired by Gilead (NASDAQ:GILD) for $11.4B in 2012; Idenix, acquired by Merck (NASDAQ:MRK); and Triangle Pharmaceuticals, also acquired by Giliad in 2003. The scientific wing of the company is headed by Dr. Roger Kornberg, the 2006 Nobel Prize winner in chemistry, also a Cocrystal cofounder with a 2.2% stake. In total, insiders account for just under 72% of total shares outstanding.

Cocrystal’s share price was not directly effected by the December 5th filing, but trading volume was over twice the average that day.

Seattle Genetics (NASDAQ:SGEN)

Four days later on December 9th, Felix Baker, a director at Seattle Genetics brought his ownership of the company up to 20.3%. This move came after a flurry of data were released by the company on its ongoing clinical trials for various drugs. First, phase 1 results were announced for an antibody-drug conjugate for acute myeloid leukemia, a type of blood cancer. Those results showed 44% of 52 patients showing either complete response to the drug or otherwise being disease free. Phase 1 results do not usually inspire intensive buying since it is only the beginning of the clinical trial process, so this type of insider move at this stage is significant.

Included in that flurry were the 4-year survival data for Seattle Genetics’ ADCETRIS, an antibody-drug conjugate for a form of lymphoma, came in at 64%, while the median overall survival for the disease is only 5.5 months. While ADCETRIS is already approved, these results could get it into first-line therapy, significantly increasing the drug’s market. It is currently approved only as a second- and third-line therapy. Baker has since bought even more shares, upping his ownership to 22.7% of the company.

Agios Pharmaceuticals (NASDAQ:AGIO)

One week later Agios Pharmaceuticals saw a major insider move. Agios is a development stage biotech valued at close to $4B, with major investment by Celgene (NASDAQ:CELG). Agios targets the way cancer cells metabolize sugars, attempting to starve them from within. On December 16th, Celgene bought over 5.24M shares, bringing its total ownership to a 27.2% stake. Celgene is investing heavily here in part because it has commercial rights to Agios’ lead candidate.

Agios showed positive preliminary results in its phase 1 trial for both efficacy and safety, with 6 complete remissions out of 14 patients, though this was in November. The catalyst for Celgene’s most recent stock purchase is unclear, but may be connected to Agios’ recent public offering. Agios stock has been on a steep uptrend all year at over 34% gains for 2014. Given Celgene’s experience with clinical trials, its commitment to Agios and latest investment could point to a good year ahead for the company.

Advaxis (NASDAQ:ADXS)

Three days later on December 19th, another biotech saw a pretty large insider move which also had the effect of putting shares to the races. Advaxis, a firm principally focused on cervical cancer treatment, is generally overlooked because there is already an effective cervical cancer vaccine available that prevents the HPV virus that causes the disease. Nevertheless, for those that already have cervical cancer, primarily patients in Asia, few treatments are available.

ADXS-HPV, Advaxis’ lead candidate, was featured on Fox News on December 10th, which began the recent uptrend. FDA acceptance of an investigational new drug (IND) application for ADXS-HPV on December 15th further propelled the stock, followed by a 4.54M share stake by Adage Capital, totaling almost 19% of the company in one trade, the same day its latest public offering closed. All those events in succession had the effect of pushing the stock up 200% since December 10.

Despite the recent gains, Advaxis is still below $200M market cap. Recent mainstream media interest and institutional investment could mean that Advaxis has entered a new stage as a publicly traded company, no longer relegated to obscurity.

All in all, a very busy month for biotech insiders. It will be interesting to see how these stocks perform in 2015 and beyond.

 

Market Exclusive Is a financial portal geared to engaging discussion on current financial topics. Market Exclusive is not an investment advisor. Please read our full disclaimer at http://marketexclusive.com/about-us/disclaimer/

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Where’s the Inflation? It’s in the Capital Goods Sector

By
Rafi Farber
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Gold Miners In Trouble

Prices everywhere are dropping and price inflation is nowhere to be seen. In fact, according to some online indices, the United States is actually experiencing an 11% annual deflation rate as of January 2, 2015. But there are two major sectors of the economy where prices are still levitating high in the sky. Those are the stock market, and mining sector costs.

At first glance these two sectors have nothing to do with each other. But at bottom, they are both essentially the capital goods sector. Mining is the first step in creating capital goods, and stock prices reflect the value of capital goods in general. With consumer prices falling by as much as 11% annually at this point, prices are being bid up almost exclusively within the capital goods sector. What causes that, chiefly, are extremely low interest rates.

Low interest rates allow capitalists and entrepreneurs to borrow money at low cost to finance long term projects. Low interest payments reflect positively on balance sheets and earnings statements, causing the value of capital, and hence stock prices, to increase. But with that increase comes an increase in producers costs as well. If money flows into the capital goods sector as a whole, capital goods costs along with values inexorably rise.

Those most affected on the cost side are the companies at the very top of production – the miners, where capital goods production begins. Since 2009, global all-in costs of gold mining, for example, have risen from $800 to $1500 in 2012.

Gold Mining Costs

They have since backed down slightly to $1200, but this fall is still paltry when compared with the rise in the cost of mining since the gold bull began in 2000. With gold prices still below $1200, the current average cost of production, average-to-marginal miners will go bankrupt. The Big Three in the mining sector by market cap – Barrick (NYSE:ABX), Newmont (NYSE:NEM), and Goldcorp (NYSE:GG), are all bleeding cash profusely. Altogether they lost a combined $16B in 2013, with numbers about to come out for 2014, and they won’t be pretty. Not to mention the other marginal juniors, nearly all of whom are unsustainable given current metals prices, gold silver and copper included.

It’s the same with oil drilling, though the situation is less dire. The cost per barrel for Exxon (NYSE:XOM), in 2013 for example was $15.42, which is still more than 50% higher than it was in 2009 at $10.25. So while the oil industry is in much better shape than the mining industry, the price inflation in production costs even in oil is still glaringly evident here. For oil to reach the dire straits that mining has reached, the price of oil would have to drop to $10 a barrel. As unfathomable as this sounds, $1200 gold for Barrick is the equivalent of $10 oil for Exxon in that sense.

Copper is only skirting its production price of around $2.60 per ounce, currently trading at $2.86, so it’s not only the precious metal miners that are in trouble, but industrial miners as well.

Taking an even broader look, the S&P is currently trading at 9 times the CRB Commodity Index. This is nearly twice as high as it was at the previous market high in October 2007.

The conclusion is simple. Either metals production prices have to come down drastically, or the price of metals has to go up drastically. Price deflation be as it may, the money supply is still increasing week by week according to Federal Reserve data, so it is very unlikely that production prices will drop for any sustained period of time.

 

 

 

 

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Airline Stocks Set Up For A Great 2015, If They Hedge Wisely

By
Rafi Farber
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Airlines

For a company that filed for bankruptcy only 10 years ago, Delta (NYSE:DAL) sure had one heck of a year. Up 82% this year, Delta had an especially strong boost since October, up 50% since October 13th. Not only are its revenues growing but its cost of business is falling fast thanks, of course, to the falling price of oil which directly impacts its fuel costs. Fuel costs are Delta’s biggest expense.

According to its last 10Q filed October 24, a 20% drop in the cost of fuel would result in a $2.53B gain and an $850M loss in hedging costs, netting a $1.68B gain. Oil has actually fallen 35% since that date. Extrapolating out, that translates to around a $4.5B gain, though with much larger hedging losses on paper. Since Delta’s derivative fuel contracts expire in 2016, paper losses could recover if oil recovers by then. If not, the net gain is still far bigger than the hedging loss.

Delta is by far not the only airline to be celebrating falling fuel costs. Southwest (NYSE:LUV) has been on a continuous parabolic ascent since October 2012, up 376%, with its bottom line just getting better and better. In 2014 alone, its stock rose 125%. Revenues look set to beat annual records while its cost of revenue remains muted.

Even Jetblue (NASDAQ:JBLU), which has been a consistently poor performer since 2006, is now back at its highs with net income doubling since 2012. American Airlines (NASDAQ:AAL) only came out of bankruptcy at the end of last year, with its stock up over 100% since.

Falling oil prices are certainly doing their part for all these airlines, but the key to success in 2015 will be hedging well for a strong oil recovery if it should happen. If oil prices head back up, the airlines now complacent with low fuel costs will be caught with their proverbial pants down.

Watch for the airlines that hedge well now, with oil at multi-year lows. Call contracts on crude oil are especially cheap now, which means the smartest airlines can hedge now for an upside move at bargain basement prices for these derivatives and lock in current jet fuel rates. Whoever decides to make that move will be in a much safer position if and when prices start to rise, not only for jet fuel, but for everything else as well.

Pay close attention to airline filings going into 2015, and keep your eyes peeled for the ones that protect themselves now. The downside from hedging now for airlines in the event that oil stays low is very small compared to the upside if oil makes a rebound.

 

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