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The Daily Reckoning | Thursday, May 6, 2010 Global markets down again on contagion fears and China's slowdown, Chris Mayer on the evolution and rediscovery of investing wisdom, Plus, Bill Bonner on the wobbly Greek economy and the importance of flossing... Abandon Ship! A few words of advice for sovereign debtors and would-be investors Bill Bonner Reporting from Baltimore, Maryland... The Dow fell 59 points yesterday. It looks to us as though the stock market is finally rolling over...it's finally putting in a big top after a long, long bounce. But it could be just another temporary setback. We won't know for a while. In the meantime, readers are advised to floss their teeth and stay out of stocks. The bounce may or may not be over. It hardly matters. There's not much upside at these prices...and a lot of downside. Flossing helps protect your teeth. Staying out of stocks might help protect your money. There are too many sticky things that could go wrong. For example: "Eurozone debt fears deepen," says the front page of yesterday's Financial Times. According to the papers, the Greeks have spooked the world's stock markets. "The sell-off in global markets accelerated [Tuesday] amid fears that the eurozone debt crisis would worsen and that China's recovery was faltering." As to the Greek bailout, there are two points of view - both of them insufficient. One group thinks the bankers should get their money. The other thinks the public employees should get the money. 'Stiff them both' is our advice. A nation is like a ship. Over time - especially when the weather is nice - it accumulates barnacles. They attach themselves to the hull, weigh it down, and slow the boat. Barnacles need to be scraped off from time to time. That's what revolutions and corrections are for. But, naturally, the barnacles don't like it. They live on pensions, public sector jobs, handouts, government contracts - and debt. And the barnacles have a way of fighting back. They vote, threaten and demonstrate. Yesterday, government employees shut down schools, airports and hospitals. Gray- haired retirees took to the streets, too, trying to prevent pension cuts. The bankers made their threats too - quietly warning France and Germany that if the Greeks didn't pay, their banks could be in trouble...which could lead to a financial meltdown all over Europe. The rescue plan calls for deep cuts in public spending - 20% of the Greek government budget. And that means scraping a lot of crusty parasites off the hull. So much the better, as far as we're concerned. Of course, some of them do useful work. Government payrolls include teachers, nurses and firemen. But there are plenty of do-gooders, bureaucrats, meddlers, paper-pushers, lobbyists, chiselers and layabouts on the payroll too. But what about the debt barnacles? The bankers speculated on Greek debt. The debt went bad. Now, they should stand up, admit their mistake, and take their losses. Advice to Greece: Haul the boat out of the water...fire one out of every five government workers, cut the budget by 20%, and default on your loans too. Advice to the US: Follow the Greeks. Advice to investors: Take a long vacation. The "Euro-feds" have turned the sovereign debt market into a 'price hiding' mechanism. Not even Mr. Market knows what the stuff is worth. A couple months ago, he thought Greek bonds might be A-OK. Now he's not so sure. Recently, Mr. Market has been turning over some other rocks...Portuguese debt...Spanish debt. He's finding slimy critters and creepy crawlers under all of them. But then, the Euro-feds stepped in. They said they'd bail out Greece. Now what's Greek debt worth? Nobody knows. Will the guarantors make good on their promises? Will the Greeks get their financial house in order? Will the IMF, Germany and France stand behind the Greeks even if they don't bring their deficit down to 3% (currently 13%)? Nobody knows. And then, the head of the European Central Bank pulled a Bernanke-style stunt to further confuse everyone. Jean-Claude Trichet announced that Greek bonds could still be used as collateral at the bank, even though the bonds do not meet their quality requirements. So, let's see...what are they worth now? This additional information from the feds is misleading. It suggests the bonds are good credits. And the bailout itself suggests that lenders have nothing to worry about - they're going to be repaid. Uh...we wouldn't count on it. David Rosenberg: "Back to Greece - the fiscal future is really messy. Latest projections show that by 2013, public debt-to-GDP will approach 150%. Debt-service charges will absorb 9% of GDP and 25% of tax revenues will be siphoned to bondholders outside the country. Government spending is 50% of GDP and the civil service does not seem willing to accept even a freeze - not a cut - to wages, benefits, and pensions. It is not difficult to see the Euro-area going the way of the Latin Monetary Union a century ago." This is just another example of rolling up small debts into big ones. Mr. Market can't tell who's on the hook, exactly. So he doesn't know where the 'good' debt ends and where the 'bad' debt begins. One thing is pretty sure. Even with the bailout and the support from the ECB, the Greeks are still going to default. They have more debt than they can carry. The bailout just muddies the waters...postpones the inevitable...and makes the situation worse for almost everyone. The proposed solution is just slow torture before the coup de grace. The debt grows...and becomes so large the Greek economy can't support it. Plus, efforts to keep paying back the bankers (mostly French and German) severely damage the Greek economy. It's easy to see how. In very broad terms, the Greeks are going to have to go from fiscal party to a fiscal hangover without a good night's sleep. That's what happens when you suddenly stop borrowing and begin paying back. And that means a shrinking economy. Instead of borrowing 10% of GDP and adding to the economy, not only are you NOT borrowing, you're also taking OUT 10% of GDP to pay the interest on the money you borrowed for the party. That's a depression-size decrease in GDP...which cuts into tax revenues and makes the country's finances even worse! Does that mean the end of the euro? We don't think so...more tomorrow... The Daily Reckoning Presents Uranium - A Place to Hide Chris Mayer A.J. Liebling, the famed New Yorker writer, once wrote about how boxers frequently "rediscover" old truths about boxing. An innovation, though seemingly new, may instead have first seen the prize ring through the fists of some 19th-century pug. "These rediscoveries are common among philosophers," Liebling wrote. "The human mind moves in a circle around its eternal problems." So too does the investor's mind grapple with ancient problems. One of his eternal problems is figuring out when to buy what commodities. Every generation spins its own new version of old truths on the matter. Robert Mitchell, a general partner at Portal Capital, gives us the 21st-century version of some timeless investing advice. "In the world of commodities, demand is rarely the compelling reason to get long," Mitchell begins. "Instead, you want to own a commodity where supply is incapable of responding to even a small bump in bids." In other words, buy the commodities where it is most difficult to produce more. Though hardly a new insight, it's one that investors sometimes forget. One commodity that aces this simple test is uranium. Sometimes it's hard to tell, because the data in the uranium world are unreliable. Trying to grab facts can be like trying to catch butterflies without a net. The market is surprisingly elusive. There are a lot of facts and figures, but the quality of this information is pretty bad. As a for instance, Mitchell points to Ux and Tradetech. These are two big pricing publications based in North America. TradeTech says 38 million pounds of uranium traded on the spot market last year. Ux says it was 50 million pounds. That's a big difference! The true number is a mystery. It's almost like you have to see the mines and piece together your own story. When you do start digging into these micro stories - Kazakhstan, Niger, Namibia - you start to doubt the world's ability to meet uranium demand at current prices. Mitchell recently visited Namibia, which is the fourth largest producer of uranium in the world. Mitchell reported his findings to readers of Marc Faber's excellent Gloom Boom & Doom Report. His notes shed some light on this opaque market. And he also adds to a pile of evidence that will warm the hearts of all investors in this sector. Let's start with Namibia, which seems a difficult place to be. "Unemployment approximates 36%, and 15% of citizens have HIV," Mitchell writes. Yet is it mining friendly, so far. Mining makes up 13% of the economy. Namibia has two uranium mines. One is a biggie - Rio Tinto's Rossing Mine, which kicks in 8% of the world's uranium production all by itself. This is an old mine. It's been producing for 34 years. As with dog years, that's a lot older than it seems. It's getting tougher to massage the ore out of the Earth's crust. Labor costs are rising. Water and electricity are also getting expensive. And the geology of the mine itself is changing - worsening as it goes deeper. "The Rossing Mine is clearly strained," Mitchell writes, "approaching the current pit's end of life and marginally profitable at today's term prices and highly unprofitable if dependent upon today's spot." The spot price, meaning the price for immediate delivery, is about $42 a pound. Term prices are the longer-term prices and hover around $60. Mitchell estimates all-in costs for Rossing are north of $50 per pound. Meaning it's barely profitable as is. And those costs have doubled in the last five years. (That spot market, by the way, is artificially held down by foolish sellers, he argues. The Uzbeks sell 6.5 million pounds a year into the spot market because the term market is closed to them. They didn't honor their contracts a few years ago and no one has forgotten it. The market for spot uranium is thin. And he argues that buyers are holding producers hostage by referring to this spot price. Sooner or later, uranium producers will realize the folly of selling uranium in the spot market.) Namibia is also supposed to be an important source of new supply with a number of new projects. Yet these suffer from the same issues. Electricity is costly and unreliable. "Electricity demand in sub- Saharan Africa has doubled during the last 20 years while the capacity has grown 10%," Mitchell notes. Water is hard to find. No surprise there, as most of Namibia is a desert. Then there is the matter of the quality of the deposits. Grades are low, meaning you have to chomp through an increasing amount of ore to get the uranium out. That means high costs. "In summary," Mitchell concludes, "Namibia's current uranium mine production has unfavorable economic metrics..." It is barely profitable at best, or not profitable at worst. We'll need to see a lot higher price to make these projects a go. Kazakhstan - the No. 2 producer - has problems too. Kazakhstan is one we talked about before, but Mitchell confirms what we found. Most industry observers were surprised Kazakhstan produced as much uranium as it did in 2009 - about 13,900 metric tons. But as Mitchell points out, the Kazakhs' "own analysis suggests their marginal cost of production rises to well above $55 per pound once 12,000 metric tons of total production is breached to the upside." Again, like Namibia, Kazakhstan is a big current producer - it is No. 2. And it is also a large source of potential supply, with one-sixth of global reserves. Yet here again we find that it is not economic to produce more uranium at current prices. So in summary, lots of issues on the supply side make responding to increased demand difficult - even with a big boost in prices. These are fine conditions for investors in low-cost uranium mines to make a lot of money. Let us consider one final reason. For years, the mines have produced uranium well short of demand. The difference has been made up by existing inventories - those old Cold War stockpiles. Most of these are from Russia. Mitchell makes a good case that these stockpiles are about gone. "It is likely that the Russians don't have much usable material left, which is why they have the right to purchase 6,000 metric tons of uranium per annum from the Kazakhs. Further suggestive of their poor ore position, they have purchased 20% of Uranium One so as to access additional material." The US has a stockpile, too. Mitchell points out that this is less than it seems. The US has about 59,000 metric tons, but mostly made of tails (or spent fuel). The usable quantity is only 16,538 metric tons. And much of the tails are "held in a variety of cylinders, many of which can't be moved because they no longer comply with DOT. The DOE doesn't even know what the assays are for most of their tails - they guess." My guess is the stockpiles run out sooner than expected, leaving a yawning gap for the industry to make up. And the industry will only do that if prices rise to make these marginal projects in Namibia and elsewhere economic. As Mitchell sums up: "Uranium is well below cost of production, with a superb demand curve." We've made the demand case before, too, and we won't rehash it here. Suffice it to say that a slate of new nuclear plants means a robust demand for uranium for years to come. There are few commodities positioned as well for the next several years. Chris Mayer, for The Daily Reckoning ------------------------------------------------------- Here at The Daily Reckoning, we value your questions and comments. If you would like to send us a few thoughts of your own, please address them to your managing editor at joel@dailyreckoning.com