Brien Lundin: Time's Ripe to Pick Up Leveraged Oil & Gas Companies
Source: The Energy Report (7/23/09)
For the next few years, Jefferson Financial President and CEO Brien Lundin is rather bullish on energy resources. Brien tells Energy Report readers he expects oil to hit or surpass the $100 mark, gives natural gas a "very good shot of at least doubling" and believes the rare earths elements sector is here to stay.
The Energy Report: We'd like to know how your views on the economic situation influence your investment strategies these days. How would you describe what dominates the environment today—deflationary or inflationary trends?
Brien Lundin: I think we're actually in the transition phase. We aren't still involved in that massive deleveraging. While we certainly still have deflation, we're transitioning into an environment where the massive government spending and stimulus programs will create inflation. In fact, the inflationary environment will take some time to develop, but the markets will look ahead toward that point. The markets themselves are transitioning from a safe-haven mindset of investing. They are moving toward a fear of inflation, or a mindset where they're preparing for the return of inflation due to the massive deficits, spending and currency creation.
TER: The actual inflation will follow the markets? As they begin to realize that inflation is going to occur, will the markets again begin to test new lows?
BL: As we've seen, the stock market has rallied on occasion as investors have gotten a little bit more speculative in their approach. The transition toward an inflationary environment suggests that the worst of the financial crisis and deflation are behind us and that we will see credit loosening up. We will see more fluid capital markets, and we will see a looser-money environment that would be conducive for an economic rebound. But that would also bring about asset inflation, if not direct price inflation.
TER: Is this your view of what the market is thinking or what actually will happen in the economy?
BL: A bit of both. Right now the market is a bit schizophrenic. It's often in the mode of reacting to negative headlines and economic indicators, in a safe-haven mode where risk is pulled back, where the dollar rebounds, and the dollar is sought after as a safe haven. Conversely, on some days—and sometimes in the middle of trading sessions—the very opposite occurs, and we see a return to a more speculative-minded market amidst a weaker dollar.
TER: Is the investing public ready for a more speculative mindset, given that they've lost an appreciable amount of their asset base?
BL: That depends on how you define the investing public. One of the things I tell people is that fear is a great motivator, but greed is the greatest motivator of all. It's very surprising to many how quickly greed can return to the market. The worst feeling of all for investors is not that they may lose a portion of their investment but that they will get left behind in a rally. They're very much trend-followers in that respect, and as we saw this spring with the rally in the U.S. stock market and in commodities, the valuations quickly got far out of hand and very much divorced from underlying economic fundamentals.
TER: Is the market's faltering in the first weeks of Q3 just a seasonal summer slump? Or is it the realization that the economic factors are not so positive?
BL: It's really both, and a bit coincidental that it's happening at the same time. This is the typical time for a seasonal slowdown and some removal of investor attention from the markets. By the same token, the market had gone from exceedingly cheap to fairly expensive by virtually all measures of value. The markets were discounting not only a rebound but a very robust economic rebound that really isn't in the cards for some time.
TER: Once we get through the summer slump, would you expect the market to continue sideways because the fundamentals really haven't changed? Or would you expect it to increase as a more speculative mindset takes hold?
BL: With the very important caveat that anything can happen and another shoe could drop, I think generally we will not retest those lows, and that we will see some reaction to the massive stimulus funding. Probably sometime toward the end of this year or early next year, we'll actually get positive economic growth.
One of the primary reasons for that is not so much that we'll see a massive economic rebound, but the fact that we had gotten so low by so many different measures. Businesses were very quick to react to the economic slowdown—slashing employment, slashing costs, etc. They also were very quick to take any extraordinary charges or write-offs that they could, some of which they'd been holding in abeyance, under the cover of a very depressing market. Everyone posted losses, and in some cases losses were greater than you might have thought.
The rebound from those levels is not so much a reflection of great economic strength as the fact that the levels had gotten so low, both in terms of the broader economy's employment and growth and in terms of earnings for individual companies. For those reasons, we'll be able to get to some level of positive growth surprisingly easily. Continuing that trend, and really getting to a more robust level of growth, will be a much more difficult task.
TER: How have the views you've shared influenced your investment strategy?
BL: Short term, I'm telling people to be very cautious, especially in the metals, commodities and mining stocks. Earlier on, investors saw some potential promise that we wouldn't have the typical summer slowdown, but those hopes have been largely dashed. There's still the possibility that the metals will rebound, but I think generally we're going to see lower prices through the middle of the summer. Perhaps the last week or so of July and the first couple of weeks in August we should get a bottom in metals prices and conversely, in the mining stocks. It will be kind of a buyer's market. Historically, it is a time when people can pick up bargains, and I think it's going to work out that way again.
TER: Is it inevitable because inflation is imminent?
BL: Yes, certainly from a classical standpoint. Money creation is inflation. Inflation is always a monetary phenomenon; the very creation of fiat currency is monetary inflation. We will see this transmitted to the buying public, not so much in the form of consumer prices as it was typically in the 1970s, but surely in asset prices—prices of stocks, real estate (once that market achieves a bottom), financial assets, commodities, raw materials and energy.
Those prices won't be as directly translated into finished goods and consumer products because of the influence of the developing countries such as China, India and Thailand, and the depressing effect that imports from those nations have on the prices of consumer goods.
TER: You're saying the classical inflation we saw in the '70s where everything went up, but this time it will affect asset prices more than consumer goods.
BL: If you consider this a correction in a bull market that began in early 2001 for commodities you see that the prices soared yet this didn't translate into a higher consumer price index in the U.S. This is due primarily to the influence of imports from the developing world. Judging from products on the shelves of the Wal-Marts, Sam's Clubs, Costcos and Targets of the world, the American consumer's buying power has never been greater, even though the dollar hasn't done correspondingly well and prices of raw materials soared over the years.
So as compared to previous years, the effects of inflation on the American public are somewhat muted, at least while the developing world supplies many of our finished goods.
There are major troubles ahead, though; the only way to erase this debt is to through inflation. One of the problems I see is the bond market and interest rates. You can't have the type of debt-to-GDP ratios that we're seeing without a corresponding dramatic rise in interest rates, which will compound the cost of carrying the federal debt load.
Trading partners that hold tremendous U.S. dollar reserves will realize this eventually. So, it's going to be a harrowing three to five years. I certainly wouldn't want to be one of the people working at the Federal Reserve charged with cleaning up this mess.
TER: Besides the precious metals, what other sectors should investors be looking at?
BL: I think energy. The fundamental factors for oil and natural gas aren't necessarily the greatest right now—the supply-and-demand factors, the amount of storage, the amount of demand destruction and supply destruction we've had. And while oil has had a bit of a run and natural gas has had a brief run, I think we are looking at a longer-term view of being far closer to the lows than the highs. For that reason, a long-term strategy encompassing some leveraged companies, as well as perhaps some long-term options, might pay off.
TER: Are you expecting lower lows over the next couple of years?
BL: I think the lows are behind us. Sometime over the next two or three years we're likely to see close to $100 oil or higher. Natural gas should move considerably higher; it has a very good shot of at least doubling at some point over the next two to three years. So this is a time to pick up leveraged companies and perhaps look at some options plays.
TER: Any examples of leveraged companies that appeal to you?
BL: I like Bankers Petroleum Ltd. (TSX:BNK) (AIM:BNK), which has a tremendous oil reserve in Albania, but they don't start making money until oil gets to about $50 a barrel. It's a great growth story, a great management story, but because of their high costs of production, it's a marginal producer and therefore its profits tend to rise much more quickly once the price of oil exceeds its breakeven level.
TER: So they're making money now.
BL: Yes, and they're back spending money to grow their reserves, their production. As for natural gas, I'll defer to Gene Arensberg, who writes the Got Gold Report in association with my newsletter. Gene follows natural gas very closely and makes great picks.
TER: Any other companies you'd like to share with us that you're watching or championing?
BL: On the uranium side, I think Hathor Exploration Ltd. (TSX.V:HAT) is obviously very undervalued with tremendous upside still left. It is the story in the uranium sector.
TER: Rare element resources are getting a lot of buzz now. Is that really a sustainable sector or is it just a flash?
BL: In the long term, I think it is sustainable. The problem has always been that the market has to appreciate the sector before it is going to go anywhere. There is no rare earth bull market; no copper bull market; not even a silver bull market. There's no investor interest in any of these sectors unless a gold bull market draws investors into the arena. Everything else is an offshoot from gold. If you recall, we didn't have that big "uraniumania" run in uranium stocks until a bull market in gold had already attracted a large number of speculative investors to the mining and resource sector.
So that's one prerequisite. The other is that someone influential must champion the sector. Uranium started a very long time ago after Rick Rule brought it to investors' attention. I've recognized a lot of the fundamentals behind the rare earth sector, but I never really championed it because the markets weren't going to look at it any time soon.
John Kaiser (Kaiser Bottom-Fishing Report editor) was perhaps the biggest proponent of the rare earth sector, and its earliest proponent. Now, Jim Dines (Dines Letter editor) has entered the picture, and you see what's happening. He has a very wide following.
Now we're starting to get investor interest in that sector, and I think deservedly so from the fundamentals, but that sector needed the exposure beforehand. I recommended Rare Element Resources Ltd. (TSX.V:RES) for its tremendous gold target on its Bear Lodge property. I was one of the first to recommend that stock years ago, along with Bob Bishop (previous editor and publisher of Gold Mining Stock Report) and I think Lawrence Roulston (publisher of Resource Opportunities GreenTech Opportunities).
But after that, this past spring, the company came out with its 43-101 resource estimate for its rare earth elements, and just doing a very rough, back-of-the-envelope estimation, you can see that they had close to $3 billion in value sitting there in the rare earths. Once they released that report, I came out with yet another recommendation of Rare Element Resources. Then a month later, Jim Dines seized upon the stock.
I still like the company, and I still think that it's going higher. It has two engines driving it right now, and either could justify where the company is right now.
TER: Even at the current price?
BL: Yes. My readers tripled their money in the stock within a few weeks, and I told them it would be foolish not to think about taking profits. But that said, I still think ultimately the stock has a good ways to go.
TER: You host the annual New Orleans Investment Conference, which is coming up in October. As you're pulling this together, what investment opportunity do you expect to see highlighted this year?
BL: I really think it's going to be metals and mining, and resources in general. This conference historically has been the place to go to get the top picks of the world's top analysts in this area. Beyond that, we've also focused on every issue that can affect investors. We cover all the major investment markets and asset classes. We touch on geopolitical issues. We've always featured some of the leading figures in modern history among our speakers.
But getting it down to brass tacks, we're going to have a tremendous opportunity this October to discover some of the best investments in mining and metals. I think we're going to see that a number of companies with ongoing exploration programs throughout the summer are going to be releasing news throughout the fall.
And at that particular juncture, about the time of the New Orleans Conference, we'll be able to winnow out the winners from the losers and find out which stocks are really on the launching pad for 2010. It seems to happen every year at the New Orleans Conference. It certainly happened last year, even in the depths of the market in November, our experts were able to pinpoint some stocks that multiplied in price since then.
TER: It's an incredible lineup of individuals coming to speak.
BL: Oh, we're very excited. Among our celebrity speakers, we're going to have a debate featuring Karl Rove (Conservative), Howard Dean (Liberal) and Doug Casey (Libertarian). I don't know that we will ever see anything like that again, and expect it to be one of the most enlightening and entertaining presentations in the history of the New Orleans conference. We've also signed up Rick Santelli, who gave the now-famous rant from the floor of the Chicago Mercantile Exchange in February and really gave a boost to the whole "tea party" movement. If you thought that rant was something, wait and see what he has to say without the television cameras. You can look at our lineup as it evolves at neworleansconference.com.
TER: And you're giving subscribers a discounted rate for the conference, right?
BL: Yes, right now they can go to the website and subscribe for $400 off the full registration fee if they sign up quickly, because that price is set to go up. They also will be able to lock in rooms at the host hotel, and begin to receive free newsletters and special reports from our speakers.
DISCLOSURE: Brien Lundin
I personally and/or my family own the following companies mentioned in this interview: Bankers Petroleum, Hathor Exploration and Rare Element Resources.
I personally and/or my family am paid by none of the companies mentioned in this interview.
With a career spanning three decades in the investment markets, Brien Lundin runs Jefferson Financial, a respected publisher of market analyses and producer of investment-oriented events. In addition to being Jefferson Financial's President and CEO, he serves as publisher and editor of Gold Newsletter, the cornerstone of precious metals advisories since 1971. It covers not only resource stocks, but also the world of investing, macroeconomics and geopolitical issues. He also hosts the annual New Orleans Investment Conference.
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