Commenting on what he views as an inevitable hike in commodity prices—and an equally inevitable shift into inflation—James Passin considers a nuclear renaissance a sure bet too. James is the co-founder and portfolio manager of Firebird Global Master Fund, Ltd. and Firebird Global Master Fund II, Ltd. In that role, he has made considerable investments in uranium, an indispensable element in the nuclear equation. In this exclusive interview with The Gold Report, James discusses the changing landscape of nuclear technology and shares his love of gold and his thoughts about where its price is headed in the coming years.
The Gold Report: In the context of all the craziness that's been going on in the markets, would you provide us your macro-level overview about what's happening with commodities and oil and gas?
James Passin: Oil and natural gas are interesting right now. My personal view is that we've seen the bottom. Energy prices are unsustainably low. Broadly speaking, the unprecedented credit crisis has triggered a host of feedback effects, which have resulted in driving down energy prices and, in fact, the prices of almost all assets.
The spectacular drop in the price of oil, for example, has been driven by the breaking of the speculative bubble that drove up the price to unrealistic levels in the first place. But the bursting of that bubble has been compounded by collapsing economic conditions.
There's no credit lines needed to finance purchases, so we're seeing catastrophic global demand destruction. We also are seeing something new, which are the effects of the exchange-traded funds on commodities.
TGR: What sort of effects are you talking about?
JP: The gold ETFs, oil ETFs and other ETFs actually became quite significant holders of commodities, which contributed to rallies earlier in the year. But aside from just becoming buyers, they actually changed the structure of the market by moving commodities that would otherwise be loaned out and available to borrow into forms that prevented them from being loaned out. So not only did you have buying pressure, but you had a continual reduction in the availability of commodities to borrow.
Then as these ETFs have come down, we've seen the opposite. We've seen ETFs liquidating commodities and thus increasing the availability of commodities that can be loaned out, leading to ever-increasing supplies.
At the same time, we've seen forced liquidation of a number of hedge funds specializing in commodities.
We've also seen something quite interesting in oil in particular. Airline hedge books have come under tremendous pressure. Those hedge books are now suffering from tremendous marked-to-market losses and there may have been some forced liquidation of airline hedge books.
TGR: What role does the dollar play in all of this?
JP: I'd say the overarching issue has been the strength in the U.S. dollar, which has completely undermined the commodity bull market as commodities are priced in dollars. The dollar rally has certainly hurt the nominal price of commodities, but the dollar rally coupled with the rally in U.S. Treasury Bonds has gradually led to a rising consensus on the view that the world is trapped in a deflationary spiral.
So we now have the deflation trade, which is expressing itself in the selling of commodities and the purchasing of Treasury Bonds and Treasury Notes and Treasury Bills. This deflationary view, which is gradually becoming consensus, has led to the final sort of death knell for the commodity trade.
TGR: People are agreeing that we're in a deflationary spiral, but won't all of the currency being generated now by the U.S. government eventually create inflation?
JP: Mainstream economists have the mistaken idea that inflation is the result of tight labor markets. Spend even five minutes in Zimbabwe; you'll find no employment and yet inflation on an annualized basis over 500 billion percent. I find it quite interesting that Dr. Gono, the Governor of the Central Bank of Zimbabwe, in the First Quarter Monetary Policy Statement of the Central Bank of Zimbabwe, just enthusiastically endorsed U.S. monetary policy. He pointed out that the Fed is doing what the Zimbabwe Central Bank started doing four years ago. This might suggest what's in store for the United States and for the world.
The unprecedented creation of liquidity will result in inflation; the debasement of money is inflation. Eventually it will manifest itself in uncontrollable increases in prices. In the short term, the depressing effect of de-leveraging and the forced liquidation of all assets are masking this inflation. But the ultimate end game is going to be inflation emanating out of the United States.
I think it's quite an interesting time to bet against deflation. The deflationary view would lead to shorting commodities and commodity stocks and buying U.S. Treasury securities. It's very interesting that the U.S. just auctioned Treasury Bills with a yield of zero. This is the first time that I'm aware of that there's been a zero-coupon debt instrument issued.
TGR: And they're selling them.
JP: I think $30 billion of Treasury Bills were purchased with a zero yield. And short-term Treasury Bills in secondary markets are now trading with a negative yield. It's extremely interesting, especially in light of the horrible fiscal position of the Treasury. The Treasury has replaced a lot of its assets with ownership of insolvent financial institutions and is essentially committed to monetizing all of this toxic debt. And yet the U.S. Treasury is able to borrow with zero cost. I applaud that; they should keep borrowing at zero cost. I wouldn't be surprised to see new Treasury Bills issued with a negative coupon. Why not make people pay to loan money to the U.S. Treasury?
This really is a manifestation of a deflation bubble, which will prove to be short-lived. At this point I don't have a short position in U.S. Treasuries, but I think it's an interesting time to begin contemplating shorting U.S. Treasury, given the cost of servicing that position is effectively zero.
The corollary of what's going on in the Treasury market is what's going on in the commodity market. Commodities have now collapsed and the CRB Index is back to multi-decade lows. There are quite significant short positions in all of the exchange-traded commodities and most commodities now are at levels that are very quickly ruining mining companies. A number of projects that were previously quite profitable are now unprofitable and there's no debt or equity capital to finance the losses needed to sustain production. This is leading to wholesale abandonment of mining projects, of energy projects.
If commodity prices stay at these levels for very long, given the absence of capital for anything, we're going to see a dramatic reduction in the output of raw materials. The interesting question really is to what extent the resource industry's financial pain and the ensuing destruction of raw material output will offset the falling demand.
We're starting to look for signs of distress in the commodity market, the kind of signs that would signal the bottom. We're seeing that everywhere from the collapse of hedge funds focused in commodities to the hundreds of junior resource companies that have market caps below their cash on the balance sheet. I think we've reached a point where if you have the time horizon and risk appetite, the market will reward you for aggressive bets on commodities.
TGR: If this massive de-leveraging that's occurring now is a short-term bubble that results in the commodity mining projects being canceled or postponed, wouldn't all of the stimulus and infrastructure projects we're hearing about in the U.S., China and elsewhere, help turn that commodity price back upward?
JP: Absolutely. China and the United States under Obama will lead the world in fiscal stimulus and that fiscal stimulus is going to be focused on infrastructure. So the raw materials required for that infrastructure and the general stimulative effect of that infrastructure build is going to have quite a significant impact on the overall world economy. Getting in front of that fiscal stimulus, especially in the current environment when there's forced liquidation of all assets and this historic opportunity to buy resource stocks at these levels, makes sense. I think that under this current environment you'd want to put some money at risk, because by the time it becomes clear that the fiscal stimulus is having some kind of effect, the first massive gains would have already been behind us.
TGR: Would you put the money at risk in commodities or in the equities?
JP: It depends on your ability to trade commodities. Personally I think having a little bit of exposure to commodities makes sense, but I'm not an investment advisor, so I really can't provide investment advice to anybody.
TGR: What about putting some of your investment in the hedge against potential inflation primarily into precious metals, specifically gold?
JP: I love gold right now. There are some very interesting ways to bet on the gold price. I think that gold is going to be well north of $1,000 an ounce over the next several years if not significantly higher than that. There's incredible value in the gold sector from my perspective. Gold's actually a fantastic bet right now.
TGR: Do you feel the same way about silver?
JP: Silver is less clear. It's harder for me to find the equity vehicles to play silver that I want to buy, but I think that silver certainly has a lot of upsides as a monetized commodity.
TGR: Since gold is a commodity that individual investors could actually take physical control of, would you recommend physical or going into pooled accounts or into the equities?
JP: Again, I'm not an investment advisor, so I'm not going to recommend any particular investment to anybody. What I'm doing personally, though, is I own some gold coins and my fund has investments in gold stocks.
TGR: You liked uranium early this year when we talked with you. You'd been investing in uranium stocks since 2001, when uranium was trading at a record low of $7 a pound, and said—at the time—that powerful supply-and-demand fundamentals would support a higher uranium price. You also talked about the inevitability of the nuclear renaissance. You were really big on uranium and, in fact, at that point you'd unloaded a bunch of uranium at a really high price. Now that the commodities are all shaking out, do you still see uranium as a potential good investment and, if so, why?
JP: It's very interesting that uranium, which led the energy complex on the way down, is now starting to rebound. The uranium price certainly appears to have bottomed. A lot of the uranium mines, which were for years touted as an important source of new production, are proving to be total disappointments. The billions of dollars raised by so-called uranium companies during the uranium bubble will result in very few additional pounds of production.
TGR: What do you mean by so-called uranium companies?
JP: There are probably over 800 uranium companies. If you were to look through the ranks of these companies, very few will ever produce uranium over their corporate life. Most of them are lifestyle companies for the management and promoters and speculative vehicles for investors. But unfortunately for the consumers, they will not be real producers of uranium. The world is still consuming more uranium than it's producing. The U.S. still gets 40% of its nuclear fuel not from uranium mines, but from Russian warheads under an agreement expiring in 2011.
Given the current state of relations between Russia and the United States, I don't think we're likely to see that agreement renewed or extended. Therefore, the United States is going to have to find some alternative source for uranium, which I think means investing in uranium mining projects.
If the enriched uranium from Russia stops being available after 2011, there will be quite a price shock. The utilities in the United States are going to begin to accumulate inventory in front of 2011, which put a bid under the uranium price.
One of the unanticipated consequences of the credit crisis is a deceleration of the nuclear renaissance. Nuclear reactor construction requires large amounts of debt and unless you're the U.S. Treasury issuing zero-coupon notes, no one seems to be willing to lend anything. Even though nuclear reactors are fairly low risk compared to other large-scale industrial projects, the absence of credit will inevitably slow down nuclear reactor construction.
TGR: It's interesting that a year ago, everyone claimed the whole reason behind rapid uranium price increases was the fact that there were so many nuclear facilities on the books for China, India, and even the U.S. Given that financial crises may delay, postpone or eliminate many of these projects, can we expect an increase in uranium price just fulfilling requirements for current reactors? Or do we need new ones to justify an increase?
JP: There's still quite a significant shortfall between production from mines and consumption by nuclear power plants.
Another factor will be disappointment in terms of the lack of new production. Most of the speculators have already liquidated. It's unlikely that the uranium price will decline significantly on any kind of sustained basis.
To increase the price significantly, though, we need a wave of nuclear reactor construction. With natural gas and coal prices checking back, the economic case for nuclear becomes less clear. However, the world politically has decided that it needs to diversify away from oil, away from hydrocarbons. Obama's advisors have made it clear that he is very interested in achieving mandatory carbon emission reductions. Any kind of realistic plan involving reduced carbon output in the United States is going to require embracing nuclear power aggressively. My feeling is that Obama will enthusiastically embrace nuclear power.
TGR: Would you say you're still bullish on the supply side of nuclear facilities, specifically nuclear construction? Or a little cautious?
JP: I don't think the number of nuclear reactors built in the next 20 years will be any lower than we're forecasting, but the initial rate of construction will be slower than anticipated.
TGR: You talked before about the importance of beryllium for certain critical components inside nuclear reactors, because of a combination of physical properties—lightweight, strong, a high melting point, efficiency as a heat conductor, resistance to corrosion and a tendency to not absorb radiation. It's lightweight, strong, and resistant to corrosion. Could you update us on the outlook for beryllium now?
JP: One of the most interesting potential applications of beryllium is in mixed oxide fuel technology. Purdue University is a world leader in mixed uranium oxide fuel research. A small company, International Beryllium Corporation (TSX.V:IB), has licensed uranium-beryllium mix oxide fuel technology from Purdue University and is now collaborating with Purdue to commercialize the technology. Beryllium-uranium mixed oxide fuel, which could work in existing nuclear reactors, has the potential to dramatically reduce the need for uranium and also to improve the safety profile of nuclear reactors. There's no substitute because of the unique thermal characteristics of beryllium.
This technology has the potential to transform the economics and political acceptability of nuclear power. Aside from this potential application, beryllium is used in certain critical nuclear reactor components and therefore an interesting play on nuclear power plant construction.
TGR: Judging from your explanation, it sounds like a great play even on existing facilities. We don't need to build any new ones for this to be a good investment.
JP: The technology could help ease the uranium shortage. There is some efforts required to complete research, but I have a strong degree of confidence in its commercial prospects.
TGR: So in essence International Beryllium is really more of a technology play than a commodity play.
JP: Yes. But I would not overlook International Beryllium's two manufacturing divisions. Last year, International Beryllim acquired two manufacturing companies, which are generating revenue and EBITDA for the parent company. These manufacturing divisions are involved in industrial applications of beryllium, not nuclear applications, but they provide a solid platform for International Beryllium's strategic objectives. International Beryllium also controls beryllium exploration properties and a few historically producing beryllium mines. Its property in Utah, the Spor Mountain extension, is very intriguing. Spor Mountain is a huge beryllium mine that is the source of 60% of the world's beryllium output; International Beryllium's claims are adjacent to Spor Mountain. In the short term, the company's primarily focused on increasing the profitability and efficiency of its manufacturing divisions and continuing to develop the mixed oxide fuel technology.
TGR: Any other plays or companies that intrigue you?
JP: Yes, and it involves depleted uranium. The nuclear fuel cycle creates two environmental problems: depleted uranium, which is the byproduct of uranium enrichment, and spent fuel rods. The nuclear industry has been quite clever at recycling spent fuel rods. So the last problem is depleted uranium.
TGR: What's the issue with depleted uranium?
JP: Some 90% of the output of uranium enrichment is actually waste material called depleted uranium hexafluoride. It's very toxic, horrible stuff with—to date—no economic value. And the world's producing 250 million pounds of depleted uranium every year as a byproduct of the uranium enrichment. As new uranium enrichment plants are built to handle the increasing demand for nuclear fuel, that number is going to increase dramatically and there are vast stockpiles already. The Department of Energy has almost 2 billion pounds of depleted uranium in the United States and there are similar stockpiles in Europe and Russia.
The good news is that International Isotopes Inc. (OTCBB:INIS), a U.S. company, has developed a fluorine extraction process. This is a potential means of harvesting the fluorine atoms in depleted uranium and producing fluorine gases and other valuable fluorine products out of depleted uranium. That has the effect of actually eliminating depleted uranium, and so it solves its major environmental issue in the nuclear fuel cycle. It also extracts potentially billions of dollars of value from these trapped fluorine atoms.
TGR: Is the investor knowledge base about depleted uranium sufficient to bring International Isotopes back up when the market comes around? Or is it more likely to lag a market rebound?
JP: International Isotopes isn't a liquid stock.. But given the importance of its technology to the nuclear fuel cycle, given the caliber of the technology and given the company's success at commercializing the technology, my view is that it has the potential to be quite a significant winner.
TGR: It sounds like an amazing technology process. Will it gain traction with Obama focusing on more nuclear facilities?
JP: Any plans to have nuclear be the means through which to meet carbon requirements without really damaging the U.S. economy will have to deal with the environmental side effects of the nuclear fuel cycle. Eliminating depleted uranium would be an obvious and clear step toward improving the political acceptability of nuclear power.
Describing him as the Indiana Jones of frontier stock markets, the Financial Times praises James Passin for visiting rough, difficult places…rather than swanning around the more comfortable nightclubs… A graduate of St. John's College, James majored in philosophy and classical literature. He is a former editor and research director at investment newsletter Taipan. Firebird Management, LLC, James' home away from home for the past decade, manages four private funds dedicated to investment in publicly traded equities of companies operating in the former Soviet Union and early-stage Eastern European countries, as well as two global portfolio equity funds. Firebird also co-manages two private equity funds focusing on the Baltic States. James serves on the Board of Directors of National Investment Bank of Mongolia; Sharyn Gol, a coal producer listed on the Mongolian Stock Exchange; and Maghreb Minerals PLC, a mineral exploration company listed on AIM. He also serves as a director of several private, venture-stage international resource companies.