No industry on earth has an existential problem like smoking.  They make billions of dollars (like, it’s getting close to $1 trillion) but kill millions of people.
 
The industry of course doesn’t want to kill the goose that lays the golden eggs—their customers—so they are always trying to find new ways to feed old habits.
 
Don’t get me wrong, harm reduction is a very real issue in the global smoking industry.  In fact, it’s kind of The Holy Grail for this $800 billion annual sector.
 
And this is an insanely profitable sector. After paying out billions of dollars annually in taxes, the Top 6 in the industry still made US$55 billion in 2018.
 
For venture capitalists, being able to tap into this revenue stream—even in a small way—means hundreds of millions of dollars. 
 
Look what happened to Podatech (PODA-CSE, now trading as IDLE.X-CSE) who sold a heat-not-burn product to Altria (MO-NYSE) for $100 million.  ONE HUNDRED MILLION DOLLARS for a well-engineered plastic product that allows smoking to continue but with only a very small fraction of carcinogens. (I covered PODA in early 2021.)
 
So when I saw Michael Saxon join TAAT Global Alternatives (TAAT-CSE) as CEO, I knew it was time to revisit this story.  He had been just an advisory board member for the last year, but jumped into the CEO role in May—right after TAAT bought its first tobacco distributor, ADCO, out of Ohio.

This immediately gave Saxon a much larger platform to turn TAAT into a large and much more profitable brand. It did US$87 million in revenue last year, and TAAT announced 2022 revenue guidance of $92 million.

As a former senior executive at both Philip Morris (PMI-NYSE) and Altria (MO-NYSE) Saxon knows the politics and business of smoking in Europe and North America.  He’s connected, he’s competent and he sees A Big Place for TAAT in the fast-growing harm reduction market. TAAT has no tobacco, no nicotine and 97% fewer chemicals.
 
“I think the TAAT product is part of the broader conversation in this space,” he told me over the phone this week. “When the product showed some early and promising signs that it was heading in a direction—that it could be part of the harm reduction conversation—that really piqued my interest.”
 
He says TAAT has a different strategy than the other junior entrepreneurs trying to break into this $800 billion market.
 
“Everybody so far in this harm-reduction conversation has tried to solve the problem with a ‘new-to-the-world-product’ as I like to call it.” (Think heat-not-burn or vaping…)
 
“But what our founder Joe Deighan did that was interesting was…other than those alternatives, he said there might be people who like the traditional form of cigarette. 
 
“I think our TAAT product looks and feels like the traditional product that smokers are already using every day. I think we’re asking for less of a hurdle in terms of the jump they need to make to make the switch to TAAT.
 
“This third version of our product has been refined to resemble the traditional smoking experience…all the hard work in product development has been done.”
 
Saxon is convinced that TAAT now has the right harm reduction product for this multi-billion dollar market—and the sales strategy to start making it pay almost immediately. In fact, urgency was the one theme that dominated our talk.  There is no existential angst here.  He is hitting the ground running, and fast.
 
“The key for a product like this is to make sure you’re available in the majority of the store—so that when they need to make that repurchase it’s easily available.

“You want to make it easy for them to find, and easy for them to purchase.  That’s  what we will be focused on over the next three months and that’s where we could make an immediate change here in my first weeks in the role.”
 
When you own a distributor, you get to quickly set your point of sales support, decide on pricing and be able to do whatever it takes to move product. 
 
TAAT paid just over $6 million for ADCO.  Big volume will bring EBITDA.  TAAT is meant to be even MORE profitable than traditional cigarettes. With no excise tax—because this is not a tobacco product—it can sell for a big discount to any other top-selling brand, and still generate huge cash flows.

Before ADCO, TAAT was selling its tobacco-free, nicotine-free “sticks” in 2500 stores and increasing sales at 10% per quarter—so they were doing OK.  And re-orders are often more than 50% of revenue—another great sign.
 
But to really ramp up product volumes and revenue, TAAT wants to be in tens of thousands of stores.  And to make that happen, TAAT needs to give the big distributors Big Data.
 
That’s what Saxon can direct ADCO to be doing.  They can now test marketing, product placement, product packaging and pricing across their own stores and the hundreds of other locations that they sell smoking products into.
 
TAAT can use ADCO to figure out what sales formats and strategies work best to get the volume and revenue up—and then pass that data on to much larger distributors. 
 
Those big distributors need that kind of sales data to KNOW that TAAT product sells strongly.  The big chains like Walmart, 7-11 and Circle-K don’t want to take chances on large product rollouts—they want to know it’s going to generate cash flow.
 
And now TAAT has the product, the CEO and the channel to make it happen—immediately.   Saxon has no existential angst; he’s on a harm reduction mission and believes he can hit some big revenue milestones in a hurry.

It’s a bear market.  That means that picking stocks just got a whole lot harder.

Bull markets are forgiving.  The trend of the market is up.  Most individual names will go up too.

Just stay away from the duds and in a bull market you can see your picks lifted along with all boats.

Not so in a bear market.  You are climbing up hill and lately it has been a steep one.  Today you fight both a higher chance of missing earnings and the chance that if a company does hit its target, the market sends it down anyway.

In this sort of market, you need to look for dislocations.  Where is the general dour mood of the market is causing too much bearishness – ignoring an easy win that you can exploit.

I came across what I thought was one yesterday.  At first glance it looked like an easy win – a layup. 

But nothing is easy in investing and that goes double for a bear market.
 

CERAGON NETWORKS – A PLAY ON 5G BACKHAUL

 
Ceragon Networks (CRNT – NASDAQ) is a name that I have been following for years. 

A 5G play!  Remember 5G?  It seems like for years 5G wireless has been hyped as the next big thing. 

I’m still waiting! 

But Ceragon is a small wireless backhaul equipment provider. They sell wireless receivers and gateways. 

Their customers are service providers, with their largest presence being in India.

Ceragon’s backhaul products are the middleman between the big base station towers and your phone. 

They handle the short leg of transmission to get the signal to the main trunk line where it can be routed.

They do it wirelessly, so they are used in areas where laying fiber is expensive or impossible.

Ceragon’s cell sites are placed on the side of a building, on a telephone pole, in a stadium, wherever there is traffic and where wireline transmission isn’t feasible.

I liked the idea of Ceragon because they are right in the middle of the 5G transformation.  They have a newly released 5G platform and other 5G products on the way.

But Ceragon has just never been able to get any traction.  COVID and a slow rollout of 5G has doomed the stock.

Source: Stockcharts.com
 

AN ALL-CASH BID

 
While I am seeing signs that 5G is back (baby?), where we are in the 5G rollout is now less important for Ceragon investors.

Why?  Because Ceragon received a takeover bid from Aviat Networks (AVNT – NASDAQ) yesterday – and its all-cash.

Aviat is offering $2.80 for Ceragon.  The offer represents a 34% premium to Ceragon’s price on Monday, and a 51% premium to the 60-day average.

That sounds great but….  a quick look at the chart tells you that bid is going to leave a lot of shareholders underwater.   Ceragon has traded a lot higher than $2.80 as recently as a few months back.

It is a low-ball offer right?  But is Ceragon seeing its business fall off the back of the truck, justifying it?  I can’t say that is the case.
 

CERAGON’S BUSINESS SEEMS CLOSE TO TURNING UP

 
In the first quarter Ceragon did miss analyst estimates.  Revenue came in at $70 million.  Estimates averaged $71 million with a high of $73 million.

But that miss was almost entirely due to supply chain issues.  On the call Ceragon said they saw “strong operating demand” and “exceptionally high bookings”, the highest in the last 4 years.

That doesn’t sound bad to me.

But Ceragon blew the quarter because they couldn’t deliver product. A well known story: component shortages and supply chain bottlenecks.

This is going to continue in the short term – Q2 will be weak. But Ceragon is projecting a better second half. 
While they reduced their fully year guidance – they did so only slightly – from a range of $305 – $320 million to a range of $300 – $315 million.

While the business is not booming, it is not falling apart either. Meanwhile 5G is gaining momentum – as slow as it may seem at times. 

A case could be made then when Ceragon traded below $2 in May and early June it was too cheap. 

Which means the bid premium is not as much as it seems.
 

WILL THE BID BE ACCEPTED?

 
Probably not.

Aviat has been targeting Ceragon since late last year.  In a letter to the Ceragon board, Aviat said that they had made offers in November and April.  Their Chairman and CEO went to Israel to engage with Ceragon a couple months ago.

It’s been a no-go.  The offers were rejected and Ceragon’s board was not responsive to requests to “engage in price discussions”.

Aviat is now going with a different approach.

Aviat holds ~5% of the outstanding shares of Ceragon. 

Because they exceed that 5% threshold, Aviat believes they have the right to nominate directors and have a special meeting called to vote.

They plan to nominate 5 directors for that meeting.

Right now, the Ceragon board has 7 directors.  The company bylaws allow for 9.

That means Aviat needs to win all 5 nominees to get a majority on the board.

 They need a 50% vote on these directors to get them voted in.
 

WHERE DO SHAREHOLDERS STAND?

 
Ceragon has a couple of large shareholders – the Joseph Samberg Trust and Zohar Zisapel.

Samberg owns a little less than 13 million shares, or 15% of the company.  The shares are held in a revocable trust, of which Samberg is the trustee. 

While the Samberg trust has owned shares of Ceragon since 2016, it substantially increased its holdings in late-2018 and early 2019.  This likely means he paid more for those shares than Aviat is bidding.

Ceragon filings are the only one’s the trust has made since 2019.  But I don’t see any indication that the Samberg Trust is involved in the daily business of Ceragon.  They appear to be investors in the stock.

Zisapel is a well-known Israeli investor.  He has big positions in many Israeli companies.  He is also Chairman of the board of Ceragon.  He owns 7.1 million shares or 8.5% of Ceragon.

Zisapel has sold shares in the past.  In 2020 he held 10.5 million shares.  He had reduced those down to the current amount in 2021, potentially during the blow-off period in early 2021.

Three of Ceragon’s 5 existing directors have close connections to Zisapel.   

They either have run or held high level positions in companies where Zisapel was chair.

It seems extremely unlikely that Aviat will be able to sway Zisapel’s vote. 

Samberg is a bit less certain, after all the trust seems to be an investor in technology stocks and while Ceragon has been a large investment, it’s conceivable they would sell at the right price.

The problem is that $2.80 is probably not the right price.  Most of the trust’s shares would be underwater. 

It is hard to imagine them accepting that.
 

IS THERE A PLAY HERE?

 
If there is, it is not for the faint of heart.

There is a case to be made that Aviat can pull this off, but it far from a sure thing.

What I am sure of is if Aviat wants to pull this off, it is going to take a higher price than $2.80.

I think that is the basis for a trade here.  It is not that this deal is going to get done – I think that is a coin flip at best – but that Aviat has every intention of trying very hard to do so.

The bears would argue that higher bid can’t happen, because Aviat just doesn’t have the resources.

It is true.  This is big acquisition for Aviat.  They are acquiring a ~$230 million company for cash when they themselves are only slightly bigger than that.  They don’t have a large war-chest at the ready.

On the other hand, Aviat would have been stupid to not think they would have to make a higher bid.  

In fact, they went to Israel with the intention of negotiating after the $2.80 was on the table. It seems pretty clear Aviat is willing to go higher.

That alone makes a trade on Ceragon intriguing.  But it all comes down to price and risk.

When I started writing this article the discount to the offer was 15%. Right now it is 10% (Ceragon is trading at $2.55 at the moment).

I’d feel a lot better about getting at least a 15% discount.

Like I said, this deal is far from certain.

Apart from Aviat there are a couple of hedge funds with a combined 4% that have been reducing and would presumably be open to a deal.

But weigh that against the 8% that Zisapel owns and the Samberg shares and its an uphill climb.

The next step for Aviat is going to be a higher bid.  But that won’t happen until Ceragon’s board inevitably rejects the current one.

When they do Ceragon’s stock may swoon.

If it swoons far enough, I will consider taking a position.  Not because of my conviction that a deal gets done. 

But my suspicion that Aviat is going to keep trying.

European natgas prices are starting to rip higher once again.  They had settled a bit after going ballistic on news of the Russian invasion of Ukraine in February.

In February it was The War News that caused the price spike.  This time Euro gas prices are surging because supply is being intentionally choked off.

What was feared is now actually happening.  Putin is using natural gas as a weapon against Europe.  Natural gas flows from Russia have suddenly been cut by two-thirds.

For some countries Russia has cut off supply by 100%.  For others the cut has been 10-15%. (2)

The general view from European leaders is that Putin won’t cut the gas supply off completely during the summer.  But that this is a strategic weapon that he is much more likely to use in the winter when the weather turns cold.

You don’t fire your big gun until you know it can cause maximum damage.

When talking about Russia completely shutting off supply Luxembourg Prime Minister Xavier Bettel just told CNBC: “I’m fully aware that they can. They can. It’s their choice, natural choice. They can close or open.”

This is the nightmare scenario for Europe.  Now the continent is scrambling. They have the same problems the rest of the world has with energy—they have vilified fossil fuels, and to a certain degree nuclear, and renewable energy has not been able to fill the gap near quick enough.

In Germany, 56% of electricity still comes from conventional energy sources (natural gas, coal, nuclear) and only 44% from renewables (wind, solar etc). (1)

The German government has now triggered the “alarm stage” of their emergency natural gas plan.  This is defined as being when the government sees a high risk of there being a long-term natural gas supply shortage.

No kidding……..

Utilities in the country can pass on high prices to customers to help lower demand. The next step up from this level is when the government steps in and actually starts rationing supply. 

This is where Germany is headed——an energy emergency where “non-essential” elements of demand are cut in favour of ‘essential’ ones.

The Race Is On To Find Supply Before Winter

Germany has been rushing to fill up gas-storage facilities——but has made only modest headway.

Reserves are currently around 58% full.  Target storage levels are for 80% by October 1 and 90% by November 1.  But storage has recently stopped increasing.

Source: Pantheon Macroeconomics, The Daily Shot  

There is some urgency as every bit that storage is not full amkes them more vulnerable to Putin and Russia.  Nobody in Europe–or anywhere in the West–wants that.

Another unfortunate supply blow for Europe came from the June 8th Freeport LNG terminal fire which has taken 2 bcf/day offline that was supposed to be heading to Europe.

US natural gas prices fell 17% on the news of the Freeport incident and they still haven’t recovered. 

What is bearish for US natural gas prices–in this case is bullish for Euro natural gas prices.  It is supply that the Eurozone desperately needed.

German companies that drive the economy are now already planning for painful cuts to reduce output. 

They are also resorting to polluting forms of energy to try and reduce consumption of natural gas. 

Chemical giant BASF (the world’s largest) is planning which factories will cut output first. 

Management said that deciding which plants will be shut off first would follow talks with both politicians and customers——some of its products are essential for pharmaceutical and food production.   War time decisions being made by a for-profit business.

Their rival Lanxess is delaying shutting coal-fired power plants.  Kelheim Fibre which is a major supplier to Proctor and Gamble is considering retrofitting its gas power plant to run on oil——burning oil for power was phased out of Europe a decade ago.

Desperate times call for desperate measures.

I keep saying Germany (which is Europe’s biggest economy)——but the crisis is impacting with 12 European Union member states affected and 10 issuing an early warning under gas security regulation.

Qatar has potential to be a great help in providing supply for the long-term, but the country is holding Europe’s feet to the fire.  Qatar is demanding that Europe sign undesirable long term LNG deals if they want more gas sooner.

The terms of these deals aren’t what Europe is looking for.  Qatar wants Europe locked for two decades of LNG purchases——something that doesn’t align with goals to reduce emissions and achieve climate goals.

Amazing that just half a year ago climate was by far the biggest concern when it came to European energy. 

Now the largest concern is whether European citizens are going to freeze this winter while also seeing a partial economic collapse.

Negotiations with Qatar have been in deadlock since March.

This sets up a very bullish market for domestic European natgas producers–potentially for years.  If there is peace in Ukraine tomorrow, Europe wants to wean itself off Russian gas and US LNG cannot compete with domestic supply economically.

Europe is going to need every single molecule of domestic natural gas supply that it can scrounge up.

There are very few juniors in this market.  As you may remember, I profiled Trillion Energy (TCF:CSE, TRLEF:OTCQB) to you earlier this year.

Trillion is developing a big, low-cost development project in offshore Turkey in the Black Sea.

This is not exploration—management is drilling seven BIG development wells over the next few months.  The Market wants this so bad, they were able to raise $37 million in just a few months.

The first well will spud within weeks, starting off a news flow that will keep investors steadily updated on results and cash flows.  And all this production will go straight up into the BEST natural gas prices that the industry has seen EVER.

Trillion’s delivery point will be Turkey where natural gas currently fetches $18/mcf. 

Wowza.

Again….these aren’t exploration wells.  The first 7 wells are already discoveries. This is simple stuff. 

The engineers know what to expect from the wells already drilled and the costs involved.  Management has said that operating costs will be less than 50 cents per mcf–and prices are over $18/mcf!! For sure costs have gone up in last few months–but the natgas price also doubled to $18/mcf!

This play is ready to go.  There are four offshore platforms, 16 km of pipe that have already carried natgas from 8 producing wells. News flow is about to start–for one of the only juniors in the best bull market in energy.

Source:

1. https://www.ans.org/news/article-3274/germany-coal-tops-wind-energy-in-2021-but-theres-more-to-the-story/
2. https://www.cnbc.com/2022/06/24/putin-is-squeezing-gas-supplies-and-europe-is-getting-seriously-worried-about-a-total-shutdown.html

Keith Schaefer

If you’re an investor over 50 years old,  you have a bar of gold in your head.

What I mean by that is—you’re aware of how gold is SUPPOSED to work in a diversified investment portfolio. It’s an inflation hedge; it’s an insurance policy…it’s nebulous now, in this market, but it’s in the back of your mind.

After watching this video on gold’s quietly growing role in geo-politics right now, it’s a little more front of mind for me — https://bit.ly/goldsreturn

Gold has actually done its job very well as a store of value in the last 20 years (gold stocks not so much).
 

Interviewee Frank Giustra—a highly successful mining entrepreneur among several careers—is a consistent believer in gold’s place in the world. 

He and Ian Telfer were the big lone wolf team at the end of the dot-com era in the early 2000s, saying gold would rise. 

They had bought into a Canadian mining shell called Wheaton River Minerals in 2001.

Folks, if you think sentiment toward gold is bad now, it is NOTHING like it was then.  The Dot-Com era produced more derision to gold than at any other time in modern financial history.

That was one of my first jobs in the stock market—working as the retail investor relations person for that company. 

The stock was 40 cents and we could not find buyers for what is now one of the most storied management teams in Canadian mining.  I couldn’t have learned from a better team.

As Frank points out in the video, they aggressively bought producing and development stage assets with a higher gold price in mind—so they weren’t being cheap.  That only got more people to doubt them!

But as gold moved higher through the 2000s (look at the above chart!!!), they moved Wheaton River up to several dollars per share, merged with Rob McEewen’s Goldcorp and sold that combined entity to Newmont NYSE-NEM for US$10 billion. They had the last laugh.

While they do mention their new grassroots gold junior (I am not long) I want you to listen to Frank’s comments on how the flow of gold has flowed EAST over the last 15 years.  Russia and China are setting themselves up to better break from the US dollar financial system that the entire world now relies on.  He goes into detail on this—the increasing geopolitical importance of gold–and shares some facts I had not connected before.

Of course, nobody knows what the tipping point will be for gold.  I think the coming Fed Flip—whenever that is—when the US FED stops raising rates, could be a big one.  The Greenback should drop then.

It could be the next US election; it could be a greater US involvement in Ukraine somehow…who knows. But the attitude towards gold now is what it was towards oil two years ago.

Here’s the video link again—a great weekend listen: https://bit.ly/goldsreturn

Gold and I, we have a love/hate relationship.  From mid 2019 – to mid 2020 — I loved it.  Since then, it has been a lot more hate than love.

Over 30 years, I’ve stuck with gold through good times and bad (apart from stop losses that is).

I have tried to believe in the yellow metal while others scoffed.

Gold is quite frustrating right now–because the set up for gold is REALLY good.  Its next big move could just be on the other side of this market downturn.  If it doesn’t move then…I don’t know.  To me, that would be THE time for gold to put up or shut up.

If gold can’t make its move on the other side of this market downturn, I’ve got to re-assess how much attention I give gold. I mean, we have 8% inflation.   We have nearly 6% core inflation.  We have slowing growth.  US GDP fell in Q1 by 1.5%.  Best estimates for Q2 are that it was flat. 

This is 70s style stagflation folks.  Yeah, we can blame energy, we can blame COVID, we can blame supply chains.  But its always going to be something.  It is stagflation, no need to mince words.

It’s not just about energy.  As Capital Economics noted last week, there were “ominous signs” that cyclical inflation was mounting, with “rent and OER prices both up by a stronger 0.6% month over month, while food away from home prices rose by 0.7%.”

At the same time, financial conditions are getting tighter.  According to Citigroup they are tightening rapidly after a benign backdrop the last two years.

Source: Citigroup

In a world of tightening conditions, gold remains one of the only assets that is no one’s liability.   No one’s liability – in good times this phrase hardly matters.  But when the tide goes out, your counterparty means everything (look at almost everything Bitcoin right now…).

Next, we have Russia.  Two weeks ago, the Russian central bank said that they expected Asian and Middle Eastern central banks would rethink their reserve strategies in light of what happened to Russia.

The bank said “”One could expect an increase in demand for gold and a decline in the U.S. dollar’s and the euro’s role as reserve assets” given that those dollar and euro assets aren’t necessarily money-good if you step offside the West.

There have been plenty of rumors and rumblings about Russia (and China) and the role of gold in their currency.  Gold never made more sense to a central bank than it does now.

Finally, FINALLY – we have Bitcoin.  Digital gold, the new store of value, the better form of bullion, all the cliches.

Well Bitcoin is now down by more than 2/3 from its peak.  It’s monikor as store of value has been tarnished, at least for now.  While I would never count Bitcoin out, it will take time for it to recover its luster.

Putting this all together – could there be a better backdrop for gold?

ARE REAL INTEREST RATES REALLY REAL?

 
If the outlook is bright, why has gold not moved?

One answer; two words–real rates.

I remember a time about 15 years ago when no one really talked about gold and real rates.   Back then gold was about trade deficits and quantitative easing.

But today any discussion of gold is tied at the hip to real rates.  Gold and real rates are now like tom-A-to and tom-a-to.

I understand the link.  Gold is an asset that does not have yield. Real rates describe the rate of interest you get on a bond (usually measured by the 5y or 10y bond) after inflation.

When real rates are negative, gold yields more (zero is more than a negative number).  That is good for gold demand.

But in 2022, real rates have gone way up–obviously a negative for gold. For the first time since 2019, bonds are yielding a real return after inflation.

Source: Multpl.com

But wait.  Didn’t we just say inflation is 8%?  Core inflation is 6%?  How can you have a positive real return with the 10 year at 3%?

Ahhh, well now we are getting to the crux of the matter.

WHAT IS A REAL RATE ANYWAY?

 
What is often overlooked is that real rates are really just an educated guess.

We don’t know what the inflation rate is going to be over the next 5 or 10 years.   To come up with a 5-year or 10-year real rate, we have to guess at it.

In the absence of knowing, we go with what the market says.  What is the market paying for an inflation adjusted bond?

The United States Government issues just such a bond – a Treasury Inflation Protected Securities (TIPS). 

TIPS include a mechanism whereby the principle they pay out is adjusted with inflation.   Essentially the government pays you more if inflation goes up.

TIPS yields were deeply negative after COVID–good for gold.  Today TIPS are positive, having popped up quite a bit since Jan 10–not so good for gold.

But TIPS aren’t telling us what inflation will be.  They are just telling us what the markets best guess is right now.

The markets estimate of what inflation will be over the next 10 years has gone up but it is still not that high – about 2.85%.  With the 10-year at around 3.5% – presto – you have a positive real rate.

But it’s all a bit of hocus-pocus.

Markets are not good predictors at inflections.  They under-estimate and then over-estimate.

The reason 10-year rates have taken off is not because we are worried about 2.85% inflation.  It is because we are worried about 8% inflation.

Chances are either the 10-year rate is too high or the market’s guess at inflation is too low.

If we go back to a 2-handle on inflation, I GUARANTEE YOU 10-year rates are coming down too.

WHAT DOES THIS MEAN FOR GOLD?

 
I believe that one thing preventing gold from moving higher is this mismatch in the inputs to real rates.
Investors are shying away from buying gold because they are worried about the rise in real rates.

But that rise in real rates is not quite what it appears to be – it is more about comparing an apple to an orange.

At some point this is going to change.

Maybe it already is?   Flipping the argument, I’d point out that even though real rates have risen quite a bit – gold has not gone down.

There are forces that have certainly tried to take gold down.  There have been many days with big drops.   But each time, gold recovers.

I suspect this is because investors are recognizing what I just described.   They have concluded that real rates are not telling us the whole story and that this is not the time to sell gold.

The other thing is that…going into panic market meltdown, everyone just reaches for the US dollar, which remains the most liquid and most transparent investment vehicle in the world–by a very wide margin.

But when the Market thinks rates have peaked–the USD comes down, real rates come down and shouldn’t that WHOOSH up gold?

WHAT TO DO?

 
One option is to just buy some gold stocks.

But gold stocks have their own problems right now–like energy; oil, diesel, gasoline and natural gas prices.  The price to run the machinery and keep the lights on has gone up a lot. Those Q2 cash costs are going to be sky-high.  That is bound to be a headwind for the miners unless the price of gold gets moving very soon.

If you are going to go with a gold stock, the bigger one’s are handling the cost pressure better.

Junior producers have seen their costs go through the roof.  Cash costs of over $1,000 per ounce were the norm in the first quarter.

Meanwhile the biggest miners like Newmont (NEM – NYSE) and Barrick (GOLD – NYSE) have managed to hold the line.  These miners still have cash costs in the $800 per ounce range. 

The reason, I suspect, is that majors have more leverage over their suppliers.  They also have more efficient fleets of equipment, having spent the cash to electrify their fleet away from being diesel guzzlers.

They also have teams that can mine sequence and high-grade when they need to get through the inflationary times without it impacting the bottom line as much.

Still with the nagging cost pressure, this might be the time to just buy gold itself.

To do that, there are lots of plain-vanilla gold ETFs, with the SPDR Gold Shares (GLD – NYSE) being the biggest and most liquid.

But if gold is really going to shine, there are some ways to take more risk.  The levered gold ETFs magnify the upside and the downside.

The one I am most familiar with is the Proshares Ultra Gold ETF (UBL – NYSE), a 2x bullish ETF linked to the price of gold.

The caveat here is that like all 2x ETFs, the fund looks to seek a return that is 2x the move in the gold price for a single day.

The ETF hold swaps and gold futures that are about double the size of the fund.   Because it has to roll these positions over, that can mean that over longer periods the performance of the ETF is not necessarily 2x. 

Consider that from the beginning of the year until the end of May the price of gold was essentially flat, but the UBL returned -2.05%.

With that in mind, the way to play any 2x product is to wait for the move to start.

You don’t want to just buy UBL and sit on it, because chances are if gold does nothing you will lose money.
With gold that must be the base case.  Regardless how bullish the outlook, or how many stars align.

Because doing nothing is what gold is doing best!

Every form of energy is going through the roof.  Oil, natural gas, refined products, coal – you name it, if it’s a fuel, it is going up.

Except for one.  Uranium prices, which caught fire in the fall and again during the first few weeks post-invasion, have taken a tumble.

The spot price of uranium traded as  high as $58 per pound in March.  But they have fallen back to below $50 since. 

Source: Morgan Stanley

What’s going on here?  Shouldn’t uranium be flying high as we re-evaluate the path to zero carbon while at the same time trying to ban every energy export out of Russia?

Well, it turns out that the Russian invasion of Ukraine is the cause of the slide in uranium prices.   But it’s not what you think and not at all bearish.

HOW THE RUSSIAN INVASION GUMMED UP
THE URANIUM SUPPLY CHAIN

Leading up to the Russian invasion uranium fundamentals were on the rise.

In 2021 and early 2022 utilities were laser focused on shoring up their uranium supply.

Last year, the price of uranium rose by 45%, going from about $29 per pound at the start of the year to $50 per pound in September.

There was a fundamental story that was gaining traction.

The Russians invasion changed that.   How?  It diverted the attention of the utilities to a bigger problem – their uranium conversion and enrichment supply chain.

As an electricity producing fuel, uranium is not like the others.  With coal or natural gas, what you get is what you use.  You buy it and you burn it.

Not so with uranium.  Uranium needs to be processed before it can be used in a reactor.

Specifically, reactors need a particular isotope of uranium – U-235.  Mined uranium has about 0.7% U-235 content.  Reactors need that content to be “enriched” to a higher value – 3% to 7% for most legacy reactors and up to 20% for newer high-efficiency reactors.

The two key processes to make uranium “reactor-friendly” are conversion and enrichment.


Source: World Nuclear Association

Conversion consists of turning mined uranium (uranium oxide) into uranium hexafluoride, or UF6.  UF6 is a gas and a necessary precursor material for the enrichment process.

There are not a lot of conversion plants out there: only Canada, France, Russia and China have them.  There is one plant in the United States, owned by Honeywell (HON – NYSE) and General Atomics (PRIVATE).  But is closed and not expected to restart util 2023.


Source: World Nuclear Association

Most importantly, Russia has 27% of global conversion capacity.

Once converted, the uranium needs to be enriched.  The process of enrichment is essentially taking the UF6 and filtering out more of the U-235 isotope that the reactors need.

There are a few ways of doing this.  Most enrichment facilities today use centrifuges to “spin out” the U-235 isotope.  There is a newer Australian process in development (more on this later) that uses laser excitation to increase U-235.

Since Fukushima there has been way too much enrichment capacity.   As the World Nuclear Association (WNA) stated at the end of last year: “there is a significant surplus of world enrichment capacity”.

No one has worried about a shortfall of enrichment capacity.  Until Russia went rogue that is.

According to the WNA about 90% of world enrichment capacity is in the five nuclear weapons states… 

And about half of that is in Russia.  Whoops.


Source: World Nuclear Association

THE RUSSIAN CORNER

Taken all together here you can see the issue.  Russia has 50% of global enrichment capacity.  27% of global conversion capacity. 

Cameco’s CEO Grant Issac described it at a recent Bank of America conference:

“Us and our competitors in the industry were seeing a lot of interest in uranium. But that changed also on February 24. Utilities shifted their attention from where’s my long-run uranium coming from to where’s my enrichment and conversion going to come from”

Since the invasion, we have seen a 40% jump in enrichment prices, from $70 to $120 per unit. Cameco described it as “a panic”, saying conversion is “about as hot as we’ve seen it ever”.

But uranium is not forgotten.  It’s just taken a back seat for the time being.

Once the enrichment and conversion capacity has been locked up, utilities will get back to focusing on uranium.

URANIUM WILL COME BACK INTO FOCUS

Uranium has very concentrated production itself.  The top 4 producers have 56% of total production

• Kazatomprom: Kazakhstan-based, ~21% of production; 13 mining assets located in Kazakhstan
• Cameco: Canada-based, ~15% of production; ‘tier-one’ operations in Canada and Kazakhstan
• Orano: Paris-based, ~13% of production; production sites mainly in Canada, Niger, and Kazakhstan
• Uranium One: Wholly-owned subsidiary of Russian state-owned Rosatom, a Canadian uranium mining company headquartered in Toronto, ~8% of production

Russia makes up 14% of worldwide production and about 20% of production that is exported to the United States.

In addition, about 50% of the uranium mined in Kazakhstan (they are the biggest uranium producer in the world) is transported through Russia, via the port of St. Petersburg.

This is all material that goes to Western power producers. 

It is a precarious situation.

On the Western end we have legislation pending in Congress to cut-off access to Russian material.

On the Russian end, there are plenty of threats that they will cut it out from their end in retaliation to other sanctions.

The bottom line here is that more Western capacity will be needed to meet Western demand. 

BUY THE DIP

While questions surround future supply, the interest in uranium has never been higher.

According to Cameco CEO Tim Gitzel, “things are moving very quickly in our industry, and we’re seeing countries and companies turn to nuclear with an appetite that I’m not sure I’ve ever seen in my four decades in this business.“

It sounds like a recipe to buy the dip.

There are a couple obvious ways to do it.  First, buy uranium.  The Sprott Physical Uranium Trust (U.UN – TSX) is trading all the way back down to where it was before Russia invaded Ukraine.


Source: Stockwatch.com

The trust is an investment vehicle for uranium – all of its assets in uranium in the form of U3O8.

The Sprott Trust made headlines last fall when its buying of physical uranium for the fund contributed to a rise in prices, setting off a virtuous circle.  That could happen again.

Second, just buy Cameco.  The biggest western uranium producer.  The only western source of operating conversion capacity.  Cameco stands to benefit from all the steps in the process.  As uranium goes, so goes Cameco.

DOWNSTREAM PLAYS – NOT A LOT OF OPTIONS

These are good ideas, but what I would really like is a targeted play on conversion and enrichment.

It’s a no-brainer that conversion and enrichment capacity will come back to the West.  Companies focused on the uranium supply chain should be big winners.

The trouble is finding the right company to fit the bill.

That’s probably not surprising.  These are niche processes with only a few operating plants.  The whole opportunity is in front of us because so much of existing supply comes from Russia.

There are two public companies with a foothold in conversion and enrichment.

The first and only North American traded one is Centrus Energy Corp (LEU – NYSE).

Centrus looks really good and really bad.  The bad is that right now Centrus is basically a middleman.  They generate revenue from buying enriched uranium from overseas producers and selling it to utilities.  

Unfortunately their main supply of enriched uranium is from the Russian company Tenex.

That makes Centrus directly in the site-lines of any coming sanctions on Russia.

The good is that Centrus has a head start producing enriched uranium in the United States.

Centrus operated an enrichment plant in Piketon Ohio until 1997.  Last year, the Nuclear Regulatory Commision (NRC) gave Centrus a license at Piketon to enrich uranium up to 20% (this is called high-assay low-enriched uranium or HALEU) using centrifuge technology. 

This is the only license of its kind.  Centrus is in the process of building the demonstration facility.   They said on their Q1 call that they now plan to supplement HALEU production with low-enriched uranium (LEU) production, the type that could be used by existing reactors in the US.

It sounds promising.   But there are more wrinkles.

The DOE partnership originally had a scope that included operations beyond the demonstration phase.

That sounded great – it meant a runway to fully operational enrichment.  But the DOE changed the terms in February, instead splitting the project up into two phases – with the second, operational phase up for another yet-to-come bid.  Centrus says they are well positioned to win this, and well, they should be – but this is government so…

Nothing is certain here.

Maybe the most intriguing thing about Centrus is the recent insider buy.  A director at Centrus recently bought over a million bucks of the stock.  Makes you wonder what they see?


Source: INK Research

The second name in the conversion and enrichment mix is an Australian company SILEX Systems (SLX – AU). 

The strike here is that I don’t invest in Australia.  But if you do, SILEX might be worth a look.

SILEX owns 51% of a joint venture called Global Laser Enrichment (GLE).  Cameco owns the other 49% with an option to increase their ownership to 75%.  SILEX also holds a 7% royalty on revenues GLE makes from the process.

SILEX licenses the rights to use their laser enrichment technology to GLE. This process is more advanced and higher efficiency that the centrifuge process.


Source: SILEX Systems Investor Presentation

SILEX is in the midst of a pilot at its Paducah Kentucky facility, with commercial operations expected in the late-2020s.


Source: SILEX Systems Investor Presentation

Maybe most interesting, SILEX also has announced they plan to bid on the operational phase of the DOE/Centrus HALEU project.  It is worth considering whether the DOE redefined their project scope to allow SILEX/Cameco and their new technology to get in the race.

JUST BUY URANIUM AND FUHGEDDABOUDIT

While both Centrus and SILEX are interesting, both companies are still years from commercial production.

These stocks are a lot like buying a copper exploration project because the price of copper is taking off.  Not usually the best expression of the idea.

While it would be great to take advantage of a seemingly sure bet on onshoring the uranium process, the simpler path is just to buy the uranium dip.

If you want some upside on conversion and enrichment, Cameco can give you that.

Utilities will refocus their attention on uranium procurement soon enough.  When they do, we will be starting at a uranium price that is way higher than it has been in years.

The long-term outlook for uranium looks better than it has in years.

And the chance of an upside surprise, either from Russia banning exports or the West banning Russian imports, could mean a payoff overnight.

GOLDEN AGE

WHAT HAPPENED?

1. A recovery in demand as travel comes back
2. Capacity rationalization – shutdowns of refineries from COVID
3. Changes to export flows – in particular the US becoming the marginal supplier of refined barrels to the world

A BOOM TO THE BOTTOM LINE

HOW LONG?