Drilling and exploration has been hit and miss over the past few years as British Petroleum caused a drilling moritorium after one of its ocean wells exploded. That hasn’t stopped a few of the small cap names from producing modest gains. Hercules Offshore (NASDAQ: HERO) is one driller with the right ingredients for a big move in share price. It has a low share float and high short interest (7%) providing explosive potential. With oil over $100 per barrel we believe drillers are poised for huge growth going forward. The stock has formed a pennant pattern on its 3-month chart and has used the 13-day exp moving average as support.

While you may think of a pizza franchise being a boring investment, Papa Johns (NASDAQ: PZZA) may prove otherwise. Taking over the pizza world, Papa Johns operates over 3,000 stores in 50 states. The company has a solid looking chart, breaking out of a 2-year base in recent weeks. As the company trends higher in coming weeks, we think it could make another run at blue skies. While the stock faces headwinds like rising commodity costs and weak consumer strength, sales somehow continue rising. Markets have sold off in recent trading, but Papa John’s continues to grind higher. Watch this stock over the next 3-months as it gains upside momentum.

NovaGold owns 50% interest in two of the worlds largest underdeveloped copper-gold properties. With proven reserves of over 17 million ounces of gold and another 12.5 million ounces of measured and inferred reserves, NovaGold is extremely levered to the price of gold. In fact, every 10 shares of NovaGold common stock represents 1.2 ounces of gold to investors. This number continues to grow each year with exploration and acquisition activities adding an average of 2.4 million ounces of gold to its resource base over the past 13 years.

In late 2007 NovaGold (NG) and Teck (TCK) announced they would delay plans to begin building mining infrastructure at Galore Creek. Feasibility concerns based on surging construction costs (5 billion) forced all Galore Creek projects to be put on hold. Investors were blindsided by the news, sending shares down over 50% the next day.  However, the bad news didn’t end there. Following the precipitous drop in stock price a class action lawsuit was brought against the company for ‘misleading statements’. Shares tanked even further on the news, bottoming in late 2008 near 40-cents from an all time high of $22.00 per share.

Long term investors who held strong during the turmoil might now be wondering when new plans for Galore Creek will emerge. You really have to wonder if the property is still deemed uneconomical with gold near $1250.00 per ounce and energy prices slightly down from where they were in 2007. At the time of the discouraging news release gold traded at $825.00 per ounce, with crude oil near $85.00 per barrel.

Plans for a new feasibility study are currently underway. Several sources close to the company have hinted that plans to start construction at Galore Creek will begin in late 2011. Teck  has leveraged down it’s balance sheet since buying Fording Canadian Coal Trust late in 2008 – putting it in a better position to take on a massive project like Galore Creek.

“NovaGold and Teck are hoping that the re-engineering and design work over the last two years, coupled with easing input costs, will help lower the capital investment required for the project. When the companies announced the project was being put on ice late in 2007, they revealed that capital cost forecasts for the mine had more than doubled, to as much as $5-billion. Construction costs went up in ’07 and ’08 but have actually come back down quite a bit since their peaks in mid-2008.”

-Investor Relations Manager Rhylin Bailie

Hedge funds have taken notice of these developments. The huge potential increase in margins has put NovaGold in the driver seat. Paulson & Co. and Soros Fund Management have taken large stakes in the company, collectively amounting to greater than 15% of the total shares outstanding. In a recent announcement, Paulson & Co has filed a 13D with the SEC indicating activist intent – declaring a  9.1% stake.

Paulson and Soros funds are well known for their gold investments at present time. What makes companies like NovaGold so special?

In order for junior miners like NovaGold to do well a few key things need to happen. First, gold must make a large sustained increase in price. This increase in price needs to occur proportionately faster than extraction costs like energy, labor and infrastructure. Lastly, companies must have huge proven reserves of gold to benefit from “economies of scale” where the average extraction cost per ounce decreases, since fixed costs are spread over a larger number of goods. The described scenario might be best supported in an economical environment where the United States has stagnant growth coupled with inflation, known as stagflation. After all, if gold prices and the costs associated with getting gold out of the ground move higher at the same rate margins won’t improve.

Are investors George Soros and John Paulson really betting on stagflation in the United States?  This theory certainly seems possible given our uncertain future. With unemployment holding steady near recent highs the consumer might be on the ropes. The United States economy is based 70% on consumer spending. You can’t help but wonder how consumption can stay elevated with such a high level of unemployment and tight credit. If economic prospects and unemployment numbers don’t start improving we could see additional stimulus paid for with money printing by the federal reserve. Debasing our currency always results in higher gold prices.

According to recent presentations from Paulson & Co, their thesis for gold is threefold. Firstly, they believe that the printing presses of money that have been working overtime in America and other countries will cause depreciation in paper currency. Secondly, they believe that demand for gold will increase, particularly as a reserve currency. In fact, they think gold could become the primary reserve currency again as they have been looking at gold as currency, not a commodity. Thirdly, their belief is that demand for gold in general will be far greater than supply, causing prices to head higher. Overall, they see a very high probability of inflation in America’s future and have selected gold related investments to hedge against this.
- MarketFolly.com

It would appear George Soros and John Paulson have caught on to the idea that in an inflationary environment you want to control as much gold and silver as possible. Taking large stakes in NovaGold allows them to accomplish just that. No other miner provides an equal amount of “bang for your buck”.  In 2006, Barrick offered $14.50 per share for Novagold and was quickly declined. Novagold’s board of directors stated the bid undervalued its massive unhedged reserves and future growth potential. With the price of precious metals making a dramatic rise since 2006, it would be reasonable to assume any takeover bids could reach $20.00 or more.

Novagold has an extremely favorable operating environment. Gold is nearing all time highs at the time of this publication, while input costs have eased proportionately. A reduction in the cost of mining infrastructure should allow Novagold to bring some of their mines online by 2015. With the end goals of the company in sight, Novagold presents a compelling speculative investment going forward.

Disclosure: At the time of publication the author was long shares of NovaGold (NG) and Barrick Gold (ABX).

Want to become a better trader? Click here to sign-up for a FREE trading e-course taught by a former floor trader!

Feasibility  ($1200.00 – $1300.00 = - $100.00)

In 2010, Company XYZ has 1-million proven ounces of gold with extraction costs of $1300.00 per ounce (when accounting for input costs like infrastructure). Since gold is currently trading at $1200.00 per ounce this company cannot profitably mine any gold in their reserves. All reserves sit idle and are deemed uneconomical for the time being.

Increasing Asset Prices ($2400.00 – $1800.00 = + $600.00)

Three years later (2013) gold doubles in price going to $2400.00 per ounce. Since Company XYZ couldn’t mine any reserves economically they devoted the past three years to building up reserves. Extraction costs like energy and labor have definitely gone up as well, but not at the same rate as gold. Extraction costs per ounce are now $1800.00 per ounce. Company XYZ can now start the long process of bringing gold production online. Permits must be built and infrastructure must be put in place to start extraction. Since this often takes years, we will assume Company XYZ goes “online” two years later (2015).

Proportion: Asset and Extraction Cost ($3250.00 – $2250.00 = + $1000.00)

To their good fortune the long process of bringing a gold reserve asset to production has taken a long time – for this example 2 years. To much amazement gold continued its climb up the “wall of worry” reaching $3250.00 per ounce. Again, production costs like energy and labor went up – not as much as gold though. Production costs increased to $2250.00 per ounce.

Massive Leverage!

Fortunes have certainly improved for Company XYZ, going from an economic production value of -$100.00 per ounce to +$1000.00 in just five years. Company XYZ started off with worthless reserves in 2010, but now has 1.5 million ounces of gold reserves with huge potential. On paper their gold reserve value may look something like this:

($1,500,000 ounces x $1000.00  = $1,500,000,000 )

Increasing prices for gold and silver have huge implications for small mining companies. Upward moves in precious metals prices can literally take a company from worthless to extremely valuable. The process described above may be happening for several small publicly trading mining companies and pan out nicely in the next 5 to 10 years.

The Right Ingredients

In looking for speculative precious metals mining stocks it is important to look for companies that fit the description of Company XYZ in the example above. Find gold stocks with large reserves deemed uneconomical with current gold prices. When gold prices move higher these companies should have dramatic profit potential. For those of you that understand options trading, this strategy could be reasonably compared to buying an “out of the money” call option. The best part about these speculative stocks is the lack of time expiration. Downside is somewhat limited while upside is potentially huge.

For the above scenario to take place, we would first of all need a dramatic rise in gold price. Secondly, a smaller proportioned rise in input costs like energy and labor would need to occur. Mining companies that hedge against rising input costs like energy and infrastructure could add to profitability. Companies with huge reserves of gold also benefit from “economies of scale” where the average cost per unit ounces decreases, since fixed costs are spread over a larger number of goods. Lastly, a given gold company must be able to bring a mine “online” or be able to find a buyer for its assets. Since so many variables are involved in the given scenario, this type of investment strategy is extremely speculative. Finding the right gold stocks will be the most difficult part of this strategy.

One Possible Example

One name that comes to mind is a gold miner called Novagold (AMEX: NG, Free Report). Back in late 2007, Teck Caminco (NYSE: TCK, Free Analysis) and NovaGold terminated plans to bring their 50% joint-venture Galore Creek property online – sending shares from $22.00 to less than $1.00. The two companies indicated the property wasn’t economical with surging construction costs and gold price levels of $825.00 per ounce. You really have to wonder if Galore Creek is still deemed uneconomical in 2010 with gold near $1250.00 per ounce and energy prices slightly down from where they were in 2007. Paulson and Soros funds seem to be catching on to this concept – buying institutional positions of 9.13% and 8.46% respectively.

Criteria

• Based in Foreign Countries (Currency Benefit)
• Large Un-hedged Reserves (Economies of Scale)
• Stable Governments (Safety)

Risks*

• Gold Decreases in Value (obviously)
• Mining Permits not Granted
• Gold Value Doesn’t Increase Faster than Production Costs

Want to become a better trader? Click here to sign-up for a FREE trading e-course taught by a former floor trader!

[wordbay]gold bar[/wordbay]

The lack of education on the difference between assets and liabilities is why many people struggle financially. Although some areas of the subject can become gray in nature others are black and white. Always remember, assets will put money in your pocket while liabilities take money from your pocket. One of the worst mistakes you can make in your financial life is thinking that liabilities are assets. With that being said here are some examples of common liabilities.

Liabilities

• Homes
• Cars
• Boats
• Clothes
• Electronics

Contrary to popular belief a house is not an asset. As many people found out during the recent crash of the real estate market in 2008, houses do not put money in your pocket. Houses have more expenses than most people think. They do not generate positive cash flow for the owner. A home mortgage is the first major expense associated with owning a home. Most Americans think they own their own home – in actuality the bank does. A typical 30-year fixed mortgage at 5.5% will incur nearly 100% interest on the principal. In other words, you will pay $100,000 in interest for a $100,000 loan.

If you are fortunate enough to have enough money to purchase your home outright you will still have monthly liabilities associated with your home. Property tax is a universal expense associated with home ownership. Homes in the city are usually subject to higher taxes than those in the county. Varying with climate, homes need energy for heating and air conditioning. A house in cold regions would obviously need to be heated for comfort and to prevent water pipes from cracking. Homes in southern regions with high humidity need air conditioning both for comfort and to prevent mold damage. Maintenance expenses may also contribute to your home as a liability. Will you need to repair a worn out roof? What about replacing an old water heater or furnace? Over the course of time maintenance expense can really add up.

Cars are another heavily misunderstood liability. One of the worst financial decisions made by people today is purchasing a new luxury automobile. Vehicles rapidly deteriorate in value when going from a new to a used condition. It is said that many vehicles drop 10-20% in value within the first week of use. Not only that, automobiles have associated expenses like fuel costs, maintenance and insurance. Although having a reliable car for commuting to work and back is a good idea, cars are not assets.

Assets

• Rental Property
• Dividend Paying Stocks
• Patents/ Inventions
• Royalties

When are houses considered assets? Although rental units incur many of the same costs as homes, rental property puts money in your pocket. Rental units that generate positive cash flow are assets. A typical single family rental property in the midwest  can reasonably demand around $700 per month in rent. Expenses for that same rental property usually cost around $500 (electric, water, cable etc), leaving $200 in positive cash flow. Because rental units have the ability to put money in your pocket, they are usually assets.

Just like houses, not all stocks are considered assets. Shares of stock in publicly traded companies are actually liabilities until you sell them at a profit. However, some stocks provide monthly payments called dividends to their shareholders. These dividend payments turn stocks into assets because they generate positive cash flow for their owner. Finding stocks that you think will increase dividend payments in the future is a great way to invest in the stock market.

In order to get out of the “rat race” you must generate enough cash flow to cover your liabilities. The best way to achieve this is to accumulate assets instead of liabilities. Once you accumulate assets with positive cash flow you can use that money to buy even more assets. Reinvesting your profits to buy more assets is one of the only ways to achieve wealth. The rich buy assets, while the poor and middle class buy liabilities that they think are assets.


Want to become a better trader? Click here to sign-up for a FREE trading e-course taught by a former floor trader!

[wordbay]silver bar[/wordbay]

Dollar Devaluation and Inflation

Although prices haven’t immediately risen, inflation is alive and well. By nature inflation is caused by an increase of the money supply or a large change in supply and demand for goods.  Simply stated, increasing money supply  always causes inflation because the underlying currency is devalued. Currency devaluation is very negative, despite what you might have been told. Devaluation through inflation steals from people who save their money. At the same time debtors are rewarded since the debt owed is  devalued. Worse yet, inflation and devaluation discourage savings and encourage spending. Hence the reason, both tactics are used during weak economic periods of time.  This key point also explains why Ben Bernanke has chosen to trash the dollar – the average US consumer is heavily saturated in debt.

Free Report: Get a Complete US Dollar Analysis Today!

US Dollar Carry Trade Beginning

Up until recent months the Japanese Yen was the currency of choice for the Carry Trade. For those who don’t already know, a carry trade exists when one country has much lower interest rates than other countries. The country with low interest rates buys up currency and assets of other countries with higher interest rates in order to achieve a better return.  With the recent decrease in US interest rates the Yen Carry Trade is unwinding and the new US Carry Trade is starting.  Now countries like Japan are selling the US dollar and buying back stronger currencies and assets. This unwinding process will put even more pressure on the US Dollar.

Trapped Inside a Box

Nothing has changed from a fiscal perspective in relation to the federal reserve. While the Obama administration boasts a policy of change, nothing has changed for the federal reserve. Ben Bernanke is well on his way to an unprecedented dollar destruction with Alan Greenspan at a distant second. Current policies could easily result in the most sever dollar destruction in history. With the economy still being fragile despite massive stimulus and spending, further dollar dilution will surely be on the way. After all, the federal reserve is trapped inside a box. If they let interest rates linger this low for long periods of time hyper-inflation will occur. If the fed tightens monetary policy to defend the dollar, the economy will go into a deflationary recession. We know this scenario won’t occur since Bernanke once stated that he would rather drop money from helicopters than suffer another deflationary depression. In either scenario bad consequences exist for the economy.

Consequences of Inflation

• Increased money supply is always inflationary
• Inflation steals value from existing currency
• Inflation helps debtors – hurts savers
• Commodity prices increase
• Middle Class and Poor Lose
• Upper Class Wins

Want to become a better trader? Click here to sign-up for a FREE trading e-course taught by a former floor trader!

[wordbay]gold bar[/wordbay]

Lower fuel costs at the pump have also eased concerns over discretionary income among McDonald’s patrons. Although the overall global economy has been weak, the company has been fairly resilient. This is in part due to a “trade down” in dining choices by consumers. When people can no longer afford expensive food they trade down to McDonald’s low priced menu offerings. This point was exemplified in 2008 when McDonald’s took away large market share from rival Starbucks. Consequently, Starbucks stock price got hammered while McDonald’s was one of the few stocks ending the year with gains.

“McDonald’s continues to deliver a relevant restaurant experience that provides consumers with a broad range of quality menu choices, affordable prices and unmatched convenience. Our underlying business performance remains strong. “  Chief Executive Officer, Jim Skinner

In its most recent earnings report McDonald’s (MCD) grew worldwide same store sales by 4.30% . This was while revenues dipped to $5.08 billion in 2009 from $5.61 billion the prior year. Now you might be wondering how same store sales can increase while total revenue decreases. Currency exchange rates play a major role in this phenomenon. Since McDonald’s is a United States based company, they must report financial figures in US Dollars. When the dollar increases, revenue earned in foreign countries is worth less when exchanged into dollars.

“In constant currencies, first quarter results reflect higher revenues, operating income and earnings per share over the prior year.” Chief Executive Officer, Jim Skinner

With more than half of McDonald’s total revenue coming from outside the United States it is easy to see how a weaker dollar helps earnings. Revenue generated in foreign countries gets repatriated at a better rate of exchange. With the United States Federal Reserve lowering interest rates to add liquidity to the credit markets and banking system, the dollar is sure to depreciate in value. This is a great thing for companies like McDonald’s trying to grow globally. Now when McDonald’s repatriates money out of currencies like the Euro and Yuan they will get more dollars in return.

Everything isn’t completely golden at McDonald’s though. One major challenge the company faces is integrating menu options over culturally diverse nations. Menu offerings from the United States don’t necessarily work in other parts of the world. McDonald’s will have to cater overseas restaurants to local tastes, integrating menu options to suit unique cultures.

McDonald’s stock offers a compelling, yet risk averse way to play the global growth story. While the United States has over 300 million people countries like China, Brazil and Japan have several billion. If McDonald’s can execute its growth strategy overseas like it did in the United States early on, you could see a major rise in stock price. Although this growth strategy may take five or more years to execute, the reliable 3.50% dividend allows you to get paid for waiting.

The stock price (MCD) has made a run off a lower support trend-line (see chart) and the 100-day moving average. Starting a position in the $53.00-$56.00 price range seems to be a good entry. A depreciating dollar, global expansion and lowered fuel costs are all reasons to be excited about McDonald’s. Furthermore, they have proven they can successfully operate in the worst economic environment in recent history. Although McDonald’s (MCD) isn’t the sexiest of stocks, we believe it will reward patient shareholders handsomely.

Disclosure: Author holds a long position in McDonald’s (MCD) common stock.