Thunder Road Report 21 6th Sep 2010

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report

6th September 2010

Silver, Luxury Goods and Rare Earths

I cant remember a time in my 23 years in the market when there

was so much confusion and uncertainty about the outlook. As the

monetary catastrophe unfolds gradually, some days things look

a little brighter, then the sheer enormity of the problem becomes

only too apparent once again. Sentiment keeps ipping between

optimism and pessimism, but the debt bubble just gets bigger!

Noel Gallagher wrote These are crazy days, but they make me

shine, and that sounds like a good enough motto for trying to

invest right now (ngers crossed).

The players are under so much duress its like Duressic Park out there

Quote: Darts commentator Sid Waddell

The silver price has started to trade differently and it appears

that BIG MONEY is moving in to the metal (at long last) and

ghting the Cartel. There is evidence that the supply of physical

silver is getting tight and it could be the beginning of a major

upward move in the price. In the more ephemeral world of

luxury goods, if youre following the emerging fashion trends,

youll know that there are some seismic changes moving into the

Autumn/Winter 2010 season. While not perfect, the link between

changes in fashion and economic prospects is long established,most famously via the Hemline Indicator. Its not for everyone,

but taken at face value, the current trends are overwhelmingly

bearish. However, there are also a few conicting signals, which

seems to sum up the state of nancial markets perfectly! Moving

Contact/additions to distribution:

Paul [email protected]

This issue:

Silver - the Call to Arms

Luxury Goods, the HemlineIndicator and the stock market

Rare Earths - going to war

FREE Martin Armstrong

Imprisoned for nancial analysis
mailto:[email protected]:[email protected]


2/242 Thunder Road Report - 6 September 2010

on to rare earths, China (which supplies more than 95% of world production) has slashed export quotas.

Rare earths elements are used in iPods, mobile phones, laptops and clean technology (e.g. wind turbines

and hybrid cars) as well as being critical to the US military. This could set the scene for a very serious trade

war between China and US, but the potential implications remain poorly appreciated. Rare earth prices

have spiked and the share prices of rare earth mining companies are responding. Ive added Great Western

Minerals and a few shares in Avalon Rare Metals since the last TRR.

Silver the Call to Arms

The Achilles Heel of the Cartel in the gold and silver markets (i.e. the US government, Federal Reserve and

their bullion banking agents) is almost certainly PHYSICAL SILVER BULLION. Just like gold, silver is money

(as well as being a vital industrial metal) - which scares the Cartel to death and is behind its attempts to

suppress the price going back more than a decade. Gold and silver not only compete with at currency but

also against Government bonds the market for which is developing into one of the biggest bubbles in the

history of nance. That assertion is refuted by the majority, which is another classic indication of a bubble.

But back to silver:

B Unlike gold, silver is no longer held as part of central bank reserves to any signicant extent;

B 76% of newly mined silver is consumed in non-investment applications (industrial, photography, etc)

thus further depleting above ground bullion stocks,

B US banks (primarily the one whose name begins with the letter between i and k) are short 21.8% of all

of the outstanding contracts on the COMEX exchange in New York. These 26,855 contracts amount to

134.3m oz of silver or 4,176 tonnes. This is equivalent to 19% of all the silver mined in 2009 and 15%

of total silver production if we include the recycling of scrap. Lets think about that a different way. If

one or two banks were long the entire annual oil output of Saudi Arabia and Norway combined, it would

be equivalent to 15% of the worlds 2009 oil production. Can you imagine the outcry from the public

and politicians about market rigging, greedy speculators pushing up the price of gasoline, etc? In termsof wheat, it would be the same as a position in 100 MILLION tonnes, equal to the entire aggregate

production of agricultural giants the US and France;

B Silver forms little or none of the Yamashita hoard of treasure which is hidden/protected in the Philippines

to the best of my knowledge; and

B Because silver is such a small market, if big money started to accumulate physical silver in an aggressive

way, the Cartel could get into serious trouble. This seems to be whats happening.

The silver price is just under US$20/oz so almost everybody (tramps like us) can afford at least a small

amount. Ive bought a bit more physical silver from ATS Bullion which has an ofce next to the Savoy Hotel

in London (you can just phone them up and take some id when you go to pick up your silver). I even had topay more than a 20% premium to spot plus VAT, but thats going to be irrelevant if Im right and the silver

price goes to US$50-100/oz (note: I deliberately avoid silver and gold ETFs). This is part of my Cascading

Defensive Strategy in gold and silver, i.e. have a bit of physical CLOSE BY, buy some ALLOCATED bullion

at closer to the screen price (e.g. from the likes of BullionVault or goldmoney.com which can also store

it overseas) and have some exposure to the EQUITIES, both the MAJOR producers and a few JUNIOR

exploration plays.

Buying some physical silver is an opportunity to send a powerful message to the corrupt interventionists

in the Cartel.



In my two-part piece Silver the best investment of all? back in January and February of 2009, I

characterised silver investors as being like:

an underground movement and one whose day in the sun is approaching

Im even more bullish on silver than gold and have the balance of my portfolio set up accordingly. In fact,

I sold some gold shares to buy the physical silver. My long-held view is that the gold/silver ratio will get

back to 30 from the current level of 62 - that would take it back towards its lows in the post-Bretton Woods

world. The gold/silver ratio was 12.5 in 323 B.C. when Alexander the Great died, was 12 during the Roman

Empire and was xed at 15 during most of the 19th Century during the golden era of the Gold Standard.

According to the gold-eagle website, the median ratio since 1687 is 15.7.

Gold/silver ratio since 1975

Source: goldprice.org

Importantly, the silver price has started to trade DIFFERENTLY in the last couple of weeks - as everybody

who stands shoulder-to-shoulder with GATA and Ted Butler in the precious metals markets has noticed.



The key was the price action in the run up to the recent COMEX (New York) option expiry on 26 August

2010. Time after time after time in recent years, the silver price has been blatantly taken down in the days

preceding option expiry to the benet of the big shorts. This time was different. Dave in Denver put up a

chart on The Golden Truth blog showing the silver price action on the 23-24 August 2010:

Silver price - 23/24 August 2010

Source: The Golden Truth

Adrian Douglas of Market Force Analysis calculated the P&L for the shorts on this COMEX silver option

expiry:

The option expiry for the cartel was an unmitigated catastrophe. The mining companies are not hedging so

we can consider nearly all the options, puts and calls, are being written by the commercials. If we consider

the whole option structure as just one book we can determine the optimal closing price to minimize the

payout on the options to speculators. When the commercials sell calls they want the price to go down to

make as many as possible expire worthless. When they sell Puts they want the price to go up to make as

many as possible expire worthless. Because they sell both puts and calls there is an optimal price to achieve

their best return or minimum loss.

Using yesterdays open interest in the various strikes of the entire put-call option structure I charted the

payout over a range of closing prices for gold and silver. The minimum payout is the optimal closing price

for the commercials as a group if they own the entire book.



The optimal closing price was $18/oz which would have been a payout of 5.5 Million USD (This would

probably not be a loss because to offset this is all the money they received from the purchases of the

options). The actual payout will be $14.5 Million USD. Almost triple the optimal. The cartel nearly ALWAYS

closes the metals at or near the optimal price month after month after month. This was a stunning change

and if the cartel could have prevented it they would have. In particular not only did silver nish at triple the

optimal payout but the cartel was struggling into the close to keep the $19 strike calls out of the money.

They achieved it by a mere 2 cents! (perhaps they will still be exercised!).

James Turk of the Free Gold Money Report was almost prophetic in his comments just days before this

expiry:

Lets see if silver can hold this level, particularly with option expiry coming soon.

Given the strength we have seen in both precious metals, perhaps this option expiry will be the one I have

been waiting for the shorts get overpowered by new buyers, and their getting squeezed results in a

moon-shot for the precious metals. Everything remains in place for an upside explosion in silver.

So whats going on in the silver market? Several days ago, GATAs Chairman, Bill Murphy, reported this from

their Stalker source whose track record is excellent:

JUST IN: Heard from our STALKER source. He has picked up a new account which is a German

conglomerate of some sort. Nothing new to report on gold, however THE London trader is

nally getting into silver and his reason is what is signicant. His clients, which have had little

to no interest in silver in the past, now want to get onboard. Perhaps this is one of the reasons

silver is trading so differently these days. AND, if his clients (which have made so much money

because of the brilliant trading and market acumen of the London trader) now want in on silver,

other major newbie investors to silver most likely are doing the same thing.

It sounds to me like BIG MONEY is starting to move in. After his emails to the CFTCs Enforcement (joke)

Division on silver market manipulation were made public back in March, LBMA whistleblower AndrewMcGuire, had this to say in a subsequent interview on King World News:

Whats going to happen if youre an Asian trader, for example, or a non-western trader who has no loyalty

or care about homeland security or whatever else, who says Hold on a minute, if I can establish this in my

mind that there is 100oz of paper gold, paper silver for example, for each ounce of real silver, then Ive got

a naked short situation here that I can squeeze And they can go on to the spot market, which is basically

a foreign exchange transaction, short dollar, long silver to ANY amount they want, billions, trillions, any

amount they want and they can take this market, squeeze this market and blow it up.

Is this what is beginning to unfold? Anecdotes from GATA supporters suggest that the physical silver market

is tightening. From Thomas:

Just 3 hours before the silver price started to move up on the 08-24 I bought 2000 silver eagles in

Switzerland for $23.68. The guy needs more than 10 days to get them. I believe, as last time, he had to

get it imported from a German supplier. I know, as before, some members will say they would have had a

cheaper source in Switzerland, but Im used to working with and trust this companyand very very soon, I

really wont care whether I bought silver at 15, 20 or 25$!

And David:

I visited the Canadian Mint in Ottawa, Canada on Saturday August 28. Very interesting tour. After the

tour we visited the boutique (gold and silver store). The mint had NO silver maple leafs for sale! The

sales girl said they wouldnt have any for weeks! We are getting very close to a massive silver shortage!Finally this from Andy:



I started watching eBay when I started buying coins in Fall 2008. As we speak, silver coins are selling for

their highest prices that Ive observed since that time. What is available is selling CONSISTENTLY at roughly

$21.50/oz. for 20 oz. rolls, and more for individuals. And, by the way, the price of and 1/10 oz. gold

coins, even at APMEX, have never traded at higher premiums to the paper spot price.

There is the possibility of another positive catalyst coming down the pipe now that the Dodd-Frank Wall

Street Reform and Consumer Protection Act has become law in the US. Here is an email from the only

upstanding CFTC Commissioner, Bart Chilton, to a GATA supporter:

Hey Angelo

Here is the deal as I see it: There doesnt appear to be any support (other than me) on the

Commission for metals position limits. We need 3 of the 5 of us. Thats the bad news. The good

news is that the nancial reg reform bill has mandatory position limits in it. That means we

will implement them regardless of the lack of support at the CFTC (as long as the bill becomes

law).

The bill also contains what is called disruptive trading practice authority, so we will have

legal authority to go after trading that negatively impacts markets. We need this. For

example, currently our manipulation standard under the law is weak...at best. We have to

actually prove intent. That means nding evidence of a traders intent (an email or wire tap

for example). We cant simply say, as some suggest, that a trader has a large concentration

of positions and the price did this or that when the trader bought or sold, so therefore, they

manipulated that market. It doesnt work that way under the law. In fact, we have only

successfully prosecuted one case in 35 years! The new law with disruptive trading authority, I

believe, will be most helpful.

Finally, we have an ongoing investigation. I meet with the staff and investigators all the

time. I did today. The work has been important and useful. I hope we will be able to discuss

that in public very soon. The thing about investigations is that we have to keep quiet during

the investigation. Most investigations, we simply dont even announce, but I thought we

needed to on this one to let folks know we were looking at it. But, that means that now folks

are saying it has been too long, etc I understand that frustration, but it is what it is. If we

werent making progress, Id yell and scream.

All of these things will make for more efcient and effective markets in my mind.

Hope that helps somewhat.

B

The leading crusader to end the manipulation in the silver market has been the independent analyst Ted

Butler. As he explained:

the new law mandates that the CFTC establish position limits in order to prevent market concentration.

Position limits in silver to break the stranglehold of concentration on the short side of COMEX silver has

been my mission for 25 years.

Ted Butler deserves huge recognition for his hard work in exposing the manipulation of the silver market.

I agree with him on this:

As to when legitimate position limits in COMEX silver should be enacted, the proper answer is yesterday.

That should always be the answer to a crime in progressTherefore I suggest that you ask them (CFTC

commissioners Paul) when legitimate position limits will be initiated and what the limits will be. Its time

to stop stalling and for the CFTC to get specic.

The chart below is a good illustration of how physical silver bullion was neglected as an investment vehicle

by US citizens for years and how there has been a sea change since 2008. Demand for new American

Eagle silver coins from the US Mint during 1999-2007 was at with, seemingly, a small number of believers



quietly accumulating - then it changed. Note: the 2010 projection is the annualized number of the January-

August data.

US Mint - production of silver eagles in millions oz. (2010 annualised on Jan-Aug)

Source: US Mint

James Turk put up an interesting chart which shows were we stand in the silver market breakout here

should signal a powerful phase in the bull market:

Source: Free Gold Money Report

0

5

10

15

20

25

30

35

40

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010E



In addition, Dimitri Speck of the Seasonal Charts website shows how buying silver in early September has

usually been a good entry point during the last 37 years:

Source: Seasonal Charts

Luxury goods, the Hemline Indicator and the stock market

I used to buy Armani jeans and other labelled attire, even preppy stuff like Ralph Lauren. These days I

dont really understand the desire for designer fashion, or is it just that I cant afford it anymore? Not sure

on that one, but Ive never (ever) got the concept of buying luxury cars. In my opinion, anybody who

buys a Porsche 911 or a Ferrari (except for a vintage model) should be tethered and pelted with rotten fruit

in public and twice if they are so stereotypical that they bought a red one. Just think how many books you

could buy instead. The usual defence when you ask them why is:

It was only because I ALWAYS wanted one, since I was knee-high to an investment banker.

But if theres one person in the luxury goods and fashion world who REALLY annoys me its her:



Despite my aversion to many luxury products:

B I nd the design, branding, retail and psychological aspect of the luxury goods sector fascinating (and

have many books about it!);

B The top 10 luxury goods companies have a market capitalisation of US$165bn excluding Porsche.

Company Market Cap . (US$bn)

LVMH 61.348

Richemont 23.181

Hermes 20.291

PPR 17.809

Coach 11.630

Swatch 10.372

Polo Ralph Lauren 7.770

Burberry 5.848

Tiffany 5.440

Tods 1.934Total 165.623

B Fashion trends are symbolic of the collective conscious and often change with broader social, business

and nancial market trends, the latter being incorporated in the once famous Hemline Indicator (see

below). Here is a quote from the French novelist and journalist Anatole France (1844-1924):

If I should be allowed to choose one out of all the books published a hundred years after my death, I would

take a fashion magazine to see how women were dressing. Their fripperies would tell me more about the

society of the future day than all the philosophers and preachers.

George Taylor was the rst to develop the Hemline Indicator in 1926 arguing that the stock market

rises and falls with womens hemlines. Hemlines got progressively shorter during the 1920s as the stockmarket moved towards its peak and fell rapidly after the 1929 crash. The idea of hemlines predicting the

stock market was revived in the 1960s with empirical work done by Ira Cobleigh. In May 1967 with the US

brokerage rm, Harris Upham, publishing a chart of the Hemline Indicator (apologies but I couldnt nd

a colour version).

The Harris Upham Hemline Indicator 1917-1967



Harris Upham was taken over by Smith Barney, which subsequently updated the chart:

Smith Barney Hemline Indicator 1917-1990

Paul Macrae Montgomery, these days CEO of Montgomery Capital Management, but writing in his Universal

Economics publication back in 1975 argued:

The connection between hemlines and the stock prices has been painfully obvious since Cobleigh published

his ndings in 1967. The micro miniskirt called the 1968 market top, and from the mini to the 1973-74

granny gowns and pantsuits, the Dow lost 480 points and the average stock was decimated.

Take note of the word granny as it will come up again in relation to Autumn/Winter 2010 trends. Here is

Shirley Willet, of the Fashion Solutions blog talking in 2006 about the Hemline Indicator:

I used this later in the 1980s when teaching about fashion marketing, production, and trends. I explained

that a lot of fashion trends have to do with collective social emotions. And those effect general business,

stocks, politics, etc, as well as fashion trends.

It also seems that it may not just be about the hemline but the overall look. From a bit of background

reading, Christian Diors famous New Look was unveiled in 1947 which coincided almost exactly with

the beginning of the upturn in the current long wave economic (Kondratieff) cycle.

After the uniforms and drabness of World War II, Dior commented:

I wanted my dresses to be constructed, moulded upon the curves of the feminine body, whose sweep they

would stylize.



From my analysis, it does seem that hemlines tend to move in tandem with the economy and the stock

market. However, the stock market (which is what we are really concerned with) is often out of sync with

the economy. Generally, its a leading indicator although there are periods, like March-October 2007 as the

sub-prime crisis was unfolding and the market continued to rise, when it is a lagging indicator. Anyway, the

key question for me was whether hemlines are a leading/coincident indicator or lagging indicator for the

stock market. In not very scientic fashion, but from straining my eyes at the Harris Upham chart above, it

seemed to me that there were 6 occasions when it could be argued that hemlines were a leading/coincident

indicator versus 3 when they were a lagging indicator which is a reasonably good track record.

I thought Id see whether there was any message for the stock market from current fashion trends.

Having traded in and out of the luxury goods sector last year, via LVMH, I also revisited the luxury stocks

themselves.

It had nothing to do with hemlines at the time, but this was my bull case for the luxury foods sector in an

August 2009 Thunder Road Report:

It struck me that a combination of the recent return of the bonus culture to parts of the nancial sector,

the possibility of a bubble developing in China and the likely response of the ultra-rich to the recent stock

market rally all bode well for this sector in the current quarter. At the same time, Japan, which is the biggest

market for luxury goods (>20% of the world market), should benet from recovery in China, its largest

export market.

I bought LVMH specically because it was taking market share and had numerous product launches to

sustain the momentum through H209. LVMH is the worlds largest luxury goods play with brands such as

Louis Vuitton, Christian Dior, Marc Jacobs, Fendi, Donna Karan, Givenchy, Moet & Chandon, etc. At the time,

I was even reading the fashion industrys leading ragand as one portfolio manager said in an email:

You reading Vogue in a Clapham coffee shop, legendary

I quoted British Vogues August 2009 issue:The fashion gods have spoken: this autumn its all about the shoulder

With hindsight, I suppose that big shoulders are reminiscent of the 1980s with yuppies and conspicuous

consumption. Hemlines were obviously still on the short side last year too. So although I wasnt thinking

about the inuence of fashion trends at the time, I guess that the omens were good for LVMH and its peers

back then. Indeed, LVMHs share price surged and has made a new relative high:

LVMH price relative to EuroStoxx 300

Source: Redburn Partners



The problem was that I lost my nerve on the prospects for the market as a whole and cut the LVMH position

in September 2009 a big mistake as it turned out.

Below is the cover of the August edition of British Vogue which reviews the Autumn/Winter 2010 collections

First Look At Autumn :

British Vogue - August 2010

Take note of some of the cover stories:

The return of real clothes

Minimal make-up maximal impact

In her editorial, Alexandra Shulman commented that the collections she saw on the catwalks representeda:

fantastic offering of clothes that I might actually be able to wear.

Have the Martians landed? Catwalk clothes which you can wear, whats going on? But the most insightful

comment was probably this one on page 104:

Pared down, wearable, comfortable, real chic - we are about to experience an extraordinary

shift in fashion, a moment when reality and desire collide and fantasy subsides.

In fashion terms, this sounds like a shift of seismic proportions and apparently it is. By page 120, in an

article titled Get real, Vogue is in full ow:

Fashion is undergoing one of those seismic shifts that reprograms how we think and feel about

the way we want to lookan altogether new avant-garde the cult of the RESTRAINED (my

emphasis).

And:

Logical, hardworking, t for purpose these are the qualities resonating with women now.

Then the Vogue writer relates this to nancial markets (it just gets better!)

The longest bull market ushered in a school of design that became consumed by theatrical

change, with dramatic mood swings between (what its only fair to describe as) prozzie dressing

and princess dressing.

Unbelievable! She admits they admit they were living in La La Land as this roughly translates as Vogue

saying to the fashion industry:



IT WAS ALL B*LLOCKS

And its hard to disagree.

Just like Greenspan and Bernanke with their easy money, obscene debt creation and bubble after bubble

for the last 20 years (and counting). While even the fashion industry is saying enough is enough, central

bankers and politicians march onwards towards monetary catastrophe. Heres Vogue making more sense

than they do:

It was quite a party with quite a hangover. But now designers have nally got their heads round a much

more cautious economic reality, were nally getting clothes that make sense.

Obviously, just like any modern central banker, Vogues centre of gravity naturally resides in La La Land,

but lets enjoy this while it lasts.

So big change is afoot, but what about those all-important HEMLINES? Here are a few sound bites from

the same Vogue issue:

B longer-length skirts from the Editors Letter (after 34 pages of adverts)

B The gentle swoosh of a full skirt personies the lady in 2010;

B Skirts from mini to full

B Seventies Style - The longer skirt is big news

B a new calf-length skirt neednt look frumpy on the over-twenty ves

I nd these references to the 1970s interesting does it send a message of austerity AND ination! Thats

been my bet for the medium term

Vogue asked London designer Roksanda Illincic, whoever she is, whether she would wear the new calf

length skirts:

Yes, yes, yes! (OMG Paul) With a uorescent belt, big necklaces and maybe a three quarter length sleeve

to keep it youthful. The new length is probably the single thing that most excites me in fashion right now.

For ages, anything but short has been out of the question. But a new length changes everything.

A cutting edge investment analyst has to crosscheck his sources (!), so I bought Grazia magazine whose

front cover had Autumns Fashion Blockbusters emblazoned on it (as well as Gaga catches boyfriend

cheating again). Grazia supported everything Vogue had to say and possibly more. Here is a quote from

the Runway to Reality article:



Totally out there on the catwalk and now totally wearable on you.

But wait for this in a two-page spread titled Lets Grab a Granny:

Until now, only grandmas wardrobe has been safe from us. But with Marc Jacobs, Daks, Marni,

Prada and Louis Vuitton all being inspired by the mid-calf skirts, bobbly jumpers, sensible

shoes and matchy-matchy accessories of our favourite cuddly relatives for their autumn/winter

runways, were sorry to report, Nana, but granny-chic is ofcially in.

This could really spell economic disaster. We ARE in really big trouble (!) - its just that most people dont

realise how much (although fashion designers seem to). Next to the text was a picture of this Louis Vuitton

creation (left hand side). On the right is an example of the new skirt length from Marc Jacobs collection:

Another major trend for A/W 2010 (as I now call it), is for Aviator jackets - Burberry are big here. I

dont know whether theres any subtle link here to the economy or the stock market, but I dont see the

attraction of wives and girlfriends looking like Biggles.



If they want to go with a ying theme, the answer is patently obvious:

Source: the recent Virgin Atalntic advert

Air hostess chic, it wouldnt be a bad thing. Thats the problem with the fashion gods, sometimes they

just dont get it.

I bet you didnt know this, but according to the editor of Elle magazine, Lorraine Candy:

An Elle girl stands out because she has an INNER BAD GIRL (my emphasis) whos drawn to

clothes that make a spirited statement.

The latest edition of Elle has a separate Autumn/Winter 2010 Style For Less magazine. Here are a few

sound bites:

B Simple, and, above all, wearable this is Autumn/Winter 2010;

B Chiffon or silk blouses in soft colours will work the tonal and the 1970s trends;

And it couldnt get much clearer than this:

B Were going downPut your minis away, a new length of skirt has arrived. Less 1950s Mad

Men, more 1970s schoolmarm, the a/w hem should hit the centre of the calf.

So more conrmation from the pages of Elle, but with my new found curiosity for the inner bad girl, I

found this blog entry from Elles Executive Fashion Editor, Stacey Duguid, on 3 September 2010:

We are not teenagers, we are not easily marketed to, we are grown women and we will not be told to wear

colours that dont suit us. Several hours later, having dismounted my high horse, a thought occurred; Id

spent a month scouting for camel, khaki, and stone coloured blouses, I had become obsessed with nding

the right coloured 70s denim skirt, I suddenly needed mustard in my wardrobe and I despise mustard.



Where had this colour fanaticism come from and why was it suddenly OK to wear colour-draining camel

and stone? So here I am, wearing all the colours I had never considered before thanks to Celine, Max Mara

and Tommy Hilger and Im way over 30 by the way...The Camel Coat - theyre everywhere and yes, you

should own one and it probably should be by the king of the camel coat, Max Mara, and possibly styled in

the manner of a 70s mum.

In shoes, the inspiration is slightly more recent according to Stacey:

Its goodbye unwearable, unwalkable, unbearable shoes and hello low-heel-height court shoes! As worn

by ofce workers and police ofcers alike, the sensible court shoe has been off the fashion radar since the

eighties but its back for autumn

Unfortunately, she was keeping her inner bad girl under wraps in the blog piece. But from Stacey to Sandy

and I reckon the latter was denitely an Elle reader:

Source: Grease, the movie from Paramount Pictures

I said to my wife that the most important items in her wardrobe are black boots, which come to just

below the knee, and a pair of black hold-up stockings and she could dispense with all the restliterally.

Her dismissive comment was that All men are amoebic but I still dont understand her point. Along with

ashbacks to my teenage years, however, I suddenly had a profound insight into the inner bad girl any

time you try too hard to nd it, youll be disappointed.

I hadnt seen my former Warburg colleague, Russ M., for 13 years until I bumped into him at Killk & Co.s

Summer party (thanks for inviting me guysand thanks to NYC brokerage Dahlman Rose for an excellent

dinner with their clients). Russs wife is a fashion merchandiser for one of the leading UK high streetclothing chains and this is her summary of current trends:

COLOUR: Camel, lots of bright reds, yellows

SKIRTS: Generally long, full-length

TROUSERS: Making a big comeback but very short shorts big this A/W as well as the full length versions

I thought this was fascinating because it also suggests some CONFLICTS which I hadnt considered while

reading through the fashion magazines. For example, the reds/yellows against the more staid camel and

very short shorts versus full length skirts (and the leg-lengthening trousers as I now know theyre called).

And before anybody emails me, yes it did occur to me that I might taking this all a bit too seriously. I always

do.

I had a wander round the Bond Street luxury stores in London - I think paid up luxury goods and retail

analysts call them store visits. It was a Thursday morning about 11am, so not a time that youd expect

lots of customers and they were very quiet. LVMH was clearly the busiest, but why a 8-foot giraffe with



jewelled hooves wearing a neck scarf had pride of place in the shop window is somehow in keeping with

the brand, God only knows:

Sometimes I feel intimidated going into these stores and this time was no different. Some of the store

assistants look you up and down and not in a positive way. The security people in the big stores like LV and

Prada wear black suits and ear piece communications like they are members of the secret service.

I was walking round these shops in faded jeans and my Abersoch Sailing School T-shirt. Dogged byinsecurity, I had even purchased a copy of the Financial Times for camouage rather than any cutting

edge market insight obviously - hoping to pass myself off as a disaffected hedge fund manager. I suppose I

amkind ofbut trading my own (v. small) portfolio from sunny Balham instead of swanky Mayfair. In terms

of the fashion trends, the camel-coloured (the new black) clothes were in evidence and other 1970s-esque

stuff like long coats. But I didnt see many of the calf length skirts on this occasion presumably they are

coming to a store near you very soon as the A/W stuff displaces the previous season stock.

For what its worth, summing up the BIG PICTURE from this foray into the world of fashion and luxury

goods:

B If we take the The Hemline Indicator at face value, its obviously indicating a decline in the economicoutlook and a better than average chance of a decline in the stock market.

B There seems to be some trends which are in CONFLICT with one another. This seems to capture the

current debate in the markets perfectly, e.g. growth versus double dip, ination versus deation, etc.

B Im fascinated by the return of 1970s trends as it ts my view perfectly bad economic performance

with ination eventually prevailing over deation thanks to the monetary drug dealers in governments

and central banks.

With regard to the European luxury goods sector itself, it strikes me that it is at an interesting juncture. If

you look at some of the share prices, Burberry, Richemont, LVMH, Hermes and Swatch are all close to their

highs. In contrast, US peers like Coach, Tiffany and Polo Ralph Lauren are c.10-15% off their May-Junepeaks.

Bullish points include:

B There was STRONG momentum in the rst half of 2010 and results were generally excellent and beat

expectations, except for outliers like Hugo Boss. If we look at LVMH, it reported a 53% rise in net income

to Eur1.05bn, which was well above Bloombergs consensus of Eur 956m.

B Taking LVMH as the example again, organic sales growth was 15% in Q209 and reportedly continued

at the same rate through July. Nomura is assuming organic sales growth of 10.6% for full year, which

already factors in a marked H2 slowdown. This is justied in part from tougher comparisons and less

benet from inventory rebuilding. However, it strikes me that there might still be some room to upgrade

2010 estimates.

B With stock markets holding up and bond markets surging, the VERY rich are in good shape to keep

spendingshame about all of us less fortunate souls!

On the bearish side:

B A Nomura luxury goods report recently showed how the rolling 12-month forward PE multiple at 17x for

the European sector is down from the 20x seen a few months back. At a 70% premium to the market,

however, it remains very close to its all time high;

B There is usually a reasonably good correlation between the global leading indicator, which is currentlyturning down, and the relative performance of the luxury goods sector. Weakness in the important

Japanese economy doesnt bode well either;



B From a Reuters report on 24 August 2010: The Spectrem millionaire investor condence index fell

to its lowest level in more than a year in August as wealthy U.S. investors worried about politics and

unemployment, according to Spectrem GroupThe move returns the index to mildly bearish territory

after 12 straight months in neutralAt the same time, the Spectrem Afuent Investor Condence Index,

which measures the outlook of households with $500,000 or more in investable assets, fell 4 points in

August to -20, its third-straight monthly decline.

B I also have half an idea that if the fantasy element of the latest catwalk fashion is being ratcheted back

(as per Vogue comments), there will be less differentiation between the luxury brands and the better

quality high street brands going forward. Consumers (except for the ultra wealthy) might be less inclined

to pay substantial premiums when the outlook is so uncertain.

What I nd most difcult to gauge, however, is the likely purchasing trends of afuent Chinese consumers

in the short-medium term. In ne wine, they seem to have bought up all the Chateau Late thats been

offered for sale anywhere on the planet! The Liv-ex Claret Chip Index of top-rated Bordeaux rst growths

is up over 40% in the last 12 months:

The Claret Chip Index (1-year)

Source: Liv-ex

If multitudes of rich Chinese suddenly decide that, say, Burberry for example, is THE must-have brand, the

prospects for a company could improve dramatically. On balance, however, Im not going to put any new

money into this sector right now - even LVMH which remains my favourite and is the cheapest of the major

European stocks which are taking market share (the others being Burberry and Hermes). My guess is that

these stocks will see their price relative peaks around the time of the Q310 earnings season.

Rare Earths - going to war

If you throw enough darts, metaphorically speaking, one of them will inevitably land in the Treble Twenty

and so it seems with rare earth stocks since the last Thunder Road Report (continued on next page).



The worlds greatest sportsman, Phil The PowerTaylor (15 times World Champion)

The timing was good, but I have to acknowledge the pioneering work of the original rare earth bug, the

one-and-only Jim Dines, who identied this sub-sector before most people knew what rare earths are. Rare

earth prices, which were already on a rising trend, have surged since China announced substantial cuts to

export quotas on 8 July 2010.

Rare earth prices 2008-10 (US$/kg)

Rare earth oxide Mount Weld 2008 2009 1Q10 21/6/10 6/9/10

Lanthanum oxide 25.5% 8.71 4.88 6.08 8.10 39.00

Cerium oxide 46.7% 4.56 3.88 4.46 7.00 39.00

Neodymium oxide 18.5% 31.90 19.12 27.56 34.50 75.00Praseodymium oxide 5.3% 29.48 18.03 26.13 34.50 70.50

Samarium oxide 2.3% 5.20 3.40 3.40 3.40 32.40

Dysprosium oxide 0.1% 118.49 115.67 156.50 210.00 286.00

Europium oxide 0.4% 481.92 492.92 512.40 520.00 605.00

Terbium oxide 0.1% 720.77 361.67 478.90 506.00 620.00

Avge Mount Weld price 14.87 10.32 13.13 16.72 50.52

Source: Lynas Corporation

The Chinese Ministry of Commerce cut back its latest batch of export quotas for 2010 by 58%. For 2010 as

a whole, the export quota of 30,258 tonnes is a 39.7% reduction on the 50,145 tonnes level in 2009. At the

same time, the Chinese are taking steps to unify pricing and reduce competition by establishing a unied

transportation and sales system and are expected to consolidate production into 3-5 conglomerates in the

long term. Reuters quoted China Daily as saying:

Chinas central government plans to publish monthly prices for rare earth metals to avoid producers

engaging in cut throat competition.

Dudley Kingsnorth of Industrial Minerals Company of Australia (IMCOA) outlined the consequences:

Chinese rare earth export quotas are now signicantly less than rest of the world consumption. The quotas

for 2010 total 30,250t REO (rare earth oxides Paul) compared with ROW forecast demand of 50-55,000

t. Total ROW production capacity is currently 10-12,000 t at best, which indicates a shortfall this year of10-15,000 t at least.



According to China Daily, the plan for the unied pricing mechanism covers ve provinces, Fujian, Jiangxi,

Guangdong, Hunan and Guangxi. What I thought was very interesting was Gareth Hatchs (of Technology

Metals Research) point that the ve jurisdictions to be combined into a unied pricing system are all in the

southern part of China. Industry estimates suggest that around half of the rare earth mines in southern

China are unlicensed and up to one third of export volumes from the region were smuggled out of the

country illegally. It is these regions which produce the majority of the heavy rare earths (like dysprosium,

europium and terbium), with most of the light rare earths being produced in Inner Mongolia in the north.

As Gareth noted:

It would thus appear that the change is an attempt by the authorities to specically control the prices of

the more valuable heavy rare earths.

If this was the idea, it has backred somewhat. While the prices of the heavy rare earths have also risen

sharply since the announcement, the price rises of the light rare earths have far outstripped them. It seems

that prot-maximising Chinese exporters have reduced sales of the light elements in favour of the higher

added value heavier rare earths. Responding to the Chinese action, the US lobbyist Jeff Green noted that:

This is exactly the situation weve been warning the US government about for several yearsand will very

likely lead to a strong political response from the US over the next 12-24 months.

It didnt take 12-24 months, the US and Japan are already whinging about the Chinese move. While China

now controls over 95% of world production, the US has only itself to blame for its cataclysmic decline

from being the worlds largest producer. During the China/Japan economic discussions in Beijing in the last

week of August, Japanese foreign minister, Katsuya Okadas, protests were rebuffed according to the Daily

Telegraph (thanks Dylan G.):

Chinas commerce minister Chen Deming said that Beijing would not back down over the export quotas.

Mass-extraction of rare earth will cause great damage to the environment, thats why China has tightened

controls, he said, repeating the ofcial line.

The US is trying to establish that China is breaching WTO rules by giving preferential treatment to domestic

companies. Even if the US gets some traction on this, the Rare Metal Blog made the following observation:

Most outside of China believe that the environmental protection argument holds little credibility in the

defense of export controls, which only serve to create distinct price advantages for domestic end-users and

manufacturers. However, production controls, which limit the annual amount of rare earth production and

are also currently applied by the Chinese government, do not create the same unequal economic conditions

as export controls and have been recognized in other industries as acceptable under the WTO. Assuming

the dispute settlement panel does nd Chinas export controls to not be in accord with WTO rules, it is very

likely that China will shift towards greater reliance on production controls. Such a change would satisfy the

WTO by creating a more level playing eld for domestic and international purchasers and allow China toescape nancial penalties or the imposition of countervailing duties. It would also allow China to maintain

control over the primary supply and global prices for many raw materials, including rare earths.

My sense is that the Chinese have embarked on a trade war - and a very clever one indeed:

B They have an almost total monopoly on both the mining of rare earths and downstream processing

capability. Its going to take western nations years to catch up obviously;

B Hypothetically, if China sought to benet in the same way from an equally dominant position in something

like beer, bread or bras, all (fairly) vital to everyday life, billions of people would already be VERY p*ssed

off. There would be demonstrations, Obama would be droning on from his autocue and it would be all

over the media. In the case of rare earths, 99% of people dont even know what they are, never mind

appreciating how vital they are in things we take for granted like iPods, mobile phones, laptops, at

screen TVs, etc.

However, it seems that Chinas intent to stiff the rest of the world on rare earths might be more longstanding



than I realized. Id read the alleged quote attributed to Chinese leader Deng Xiaoping that:

There is oil in the Middle East, but there is rare earth in China

Recently I read Cindy Hursts report Chinas Rare Earth Elements Industry: What Can the West Learn?

published by the Institute for the Analysis of Global Security. Cindys day job is being an analyst for the

US Armys Foreign Military Studies Ofce. Ms Hurst quotes the Deng comment and notes that he made it

in 1992 so maybe it is true.

The report is also interesting because it puts an entirely different slant on Chinese oil company CNOOCs

attempted US$18.5bn acquisition of US oil company, Unocal, in 2005. While the US blocked the deal on the

grounds of energy security, Ms Hurst speculates that the real motivation behind the takeover bid was to

take control of the Mountain Pass rare earth mine then owned by Unocal (and recently listed as Molycorp

on the NYSE). Last year, China failed in an attempt to take a controlling 51.6% stake in Lynas Corporation,

but did take 25% in Arafura Resources both Australian-based rare earth developers. On 9 August 2010,

the East China Exploration & Development Bureau took a 51% stake in Northern Uranium, a uranium and

heavy rare earth exploration company inAustralia (again). In military jargon, I think this is called full

spectrum dominance.

If China refuses to back down on exports, the question is how long a drawdown in inventories can persist

until we reach a crunch point in supply. According to industry consultant, Jack Lifton, there will be a

period of calm before what could be a storm:

In the short-term, the end-users supply of rare earth metals and alloys from China will not be affected

because they have been building inventory in Japan, the majority (sic) direct user of rare earths outside

China.

With tiny amount of rare earths needed for iPods, mobile phones, TVs and computers, I wonder if anybodys

told Apples Steve Jobs whats going on? When I was a mining analyst and there was a global shortage of

the huge tyres used on the giant trucks and earth movers back in 2006-08, I was told that BHP Billiton hadapproached a reluctant Michelin and told its bosses that if they didnt build new capacity their company

would be taken over. I wrote that last comment several days ago and then saw this on the Rare Metal Blog

on Sunday:

I think we will be in the late innings of this story, when nally a tech company or a conglomerate

of tech companies nally (sic) reach upstream to secure their supplies of REEs. The lack of

vision that J. Lifton is always talking about really is astounding, but I guess that makes it a

good potential investment. They could have a 50 year secure supply of materials for a rounding

notation on a lot of these companies balance sheets, and yet it still goes unaddressed.

In June, Alaskan senator Lisa Mekowski introduced a bill aiming to re-establish a competitive rare earths

industry in the US - the Rare Earth Supply-Chain Technology and Resource Transformation (RESTART)

Act. This is similar to legislation introduced to the House by Republican Representative, Mike Coffman, in

March this year. The US Government Accountability Ofce (GAO) published a report on 14 April 2010 which

highlighted the near-term need for a sustainable supply chain of rare earths in the US for critical American

national defense and industrial applications.

The two western producers with projects at an advanced stage both have deposits skewed heavily towards

light rare earths. Lynas Corporations Mount Weld deposit has a heavy-to-light rare earth ratio of 5%-

95% and recently IPOd Molycorps has a 9%-91% ratio. For this reason, I bought some shares in Ucore

Rare Metals, which is a much earlier exploration play, but does have a heavy-to-light ratio of 50%-50%.

Its deposit is also on, or rather under, US soil in Alaska. Last Thursday, the company issued the followingannouncement:



the United States Geological Survey (USGS), a division of the US Department of the Interior,

has moved to increase its involvement at the Companys Bokan Mountain Heavy Rare Earth

project in Southeast Alaskathe USGS has now sent a team of geoscientists to Bokan for the

purpose of advancing the US governments understanding of the areas unique Heavy Rare

Earth (HREE) mineralogy, believed to be the largest historically documented HREE deposit in

the United StatesOf particular interest are terbium and dysprosium, which are among the

most scarce and valuable metals in the world, and which have been found in anomalously high

grades in the Bokan area. The U.S. government is quite interested in these minerals because

they are of military importance, said Dr. Mariano. China has moved to decrease the export of

these essential metals to the U.S. and elsewhere, thereby increasing interest in securing short

and long term domestic supplies within the U.S.

The timing of the Ucore announcement is interesting since we have the prospect of another positive

catalyst for rare earth stocks coming in September. The US Department of Defense is due to publish its

assessment of its dependency on these elements by the end of this month. For a country which spends

the same amount of money annually as the rest of the world combined, has 737 overseas military bases in

60 countries, and is at war, its hard to imagine it is going to take any risk with regard to supply. Two keyndings from the GAOs study of rare earths were:

B The use of rare earths in defense systems is widespread including precision-guided munitions, lasers,

communications systems, radar systems, avionics, night vision and satellites;

B The US military began to recognise the rare earth supply issue as long as seven years ago, but did

nothing about it. The Air Forces Materials and Manufacturing Directorate prepared a report in 2003

which raised concerns about the dependency on China. In 2006, the Navy considered funding Molycorps

Mountain Pass mine, but subsequently lost interest.

In broader terms, the GAO report also highlighted that mining rare earth ore is merely the rst step in a

number of downstream processing steps:

B separating the rare earth ore into individual rare earth oxides;

B rening the rare earth oxides into metals; and

B forming the metals into rare earth alloys.

In her report, Cindy Hurst remarked:

Dr John Burba, Chief Technology Ofcer at Molycorp Minerals, the company that runs the only rare earth

mining operation in the US pointed out that, a lot of people dont quite understand why rare earth operations

are different (from other mining operations). Mining gold, for example, is a much simpler procedure than

mining rare earth elements. One method of processing gold ore, simply put, is to mix the ore with sodiumcyanide. The gold is then leached right out. Rare earth metals are far more complicated and costly to

extractEach element has its own unique extraction steps and chemical processes and at times, these

elements will require reprocessing to achieve the ideal purity.

According to the GAO rened rare earth metals are almost exclusively available from China. Lynas

Corporation, for example, is developing a rare earth processing facility in Malaysia and Molycorp is also

pursuing an integrated strategy. I searched for a junior rare earths play with reasonable exposure to the

more valuable heavy rare earths while also having downstream processing expertise. At the end of my

search, I bought some shares in Canadian-listed Great Western Minerals Group (GWG) and as giraffes say,

you dont get no leaves unless you stick your neck out. In darts throwing terminology, the GWG purchase

is an UNDERSTACKER.

GWG has a fully diluted market cap of US$81m and owns the rights to 100% of the production from the

Steenkampskraal deposit in South Africa which should be in production in 2013. This project is a past-

producing mine and will only require about US$30m of capital expenditure a VERY big positive in my



view. Coming behind this deposit, CWG has four further exploration projects, three in Canada and one in

the US. Hoidas Lake, in Saskatchewan, Canada, is the most advanced of these and CWG estimates that

it will require c.US$115m of capital expenditure but could be onstream in 2015. Due to a combination of

high ore grade in the case of Steenkampskraal, for example, or due to very high levels of heavy rare earths

themselves in the case of the Douglas River deposit (also in Saskatchewan), the investor presentation

argues that GWGs revenue per tonne of ore will compare favourably with its peers.

The President and CEO of CWG, James B. Engdahl, was interviewed on Jim Puplavas Financial Sense news

hour a few weeks ago. He also emphasised the importance of processing the mined rare earth ore:

There is a tremendous process downstream in this whole rare earth business and thats one

of the things that the market also doesnt understand. Most of these other companies outside

China, the only thing that they have is a deposit. They do not have the downstream processing

capacity, which is one the things which makes Great Western unique outside China. We have a

plant in England and we have a plant in Michigan, both of which are capable of processing oxides

into powders and making alloys and metal materials.

And discussing the vision of the companys Executive Chairman, Gary Billingsley, Engdahl commented:

He also understood that you couldnt just get into mining, because there was a high probability

that just mining itself wouldnt make money. And thats one of the things weve been focusing on,

a fully integrated mine-to-market modelthe project we have in South Africa, Steemkamskraal,

it will produce only about 2,700 tonnes based on the historical resource calculation over the

next ten years, but we think theres a high probability of expanding thatwe will take that

material and separate it in South Africa and well process it at our plant in England and well

sell it then to the end usersfrom the mine to the market, to the end users, 2,700 tonnes will

generate for us about S$160m in revenue and about US$65m in cash ow. But only 15% of that

is attributable to the actual mining entity, the rest of it is all downstream.

The fully diluted market capitalisation of GWG is currently US$81.4m (US$0.28 x 290.8m shares), net cash

is about US$2m, but the capital requirement for Steemkamskraal, is VERY modest as I emphasised.

Im waiting to see what the US Department of Defense comes up with later this month. I cant see how they

can disagree with the US militarys Cindy Hurst:

With so much at stake, it is imperative that the US develop methods to acquire a secure, long-

lasting source of rare earth elements.

.


24/24

Author: I started work the month before the stock market crash in 1987. Ive worked mainly as an analyst

covering the Metals & Mining, Oil & Gas and Chemicals industries for a number of brokers and banks

including S.G. Warburg (now UBS), Credit Lyonnais, JP Morgan Chase, Schroders (became Citibank) and,

latterly, at the soon to be mighty Redburn Partners.

Disclaimer: The views expressed in this report are my own and are for information only. It is not intendedas an offer, invitation, or solicitation to buy or sell any of the securities or assets described herein. I do not

accept any liability whatsoever for any direct or consequential loss arising from the use of this document or

its contents. Please consult a qualied nancial advisor before making investments. The information in this

report is believed to be reliable , but I do not make any representations as to its accuracy or completeness.

I may have long or short positions in companies mentioned in this report.

Documents

Thunder Road Report 21 6th Sep 2010