Investing

With the recent, incredible, drop in the Australian dollar foreign stocks look a lot more expensive based on purchases with AUD. It's very likely that the AUD will eventually appreciate against the USD and lots of other currencies but any investment in those other currencies has an automatic headwind once that happens.

I used the Economist Big Mac Index as published in July 2008 and updated it with the most recent exchange rates. The economist calculated that the AUD was 6% undervalued in July 2008 (at 0.97), that has now moved to 40% undervalued (at 0.62). In July there were 14 major currencies that were cheaper than the AUD, now there are only 7.

• South Africa
• Malaysia
• Hong Kong
• Phillippines
• Thailand
• Iindonesia
• China

The following countires fell off the list, even though they are still undervalued, just the AUD fell further

• Taiwan
• Russia
• Japan
• Singapore
• South Korea
• Chile
• Mexico

Of the major currencies that I might invest in

• Canada could see a 33% depreciation against the AUD,
• USD 40% depreciation against the AUD,
• Euro 50%depreciation against the AUD,
• Japan 28% depreciation against the AUD,
• New Zeland 21% depreciation against the AUD,
• Singapore 18% depreciation against the AUD.
  
  On the upside
• China has about 17% upside but is pegged,
• Indonesia and Thailand have 20% upside,
• Hong Kong has 25% upside but is pegged,
• Malaysia has 40% upside and
• South Africa 42% upside.

Those countires with even weaker, unpegged, currencies than the AUD are not exactly the most desireable investment locations!

For example imaging buying a canadian company for $2 CAD with $2.51 AUD at today's exchange rates. If that company rises to $20 CAD but exchange rates move to purchasing power parity then that $20 CAD becomes $16.8 AUD. That is a 6.7 times return instead of the 10 times return in Canadian dollars.

Conversely buying a Hong Kong company at $2 HKD for 41c AUD today would be $5.18 AUD if the company rose to $20 HKD and the currencies moved to PPP. A 13 times return in AUD for only a 10 times return in HKD. Unfortunately the HKD (and largely the Chinese RMB) is still pegged to the USD so it's likely to be weak in the medium term until the pegged is eventually dropped.

The bottom line is that Australian companies with expenses in AUD have a 20%-40% appreciation advantage over other major exchanges right now. This point is unlikely to be lost on international investors for long and makes a strong case for AUD denominated accounts to remain local.

See my previous posts on STM here, here and here.

It is worth looking at the previous, savage, bear market in Strathmore's stock to understand why things will work out ok this time around. Yahoo has STM weekly price records back to late 1997. It started trading at about $3.85 in late '97.

In March 2001 it dropped below 30c for the first time. It then bounced around reaching a low of 6c and didn't definitively break back up above 30c until October 2003. That is about 2.5 years.

It rose to $5.18 in May 2007 and first broke 30c again in October 2008. If history repeats we could go nowhere for 2.5 years and we'd be looking at 2011 before Strathmore's stock price recovers. Though keep on reading to see why I don't think it will even take that long.

March 2001
In March 2001 Uranium was trading around $7 per pound. At that time STM "elected to sharply reduce its expenditures and conserve cash. The Company eliminated all exploration and pared back on the non-essential properties decreasing the number of claims held ". As of December 31st 2001 they had $119,000 cash and equivalents. They periodically sold shares to raise a few hundred thousand dollars primarily to stay in business. In the year 2000 the loss for they year was $400,000.

2002
By the end of 2002 they had $11,784 in cash and equivalents and used $213,735 in cash for the whole year 2002. By this point there were about 8M shares outstanding.

2003
By June 30th, 2003 they had $5,308 in cash and equivalents and were spending annuazlied about $300,000 a year.

October 2008
In October 2008 STM broke down below 30c. Spot uranium is down to $44 but according to Resource Capital Research's September 2008 review, long term contracts are still priced around $80. The spot prices in the low $40's are "driven by the emergence of distressed sellers and others driven by cash flow requirements according to TradeTech."

This time around STM has around $11M in cash and equivalents. They may have a current burn rate of up to $800,000 a month to meet current exploration commitments.

Future Budgets
The CRITICAL question is what comes next. It seems obvious that once cash gets down to $4-$5M they will dramatically reduce expenses and move into maintenance mode just like they did last time. Even if maintenance costs $1M now instead of $200-$300k last time around, then they will have 4-5 years cash. When they get down to the last couple of million then they can fire everyone and pair back their claims to bring expenses down to the 0.5M level which stretches out their life even more.

It is ridiculous to think that STM is going to keep spending $800,000 a month until all their cash runs out. They have been through exactly this experience before and they have a track record of putting the company on hold while they wait for things to improve.

Similarities to last time

• Bear market
  
• Dramatic fall in stock price

Differences to last time

• Uranium prices are still profitable for STM, last time around they were not
  
• STM has a lot more money, $11m versus only $120,000 last time
  
• Massive deleveraging of hedge funds
  
• Uranium fundamentals are still in place, last time around they were not. Resource Capital Research says "Planned and proposed new nuclear power reactors worldwide have increased in the past two years. From Jan ’07 to Aug ’08 there was an increase of 96 reactors from 222 reactors (Jan ‘07) to 318 reactors (Aug ‘08), a rise of 43% since Jan ‘07. This compares with 439 nuclear power reactors currently in operation and 36 under construction. A total of 60 new reactors are expected to be commissioned by 2014."

Bottom Line

• Uranium fundamentals are still in place.
  
• Strathmore can easily wait 5-6 years, if need be, with current cash reserves. The financial crisis is not going to last 5-6 years. Even if they have to issue equity at 10c to raise $500,000 for another year that would only be 5M shares out of 72M or 7%, compared to 62% of the company back in 2002.
  
• STM has gone through exactly this scenario before, a cratering stock price and a bad economic backdrop. They survived and can use the same strategy this time around.