Category Archives: Precious Metals

Trump’s Dilemma And Refuting The Gold/Yuan Peg Theory

The following is an excerpt from my December 6th issue of the Mining Stock Journal:

Trumps Dilemma – The dollar index has been rising since Trump began his war on trade. But right now it’s at the same 97 index level as when Trump was elected. Recall that Trump’s administration pushed down starting in 2017 to stimulate exports and attempt to cut the trade deficit.  The dollar  fell from 97 to 88.  Gold ran from  $1125 to as high as $1360 – a key technical breakout level – by late April 2018.  Something had to be done to keep gold from moving higher…Trump started his Trade War in March, which  pushed the dollar higher.  Gold began tank.   Ironically, the trade deficit one again began to balloon.

If Trump wants to “win” the trade war, he needs to push the dollar a lot lower. This in turn will send the price of gold soaring. This means that the western Central Banks/BIS will have to live with a rising price gold, something I’m not sure they’re prepared to do. This could set up an interesting behind-the-scenes clash between Trump and the western banking elitists.

I’ve labeled this, “Trump’s Dilemma.” As anyone who has ever taken a basic college level economics course knows, the Law of Economics imposes trade-offs on the decision-making process (remember the “guns and butter” example?). The dilemma here is either a rising trade deficit for the foreseeable future or a much higher price of gold.

The other problem with pushing the dollar lower to stimulate exports – or at least attempt to stimulate exports – is the funding of Treasury debt. If foreign investors, who fund a large percentage of Treasury issuance, expect the dollar to decline it will significantly reduce the foreign funds that finance Trump’s spending deficit. That deficit – on-budget + off-budget – will likely end up somewhere between $1.5 – $2 trillion this year…

Refuting the yuan/gold peg theory – When the theory about the Chinese pegging gold to the yuan based on the chart correlation was floated, how come nobody bothered to check the other major currencies vs. the dollar and vs. gold? The dollar has traded higher as if on steroids since late-April. Gold was trading at $1360 in late April. Between now and then it has traded as low as $1170. The yuan began falling vs. dollar in late April. But so did the Swiss franc and yen. The euro began falling vs. the dollar in February.

The charts of the Swissy, euro and yen vs the yuan over the last 12 months are all largely flat over that time period. More to the point, the chart of gold vs all four of those currencies (yuan, Swissy, euro and yen) over the last 12 months looks very similar:

As the chart above shows, the price of gold in all four currencies – yen, yuan, euro, Swissy – has been correlated. The argument could be made that gold is “pegged” to any four of those currencies. The yen, euro, Swissy make up a large portion of the dollar index. Gold is thus not pegged to the yuan so much as it is trading inversely to the dollar,  which is expected.

The Trade War Is Not The Problem With The Global Economy

I chuckle when the hedge fund algos grab onto “positive” trade war headlines and trigger a sharp spike in stock futures.  Settlement of the trade war between the Trump Government and China will do nothing to prevent a global economic recession – a recession which will likely deteriorate into a painful depression.  The Central Bank “QE” maneuver was successful in camouflaging and deferring the symptoms of economic collapse.  Ironically, treatment of the symptoms made everyone feel better for a while but the money printing ultimately served only to exacerbate the underlying financial, fiscal, economic and social problems that blossomed after the internet/tech bubble popped.

Trade war “hope” headlines coughed up by Larry Kudlow last Friday morning were designed to offset the disappointing job report and sent the Dow up 156 points in the first 12 minutes of trading. But alas, the gravity of deteriorating systemic fundamentals took over and the Dow ended up down 558 points:

All three major indices closed below their key moving averages (21, 50, 200 dma). I wanted to show the chart of the Nasdaq because, as you can see, the 50 dma (yellow line) crossed below the 200 dma (red line) last week. This started to occur for the SPX on Thursday. The Dow’s 50 dma remains above its 200 dma, but that will likely change over the next few weeks.

The point here is that investors, at least large sophisticated investors, continue to use rallies to unload positions. The stock market has a long a way to fall before the huge disparity between valuations and fundamentals re-converges. This reality will not be altered even if Trump and China manage to reach some type of trade agreement. Nothing but a painful “reset” can correct the massive overload of fiat currency and debt that has flooded the global financial system over the last ten years.

I also believe that a massive credit market liquidity problem is slowly engulfing the system. This is a contributing factor in the yield curve inversion, which moved from the 3yr/5yr interval to the 2yr/5yr interval last week, thereby reflecting the market’s growing awareness of the percolating systemic problems. In 2008 the liquidity problem began with widespread sub-prime bond defaults and was compounded by derivatives connected to the sub-prime credit structures. This time, it appears as if the credit market problem is starting in the investment grade bond and leveraged bank/senior loan markets.

It was reported last week that $4 billion was removed from leveraged loan funds over the last three weeks. Although the loans are leveraged, these are typically senior secured “bank debt equivalent” loans. Money is leaving this segment of the loan market because of a growing perception that the leveraged senior loan market is becoming risky. Loan and bond investors are more risk-averse than stock investors. They thus tend to be more vigilant on the ability of debt borrowers to make loan payments.

Currently there’s a record high amount of triple-B rated corporate debt outstanding. This amount outstanding is higher than any other rating category. At some point, as the economy continues to weaken, a large percentage of this triple-B rated will be downgraded. Assuming cash continues to flee the loan market, and as a lot of low investment grade paper is moved into junk-rated territory, it will exert huge pressure on bond yields. It will also make it much harder for marginal credits to raise capital to stay alive.

General Electric losing access to the commercial paper market is an example of the market cutting off a source of liquidity to companies that need it. It’s also a great example of a company with a large amount of outstanding debt that is headed toward the junk bond pile (GE is one notch away from a junk rating – at one time it was a triple-A rated company). Ford is headed in the same direction – the stock of both companies trades below $10. If this is happening to a companies like GE and Ford, it will soon happen to smaller companies en masse.

The commentary above is an excerpt from the latest issue of the Short  Seller’s Journal.  Also included is an updated analysis on Tesla and why I am increasing my short exposure in the stock plus follow-up on my Vail Resorts (MTN) short presented a week earlier. You can learn more about this newsletter here:  Short Seller’s Journal information.

 

Trump’s Trade War Dilemma And Gold

If the “risk on/risk off” stock market meme was absurd, its derivative – the “trade war on/trade war off” meme – is idiotic.  Over the last several weeks, the stock market has gyrated around media sound bytes, typically dropped by Trump,  Larry Kudlow or China,  which are suggestive of the degree to which Trump and China are willing to negotiate a trade war settlement.

Please do not make the mistake of believing that the fate the of the stock market hinges on whether or not Trump and China reach some type of trade deal.  The “trade war” is a “symptom” of an insanely overvalued stock market resting on a foundation of collapsing economic and financial fundamentals.  The trade war is the stock market’s “assassination of Archduke Franz Ferdinand.”

Trump’s Dilemma – The dollar index has been rising since Trump began his war on trade. But right now it’s at the same 97 index level as when Trump was elected. Recall that Trump’s administration pushed down the dollar from 97 to 88 to stimulate exports. After Trump was elected, gold was pushed down to $1160. It then ran to as high as $1360 – a key technical breakout level – by late April. In the meantime, since Trump’s trade war began, the U.S. trade deficit has soared to a record level.

If Trump wants to “win” the trade war, he needs to push the dollar a lot lower. This in turn will send the price of gold soaring. This means that the western Central Banks/BIS will have to live with a rising price gold, something I’m not sure they’re prepared accept – especially considering the massive paper derivative short position in gold held by the large bullion banks.  This could set up an interesting behind-the-scenes clash between Trump and the western banking elitists.

I’ve labeled this, “Trump’s Dilemma.” As anyone who has ever taken a basic college level economics course knows, the Law of Economics imposes trade-offs on the decision-making process (remember the “guns and butter” example?). The dilemma here is either a rising trade deficit for the foreseeable future or a much higher price of gold. Ultimately, the U.S. debt problem will unavoidably pull the plug on the dollar.  Ray Dalio believes it’s a “within 2 years” issue. I believe it’s a “within 12 months” issue.

Irrespective of the trade war, the dollar index level, interest rates and the price of gold,  the stock market is headed much lower.   This is because, notwithstanding the incessant propaganda which purports a “booming economy,” the economy is starting to collapse. The housing stocks foreshadow this, just like they did in 2005-2006:

The symmetry in the homebuilder stocks between mid-2005 to mid-2006 and now is stunning as is the symmetry in the nature of the underlying systemic economic and financial problems percolating – only this time it’s worse…

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The commentary above is a “derivative” of the type of analysis that precedes the presentation of investment and trade ideas in the Mining Stock and Short Seller’s Journals. To find out more about these newsletters, follow these links:  Short Seller’s Journal  information and more about the Mining Stock Journal here:   Mining Stock Journal information.

The Trade War Shuffle And The Fukushima Stock Market

The market is already fading quickly  from the turbo-boost it was given by the announcement that China and Trump reached a “truce” on Trump’s Trade War – whatever “truce” means.   Last week the stock market opened red or deeply red on several days, only to be saved by a combination of the repetitious good cop/bad bad cop routine between Trump and Kudlow with regard to the potential for a trade war settlement with China and what has been dubbed the introduction of the “Powell Put,” in reference to the speech on monetary policy given by Fed Chair, Jerome Powell, at the Economic Club of New York on Wednesday.

It’s become obvious to many that Trump predicates the “success” of his Presidency on the fate of the stock market. This despite the fact that he referred to the stock market as a “big fat ugly bubble” when he was campaigning.  The Dow was at 17,000 then. If it was a big fat ugly bubble back then, what is it now with the Dow at 25,700? If you ask me, it’s the stock market equivalent of Fukushima just before the nuclear facility’s melt-down.

Last week and today are a continuation of a violent short-squeeze, short-covering move as well as momentum chasing and a temporary infusion of optimism. I believe the market misinterpreted Powell’s speech. While he said the Fed would raise rates to “just below a neutral rate level,” he never specified the actual level of Fed Funds that the Fed would consider to be neutral (neither inflationary or too tight).

I believe the trade negotiations with China have an ice cube’s chance in hell of succeeding. The ability to artificially stimulate economic activity with a flood of debt has lost traction. The global economy, including and especially the U.S. economy (note: the DJ Home Construction index quickly went red after an opening gap up), is contracting. Trump and China will never reach an agreement on how to share the shrinking global economic pie.

While Trump might be able to temporarily bounce the stock market with misguided tweets reflecting trade war optimism, even he can’t successfully fight the Laws of Economics. His other war, the war on the Fed, will be his Waterloo. The Fed has no choice but to continue feigning a serious rate-hike policy. Otherwise the dollar will fall quickly and foreigners will balk at buying new Treasury issuance.

For now, Trump seems to think he can cut taxes and hike Government spending without limitation. But wait and see what happens to the long-end of the Treasury curve as it tries to absorb the next trillion in new Treasury issuance if the dollar falls off a cliff.  Currently, the U.S. Treasury is on a trajectory to issue somewhere between $1.7 trillion and $2 trillion in new bonds this year.

Despite the big move higher in the major stock indices, the underlying technicals of the stock market further deteriorated. For instance, every day last week many more stocks hit new 52-week lows than hit new 52-week highs on the NYSE. As an example, on Wednesday when the Dow jumped 618 points, there were 15 news 52-week lows vs just 1 new 52-week high. The Smart Money Flow index continues to head south, quickly.

For now it looks like the Dow is going to do another “turtle head” above its 50 dma (see the chart above) like the one in early November. The Dow was up as much as 442 points right after the open today, as amateur traders pumped up on the adrenaline of false hopes couldn’t buy stocks fast enough. As I write this, the Dow is up just 140 points. I suspect the smart money will once again come in the last hour and unload more shares onto poor day-traders doing their best impression of Oliver Twist groveling for porridge.

Stock, Bond, and Real Estate Bubbles Are Popping – Got Gold?

“I don’t know how this whole thing is going unwind – I just think it’s not going to be pleasant for any of us, even if you own gold and silver.  I think owning gold and silver gives you a chance to survive financially and see what it’s going to look like on the other side of what is coming…”

My good friend and colleague, Chris Marcus, invited me on to his Stockpulse podcast to discuss the financial markets, economy and precious metals.  In the course of the discussion, I offer my view of the Bank of England’s refusal to send back to Venezuela the gold the BoE is  “safekeeping” for Venezuela.

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If you are interested in ideas for taking advantage of the inevitable systemic reset that  will hit the U.S. financial and economic system, check out either of these newsletters:   Short Seller’s Journal  information and more about the Mining Stock Journal here:   Mining Stock Journal information.

Mining Stock Daily: Western Copper & Gold Is Undervalued

The Mining Stock Daily, a collaboration between ClearCreekDigital and Investment Research Dynamics, interviewed the CEO, Paul West-Sells, to learn more about Western Copper & Gold (WRN on both the NYSE and TSX). But first, here’s background on WRN:

Western Copper & Gold is advancing the Casino Project, a world-class copper-gold porphyry deposit, in the Yukon. The deposit contains 4.5 billion lbs of copper and 8.9 million ounces of gold reserve and 5.4 billion lbs and 9 million ozs of inferred resource.

Western Copper was a spin-off from Western Silver after Glamis Gold acquired Western Silver in May 2006 (three months later Goldcorp acquired Glamis). WRN acquired the old Lumina Resources in September 2006 for Lumina’s three copper properties, one of which was Casino. WRN spun-off the other two properties.

WRN only has 106.4 million fully-diluted shares outstanding (including options/warrants), which is remarkable for company that has been developing a massive copper-gold project for 11 years. Insiders own 8% of the stock. A small group of high net worth private investors who have made a lot of money on companies run by WRN Executive Chairman, Dale Corman, own 48% of the stock and institutional/retail own the remaining 44%.

WRN raised $32 million in 2012 selling a Net Smelter Return royalty to Orion Capital. That NSR was sold to Osisko in June 2017 when Osisko acquired a portfolio of royalty assets from Orion.

With a market cap of US$70 million (fully-diluted basis), WRN is extraordinarily undervalued on a risk-return basis. This is especially true considering the recent wave of copper-gold porphyry project M&A activity. Recall that Newcrest invested approximately US$14 million for a 19.9% stake in Azucar’s El Cobre, which valued that early-stage copper-gold project at US$74 million. In 2017, Goldcorp paid US$185 million for Exeter’s Caspice copper-gold project high up in the Chilean Andes.

There have been several other transactions in the copper-gold space, including Zijin’s (Chinese company) acquisition of Nevsun for $1.41 billion (September 2018) for the Timok copper-gold project in Serbia and the recently closed sale of the Malmyzh copper-gold project (Freeport, EMX Royalty) to Russian Copper Company for US$200 million.

WRN’s project is not as large or as high-quality as Malmyzh, but it’s several years closer to being converted into an operating mine. At this juncture, with the current price of copper and gold, the “asset value” of WRN, based on the roster of comparable transactions, is at least US$140 million. I would not be surprised to see one of the companies with projects near Casino make bid a for WRN at some point in next 6-12 months. There’s also a list of other potential acquirers, including RioTinto, BHP and Freeport.

Click on the graphic below to hear Trevor Hall’s interview with WRN’s Paul West-Sells (you can also download the interview on your favorite app by clicking here: MSD platforms):

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The analysis above on WRN is from the November 8th issue of the Mining Stock Journal. To learn more about this newsletter, click here: Mining Stock Journal information

Treasury Debt And Gold Will Soar As The Economy Tanks

“People have to remember, mining stocks are like tech stocks where everybody and their car or Uber driver piles into them when they’re moving higher. It’s not a well-followed, well-understood sector which is what I like about it because it means there’s plenty of opportunities to make a lot money in stocks that don’t end up featured on CNBC or everybody’s favorite newsletter.”

Elijah Johnson of Silver Doctor’s (silverdoctors.com) invited me on his podcast to discuss the fast-approaching economic crisis and my outlook for the precious metals sector:

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I’ll be presenting a detailed analysis of the COT report plus a larger cap silver stock that has had the crap beat out of it but has tremendous upside potential in my next issue of the Mining Stock Journal. You can learn more about the Mining Stock Journal here:  Mining Stock Journal information

Tesla’s Q3 GAAP “Net Income:” Manipulation If Not Outright Fraud

I perused Tesla’s Q3 10-Q and scrutinized the footnotes to figure out, to the extent possible, where Tesla manipulated GAAP accounting standards and outright “cooked” its numbers. Before I had a chance to analyze the 10-Q, others had already posted their findings on Twitter or in Seeking Alpha articles. In the analysis below, I’ve double-checked and confirmed the findings presented by others. In addition, where appropriate, I’ve added my findings to the previous work of others and explained how and why Tesla’s numbers are highly misleading, if not outright fraudulent.

Net income – Tesla reported GAAP income of $311.5 million. But what it did not disclose when it released its earnings report was that $189 million of that income was generated from selling regulatory credits – Greenhouse Gas (GHG) credits and ZEV (Zero Emission Vehicle) credits. Automakers in 10 States are required to sell a specified number of electric or hybrid vehicles within the State. Credits are earned for the number of emission-friendly vehicles sold. Automakers are required to maintain a level of credits based on each automaker’s overall vehicle sales volume within the State. GHG credits function in a similar way at the Federal level.

Some companies, like Tesla, generate more GHG and ZEV credits than required to be in compliance with the law. Companies with excess credits are allowed to sell their excess credits to car manufactures and other companies that manufacture carbon-emission equipment and do not generate enough credits to be in compliance with the regulation. Selling excess credits over the past few years has been a significant source of cash flow generation for Tesla. The money raised by selling these credits is accounted for as income under GAAP.

The problem is that, in its presentation of its Q3 earnings, Elon Musk and the CFO did not disclose that nearly 61% of its GAAP net income was derived from selling these credits. While Tesla referenced that $52 million was generated from ZEV credit sales in Q3, they did not disclose the $137 million GHG credit sales in the earnings press release or the analyst conference call. Rather, they postured as if the net income was generated thru cost-efficiencies and sales volume. The $137 million in GHG credit sales was buried in the 10-Q.

In the chart above, you can see that TSLA’s use of GHG credit sales has been inconsistent over time. In all probability, Musk chooses the timing and quantity of the credit sales based on when he needs to generate cash. It’s pretty obvious that he decided to unload a massive quantity in Q3 in order to help generate the GAAP net income and positive cash flow he had been promising for months.

Technically, the manner in which Musk utilized,and disclosed the use of, ZEV/GHG credits to manufacture income, is highly deceptive. Selling regulatory-derived environmental credits is a low-quality, unreliable source of income. As Tesla’s competition ramps up production and sales of EV’s, the supply of credits will escalate rapidly. This will drive down the resale value of these credits toward zero. And there’s always the possibility that regulatory requirements will be rolled back. Over time, this source of income and cash will disappear.

Warranty Provision – Every quarter companies that issue warranties have to take a warranty expense provision, which is an estimate of the quarterly expense that will be incurred under warranties on products sold by the company. The warranty provision hits the income statement as an expense. The idea is to match estimated quarterly warranty costs that will be incurred from selling products covered by the warranty each quarter. Warranty expense is part of the cost of goods sold. The information on warranty expenses is found in the footnotes (this is standard).

In Q3 this year, Tesla expensed $187.8 million, or $2,249 per car delivered, vs $118.6 million, or $2,913 per car delivered in Q3 2017. If Tesla had kept the cost per vehicle delivered constant, the provision for warranty expense in Q3 would have been $243.2 million, or $55.4 million higher than was expensed in Q3. In this case, Tesla’s cost of goods sold would have been $55.4 million higher and the gross profit would have been $55.4 million lower. This is part of the reason Tesla’s gross profit margin was much higher than anyone expected. It also translates into a $55.4 million net income benefit.

In Q3 2108, Tesla sold a little more than double the number of vehicles sold in Q3 2017. At the very least, and to be prudent, in Q3 this year Tesla should have at used at least double the warranty provision it used in Q3 2017. This is especially true since the Model 3 is in its debut model year and will likely require higher than expected warranty-based repairs. The probability of greater than expected warranty repairs for cars sold during Q3 is even higher when taking into account the high number of production difficulties the Company encountered – and about which Musk whined publicly.

Using a warranty expense estimation method simply based on doubling the warranty provision taken in Q3 2017 – given that Tesla sold more than double number vehicles, Tesla’s warranty provision expense would have been $237.2 million in Q3 rather than the $187.8 million recorded, which would have reduced net income by $49.4 million.

To be sure, the warranty expense provision can be adjusted based on using the actual amount of warranty costs incurred over time. But given the limited history of Tesla, and given that the Model 3 is a 1st-year production automobile with noted production and quality control issues, Tesla probably should have used a warranty provision that was higher on a per car delivered basis than the number used in Q3 2017. But, then again, Musk and his CFO were goal-seeking positive net income and thus likely decided to reduce the provision per vehicle delivered by nearly 23% and pray that they figure out a way to bury an increase in the actual amount spent on warranty repairs in future quarters.

Inventory Write-Down – An inventory write-down is recorded as an expense in the quarter in which it is taken. For a company like TSLA, an inventory write-down occurs for excess or obsolete inventories (unsalable cars, worthless parts and supplies) or when the carrying value of certain cars held in inventory is greater than the realizable value. The latter would primarily apply to cars taken back by Tesla under lease guarantees (keep this tidbit in mind for reference below) or cars held in inventory deemed unsalable because the cost of fixing manufacturing defects is greater than the gross margin generated from selling the car.

Over the last six quarters, Tesla’s inventory write-down as a percentage of total inventory has averaged 1.4%. In Q3 2017, the write-down was 1.1% of inventory; in Q2 2018 it was 0.9%). However, in Q3 Tesla’s inventory write-down was 0.4% of inventory. In terms of numbers, Tesla’s inventory expense in Q3 was $12.4 million vs $26.2 million in Q3 2017 and $24.6 million in Q2 2018. This chart shows the degree to which it appears as if Tesla purposely minimized the inventory write-down expense in Q3 2018:

(Kudos to @TeslaCharts for the charts he created illustrating the extreme inconsistencies in Tesla’s Q3 financial statements)

The effect of taking an inventory write-down that is far lower than the historical average reduces the cost of sales and thereby increases the gross, operating and net profits. If TSLA had used the historical average of 1.4%, the expense taken for the Q3 inventory write-down would have been $46.2 million, or $33.8 million more than the $12.4 million used. The reduced write-down had the effect of reducing cost of sales by $33.8 million and increasing gross profit and net income by $33.8. This also contributed to the large increase in the gross profit margin in Q3 vs historical quarters.

The inventory write-down charge was clearly an extreme outlier in relation to the historical application of this write-down over the previous six quarters. Make no mistake, the minimization of the inventory write-down expense in Q3 was a blatant effort to exploit accounting standards for the purpose of reducing GAAP expenses and thereby increasing GAAP income. The discrepancy between the Q3 charge vs historicals predictably was not addressed by the CFO or by analysts in the Q3 earnings conference call.

Tesla’s Actual Net Income? Telsa reported $311 million of GAAP net income. Of this, $83.2 million represents the highly questionable reduction in costs attributable to lower than usual warranty and inventory write-down expenses. Tesla also sold an unusually high amount of GHG/ZEV credits, which boosted net income by $189 million. While this is a source of actual cash income, it’s not a long-term sustainable source of income. Combined, these items accounted for $272 million – or 87.5% – Tesla’s GAAP net income in Q3.

In addition to the items presented above, Tesla “achieved” significant and highly questionable reductions in the expenses taken for R&D and SG&A. In Q3 Tesla recorded $350 million for R&D and $729 million for SG&A – $1.079 billion combined. In Q2 Tesla recorded $386 million for R&D and $750 million for SG&A – $1.36 billion combined. Tesla wants the market to believe that R&D and SG&A expense declined by $290 million from Q2 to Q3, despite the fact that Tesla’s overall operations were expanded to accommodate a large increase in vehicles sold in Q3 vs Q2. On average, over the last six quarters, R&D plus SG&A has been running at 39.5% of revenues. In Q2 2018, these charges were 33.84% of revenues. But in Q3 2018, R&D and SG&A dropped to 17.7% of revenues.

To be sure, there are “economies of scale” with respect to R&D and SG&A expenditures as revenues grow. But for R&D and SG&A to decline nearly 50% as a percentage of revenues from Q2 is simply not credible, unless Tesla intentionally drastically cut back on R&D and administrative/sales functions in Q3. Without question, Musk and his CFO played games with the R&D and SG&A expense accounts in order to reduce the charges expensed for these categories in Q3 vs the previous six quarters and especially vs Q2 2018.

It’s quite possible that Tesla loaded R&D and SG&A expenses into Q2 that technically belonged in Q3 knowing that it was going to report a big loss in Q2 ($717 million loss in Q2) anyway and had promised profitability in Q3. But it’s impossible to know if this occurred without having access to the inside books and bank statements. The stunning plunge as a percentage of revenues for these items in Q3 vs Q2 is the equivalent of asking us to believe in the existence of Santa Clause.

If we give the Company the highly doubtful benefit of synergies which reduced R&D and SG&A to just 20% of revenues – despite the fact that it has been running nearly double 20% over the last six quarters – the combined charge for these accounts would have been $1.219 billion rather than the $1.079 billion used by Tesla (note, at the very least it would have been reasonable to assume that the expense level at a minimum stayed flat vs Q2, meaning I’m being overly generous in my assumption). Under this scenario, Tesla’s operating expenses would have been higher by $140 million.

Adding this $140 million in incremental expense to the $49.4 million warranty expense manipulation and $33.8 million inventory write-down manipulation implies that Tesla’s GAAP net income was overstated by $223 million. Using the historical experience for these expense accounts, including an overly generous benefit in the assumption I use for “normalized” R&D/SG&A, Tesla’s GAAP income as reported would have been $88 million instead of $311 million. Tesla’s $88 of net income as adjusted less the $189 million in income attributable to GHG/ZEV sales turns the $311 net income reported as net income into a $101 million loss.

In addition to the questionable accounting used by Tesla to generate $311 million of GAAP “net income,” Tesla engaged in questionable, if not problematic, balance sheet maneuvers to boost the level of cash presented at the end of Q3. The purpose of this was to create the illusion of solvency. In the Q3 10-Q, Tesla shows a cash balance of $2.96 billion. At the end of Q2 Tesla had $3.11 billion.

Tesla’s accounts payable jumped jumped by $566 million from Q2 to Q3. Companies will stretch out their bills in order to conserve cash. Tesla has made a habit out of dragging its feet on paying vendors, suppliers and service providers as evidenced by the large number of court filings from smaller vendors who are forced to get a court order for payment. The same dynamic applies to “other accrued liabilities,” which contains other short term liabilities for which payment has not been made (payroll, taxes, interest and smallish items).

While accounts payable and other accrued liablities will naturally rise with the organic growth of a company, the rise in Tesla’s payables year over year is nothing short of extraordinary. Through the first nine months of 2018, per the statement of cash flows, Tesla generated $1.6 billion in cash “financing” from “stretching out” its payables vs $170 million in the first nine months of 2017. While Tesla’s revenues nearly doubled over the same period, this amount of unpaid bills has a reason behind it.  The net effect of withholding payment of its bills longer than necessary is that it makes the cash on Tesla’s balance sheet appear larger than otherwise. Accrued payables and other short term liabilities are the equivalent of a short term loan to a company. These liabilities should be treated as a form of short term debt.

Subtracting current liabilities ($9.78 billion) from current assets ($7.92 billion) shows that Tesla has negative working capital of $1.86 billion. Technically Tesla is insolvent, which explains the games the Company plays with its supplier/vendors.

Another curiosity on Tesla’s balance sheet was accounts receivable, which more than doubled, from $569 billon to $1.155 billion. In the footnotes under “credit risk,” Tesla disclosed that “one entity represented 10% or more of our total accounts receivable balance” at the end of Q3, whereas previously no entity represented 10% of receivables. In other words, one entity owed Tesla at least $115 million.

When asked about the big jump in A/R during the earnings conference call, the CFO dismissed it by claiming that the quarter ended on a Sunday. It’s beyond absurd that the analysts on the call accepted this answer without further interrogation. Subsequent to the release of the 10Q, a company spokesman told a reporter from the L.A. Times who had inquired about the 10% disclosure that the receivable was attributable to a large partner bank for car loans issued to U.S. customers. The spokesman said that “all of this receivable was cleared in the first few days of Q4.”

The inference was that Tesla sold $115 million or more worth of cars after 5 p.m. on Friday and over the last weekend of its quarter financed by one bank that could not be processed by the banking system. If this were truly the case, why not just state this as fact openly rather than leaving the market guessing what might have happened? 10% of $1.155 billion is considered “meaningful” under strict GAAP, which means this issue requires more detailed disclosure. The CFO’s vague response to the question about the issue reflects intentional obfuscation of the matter.

Unfortunately, we may or may not be able to figure out exactly what happened when the 10-K is released. I’m not optimistic that the Company will come clean. However, an analyst posted an assessment on Twitter (@4xRevenue) which seems to be a very reasonable explanation to this mystery. This analyst believes that the 10% receivable is from a lease partner (a bank) who has underwritten leases that contain Residual Value Guarantees from Tesla.

Tesla had been offering Residual Value Guarantees (RVG) on leases as an incentive to generate sales. The RVG is a guarantee from Tesla on the value of the car at the end of a lease. In order to stimulate lease-based sales, auto companies will guarantee the lease-end value of car at a level that is typically above the market value for that car at the end of the lease. It’s a “back-door” mechanism used to lower the monthly cost of a lease to the lessee.

If the receivable in question is from a bank that financed Model S&X leases, it means that a large number of vehicles came off lease at the end of Q3 and the bank was returning these cars to Tesla. The “receivable” is the guaranteed residualy value of these vehicles. It also means that Tesla likely will have a large cash payment (at least $115 million) to make to the bank that would be connected to the RVG. Based on actual market data, that the resale value of used Tesla’s has been declining rapidly. This being the case, Tesla has a large make-whole payment to make to the bank who represents at least 10% of the receivable. Tesla will then look to unload these used Teslas and recoup as much as possible, though it will be substantially less than the guaranteed make-whole made by Tesla.

This analysis would explain why Tesla’s payables and receivables were unusually high at the end of Q3. If this transaction had been processed before the end of Q3, Tesla’s accounts receivable would have been lower by the value of the cars being returned to Tesla under the RVG. The accounts payable would have lower by the amount Tesla owes to the bank. Tesla’s cash balance would have been lower by the amount that Tesla paid to the bank under RVG.

Recall that the Tesla spokesman said that this specific A/R was “cleared” in the first few days of Q4. Holding off on processing this transaction until after the quarter ended enabled Tesla to show a higher cash balance than it would have otherwise. It also kept the used Teslas out of Tesla’s inventory, which further enabled Tesla to manipulate the inventory write-down by taking a much lower write-down than historical write-downs. This is because the market value of the used  Teslas received is lower than the amount Tesla paid under the RVG. This would have required Tesla to write-down the value of the used Teslas, thereby increasing the inventory write-down charge, increasing cost of goods sold, lowering the gross margin and lowering the amount GAAP “net income” reported.

This also explains why Tesla moved $73 million worth of cars out of finished inventory and into the PP&E account on the balance sheet. Tesla accounts for vehicles used as service loaners as part of PP&E. I don’t have a problem with that. But moving $73 million of these vehicles allowed Tesla to avoid including those vehicles as part of its inventory write-down expense. It also allowed Tesla to move the cars taken back under the RVG transaction described above without causing an unusual change in inventory that required explanation. In other words, it’s entirely possible, if not probable, that Tesla wanted to “make room” for the used Teslas.

The bottom line – Tesla pulled out every accounting manipulation available to it in order to produce the promised positive GAAP net income, positive cash flow, extraordinarily high gross profit margins and a higher quarter-end cash balance. It was accounting deception, and in some areas probable fraud, at its finest. The Wall Street ass-kissing analysts did nothing other than cheer the results and lob easy questions at management on the conference call. Many of them are likely clueless about the degree to which Tesla manipulated reality.

It will be very interesting to see how Q4 turns out for Tesla. Based on reports from China and Europe, car sales have fallen off a cliff in October. Norway reported the first week of EV sales, which showed that Jaguar i-Pace deliveries, new to the market, were 44 vehicles vs. just 11 for the Tesla models S&X combined (the Model 3 has not been approved for sale yet in the EU). In October the i-Pace sold 441 units vs 201 for the Tesla S&X. This gives us a valuable glimpse at the effect competition will have on Tesla’s sales. Soon the Audi e-Tron will be available. It will likely smother any demand for Teslas.

Tesla had to make a $230 million convertible bond maturity payment in a couple weeks. It then has to start figuring out how to generate enough cash to make another $930 billion convertible bond maturity payment in March. On the assumption that Tesla’s sales are highly negatively affected by competition and the economy, Tesla will have a hard time raising the money needed to refinance the March convertible bond payment. Accounts payable will also become a problem, especially if Tesla is unable to raise more cash selling ZEV and GHG credits. On top of this, the tax-credit that Tesla car buyers receive from buying a Tesla EV will soon run out. This will make buying a Tesla more expensive.

The above analysis is from my Short Seller’s Journal from November 11th.  I also provided some ideas for shorting Tesla using short term and long term puts.  You can learn more about this newsletter here:  Short Seller’s Journal information.  Note:  one of my subscribers emailed me this morning that he just took $3500 in profits on January KB Home (KBH) puts that I recommended a few months ago.

Paramount Gold: An Undervalued Advanced-Stage Junior Gold Stock

Paramount Gold (PZG) owns a 100% interest in the Grassy Mountain Gold Project in eastern Oregon and a 100% interest in the Sleeper Gold Project in northern Nevada. PZG acquired Grassy Mountain (GM) in July 2016 via the acquisition of Calico Resources for $15 million in PZG shares. GM has a total resource of 1.65 million ozs of gold (mostly measured) and 4.96 million ozs of silver. Of this, 504k ozs of the gold is underground with a grade of 5.32 g/tonne. The rest is 1.15 million ozs of low grade, open pit resource. PZG now controls all of the mining claims within its 10,000 acre Grassy Mountain land package.

Contrary to what one might think, the State of Oregon is highly supportive of developing the mining industry in eastern Oregon.  At this point, PZG is in the final stages of permitting. The Company has already received preliminary outline proposals for financing mine construction. The existing PEA shows a project with an after-tax NPV of $87 million. The market cap of the stock, fully diluted, is $30 million. Because of the high-grade nature of the underground material, at higher gold prices this project is a literal cash cow.

The Sleeper Gold Project is a former high-grade open pit gold mine operated by AMAX Gold from 1986-1996 (AMAX closed the mine due to the falling price of gold). It produced 1.66 million ozs of gold and 2.3 million ozs of silver. This asset has over 4 million ozs of low-grade measured, indicated and inferred resource. With a gold price a few hundred dollars higher, this project is potentially a home run for a large mining company.

My colleague, Trevor Hall, sat down with PZG’s Executive Chairman, John Seaberg, to take an in-depth look at Paramount’s operations (you can download this podcast from 11 different platforms – MSD apps) :

Mining Stock Daily is collaboration between Clear Creek Digital and The Mining Stock Journal

Overvalued Stocks, Undervalued Gold And Silver, Insolvent Tesla

Craig Hemke, the well-known proprietor of the TF Metals Report  invited me on this his new “Thursday Conversation” podcast to discuss the stock market,  economy, precious metals and Tesla.

“If you adjusted the current S&P 500 earnings stream using the same GAAP accounting standard that were applied in 1999, the current S&P 500 P/E ratio – expressed in 1999 GAAP accounting terms – would be the most overvalued in history.”

“Deutsche Bank is a zombie bank that would have blown up in 2012 if the Bundesbank, ECB and German Government hadn’t bailed it out.”

“Elon Musk used a Halloween bag full of accounting tricks to generate GAAP ‘net income.'” The fact remains that Tesla is closer to insolvency this quarter than it has been at any point in the history of the Company.

“Mining stocks are cheaper now in relation to the S&P 500 and to the price of g old than they were at the bottom of the 20-year gold bear market in 2001”

You can listen to my conversation with Craig “Turd Ferguson” Hemke by clicking on the graphic below:

(NOTE: You can download the MP3 by using this LINK and right clicking on the audio bar)

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If you are interested in ideas for taking advantage of the inevitable systemic reset that  will hit the U.S. financial and economic system, check out either of these newsletters:   Short Seller’s Journal  information and more about the Mining Stock Journal here:   Mining Stock Journal information.