by Robert Cardwell
Stock Trader's Almanac Investor

       It has now been seven months since crude oil first breached the psychologically important $50 level. A sharp correction soon followed, but to the surprise of most analysts, oil quickly rebounded to $58 a barrel. Subsequent dips have also been followed by sharp rallies to all-time price highs.
        True, oil has been higher on an inflation-adjusted basis, but only in the wake of the Iranian revolution and the Iran-Iraq war, and then only briefly. All the previous price spikes were brief, occasioned by temporary supply emergencies or perceived emergencies. One is almost afraid to say it, but this time really does look different. The supply problem is real and it's probably here to stay.
        Supplies of crude are quite adequate for the moment, confusing some people. But the market is worried about demand during the winter heating season and beyond. At this writing OPEC is again trying to talk the market down - or at least claiming to want lower prices. They will increase production quotas, but that is largely meaningless as OPEC is already producing at or close to the maximum. At this writing crude oil is surging in the face of OPEC's decision. We face a future of steadily rising demand versus limited if any capacity to produce more oil on a global basis. New discoveries have been made and will be made, but at the same time the giant fields we depend on today are declining.
        In most situations, high prices bring on more supply. But oil is now a peculiar commodity in that most of the world's remaining supply lies in inaccessible or politically difficult countries. Lofty prices don't make these nations eager to increase output, but rather to gather in more of the revenue for themselves. In Venezuela, Central Asia, Russia and elsewhere, we see attempts to abrogate previous agreements, increase taxes and generally make things difficult for foreign oil companies. This doesn't make for discovery and development of new fields. There's an increasingly vigorous debate about whether "peak oil" is here or approaching. Whether it is or not geologically, there is reason to worry about energy supplies.
        What are the investment implications? Oil and gas stocks have been the market's best performers for some time. At this point we would emphasize buying them on corrections - understanding the fundamentals, you can buy with confidence when others are selling. We like companies with the potential to find substantial reserves. Such situations can be rewarding in any environment, but given current fundamentals, discoveries are all the more valuable.
        American Oil & Gas (AEZ) jumped to a new high and has since been consolidating around the 4 level. The gain was almost surely related to the Fetter well, which is now drilling in the target zone. This is a "tight hole" (no information available from the company) but we should get a report soon. The odds of success are good - the question probably will be whether the well is a big success or just marginally commercial.
        Keep in mind that the Fetter is a known gas deposit. Production in the past has been limited due to the difficult nature of the formation, but AEZ and partners hope to change this with advanced drilling and completion techniques. Even if the first wells look good, the partners are likely to try various technologies to optimize results. In recent years, such an approach has opened up several now prolific unconventional fields. The Fetter property is vast (and American has other projects besides), so there is still big upside potential in this stock.
        Parallel Petroleum (PLLL) went through a sharp correction and an equally sharp rebound (demonstrating what we are talking about re buying on dips). The stock is now testing its April high. PLLL participated in a very successful recent well, but the buying seems to be in recognition of increasingly evident growth potential from several projects.
        Vintage Petroleum (VPI) made a speculative high in March and then gave back some 10 points over the next two months, which allowed us to take a position. We still think Vintage likely has accumulated a very valuable land package in West Texas, but the company is saying nothing about its well tests and market enthusiasm has cooled considerably. The lack of news is most likely strategy and not an indication that nothing is happening. We'd buy weakness in VPI as it's worth the current price even without West Texas.
        Bankers Petroleum (BNK.V), the other main participant in that West Texas Palo Duro Basin play, is somewhat the same story except that the stock has made less of a recovery from its correction. Unlike, Vintage, Bankers is a very expensive stock except for the potential of the West Texas shale. We've had BNK on Hold and are keeping it there for now.

Metals and Mining

        The European Union has come under considerable strain with the French and Dutch rejection of the proposed constitution. That relieved pressure on the dollar as the euro slid. Still, precious metals have held their ground in dollar terms. It's partly fundamentals and partly a continuing unease about the dollar. The Italians are thinking about abandoning the euro, demonstrating the tenuous nature of all fiat currencies.
        With American's structural economic problems, we don't think dollar strength will be long lasting. We would continue to accumulate undervalued mining stocks, but use patience and buy on weakness. Copper has made new highs, but copper stocks are lagging, held down by negative sentiment on mining in general. This is an excellent buying opportunity.
        Northern Orion (NTO) released an updated resource estimate for its Aqua Rica property. The calculated net present value was $282 million based on conservative prices of $1.00 for copper, $400 for gold and $5.00 for molybdenum. The payback of capital costs for a mine and mill would be 6.1 years at those prices, but only 1.9 years at current metal prices. NTO has cash equivalents of $143.1 million. So adding the cash and a conservative valuation for Aqua Rica, we come up after subtracting debt with assets worth $399.1 million. That compares with the market cap of $346 - but we haven't included any value for the company's equity in the Alumbrera mine. In the first quarter, Alumbrera contributed $8.9 million in earning to Northern Orion, or 7 cents a share. The net cash flow was higher at $13.8 million.
        Orezone Resources (OZN) remains the same story. The stock dipped, went into a basing pattern for a month, and now is on the upswing again, outpacing the group. The company keeps drilling off impressive intervals of good grade ore - from several properties. There's little doubt that Orezone will either be a significant gold producer or sell out to a larger company at a nice premium. We continue to suggest buying on corrections.
        We suggested two very junior companies for their exploration potential in Nevada. They don't have any booked assets but have a lot of projects - and the stocks are quite depressed. White Knight Resources (WKR.V), which has the backing of more substantial partners, says it will drill no less than nine properties during the balance of the year, with multiple holes in most of them. Work has started on some of these projects. Good results could put the stock up several-fold, while we see limited risk from current levels.
        Victoria Resources (VIT.V) is much the same story. It has raised some money (at C$0.55) and recently begun drilling again on a property where it obtained some encouraging results earlier. We'd buy both these issues on weakness.
        Editor's Note: Robert Cardwell is Director of Equity Research at the Hirsch Organization, publishers of The Stock Trader's Almanac Investor, 79 Main St., Ste. 3, Nyack, NY 10960, 1 year, 12 issues, $295.
       Mr. Cardwell holds positions in American Oil & Gas, Bankers Petroleum, European Minerals, Northern Orion, Orezone, Pacific Northwest Capital, Parallel Petroleum, US Energy and Vintage Petroleum.