The promise of oil sands

Encana (ECA, NYSE)) is among the largest holders of gas and oil resource land onshore North America, and is a technical and cost leader in the in-situ recovery of oil sands bitumen. As such, and given a declining hedge book, the company offers robust leverage to rising energy prices in our opinion. Following a recent correction in oil prices, and with full year results looming, we are placing Encana on a 'traffic light' alert - with the possibility of a buying opportunity emerging in the coming weeks.

The most significant feature on Encana's charts is the broad trading range that has developed over the past three and a half months. This band of consolidation has developed in the wake of a four and a half year rally which saw the share price hit a record high of $59.82 in October. Resistance is provided by the upper end of the range at $52 while support is present at the November low of $42. With prices currently dipping below $45 we will be watching closely to see how the stock reacts to a test of the lower end of the range.

Encana was born out of the 2002 merger between PanCanadian Petroleum and Alberta Energy Company (AEC). PanCanadian's original roots go as far back as 1883 and the first natural gas discovery in Alberta. AEC meanwhile was privatised by the Government in 1975. After diversifying into a range of resource investments, AEC was rationalised during the early 1990's with the focus returning to core opportunities in oil and gas.

Today the group's strategy centres around the development of huge unconventional hydrocarbon reservoirs using large-scale drilling programs. Encana's portfolio of long-life resource plays includes 10 key properties in Canada and the United States, eight producing natural gas and two focused on oil. These unconventional resource assets typically boast low geological and commercial development risk, low average decline rates and long production lives. The use of technology to unlock resource potential is central to Encana's aim of increasing production and reserves and decreasing costs over the life of these assets.

The robustness of third quarter results released in October give us much confidence regarding the impending release of full year results next week. Third quarter operating earnings increased 33 percent on the prior year to US$704 million on the back of higher gas sales along with stronger natural gas and liquids prices. Net earnings of US$266 million for the quarter were impacted by unrealised hedge losses of US$604 million. The future earnings impact of these hedges will be less significant, with around 60 percent relating to the 2004 acquisition of energy producer Tom Brown plc, and all positions expiring at the end of 2006.

Given our bullish view on energy prices we are encouraged by the status of Encana's hedge book. This year around 82 percent of forecast sales will be fully exposed to price upside. About 80 percent of 2006 forecast gas sales and around 91 percent of oil and natural gas liquids (NGL's) sales are exposed to price upside. Encana is estimating gas sales of between 3.50 and 3.63 billion cubic feet per day (bcfd), and North American oil and NGL sales between 155,000 to 160,000 barrels of oil per day (bopd) in the year ahead.

Full year gas production next year is expected to be between 3.25 billion to 3.30 bcfd, nearly 9 percent ahead of 2005. Declining production in conventional oil properties and higher royalty rates should be mitigated by growth from expanding oil sands. Encouragingly, full year operating costs last year are forecast at 55 to 60 cents per thousand cubic feet of gas equivalent (Mcfe), which leaves Encana amongst the lowest cost operators in the industry. We believe this bodes well for earnings in the future.

Recent drilling successes at Encana include a substantial natural gas discovery in British Columbia. The 'Cutbank Doig' find is estimated to contain 350 to 550 billion cubic feet (bcf) of original gas and is now producing about 25 million cubic feet of gas per day from five wells. The find is believed to have similar characteristics to the nearby 'Sinclair Doig' which has produced more than 250 bcf since discovery in the 1970's and is expected to yield more than 400 bcf during its life.

Complementing Encana's unconventional gas strategy is a tremendous growth opportunity in Canadian oil sands. These have the potential to deliver more than a twelve-fold production increase from the current level of about 42,000 bopd to around 500,000 bopd within the next 10 years. The combination of advances in thermal extraction technologies and the strengthening of world oil prices now make the development of oil sands a viable option.

With 1.2 million acres, Encana is the largest owner of Canadian oil-sands tenements. These properties contain an estimated 40 billion barrels of original oil in place, with recoverable resources of between 5 and 10 billion barrels. The oil-sands projects, Encana believes, could translate into a growth rate of 15 to 20 percent in North American oil and natural gas liquids sales between 2006 and 2009.

Encana's industry-leading oil sands recovery teams have proven the technical capabilities of steam-assisted gravity drainage process (SAGD). Encana has received around 20 inquiries from a variety of oil companies, including major multinationals, integrated producers and national oil companies, seeking to participate in oil sands projects.

Presently, Encana is considering various business opportunities, such as possible equity investments, farm-ins, asset swaps, long-term bitumen supply agreements and the integration of upstream and downstream assets. These options would diversify earnings and reduce financial risk for the company. Capital development requirements are estimated at between $5 and $7.5 billion over the life of these projects if the 500,000 bopd target is to be reached.

The Foster Creek project, the largest and most advanced commercial SAGD project, is in the midst of doubling its planned production to an estimated 60,000 bopd by the end of 2006. The project is capable of returning more than Encana's cost of capital at an oil price of $20 per barrel. An expansion of the Christina Lake project from 7,000 to 18,000 bopd by the first quarter of 2008 has also been approved. Longer term Foster Creek and Christina Lake are expected to deliver up to 150,000 and 250,000 bopd respectively while Borealis, a new in-situ project, has the potential to reach production of 100,000 bopd.

From a balance sheet perspective Encana is in sound shape. Net debt to market capitalisation and EBITDA (earnings before interest, tax, depreciation, and amortisation) stood at 40 percent and 1.6 times respectively at the end of last quarter. Further improvements are expected (along with the potential for share buybacks) following a series of asset sales.

In November Encana sold a 50 percent interest in the Chinook heavy oil discovery offshore Brazil for around $350 million, at an after tax profit of more than $200 million. In December the majority of the natural gas liquids business was sold for $586 million - a gain of around $400 million.

We believe that Encana is strongly positioned to take advantage of an ongoing bull market in energy. The company has proven reserves (at 31/12/04) of 10.5 trillion cubic feet of natural gas and around 501 million barrels of oil. In addition the hedge book is being reduced rapidly. We also believe in the tremendous growth potential offered by the development of oil sands assets.

Whilst oil and gas prices have suffered a minor correction this week on the back of a higher than forecast build in US inventories, long-term supply demand fundamentals are supportive of higher prices in our opinion, making exploitation of these resources more than economical.

Given the positive long-term uptrend in ECA, a rebound off the US$42 region would be an encouraging sign of further gains. Should this occur we will look to make a buy recommendation in the weeks ahead. Alternately, a break above resistance at the 2nd February high of US$50 would also present a potential buy signal.

Prior to one of these scenarios eventuating, we believe the best strategy is to monitor ECA. From a fundamental perspective Encana offers sound value with a price earnings multiple around 11 times. Accordingly, we will alert Members should an appropriate buy opportunity occur in the coming weeks.

Prior to one of these scenarios eventuating, we believe the best strategy is to monitor ECA. From a fundamental perspective Encana offers sound value with a price earnings multiple around 11 times. Accordingly, we will alert Members should an appropriate buy opportunity occur in the coming weeks.

Shining despite operational difficulties

Lihir Gold (LHG, NASDAQ) is a substantial gold producer with operations in Papua New Guinea in the South Pacific. The core operation is the massive gold mine located on Lihir Island. The current mining plan consists of some 26Moz of gold reserves and a resource of 40Moz, for a mine life of over 20 years. After a number of production setbacks over the years, Lihir is now poised to increase production substantially. Following a hedge book restructure last year, the company has significant exposure to the spot gold price.

Lihir has performed solidly since last November, posting gains of more than 30 percent despite unforeseen production difficulties during October that negatively impacted production. In our view the share price re-rating in recent months reflects Lihir's enhanced status as a highly leveraged, quality gold stock.

The company has regained the market's confidence through a dramatic improvement in operational performance during 2005, with higher gold output and lower operating costs. Also boosting sentiment has been a substantial reduction in the size of Lihir's hedge book, which has increased the overall leverage of the stock to the gold price.

Lihir has announced what we consider to be a solid operating report for the December 2005 quarter. Amongst the positives was record gold production of 94,000 ounces during the month of December, a record gold grade of 8.54 grams per tonne (g/t) for the quarter and higher revenues during the second-half of $156.1 million compared to $130.7 million during the same period in 2004. The company also achieved full-year gold production of 596,000 ounces which was slightly below the previously revised guidance.

Investor sentiment toward Lihir remains very positive, with the solid rally of the past 10 months lifting the shares to $38.01 in January. This is the stock's highest level in almost eight years and is clearly associated with the 25 year highs recently seen in the physical gold market. The most noteworthy development on the charts has been an upward breakout from a triangle pattern in late December. A triangle is easily identified by narrowing boundaries and is often viewed as a consolidation phase ahead of a significant advance in prices.

As seen on the weekly chart, Lihir is heading toward the all-time high of November 1996 at $40.75. Considering the speed of the recent advance, we believe some consolidation is possible prior to this level being successfully challenged. However with investor sentiment remaining buoyant and firm support around $30, we believe that any pullback should attract firm buying interest.

Lihir was able to achieve near record gold production despite interruptions, with mining operations effectively back to normal by the end of the quarter. Furthermore the new era of independent management implemented during the quarter should help sustain the improved operational performance.

A total of 171,695 ounces of gold were produced during the quarter (193,031 ounces during the September quarter) at a total cash operating cost of $246 an ounce ($217 during the September quarter) and a total production cost of $298 an ounce ($259 during the September quarter). The operation was impacted by the unforeseen interruption related to a landslide on October 9th that blocked road access to the mine-site. The landslide also destroyed a portion of the pipeline that supplied water to the plant, in turn halting gold production for a month. Tragically, two workers were killed in the incident.

The production result was nevertheless a strong one, helped by the increase in gold head grade to a record 8.54 g/t, up 74 percent on a full-year basis compared to 2004.

For the full-year to December 2005, Lihir produced 596,000 ounces of gold, which was marginally below the revised full-year guidance of 600,000 ounces issued in October and just short of the 2004 production result. As a result full-year cash costs for 2005 increased by 4 percent to $282 an ounce, while production costs rose by 10 percent to $331 an ounce.

Production however increased strongly as the year progressed, with 231,000 ounces of gold produced during the first half of 2005, rising to 365,000 ounces during the second. This boosted revenue sharply from $68.8 million in the first half to $156.1 million in the second, based on stronger production and a firmer gold price.

It is clear from our view point that there is now a significant downward trend in the company's operating costs, best demonstrated by a comparison of the first and second halves of 2005. Total operating cash costs fell by 36 percent from $363 to $231 an ounce from the first to the second half of 2005, whilst there was a 33 percent fall in total production costs from $415 to $278 an ounce between the first and second halves of the year. A full year's operation of the recently commissioned geothermal power station will help maintain operating costs at low levels, with total cash costs for 2006 anticipated to be around $230 an ounce.

In terms of the production outlook, equipment shortages have meant that the rate of mining has unfortunately been below expectations. This situation is anticipated to continue during 2006, which will delay the development of the Leinitz orebody and hence impact on full-year production forecasts. We have revised our 2006 gold production target down from 700,000 ounces to 650,000 ounces, which is below the company's revised forecast of 670,000 ounces.

We feel more comfortable with the lower figure given the potential for ongoing equipment shortages. This still represents a production record for Lihir and the company is on track to achieve the full benefits of the production expansion from 2007 and beyond, with output of 800,000 ounces projected in 2007 and 900,000 ounces in 2008.

The major plank of this expansion is the flotation project, which will enable the treatment of lower-grade ore that would otherwise not have been suitable as mill feed. Further advances have been made on the flotation expansion, with engineering work now 25 percent complete and construction expected to be completed by the end of 2006. Annual production is expected to be boosted by around 140,000 ounces (over seven years) when construction is completed in 2007. The flotation project also has the potential to increase the gold resource base and a revised statement is expected in early 2007.

The flotation project is being funded by a gold loan, which in turn has necessitated a restructuring of the company's hedge book. What this hedge book restructuring has done is substantially increase Lihir's leverage to the gold price - a traditional attraction of the company that had been lost in recent years as the total hedge position grew. Following the hedge book restructure, Lihir's committed gold deliveries as a percentage of gold reserves and resources has fallen to less than 6.5 percent and 3.1 percent respectively.

Lihir currently has 1.047 million ounces forward sold at prices between $330 and $371 an ounce, deliverable by 2011. The current delivery schedule will see the hedge book fall to around 1 million ounces by 2008. Lihir intends to continue delivering into hedge commitments throughout 2006 and although 206,500 ounces are to be delivered into hedge contracts this year, the majority will be sold at spot prices.

The resolution of the management situation at Lihir has been a long time coming, with the company now achieving full managerial independence from Rio Tinto following the disposal of their 14.6 percent stake. Lihir now has a fully independent management team, with Arthur Hood as Managing Director. Mr Hood comes with considerable high-level executive experience from global diversified resource giant, Placer Dome, where he spent 16 years.

From a financial perspective, full-year 2005 revenues were down by 4 percent to $224.9 million compared with the previous year. This primarily was a result of lower gold production during the first half as mining operations transitioned from the original Minifie pit to the new Lienitz pit. As we have indicated, operational performance improved significantly during the second half, which augurs well for 2006. Despite the production loss due to the landslide, Lihir reported a net profit of $30.6 million for the second half, taking full year profit to $9.8 million.

In terms of profit outlook, we have revised downwards our 2006 forecasts in line with anticipated lower gold production to around $80 million, but maintain our 2007 net profit forecast of $160 million.

Lihir remains our preferred heavyweight gold exposure. The company's primary attractions in our opinion are its highly leveraged exposure to gold, along with a significant reserve base of more than 20 million ounces. The re-emergence of corporate activity in the gold sector is an added bonus, with Lihir offering a unique, long-life mining operation for a potential suitor.

Notwithstanding the possibility of some near term consolidation and volatility, we believe Lihir continues to possess considerable longer term upside potential. Accordingly the shares remain held in the Fat Prophets Portfolio. For those Members with no exposure, we recommend Lihir ADRs (LIHRY) as a long term buy up to $33.50.

Disclosure: Interests associated with Fat Prophets declare a holding in LHG.

The turnaround begins

Telstra (TLS, NYSE) was first recommended in the Australasian report in February 2005 at A$5.02 at a time when the ADR was trading on the New York Stock Exchange at around $20.20. After hitting a high of $21.99, the share price declined steadily, a trend exacerbated by high dividend payments and capital returns amounting to A$0.40 cents. Since hitting a low of $14 late last year, the share price has recovered, and we believe the worst is now behind the company.

Telstra is Australia's incumbent telecommunication carrier and one of Australia's largest listed companies. The company has strong brand recognition and provides a broad range of telecommunications and information services, including over 10.3 million fixed line services and 6.5 million mobile services.

Telstra provides a range of services for its customers: 1. Basic access services to homes and businesses; 2. Local and long distance telephone calls, both domestic and international; 3. Mobile telecom services; 4. Management of business customers IT and telecom services; 5. Advertising, directories and information services; 6. Cable distribution services for FOXTEL's cable subscription TV services.

Despite Telstra's huge range of services, the company's share price was under pressure throughout 2005. The recent woes stem from a combination of industry overcapacity and regulatory uncertainty, both products of the company's history. Telstra was first privatised by the Australian Government in 1997 after being the monopoly provider of telecommunications services. To foster competition, Telstra was required to open access to its copper wires which link homes to the Telco's exchanges.

Years of competition and the advent of new telecommunications technology have seen Telstra's monopoly margins and profits decline. Like other telco's around the world, Telstra is suffering from a sharp decline in 'fixed line' revenues, as users opt for other, lower margin products. To some extent, this is being offset by growth in new technology areas such as broadband. However, declines in traditional revenues are faster and this is pressuring profitability and margins. For the year ending June 2006, Telstra is expected to post an EBIT decline of more than 20 percent.

In addition, Australia's regulatory authority, the Australian Competition and Consumer Commission (ACCC) is trying to get Telstra to slash the cost of its wholesale service, that is, what it charges competitors to access the country's telecommunications infrastructure. Telstra, of course, is resisting the planned changes, arguing that the ACCC is proposing an unfair pricing regime.

To complicate matters further, the Australian Government still owns just over 50 percent of the company, and is conducting what will be the world's largest float later this year. The conflict of interest issues regarding regulation and a government trying to get the best price for the impending sale have lead to further pressure on the share price.

In our opinion, all these ingredients combine to provide a solid opportunity for the contrarian investor. All the information is known, and we therefore believe that the negative sentiment directed towards Telstra is contained in the price. The company is embarking on a radical restructure which is designed to update the network with state-of-the-art technology and slash costs over the next few years. While a turnaround may take some time, the potential is not built into the share price.

The company's turnaround is being engineered by American Sol Trujillo. Readers may know of Sol from his days running US West. He has received much negative publicity regarding his previous exploits, however based on his performance in Australia so far, we are supportive of the strategic direction he is taking Telstra in.

Another reason for our positive long term view on Telstra is that we believe the industry is ripe for consolidation. Competition in the Australian market is fierce, especially in the mobiles market where growth has all but stalled. The classic symptoms of overcapacity are now occurring; margins, profits and share prices are all declining. As the pre-eminent Telco in Australia, we believe Telstra will benefit strongly from rationalisation.

While a turnaround in performance and industry conditions may take some time, investors will be rewarded with solid dividend payments. At the current price, Telstra's yield is attractive at around 7 percent.

Given the recent positive price action and the proximity of support at the January and December lows, we believe that downside risk is relatively low. Accordingly, we recommend Telstra as a buy to all Members at around $15.20

Disclosure: Interests associated with Fat Prophets declare a holding in TLS

A new bull market stirs!

Over the past half century Taiwan has grown to become the 17th largest economy in the world. Services account for 72.7 percent of total gross domestic product (GDP) industry, 25.6 percent and agriculture the remainder. Taiwan's economy is open and heavily impacted by global economic growth and trade.

In 2004, the country exported $174 billion in goods and services. The main export industries are; electronics, information and communications products, textile products, plastic and rubber products. Taiwan's biggest customers are China and Hong Kong ($64 billion) the US ($28 billion) and Japan ($13 billion). On the import side Taiwan absorbed $168 billion in goods and services, giving the country an annual trade surplus of $6 billion. Imports consist of electronics, information and communication products, chemicals and crude oil. Major suppliers to Taiwan are Japan ($43.6 billion) the US (21.6 billion) and China ($18.8 billion).

After stagnating for nearly a decade, we believe the Taiwan stock market now presents an attractive investment opportunity to Members. Rapid growth and a successful export industry have helped Taiwan become a creditor nation, holding the world's third largest stock of foreign reserves ($257 billion as of January 2006). Solid economic growth of around 4 percent is forecast to continue in 2006. Inflation is well contained, running at an annual pace of around 2.7 percent, despite a low unemployment rate of 3.8 percent.

One investment vehicle which we believe is an excellent proxy to the Taiwanese economy is the Taiwan Fund, Inc. (TWN, NYSE). TWN is a diversified, closed-end management investment company which commenced operations in December 1986 following an initial public offering. The Fund has around 16.4 million shares outstanding which are listed on the New York Stock Exchange (NYSE) and is currently capped at around $270 million.

The Fund is designed principally for U.S. investors who wish to participate in the Taiwan economy through investment in equity securities listed on the Taiwan Stock Exchange (TSE). The Fund aims to invest at least 90 percent of the underlying assets in equity securities that trade on the TSE. The Fund may also invest in equity securities which intend to list on the TSE in the near term, along with securities that trade in the over-the-counter market in Taiwan.

Investor sentiment toward TWN has improved significantly over the past four months. Renewed buying interest in the closed end fund has seen the share price break above resistance at US$14.50 and run to a five and a half year high of US$17.35 in recent weeks. The advance above US$14.50 is the most significant feature on the weekly chart as it represents a positive breakout from a five year basing pattern that formed after a decade long bear market.

We believe the underlying valuation of the Taiwan stock market is attractive, with a dividend yield of around 4 percent which is significantly above Taiwan's 10 year bond rate of 1.8 percent. The market is valued on a prospective price earnings ratio of 13 times and a price to book ratio of below 2 times. This valuation compares favorably to other Asian countries such as China, South Korea, Japan and Thailand.

The Taiwan Fund is diversified over a broad spectrum of the economy, with investments in cement, chemicals and plastics, construction, electrical/electronics, finance, banking, food, textiles, glass, rubber, pulp and paper, metal products and machinery, retailing and tourism.

As at the end of November 2005, the Fund had the following weightings in the top 10 sectors.

When investing in new companies, the Fund considers overall growth prospects, competitive position in export markers, technology, research and development, productivity, labor costs, raw materials costs and sources, profit margins, return on investment, capital resources, government regulation, management and other factors.

In summary, we believe the Taiwanese stock market is now undergoing a broad based recovery after a lengthy bear market. The underlying value of Taiwan equities compares favorably with other countries in our opinion. We believe the Taiwan Fund represents an investment opportunity to investors, being a proxy for the Taiwanese stock market. Given the extent of the recent advance some consolidation is possible in the near term, however, we believe firm support between $14.50 and $14 should underpin a broader recovery. In the coming months, we believe prices will extend above $17.35 toward the $19 region. Accordingly, we recommend TWN as a buy to all Members around $16.50

Background information
Taiwan, an island just off the mainland of China, is one of Asia's most developed and prosperous economies. Unlike the emerging economies of mainland and South East Asia, Taiwan boasts a highly skilled workforce which has assisted the country greatly with producing high value added goods.

Background information
Taiwan, an island just off the mainland of China, is one of Asia's most developed and prosperous economies. Unlike the emerging economies of mainland and South East Asia, Taiwan boasts a highly skilled workforce which has assisted the country greatly with producing high value added goods.

Background information
Taiwan, an island just off the mainland of China, is one of Asia's most developed and prosperous economies. Unlike the emerging economies of mainland and South East Asia, Taiwan boasts a highly skilled workforce which has assisted the country greatly with producing high value added goods.

The story of Taiwan's emergence as a largely 'westernized' (and wealthy) economy is an interesting part of history. Prior to 1895, Taiwan came under the auspices of China, however, following the Chinese defeat in the Sino-Japanese War, control passed to Japan. From 1845 to 1945 Taiwan was under Japanese colonial rule, during which time some effort was expended to develop the economy. This included compulsory Japanese education.

Subsequent to Japan's defeat in WWII, Taiwan reverted to Chinese rule. It is this period of history that had the most impact on Taiwan's future development. At the time China was in the midst of a civil war between the Nationalist Chinese and Mao Zedong's Chinese Communist Party. Following the communist victory in 1947, 2 million refugees, predominantly those from the Nationalist government and business community, fled to Taiwan.

At the time Taiwan was an agricultural economy, supported largely by sugar and rice. However, the influx of businessmen from the mainland joined cashed-up former landowners (who received government compensation in a land re-distribution scheme) to become Taiwan's first industrial capitalists. The combination of capital and business acumen transformed Taiwan from an agricultural to an industrial economy. Over the ensuing decades Taiwan has grown into a technologically advanced and wealthy nation.