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Has the commodity cycle hit a tipping point?
Peter Major
Posted: Tue, 11 Mar 2008
[miningmx.com] -- JUST four months ago I wrote an article with nearly the same title as above.
Commodities had been running nearly non-stop since 2001 and equities nearly non-stop since 2003. And at the time - I genuinely thought it was a very prudent and opportune time to take a lot of money off of the table, to reduce commodity exposure dramatically.
All the signals were there.
And so it was, lo and behold, for the next 2 & 1/2 months everything seemed to be going to plan. In retrospect, it looked like a well-reasoned (and profitable) decision.
Many commodity prices did deteriorate or at least went flat. Oil lost $10, natural gas, uranium, copper and nickel fell. Precious metals were mainly flat to barely up.
But equities followed the script almost too well, with the ALSI 40 losing 18% and the RESI 20 falling by 23% through the rest of November
until the 3rd week in January.
But by then one had to seriously address the issue again: were these large and rapid falls warranted by the macro-information?
Commodity prices had not fallen that dramatically or rapidly. And on average, by the third week of January, most commodity prices had now turned up or continued upward Added to that fact was a rand that now had lost over 10% as
well.
With shares like Anglo American down almost 35% from its highs in November, ditto BHP Billiton and most other mining shares down over 20%, we were again looking set for a correction: but this time upward.
And boy did we get it. Hard and fast! No warnings at all and faster and more ferocious than had been the fall.
And this was fully led by the commodity prices. Gold gained $120/oz. PGMs rose over 35%. Oil raced to over $102 bbl and base metals gained over 20%. The result: the RESI gained 43%, the Alsi 23% and many mining shares over 55 - 60%. All in just 6 weeks.
So, where to from now?
On this, the 10th of March 2008, I believe most of the above is led by panic, speculation and opportunism, and mostly with respect to the USA.
Inflation hasn't been a problem in the world for the past 25 years and has averaged 3.1% in the U.S. during that time. It's now 4.3%. Worse yet: U.S. 30-day cash is now 1.75%, and the 10
year bond at 3.6%. Even worse, the dollar is 1.54 to the Euro.
With continued huge trade and budget deficits, and a plethora of presidential candidates preaching how they're going to do whatever it takes to avoid a recession - this all tells me 'cheap excess money' is bringing more and stickier inflation.
Possibly costs and demand have risen so rapidly and stickily that prices just CAN'T come down much. Now, this might be a heretical statement for anyone to make in the investment world, I know. And costs aren't there yet! In fact, average profit margins in the world's mines are now near 50%: an all time (since 1950 anyways) high.
Margins have been close to this level before, but only twice in 58 years: and neither time did they stay here long. And that is where the disconnect will probably come from.
Commodity prices may very well not fall back by very much. But the rapidly rising (and almost uncontrollable) costs will continue gaining on
commodity prices, thereby eroding margins.
And as we all know, share prices eventually settle relative to profitability, and not with respect to commodity prices. Once the market senses margins and profits are now likely to start falling it will knock these share prices respectively.
Is that where we are at now? Today? I don't know. But I do know that costs have a bad habit of following commodity prices fairly closely.
And with the recent massive jump in most commodity prices (30% plus over the past two to three months) costs are escalating close behind. And costs have much more 'momentum' than commodity prices.
Costs are much stickier than commodity prices. Costs are extremely hard to make go down. Commodity prices can often fall down (and stay down) with almost no apparent effort whatsoever.
Everything can be called relative in life. Mining and resource stocks aren't necessarily a “sell” just because they've had a big run up. But,
they can be a “sell” if the shares are discounting commodity prices that are not realistic.
And not realistic can even mean failure to rise by more than five or 10% per annum from here on. (Heaven forbid they rise even less, or even fall for awhile!).
And we've already had previews of those situations in our gold and platinum shares lately.
The rand may well help to protect earnings of our shares, but a weak rand won’t help those same shares ratings.
I am worried about stagflation in the world today, especially in America. And I'm worried America may be the swing factor, the marginal buyer or seller of commodities in this cycle.
And as we saw in the last true commodity cycle, that of the 1970s: once governments were forced to act seriously against inflation, economic growth did moderate as did commodity prices and then so did the respective share prices.
I have always found that it's just after the rapid big moves when
decisions about asset and equity allocations are the most easily made.
And though you may not be right as soon afterwards - as last November through January (and then back up again): your decision will almost always be the correct one, sometime in the next 6 to 12 months,
In late October I thought there were better investments than our Mining and Resources shares. But by early January 08, when they had fallen 20 to 30% I no longer believed that to be the case.
Yet here we are six weeks later and more than 25% higher (many are more than 50% higher) and I all of a sudden see a lot of better relative value elsewhere. I am switching.
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