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Saturday, May 26, 2007


$200bn ‘super cycle’ intact

Investors to pour a further $15 to $25bn into commodities, metals & related indices, during 2007.

Barry Sergeant
22 May 2007

For years bulls and bears have fought over the notion of a "super cycle" in commodity and metal prices. Bears are now poised to again end this year with bloody noses. According to an analysis by Daniel Raab, MD of AIG Financial Products Corp, investors have this year already placed $8bn into commodities, metals and related indexes.

He estimates that the figure for the full year could come in at about $15bn, aided by the launch of more exchange-traded funds (ETFs), and other passive investment strategies for commodities and metals.

The unprecedented flow of funds into commodities, metals and related indices is consistent with the theme developed over the past few years by the likes of Alan Heap at Citigroup in Sydney, Melbourne-based Peter Richardson, London- based Michael Lewis of Deutsche Bank, and Goldman Sachs's Jeff Currie in London. Citigroup has defined a super cycle as a prolonged (decades) trend rise in real commodity prices, driven by the urbanization and industrialisation of a major economy.

The commodity and metals story continues to gain new dimensions, in line with increasing fund flows. With more than five years of an apparent super cycle in the bag, investment bank Lehman Brothers this year anticipates growth of about $25bn in the broader field of commodity investment. Analysts have put the cumulative figure-to-date at between $150bn and $200bn.

The current cycle has seen a significant growth in commodity indexes such as Dow Jones-AIG, Reuters-Jefferies, and S&P Goldman Sachs Commodity Index (GSCI). The rationale behind the latter index (as an example) was creation of an easily traded instrument providing investors with a reliable and publicly available benchmark for investment performance in the commodity markets, comparable to the S&P 500 or FT equity indices.

The S&P GSCI represents an unleveraged, long-only investment in commodity futures, broadly diversified across the spectrum of commodities. Specialised investors can go further, into related instruments, such as the S&P GSCI futures contract (traded on the Chicago Mercantile Exchange), or over-the-counter derivatives, or the direct purchase of the underlying futures contracts.

ETFs are also playing an increasingly important role, having attracted around $2bn in the first three months of this year alone. ETFs are open-ended securities that can be bought and sold by investors on a regulated exchange, in the same way as stocks and bonds. ETFs give investors exposure to commodities without the need to set up futures trading accounts or taking physical delivery of a commodity or metal.

The growing respectability of investing in commodities and metals - raw materials in the broad sense - has been fuelled by investors seeking a hedge out of stocks, bonds, and even cash. There is also the diversifier factor: if the price of crude oil declines, it could potentially be supportive to the equities side of a portfolio, if it reduces inflationary pressure, supporting, in turn and in time, lower interest rates. It has been noted that the US's Calpers, a giant pension fund with assets of more than $230bn, invested $450m into the S&P GSCI in March, just ahead of another rally in crude oil prices.

On the fundamental side, there is no question that serious investor interest in commodities and metals is now increasingly attracted by the merits of the "super cycle" story. According to Heap, there have been two super cycles in the past 150 years: late 1800s-early 1900s, driven by economic growth in the USA, and 1945-1975, prompted by post-war reconstruction in Europe and by Japan's later, massive economic expansion.

Deep research by Citigroup shows that in 1800, the Chinese and Indian economies were by far the largest in the world, dominating global gross domestic product (GDP), with Germany and Japan playing distant second fiddles. During the next few decades, the US economy really started moving, and took over as number one economy soon after 1900.

According to the Bank Credit Analyst, the odds are good that the commodities and metals bull market that began in 2001 has not yet run its full course. Chinese industrialisation and "rapid trend growth in the entire developing world will act as key forces to sustain structural demand for commodities". Heap's team has long stated that the key driver of the super cycle is without doubt materials-intensive economic growth in China.

Few prices go up in a straight line, and speculators inevitably contribute to the story. In January last year, the Citigroup global metal and mining team put it riotously: "A flood of investment funds is driving base metal prices much higher than can be supported by fundamental analysis of supply and demand. It's a bubble which could grow a lot bigger before bursting". There have been some bouts of savage profit taking in commodities and metals, but the fundamental story remains intact for the meantime.

Thursday, May 24, 2007


Still bullish on base metals

Coxe, Laciak convinced rally just getting started

Sean Silcoff
Financial Post

Wednesday, May 23, 2007

Don Coxe has a theory about cyclical sectors that have been in hibernation for a long, long time. Those companies that survive "are left in a sustained state of shock and fear," the global portfolio strategist for BMO Financial Group says. After things have been down for so long, the sector's key players have a hard time accepting the upturn is more than another false start.

"The greatest investment opportunities come from an asset class where those who know it most love it least, because they've been disappointed most," Mr. Coxe says.

Not surprisingly, he's one of the biggest bulls around on base metals and other commodities, putting him at odds with a lot of skeptical market watchers. They believe that after a few hot years, prices for zinc, copper and nickel will fall, and fall hard.

Mr. Coxe doesn't, and neither does one of his disciples, Steve Laciak. In fact, Mr. Laciak, a former star analyst who now manages money for Dundee Wealth Management, has invested a full 20% of his portfolio in base metal companies. He is convinced that Mr. Coxe is right: that firms in the business of extracting base metals from the ground have just started basking in high metal prices and earnings. And he believes that the market doesn't love them nearly as much as they will, eventually.

"I believe that the pricing will stay strong and these stocks will be revalued upwards," Mr. Laciak says, citing Canadian-listed AUR Resources, First Quantum Minerals, FNX Mining Company, HudBay Minerals, Inmet Mining, and Teck Cominco as those most likely to benefit from an increase in valuation multiples. Those stocks currently trade for between five and seven times earnings, net of cash. Mr. Laciak predicts the multiples will rise to above 10.

To understand his enthusiasm, look back to 2004 to see what happened to another longsuffering commodity: steel.

Back then, industry players pinched themselves as the price soared to US$700 per ton of hot rolled steel, breaking out of a longterm range in which prices drifted down to the low $200s, making the sector a palliative care unit.

Nobody quite believed it. As profits rose, valuations trailed. After selling off through 2005, you could buy Nucor for six times profit. Prices did indeed cool off -- but to US$500 to US$600, not $300, as before. Add in a period of consolidation, and these firms now trade for 10 to 13 times profit.

"Over time, people got comfortable with the earnings durability of those companies and valuations increased," says Mr. Laciak. "The same thing should happen to the base metal companies."

Many analysts still don't believe copper is worth US$3.40 a pound or nickel US$24. In fact, the sector suffers from a Charlie Brown mentality. BMO Nesbitt Burns analyst Victor Lazarovici says base metal stocks usually peak before prices and profits do, as investors call the top of the cycle, often prematurely.

Funds stop flowing into the sector, multiples fall and eventually, the pessimists are proven right, he says. With stocks on his watch forecast to earn an average 44% return on equity this year -- the longer term average is under 10 -- "the only question is how long does the cycle last and when will it correct -- and how low it will go," Mr. Lazarovici says.

Of course, the reason why Mr. Coxe and Mr. Laciak are bullish is the fact the world, led by China, is undergoing a broad economic expansion. But Mr. Coxe sees a sustained tightness of supply and demand due to the sector's Charlie Brown mentality.

"In 1982 there were more commodity than tech analysts" he says. "What you should have done then was dump commodities and buy tech." That delayed reaction, he believes, is matched by underinvestment by mining firms.

Miners will encounter high costs for energy, steel and skilled workers, since the world is undergoing a hot engineering and construction cycle. Plus, mines take longer to build than they used to, as environmental and legal challenges are routine. "It will take years to get a full supply side response," Mr. Coxe says.

Jeff Rubin, chief economist and strategist with CIBC World Markets, agrees. "To exit the commodity market today would be to leave a lot of money on the table. I would say low double-digit multiples is probably where we'll head up to."

As an analyst, Mr. Laciak made brave bets, advising others what to do with their money. Now he's got his own funds on the line. He doesn't sound worried. "Steel stocks used to get zippo respect," he says. "The time for these base metals companies will come to get respect as people become more comfortable with these prices."


"Crazy" to ignore commodities plays: JPMorgan fund

Tue May 22, 2007 9:11AM EDT
By Dominic Lau

LONDON (Reuters) - Investors who think it is too late to get into commodities-related stock because the market has risen so much are "crazy" as prices will only go higher due to tight supply and growing demand, JPMorgan Asset Management said.

Ian Henderson, fund manager of the UK-registered JPMorgan Natural Resources Fund, told Reuters in an interview that China's latest move to rein in its booming economy would dampen speculative activity but metal inventories remained low.

"I think people are crazy not to be in it (commodities). I just can't imagine anybody being so naive as to imagine this is not a revolution like the way people have never seen before in their lifetimes," Henderson said late Monday.

"It's absurd to imagine that with the enormous amount of infrastructure going on, whether that be railroads or roads or power stations or subways or airports, this is other than a revolution in terms of demand going on."

The fund, which invests mostly in stock and is 1.18 billion pounds ($2.33 billion) in size, has handed investors more than 22 percent in returns this year as of the end of April.

Its portfolio consists of: base metal and diversified 37 percent; gold and precious metals 27.5 percent; energy 25 percent; diamonds/other 8.2 percent, with the rest in cash.

Henderson, with 35 years of investing experience, also said there was no risk in investing commodities.

"For mineral producers the current situation with the arrival of China, India and other emerging markets as major commodity consumers sitting down to the table, can be likened to a hostess having prepared a dinner for eight having a further eight guests arrive for whom no food has been bought or prepared," he said.

The fund manager said that the emerging economies accounted for 29 percent of the world's gross domestic product, bigger than the United States, and were growing by 5 to 10 percent a year, supporting the demand for raw materials.

"The basic outlook is that most people imagine that mining companies will be able to bring new projects into production on time and on budget," he said.

"The honest truth is that at least in the past five years people's expectations for production growth had been almost twice as great as the actuality."

Energy supply would also remain tight as companies were finding it difficult and expensive to accelerate their exploration programs, said Henderson, who has run the fund since 1992.

As for stock picks, the fund manager said he liked "small and micro cap" companies, where half of his fund is allocated, but he declined to give any names.

But, he added, there was good value in the larger companies.

"Among the big companies, I would buy almost all of them today. All the major companies are undervalued quite a lot. And if I have to rank them in this very minute, I would be buying Norilsk (GMKN.MM), CVRD (VALE5.SA), (RIO.N)," he said.

"Their commodity mixes are quite favorable. The markets are not valuing them using sensible forward earnings estimate. In addition, in the case of Norlisk there will be an $8 billion return of equity by way of a distribution of their energy subsidiary next year."


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