Great Investment Articles

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."

ssilcoff@nationalpost.com