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Saturday, July 28, 2007


Base Metals Bears

By David Galland (Casey Research)
27 Jul 2007 at 12:50 PM GMT-04:00

STOWE, Vt. (Casey Research Advertorial) -- It is not our purpose here at Casey Research to massage the data to fit our point of view. In fact, we are nothing if not open minded. Recently, we asked readers to propose scenarios that might cause things to break in a direction other than that we expect. In response, a subscriber forwarded an article from Bloomberg with a very sound-sounding bearish view on base metals. You can read the entire article by clicking here.

To save you some reading time, the theme of the article is that, due to high prices, the supplies of base metals coming onto the market will quickly reach the point where they’ll overwhelm demand, driving prices down. This scenario will be exacerbated, according to the base metals bears, because China’s rocket-like economic expansion must surely slow, thereby simultaneously reducing the demand at the same time supplies are increasing.

According to the Bloomberg article, despite the strength of their argument, these same bears, most notably the folks at JP Morgan, have been wrong about the base metals for some time now. To quote:

“An investor who acted on the advice of JPMorgan, the third-largest U.S. bank, missed gains of 67% for nickel, 30% for copper and 41% for lead, the best-performing commodities in the 26-member UBS Bloomberg CMCI Index.”

Even so, just because they have been wrong in the past doesn’t mean they are going to continue to be wrong, and so one shouldn’t use that as an excuse to dismiss their arguments. (We have also been cautious on the base metals, but rather than eschew the sector altogether, we have simply tightened the criteria a base metal play has to meet before we recommend it in the pages of our monthly International Speculator newsletter.)

Always happy for a second opinion, I forwarded the Bloomberg article on to long-term friend Clyde Harrison, the brains behind both the Rogers International Commodity Index and now the Bridgewater Index.

After reading it, he gave me a call. His view can be summed up as “They may be right, in the short term. But a year down the road, the base metals are going to be trading much higher than they are today.”


According to Clyde, the debate about China’s growth is already over, underscoring that contention by sharing just a few data points.

For instance, there are currently 168 power plants being built in China. In addition to the massive amount of metal used in constructing those plants, consider the copper wire those power plants are going to be connected to. “Will there be a fall-off in demand for copper? Not likely,” Clyde replied, answering his own question.

He also noted that China built and sold as many cars as the U.S. last year.

And it is important to understand, Clyde continued, that today one billion people use 2/3 of the world’s natural resources. The balance of 5.6 billion people use the other third, but they are quickly becoming more successful, setting up a serious competition.

Which goes a long way toward explaining why there are now 50,000 students studying geology in China, versus 900 in the U.S. (of which 300 are foreign). And why the Chinese are increasingly showing up in remote corners of the world, checkbooks open, eager to trade our dollars for tangible resources. Unlike businessmen from the U.S., the Chinese buyers don’t insist that the sellers start labor unions or clean up their pay practices, they’re just there to do business.

In that regard, the Chinese have no qualms of passing across a briefcase full of cash if that’s what’s required to get the deal done. That’s something a U.S. executive would go to jail for. Behind Door A is a briefcase full of cash. Behind Door B is a Happy Meal and nothing else. Who do you think is going to get the deal?

Then there’s this.

According to Clyde, historical data shows that when a country starts to industrialize, per-capita usage of oil typically goes from about 1 barrel (bbl) at the beginning of the industrialization, to between 17 and 27 bbl per capita by the time the industrialization is completed.

That China is just beginning to industrialize, and has much further to go, is evident when you consider the Chinese currently consume just 1.7 bbl per capita per year. And the citizens of India use just 0.9.

Like Clyde, we believe there is no putting the Chinese genie back in the bottle. In fact, in our view, what we are witnessing in China is evidence that when the mainland Chinese, while preparing to take Hong Kong back from the British, came to the realization that free market capitalism with little hindrance from the state was the only way forward.

A New Economic Age in the Making?

The implications of that shift in thinking are making itself felt around the world, with the world’s largest nation now super-charged by the world’s best economic system.

That is not to say that there won’t be rough spots in China’s future - the level of stock market speculation there is bound to cause a problem - but the trend in China, and elsewhere, is well entrenched and not going to change any time soon.

If you take another step or two back, it is worth noting that Dubai, a patch of desert with little in the way of natural resources, has used the same laissez-faire economic approach to transform itself into a global economic powerhouse. It is not out of the question that other countries may begin to take note, and follow suit. In which case, the future is bright indeed… as is the case for all the natural resources.

© Casey Research 2007

David Galland is the managing editor of Doug Casey’s International Speculator newsletter, now in its 27th year, dedicated to bringing investors unbiased research on precious metals investments with the potential for 100% or better returns within 12 months.


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