Five Ways To Profit From The New Year Rebound In
Five Ways To Profit From The New Year Rebound In Commodity Prices
By Martin Hutchinson
Contributing Editor
Money Morning
Between September 2007 and June 2008 oil prices doubled gold rose 30 and commodities in general advanced by a similar percentage.
So why six months later when prices have fallen back below last years levels does everybody think they wont rise again? The difficulties of extraction havent gone away nor have the prospects of increasing consumption in the fastergrowing emerging markets such as China. Yes the prices of commodities are severely affected by marginal moves in supply and demand but this is ridiculous!
Rest assured commodities prices will rebound in the New Year. The reasons will soon become quite clear.
The decline in commodities prices since the summer is broadbased. The Reuters Continuous Commodities Index traded recently at 341 down 25 from a year earlier and off about 45 from its June high. At 48 a barrel oil is trading at less than onethird of its June high. And gold which appreciated less than other commodities in the spring is still down 18 from the 1000perounce level it reached earlier this year.
Conventional wisdom blames the decline in commodity prices squarely on the global recession. Since the rise in demand from emerging markets ndash; particularly the huge consumption bases of China and India ndash; had caused the previous runup it seems natural that the absence of that demand growth would cause prices to decline. After all that happened in 1982 when a deep recession in the United States spread to a number of other countries. Oil prices plunged from 40 a barrel to a mere 10 breaking the back of the Organization of the Petroleum Exporting Countries OPEC in the process.
This time around however the math doesnt seem to work. For one thing the world as a whole is by no means locked into recession. We in the rich countries think of our economies as spiraling into a deep decline but the reality is that we may only be witnessing a secular shift caused by the narrowing of income differentials between rich and poor countries as globalization proceeds.
In countries such as China India and Brazil ndash; three of the four socalled BRIC; economies ndash; growth has slowed and many are suffering imbalances in their financial structures but there is little sign of actual decline in any of them. Indeed if Chinas recently announced 590 billion infrastructure investment serves to redirect growth toward domestic consumers it is possible that the demand for oil and other commodities there may show very little dip at all; it takes a great deal of iron ore and other commodities to produce 100 billion worth of railroads for example one of Chinas stated objectives.
On the supply side OPEC was full of spare capacity in the 1980s. South Africa and the Soviet Union were still expanding gold production and the explorations of the 1970s had produced surpluses of many other commodities. But in the past two and a half decades things have changed.
Oil for example remains in short supply. Both deep offshore fields ndash; like those discovered by Petroleo Brasileiro SA or Petrobras ADR: PBR in the Tupi Complex ndash; and the tar sands like the ones in Canada and Venezuela are economically unfeasible with oil trading at such a low price. And if prices remain low the expansion and exploration of new sources of production will be curtailed even further.
More importantly though supply and demand is only one of the reasons commodity prices rise and fall. What really spurred the big price rise in commodities that took place earlier this year was the explosion in the money supply throughout the world.
Money supply unlike demand is something that hasnt evaporated with the economic downturn. In fact it has actually ramped up. Even though money markets have become illiquid central banks throughout the world are forcing down interest rates and pumping out liquidity by every means they can think of Indeed the policymaking arm of the U.S. Federal Reserve meets today Tuesday and is expected to cut rates yet again. For a related story click here.
Meanwhile governments everywhere except Germany are implementing massive stimulus packages; that will destabilize budgets and insert huge additional demand into the global economy. Since the governments will have to borrow the money to finance those stimulus packages ndash; and the budget deficits that are inevitable in an economic downturn ndash; central banks will be compelled to pump out even more money to accommodate all the increased debt; otherwise interest rates would go through the roof and finance for the private sector would become unobtainable hardly the object of this whole costly exercise.
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The future is thus one of rapidly increasing inflation combined with a healthy recovery in global demand at least in the emerging markets as Europe and the United States may suffer deep recessions this time around.
To take advantage of this likely trend I would recommend a broad portfolio of shares whose prices are closely linked to the prices of major commodities. Among those you might consider:
- Vale ADR: RIO: As a gigantic Brazilian iron ore producer Vale will benefit enormously from Chinas new infrastructure program Think of all those steel rails!. The stock is currently trading at just over 12 a share with a Price/Earnings ratio P/E of about 7.0 and a yield of slightly more than 1.0.
- Rio Tinto PLC ADR: RTP: Another huge mining conglomerate the longandbloody attempted takeover of Rio Tinto by BHPBilliton Ltd. ADR: BHP recently fell apart. At 93 Rio Tinto shares have a yield of 5.8 and a prospective P/E of about 3.0. The company is overleveraged so somewhat dangerous but youd be getting paid for the risk.
- Suncor Energy Inc. SU: The largest pure player in the Canadas Athabasca tar sands Suncors marginal cost of production from operating facilities is about 30 per barrel and the cost of opening new facilities is about 60 per barrel. Its currently trading with a P/E of 8.0 but has a yield of less than 1.0 as it needs all its cash.
- SPDR Gold Trust GLDexchangetraded fund ETF: The largest ETF that invests in gold GLD has more than 750 tons of the yellow metal; held in trust.
- Yanzhou Coal Mining Co. ADR: YZC: Chinas largest coal miner Yanzhou has a P/E of 4.0 yields 3.5 and enjoys low costs ndash; not to mention a superclose proximity to the gigantic market that is China.
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About the writer: Martin O. Hutchinson is a Contributing Editor to both the Money Map Report and Money Morning. An investment banker with more than 25 years experience Hutchinson has worked on both Wall Street and Fleet Street and is a leading expert on the international financial markets.
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