Out of their dismal lows in early March, the
stock markets rocketed 27% higher in a single month! After such fast
gains, Wall Street remained skeptical. Was this a typical bear rally
that would soon collapse? But as the last couple weeks have shown, it
didn’t. Stocks not only held their rally gains, but they
continued moving higher.
The result is the biggest
advance since the stock panic ignited. Even more importantly, these
recent gains have generally been measured and orderly. This is a
signature of new bull markets in contrast to the violent and short-lived
bear-market rallies. The persistent stock-market strength is restoring
hope and leading ostrich
investors back to the markets. They are wondering which
sectors have the best potential to thrive.
For a variety of reasons
I’ll outline in this essay, I believe the commodities stocks will be
the best-performing sector in the coming years. Their incredibly
bullish fundamentals, combined with dirt-cheap prices driven by stock-panic
psychology, have created one of the greatest investment opportunities
I’ve ever seen. This bullish sector deserves a sizable fraction
of every investor’s portfolio.
In order to grasp commodities
stocks’ epic potential, you first have to consider the products they
produce. Commodities are essential to everyday life. Everything
physical in your world, from the home you live in to the energy that moves
you around to the food you eat, is made from commodities. Without a
never-ending flow of these raw materials, the vast majority of the
world’s population (everyone without hardcore survival skills) would
soon be dead.
Thus perpetual demand exists for
commodities. And this demand is growing globally. We in America are used to an incredibly rich standard of living
fueled by heavy raw-materials consumption. And at least half the world,
primarily Asia, is zealously striving to
close the gigantic gap between its own standards of living and those we enjoy
in the first world. The unstoppable juggernaut of Asian
industrialization alone will consume commodities at levels far beyond
anything ever before witnessed.
The resulting secular
(long-term) commodities bull has already been exceedingly profitable to early
investors like us. And it is far from over. The more
Asians and Africans and South Americans taste better qualities of life for
their families, the harder they work to accelerate their rate of material
advancement. While their per-capita commodities consumption remains
small relative to ours, their aggregate consumption is already
enormous. Soon it will probably exceed that of the first world, if it
hasn’t already.
In the stock markets, any
company’s fundamentals are defined by its future profitability. If
it has the potential to grow profits, if demand for its products is likely to
expand, its fundamentals are bullish. And few other companies enjoy
such a guaranteed growing market as commodities producers. While demand
for the latest technology gadget or pharmaceutical will collapse as soon as
something better comes along, the world will always need the basic building
blocks of our physical existence such as copper or fertilizer.
Even better for commodities
producers, supply is constrained no matter how fast demand grows. Producing
more metal is not like adding a factory to make more iPods. It is
vastly more challenging. Between exploration for new deposits, planning
and permitting mines, financing and building mines, and actually bringing new
commodities to market takes over a decade. Sometimes multiple
decades! So no matter how fast rising demand drives up prices, the
natural supply response takes many years to unfold.
You certainly don’t have
to take my word for the bullish nature of commodities fundamentals. The
best commodities index is the Continuous Commodity Index (CCI). Once
known as the CRB Index, it tracks the
prices of 17 key commodities. With these components equally weighted
and geometrically averaged, the CCI beautifully reflects overall commodities
price trends. Here is a chart of the CCI (blue line) since 2001.
Between late 2001 and mid-2008
(just before the stock panic), the CCI soared 235% higher! Over this
same span, the stock markets (S&P 500) merely rose 16%. As I
predicted in early
2001, commodities have indeed entered a secular bull that radically
outperformed the stock markets. And due to the profits leverage
inherent in producing commodities, the commodities stocks have fared even
better.
Any company producing a
commodity has a roughly fixed cost of production. Consider copper as an
example. If a company can mine copper for $1 a pound, and its price is
$2, it can earn a $1 profit for each pound it sells. But if copper
rallies 50% to $3, this company’s profits don’t just march up 50%
with copper. Instead they double. Still producing at $1
yet selling at $3 yields a $2 profit, twice as high. Thanks to this
accelerating profits leverage, profits for producing rise far faster than
underlying commodities prices.
As this CCI chart reveals,
speculators did flood into commodities in early 2008. After more than 6
years of rallying with little fanfare, mainstream investors finally started
getting interested in commodities stocks in late 2007. But in early
2008 commodities grew overbought and due for a correction, and it started
last July before the stock panic hit. Yet still in August 2008, the
last pre-panic month, the CCI averaged 518 on close, oil $117, and copper
$3.46. And then the storm of a lifetime slammed into the markets.
It was the first true stock
panic witnessed in 101 years! The key
characteristic of a panic is inherent in its dictionary definition. “A
sudden widespread fear concerning financial affairs leading to credit
contraction and widespread sale of securities at depressed prices in an
effort to acquire cash.” The stock panic’s fear bubble soon
engulfed commodities and commodities stocks, as traders dumped both in a
frantic effort to move capital out of harm’s way into cash.
So instead of merely retreating
to its secular support line drawn above (450), the panic selling drove the
CCI down under 350. This plunge was the fastest and largest decline in
commodities prices ever witnessed, even dwarfing the Great Depression’s
declines! By the time the dust settled, the CCI had retreated to
November 2005 levels. This sounds bad, and it was. But realize
the 37-month lows in commodities prices were nothing compared to the
recent 150-month lows seen in the stock markets.
Commodities prices handily
outperformed the stock markets during the epic stock panic. Unfortunately,
due to a popular yet misleading commodities index not a lot of traders
realize this. The financial media follows today’s CRB index (red
line above), which was actually created in mid-2005 as a radical departure
from CRB history. Now dominated by oil, this new tenth-revision CRB
isn’t comparable to any history prior to its creation. So please
don’t be fooled by this misleading new CRB, it is a false
witness to investors.
Even though commodities prices
held up better than the stock markets, retracing less ground, commodities
stocks were disproportionately hammered. Investors and speculators,
scared to death by the stock panic anyway, were further frightened by the
plunging commodities prices. Their frantic and mindless selling drove
the stock prices of the biggest and best commodities producers on the planet
to impossibly low levels. In some cases, these companies’ entire
bull markets were nearly erased at the panic’s climax!
While painful and frustrating
for us existing commodities-stock investors, this once-in-a-lifetime fear
bubble drove the greatest bargains I’ve ever witnessed deep within a
secular bull. In early November in our subscription newsletter we bought and recommended
long-term investments in the world’s largest gold miner, one of its
biggest and best copper miners, an oil major actually discovering massive new
oil finds, and one of the most elite silver producers. These
investments soon thrived even while the stock slump lingered.
The stock markets carved their
initial fear-driven panic low in late November, but they slumped to a
secondary despair-driven low in early March. The flagship S&P 500
stock index was down 10% over this span. Yet commodities stocks thrived
while general stocks languished. Unfortunately there aren’t any
excellent general commodities-stock indexes yet, so I have to use
individual stocks to illustrate this.
Over the exact stock-market
low-to-low span, BHP Billiton, the world’s largest miner, rallied
48%. The elite oil major Petrobras climbed 78%. Giant copper
miner Freeport-McMoRan surged 84%. Elite gold and silver market
darlings Goldcorp and Silver Wheaton powered 48% and 140% higher. These
gains were to the very day of the lower S&P 500 lows, very
impressive. In the interest of disclosure, we have long-term investment
positions in each of these companies, and have recommended our subscribers do
the same.
So even in early 2009, a very
difficult time in the stock markets, commodities stocks have already been
performing exceedingly well. Both in an absolute sense and certainly
relative to the general markets. But the opportunities have not
vanished. The price anomalies in commodities and commodities stocks
created by the stock panic’s unbelievably intense fear still persist to
this day. In fact for most commodities and their producers’
stocks, not even half of the panic anomalies have yet been erased.
As many on Wall Street argue,
there is no doubt we live in a different world since the panic. It
might be years yet before we see commodities prices return to their lofty
summer 2008 levels. But commodities-stock prices are still so beaten up
that they don’t need to see those stellar commodities prices again in
order to thrive. And commodities prices will establish new post-panic
equilibriums above today’s levels.
Why won’t today’s
low commodities prices persist? There are many reasons but several
major ones more than make this case. Long-term commodities prices must
exceed their costs of production, enormous monetary inflation is baked into
the pipeline, and the ascent of the developing world will continue.
Like any business, commodities
producers need to operate at profits. If they can’t produce their
commodities at a profitable price, they’ll slow or stop production at
their key operations. Many commodities today are trading near or under
their average global costs of production, so producers are reacting
accordingly. And unlike building new mines, it only takes months to
scale back production. This natural free-market mechanism soon reduces
supplies which results in higher commodities prices.
Like everything else,
commodities prices are also affected by the supply of money. When money
supplies increase faster than commodities supplies, commodities prices rise
as relatively more money bids on relatively less commodities. Across
the globe, governments have been ramping monetary growth tremendously
in their attempts to fight the financial panic. In the US alone, the Federal Reserve has doubled our monetary base in less than a
year! Big inflation is coming, which
will result in higher commodities prices as always.
And the panic’s slowing impact
on demand won’t persist for long. Even before the panic,
governments around the world were spending hundreds of billions on building
infrastructure. This has accelerated dramatically since the panic as
governments try to goose their economies. And around the world,
hard-working ordinary folks like you and me haven’t given up on their
dreams of a better life for their families. The developing world will
continue its long-term trend of greater per-capita commodities consumption.
Because of these factors and
many more, commodities prices are not doomed to forever languish near their
panic lows. They have already started rising back up towards a new
equilibrium. I’m not talking lofty summer-2008 speculation-driven
levels of course, but some happy medium between there and the panic
lows. I suspect it will end up within the CCI’s secular uptrend,
say around 500 on this index. This is 35% above today’s levels.
Commodities stocks’
reactions to this normalization of commodities prices to underlying global
supply-and-demand trends should be impressive to say the least. Their
famous profits leverage will come into effect, with the best producers’
profits growth (and hence stock prices) multiplying the underlying gains in
the commodities they produce. But first over the near term another
extremely bullish factor will come into play.
Thanks to the horribly
pessimistic psychology of the stock panic, many commodities stocks are not
even reflecting today’s prevailing commodities prices let alone future
ones. In the heart of the panic their stock prices were driven far
lower than commodities prices warranted, and they have not yet recovered
sufficiently to close this gap. Thus even if commodities prices
flatlined going forward, commodities stocks are generally too cheap. Gold
stocks are a fantastic example.
For 5 full years prior to the
stock panic, the flagship HUI gold-stock index averaged just over half the
price of gold. And the resulting 0.51x ratio of the HUI level to the
gold price was established in a tight and consistent secular trading range. But
the stock panic temporarily blew this relationship between the gold stocks,
and the metal they produce (which drives their profits and hence stock
prices) all out of whack.
In the depths of the panic, the
gold stocks were sold off so aggressively that the HUI reflected a gold price
of $350! Yet gold itself never fell below the low $700s in the
panic. This decoupling phenomenon occurred in many commodities stocks,
where irrational fear drove them to levels far below what then-prevailing
commodities prices warranted. While this anomaly is gradually being
rectified, it still persists even today.
In gold stocks’ case, so
far in April the HUI has been reflecting a gold price of $585. Yet gold
itself has averaged $885 this month! Gold stocks are still far too
cheap relative to gold today, let alone where it goes in the future due to soaring
worldwide investment demand and unprecedented fiat-currency inflation. Many
producers of other commodities share in this panic-induced undervaluation,
they have far to rally merely to reflect today’s commodities
prices.
For all these reasons, commodities
stocks have great potential going forward. I suspect that a year from
now, 2 years from now, investors will look back at this still-neglected
sector and marvel at its stock-price appreciation since. And this is
really saying something, since the best years stock markets ever witness in
history occur immediately after
the worst years. So after the disastrous 2008, 2009 is due to be
a huge up year (approaching 50%) for the general stock markets. Commodities
stocks should easily double, triple, or quadruple these already large
stock-market gains!
If you are interested in riding
this accelerating post-panic commodities-stock rally, the resumption of this
sector’s secular bull, you’d love our work at Zeal. We’ve
been intensely researching, and actively investing and speculating in, this
sector since 2001. We have
unparalleled experience in trading commodities stocks in this secular bull.
And we share our world-renowned work and resulting high-potential stock picks
with our subscribers in the form of acclaimed subscription newsletters.
Subscribe today to deepen your market knowledge
and wisdom and to capitalize on handpicked commodities-stock opportunities
going forward! You too can profit from the fruits of our labors and
build a better financial future for your family.
The bottom line is commodities
stocks probably have the most bullish fundamentals of any stock-market
sector. They produce the physical building blocks of all the
world’s necessities. They have a guaranteed and endlessly growing
global market for their products. And the underlying commodities
fundamentals virtually ensure higher commodities prices and hence higher
profits for production in the years ahead.
In early 2008, many investors
feared this unprecedented bull market (Asia has never universally industrialized
before) had left them behind. But the once-in-a-lifetime stock panic
temporarily slashed commodities and commodities-stock prices so severely that
buying now is almost as attractive as getting in on the ground floor back in
the early 2000s. This sector is still due to outperform for many years
to come.
Adam Hamilton, CPA
Zealllc.com
April 24, 2009
Read
all articles published by Adam Hamilton
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