There is nothing
that possesses all the qualities of money in the way that gold does, so there
really isn't a competitor to gold as "the ultimate money".
Base metals do
share a number of qualities of money with gold. They represent assets which
have a value based on usage. They can be stored and will retain or increase
in value as the US dollar declines in both purchasing power and on foreign
exchange markets. Base metals are not someone's liability and do not rely on
a third party's promise for their value. They can provide protection against
the certain future demise of all global fiat currencies.
There is a high
probability that base metals are at the start of a major bull market, a bull
market that may last for many years and propel metal prices to much higher
levels. This is not a prevalent point of view. Most media articles over the
past six months have been negative on base metals for one or more of the
following reasons:
- The base metals have been in a
"bubble" which has burst;
- The US
economy is headed into a recession propelled by a slump in the housing
market which will result in China
selling fewer goods to the US and thus requiring fewer
base metals;
- The CRB Index has broken down and given a major
sell signal;
- The surge in base metal prices will generate
rapid increases in new supplies of metals which will cause the prices to
collapse;
- Hedge Funds and Commodity Funds have been
buyers and when they dispose of their holdings, prices will drop.
These reasons
are all false, as I will attempt to demonstrate below:
Was it
a "Bubble" that has burst?
It is easy to
understand why people might think that base metal prices have been in a
"bubble" when one looks at the very long term chart of copper
below.
This chart
condenses over 35 years of price history for copper. Two very important
points emerge from a study of this chart.
- The copper price in 2003 was the same as the
copper price that prevailed in 1973! What an incredible bear
market.
- Just over a year ago, during the September 2005
quarter, copper burst upwards out of a base that extended over no less
than 30 years!
Once out of the
base, the price of copper rocketed upwards, more than doubling in price in
the space of little more than six months. Since the peak in May 2006, copper
has been consolidating in a sideways movement not reflected on this long term
chart.
Is this a
"bubble" as many have suggested or is it the initial move in a very
much bigger bull market that is in its very early stages? From a technical
point of view it is highly unlikely that a massive upside break such as this
one from a 30 year-long base will exhaust itself in just 6 months. It is more
likely to be just the first upside run in a new bull market.
If copper had
been in a "bubble" one would expect to find many of the symptoms of
a "bubble" present, e.g.
- Vast public participation and enthusiasm for
the item concerned;
- Very bullish and continuous media coverage of
the item;
- Stocks involved in the item selling for
ridiculously high and unsupportable valuations (think technology stocks
in the bubble of the late 1990's).
None of these
factors are present in base metals or base metal share prices at present. There
is virtually no public participation or enthusiasm for base metals; the media
coverage tends to be almost universally negative and base metal stocks are
selling at mouth-watering valuations that can only be justified by factoring
in an expectation of much lower metal prices.
Turning to
nickel, there is a similar situation of a decline in LME stocks leading to a
sharp increase in the nickel price - as depicted in the 5 year charts of LME
nickel prices and stocks:
There is a current
shortage of refined nickel of about 100,000t tons per annum. Despite new
production expected over the next few years from Ravensthorpe,
Voisey's Bay, Goro and a
variety of brownfield expansions, Steve Barrett,
the President of the Nickel Institute, in a recent presentation at the Nickel
Conference in Perth,
indicated that the production shortfall would not only continue, but actually
increase, through 2010. The main drivers on the demand side being increased
stainless steel capacity installed in China
and Korea.
What is the
nickel price outlook in these circumstances? Barring a world depression, it
seems that nickel will continue to rise in price, possibly for a decade. I
have a target price of US$25 per lb during the next year or two, compared
with the current price of around $15 per lb.
This forecast
price (or even the current price) will do wonders for the earnings of a
number of small Australian nickel producers.
There are many
other examples of base metal companies trading at very low valuations. Even
the major base metal companies such as BHP and RIO are trading on forward P/E's of about 9 according
to most analysts, and even lower P/E's if metal prices continue to rise.
I conclude from
this discussion that there is no evidence of a "bubble" in base
metal prices. On the contrary, there is evidence that base metals have
commenced a major new bull market.
China Factor and a
Possible US
recession?
One cannot
understand what is happening to base metals without a deeper appreciation of
the China
factor. This is something I have come to appreciate after visiting China
recently. I simply didn't have a sufficient understanding of the history of China.
For centuries,
indeed millennia, China
has been a hugely productive, entrepreneurial nation. Historically it has
been largely self-sufficient, providing the rest of the world with much
wanted goods. The modern history of China
from the 1930's when Japan
invaded the country, has been different. The
Japanese were not evicted until after the second World War. Thereafter there
was an internal civil war between the Communists and the Nationalists. The
Communists won, the Nationalists went to Taiwan and Mao Zedong took
draconian control of the country, imposing Stalinist type Communism.
The essentially
free enterprise Chinese people were deprived of their land and other assets. The
State told everyone what to do and how much they would get paid. It was a
disaster economically. When the nation was facing starvation in 1978 a bunch of farmers
took matters into their own hands and formed what was effectively a
co-operative society. They ignored instructions and did what they knew would
be most productive. Food production soared and the farmers became wealthy.
Soon others copied them and the movement spread.
It was the start
of a free market underground rebellion. People were prepared to break laws in
order to progress and eventually the State accepted what was happening and
went along with the new movements, finally officially encouraging the
"new" system.
What is
essential to understand is that for nearly 50 years the Chinese economy was
brutally suppressed. From 1978 onwards this massive 1.3
billion productive Chinese population has been released economically
and they are making up for lost time. Some analysts claim that the population
figure is higher, probably 1.5 billion, a claim derived from food consumption
statistics. In any event, the growth in China over the last 20 years has
been staggering with annual growth rates of around 10%.
The Chinese now
want what other developed nations take for granted. The top 3 items desired
by Chinese at the moment are condominiums, automobiles and education. The
number of automobiles in the country is tiny relative to the population, some suggest as few as 40 million motor cars. No
wonder automobile sales are running at a rate of 6.5m per annum and growing
rapidly. The building boom in China
has been awesome and it continues unabated.
The
infrastructure of the country is being revived after over 50 years of
neglect. One should not forget the Beijing Olympics scheduled for September
2008. This is a major driver in many projects and it seems that there will
not be a slow down in China's
growth rate until after the Olympics in 2008. This is why China has an insatiable demand
for raw materials, especially base metals.
There was a time
when America
sneezed the rest of the world caught a cold. That probably no longer applies
and it is doubtful whether a recession in America now would cause any
significant dent in the Chinese growth rate.
The CRB Index
has broken down and given a major SELL signal?
It is correct
that the CRB index has broken down sharply and given a sell signal - but it
gives a false impression of what is transpiring. The components of the CRB
index were radically changed during 2005 and the CRB index is now heavily
weighted towards oil and energy. The CRB is no longer a reliable index of
base metal prices. This is clear from the fact that zinc, nickel and lead
have made new all-time highs recently despite this so-called sell signal in
the CRB Index. The sell signal in the CRB index was triggered by the decline
in oil and natural gas prices, not base metals.
We can safely
ignore the CRB Index as an indicator of whether one should or should not get
involved in base metals.
Will new metal
supplies generated by current higher prices swamp demand leading to lower
metal prices?
This is the
classic argument put forward by economists and has been the reason for
cyclical declines in metal prices in the past. No doubt it will work again,
but not for many years, maybe even a decade or more. New supplies cannot be
easily garnered for quite some time.
During the protracted 30
year base metals bear market, mining companies laid off geological and
exploration staff. There was no need for companies to look for new deposits
and projects. The result is that there are very few new deposits being
brought to production and those that are about to commence are barely
replacing production lost from older mines that are coming to the end of their
days. This is evident in the nickel statistics mentioned earlier, but it also
applies to other metals. How many new large copper mines about to come into
production can you name?
There are other
contributing factors flowing from the 30 year bear market. The University
enrolment of geologists and mining engineers slumped during that period,
understandably so. Consequently there is a major skill shortage in the mining
industry that is delaying exploration and development of new projects. One
hears stories of shortages of drilling rigs and also drilling crews. Drill
rigs require two or three crews to operate effectively around the clock and
to give crews time off. Many rigs now have limited crews. When they
eventually get the cores to the assay labs for analysis, there are long
delays in the labs before results are available for study and co-ordination.
New projects now
require much more detailed feasibility studies before Boards of Directors
will approve projects. Then the permitting and financing process starts.
Finally the mine has to be constructed and brought to production. The average
pipeline delay for a new project is between 7 and 10 years - and that is the
earliest timeframe that one can visualise for a ramp up of major new
supplies. Given current and expected inflation rates, what metal prices will
be required to encourage that new production and to ensure profitability in
10 years time? I suggest that it will require metal prices very much higher
than at present.
Finally, a
related comment about a different staffing problem. During the protracted
metals bear market, investment houses and stockbrokers laid off their mining
and resource analysts and hired analysts capable of following high technology
and industrial companies. The result is that there is now an acute shortage
of good mining and resource analysts in the investment industry. That is why
there are so many mouth watering investment opportunities around for those
who care to look for them. This is another indication of how early we are in
this metals bull market and further evidence that this is no
"bubble".
Will Metal
Prices drop when Funds sell their holdings?
Before funds can
sell, they must first buy. Unless they go short, of course.
The chart below
shows the weekly copper price and what are known as the COT's
- the Commitment of Traders statistics.
The green line
below the copper graph shows the positions taken by the large funds. The red
line represents small speculators, and The blue line shows the position of
the "Commercials" - those major players in the industry who may
wish to protect their situation from time to time.
These lines
provide some very interesting information.
The green line
(the net position of the large funds) shows that they were at their maximum
long position in March 2005, just before the copper price started to go
vertical. Since then the green line has trended steadily downwards as the
large funds firstly disposed of their long positions and then went into a net
short position. That is where the large funds sit at the moment, short of
copper.
The blue line
(the commercials) has been climbing steadily over this period as the
commercials have bought into copper. They now have a large net long position.
Historically the commercials have been right in their market calls.
So there is no
need to be scared of the large funds off loading their positions. They don't
hold any copper and indeed are short of the metal. Their buying will actually
help push copper higher when they eventually close their short positions.
One final
comment relating to those people in the base metals industry who know most
about their industry, i.e. the people who run the major base metal companies.
What have they been doing? Trying to buy up their major rivals is what they
have been doing.
Why would they
want to do that? The answer is that they can smell a bull market coming and
the quickest way to increase their reserves and resources in the ground is to
buy rival companies while they are still cheap and before the metal prices
rise sharply. It is much easier than trying to go the long route of finding
new deposits.
Conclusions
In my opinion
there is no evidence of a "Bubble" in the base metals markets.
There is
technical evidence of a major upside break from a 30 year bear market in the
base metals, a base from which very much higher metal prices can be
anticipated and which should be a new bull market that spans at least 10
years.
Many of the base
metal shares are extremely cheap relative to current metal prices and look to
be absolute bargains relative to the much higher metal prices that may be
anticipated as the bull market unfolds.
Base metals are
not a strict alternative to gold, but they do allow for portfolio
diversification and should provide protection to the inevitable currency
upheaval that lies ahead, especially relating to the US Dollar.
Alf Field
Disclosure and Disclaimer
Statement: The author is not a disinterested party in that he has personal investments
gold and silver bullion, gold and silver mining shares as well as in base
metal and uranium mining companies. The author’s objective in writing
this article is to interest potential investors in this subject to the point
where they are encouraged to conduct their own further diligent research.
Neither the information nor the opinions expressed should be construed as a
solicitation to buy or sell any stock, currency or commodity. Investors are
recommended to obtain the advice of a qualified investment advisor before
entering into any transactions. The author has neither been paid nor received
any other inducement to write this article
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