A Great Deal of Potential Reward and Risk in Metals, Energy and Commodities

I've been writing this series of articles because all of us face some tough choices and decisions as to how to take advantage of the schizophrenic, deflationary drama that is playing out in the commodities like energy and metals.

Dorothy Kosich with Mineweb.com has been attending the Northwest Mining Association conference in Reno, NV.

One of Canada's top investment strategists warned miners attending the Northwest Mining Association conference Thursday "that this quarter is going to be even nastier than people are thinking and the first quarter will be worse."

In an industry outlook speech to the NWMA conference in Reno, Frederick Sturm, executive vice president and chief investment strategist for MacKenzie Investments, noted that the mining industry has come down hard, will snap back, and then come down hard again. "Do the deals that you need to be done quickly," he urged mining companies.

The good news for miners and explorationists during the global economic crisis is that investor cash reserves are as high as they have ever been and will be looking to get reinvested, he explained.

Unfortunately, Sturm also warned, "The window for you to get capital is going to be very hard or the gate shut for quite some time."

Sturm, who manages the Ivy Global Natural Resources Fund in the United States, outlined several factors that are shocking commodities and resource stocks including:

1. General broad market re-pricing of risk.
2. Extra concern about slower economy and deleveraging.
3. Emerging markets not strong enough yet to "go it alone." Dislocation of currencies, local banking and letters of credit will take time to ease.
4. Forced and voluntary liquidation of broker/bank hedge position. Commodity index blanket selling is not differentiating between commodities.
5. Ability to short never has been easier. Strong balance sheets should, in time, help rebuff bear raids.
6. Electronic trading algorithms set to "participate", become price indiscriminate and add to volatility in thin markets.

When the U.S. dollar starts to ease again next year, Sturm predicted the gold price will experience another run.

Nevertheless, Ivy Global Natural Resources price forecasts revealed by Sturm Thursday are not especially encouraging for the near-term future of metals and minerals: Copper $1.60/lb; nickel $7.50/lb; moly $10/lb; gold $800/oz; uranium $60; silver $13/oz; platinum $1200/oz; iron ore fines $55; coking coal $150; and aluminum $1.10/lb.

Sturm forecasts that the long-term outlook for resources will remain solid. Fiscal policy efforts to stabilize financial system will succeed in averting depression conditions. He is particularly enthusiastic that the world's central banks "are all sailing in the same direction."

The mining industry must forget about recent highs in resource prices, Sturm advised, because "they will not be seen for years." Nevertheless, he added, "gold may be the exception."

Low cost miners will remain profitable, while high-cost mining operations "will be strangled by lack of access to capital," he warned. Nevertheless, "good companies should come through" the current global financial crisis.

He urged mining companies to exercise supply discipline. "Produce what your clients need, less one tonne. This will be key in maintaining profit margins and shortening the recovery cycle," Sturm advised, urging mining companies to focus on their profit margin, not recovery.

Sturm had praise for mining companies, such as Freeport-McMoRan Copper & Gold, who are "facing reality, shelving projects." Honored as the Canadian Investment Awards' Fund Manager of the year, Sturm advised miners to not be discouraged by the "guys that are selling who just discovered natural resources a year and a half ago."

He remains bullish on the demand for metals by developing economies. "Too many people in the world still want a better life," Sturm said, noting that China's expected urbanization in 2025 presents "several challenging years, decades of opportunities" for miners.

Meanwhile, as India plans to spend US$1.5 trillion on infrastructure over the next 10 years, the country must consume more energy and more materials that will come from the global mining industry, he noted.

Sturm advised that a lack of major minerals discoveries suggest a return to the metals and minerals surplus of the 1980s and 1990s is unlikely.

The top four holdings of the Ivy Global Natural Resources Fund (IGNAX)--which managed $10 billion in assets before the global financial crisis hit--include Brazilian Petroleum Corp., PotashCorp (POT), Gazprom (OGZPY.PK), and Petrohawk Energy (HK).

Jim Kingsdale recently wrote in a clear and concise manner the dilemma and choices we all face at this point.

But the cost of buying now or owning now will be steep if the bottom of the business cycle is two or three or four years off. A great deal of additional asset value destruction could take place over two, three or four more years of declining GDP. So if one's objective is to buy at the bottom, or at least to own at the bottom, one best hope that the bottom is not too far off. And that in fact is what many people are doing now - owning energy stocks in the hope of a quick upturn in GDP.

So the choice for the oil stock investor is whether to own them now, thus risking further portfolio value declines, or stand aside for now thus avoiding the risk of more portfolio declines but taking an opportunity risk that you will miss out on the early part of what could be a huge rally in stock prices. It is an individual choice.

Whatever your choice, make it with the knowledge that in owning oil-related stocks you are super-leveraging yourself to economic conditions. If we are near a bottom in terms of GDP reduction, you could do very, very well. But if we are years away from it, the additional decline in your portfolio from here could be serious. That's because the price of oil and the value of oil related equities are so closely tied to GDP growth or decline.

Perhaps the bottom line is that there is not only a great deal of potential reward with these markets at these level, but there is a heck of a lot of risk and uncertainty. Many of us are not in a position to try to catch "falling knives", and maybe the best plan is to watch, "paper trade", create a wish list with "stink bids" and/or learn vicariously.

Nobody, and I mean nobody, knows what will happen next and where these markets will be 7 days from now or 7 months from now. The markets are telling us now we are stuck in waist-deep deflation, and when the market anticipates a shift towards inflation, it will let us know.

Stock position: None.

Comments

[Pipo:]

Oil had its Biggest weekly drop since the Persian Gulf War in 1991. Is a short covering rally ust around the corner?

www.oiltradersblog.blo...

2008 Dec 07 12:01 PM

[fran:]

great time to practice dollar cost averageing and purchase strategic buying of low multiples of cash--almost any high global use commodity.

2008 Dec 08 04:39 PM

[Marc Courtenay:]

Wouldn't you know it. I posted the article and the commodities (except natural gas) start rallying. The best analysts I know think a "short-covering rally" might be just around the corner. They also suggest that a "black swan event" might surprise the markets over the next 90 days leading to a spike upward. My guess is that oil will trade in a range between $40 and $80 for the foreseeable future.


On Dec 07 12:01 PM Pipo wrote:

> Oil had its Biggest weekly drop since the Persian Gulf War in 1991.
> Is a short covering rally ust around the corner?
>
> www.oiltradersblog.blo...

2008 Dec 08 08:07 PM

[E.D. Hart:]

And lets not forget dividend paying oil companies that pay a dividend higher than the 30 year treasury. BP comes to mind at about a 7% dividend, and COP with approximately a 4% dividend. Whats the downside in that? I can get paid to wait, and have a built in hedge to inflation that will beat a TIP.

2008 Dec 16 02:59 AM