It seems the world is betting on the reemergence of growth. Stock prices are rising in response to reports of higher-than-expected earnings in the manufacturing and construction industries.
However, this good news does nothing to change our long-term expectations that the market will remain in a trading range. While we can't pick a precise upside limit, we can say with confidence that stocks will not enter a full-fledged bull market. Commodity prices, which will rise along with growth, will act as a major tax on the American consumer and put the brakes on the market.
On the other hand, a bear market seems equally unlikely. A real tumble in stock prices would be a clear sign that the economy is also faltering. That would prompt the Fed to launch another huge round of monetary easing which would stop the losses.
While this trading range continues, one of the best places to make money is in commodities. So let's look at the contrasting fortunes of oil and copper. Though oil will be no slouch, it is copper that should steal the long-term spotlight. Still, oil is the giant in the commodity patch so we will start there.
To quote a friend of mine, oil is a macro-commodity. At today's price of more than $80 a barrel, the world consumes roughly $2.5 trillion worth of oil each year – a huge expenditure by any measure. With so much money involved, players naturally must consider how high oil prices could rise.
Since even the Saudis have said that they are cutting back on exploration in order to save what they have left for future generations of Saudis, it seems pretty clear that oil will remain scarce from now on, so prices will be driven largely by demand. And with the developing world continuing to grow like topsy, new highs in oil would seem to be a given. But not so fast.
Even if the U.S. economy does pick up, unemployment will remain much higher than in the past. It would be bad enough to pay $4-5 a gallon for gasoline in a country with 5% unemployment. It's far worse to pay those prices with nearly 10% unemployment and far fewer quality jobs. The more people there are out of work, the faster rising oil prices will cut short economic activity.
In 2008, oil at $140 was a massive tax that the Fed did not try to offset with monetary stimulation. They figured that to stimulate with inflation already approaching 5 percent would risk much higher inflation – and, who knows, even hyperinflation. High oil prices, remember, are the worst of all possible worlds – they are both a massive tax and a potential catalyst for inflation. The steepest downturn in the West since the Depression led to a massive fall in commodities. (But worth noting is that even oil at $30 was still three times higher than its low near $10 in 1998.)
Over time, the developing world has come to account for a larger and larger slice of the global economic pie. Plus, the developing world – and especially China - is growing much faster than the West. Therefore, it takes an ever bigger downturn in the U.S. to reduce global oil demand.
We can't tell you how high oil prices will climb over the next few years. Certainly, we expect a return to triple digits. On the other hand, median incomes have fallen so much (due in part to already high commodity prices and unemployment) that $150 oil would be too great a burden for consumers to bear. A massive U.S. downturn could happen well before reaching those heights again and indeed force the Fed to choose between Depression and surging inflation. We are not going to handicap that outcome right now, but instead want to turn to copper.
No one pays enough attention to copper because it has never been a macro-commodity like oil. At least not yet.
The amount of money spent on copper each year has been an insignificant percent of gross world product. Only about $100 billion were spent on copper in 2009 – about 4% of what was spent on oil.
Of course, if copper prices were to climb ten-fold, the situation would be different. Then, $100 billion would become $1 trillion and the world would start noticing copper in a big way.
We're not predicting copper prices will rise that high, but we should point out that copper has dramatically outperformed oil of late. Oil remains well below its 2008 high of $140, whereas copper prices (currently around $3.40 a pound) are within striking distance of the level they hit in 2008 (around $4). Copper has also staged a much bigger rebound off its lows than oil.
Longer-term, copper has been a sensational performer. It sold for just 60 cents a pound in 2001, which makes today's price more than 5X higher. Oil, on the other hand, has risen just four-fold from $20 to $80.
We fully expect that copper will attract more attention from now on. Within 5-10 years, it could become the new macro-commodity, as it starts to account for a noticeable percentage of the gross world product. We should point out that the growing scarcity in copper is much more severe than with oil (as measured by the annual consumption versus known reserves).
For instance, copper is essential if the world is to segue from oil into renewable energies. Smart grids require massive amounts of the red metal. China alone will need $300 billion worth of copper for its smart grid – an amount equal to 10% of all the world's remaining copper deposits. And that's just one application for one country!
The manufacturing of hybrid cars also requires copper, since these vehicles contain twice the amount of copper as gasoline-powered ones – mostly because of the batteries.
And, of course, the process of building cities to house hundreds of millions of people in developing nations is creating a huge demand for copper, which is used in plumbing and wiring.
We could go on, but the point is made. Scarcity of copper will push prices much higher down the road. But even $10 copper will not make big headlines in that copper would still be a relatively small part of the world economic product. The world must tackle the problem of copper shortages before it reaches the point where it too starts to short circuit economic activity. Unfortunately the record on anticipating events is dismal.
In the last year and a half, we have seen copper prices double, and we think you should invest in it before it triples.
We don't see a lot of great copper plays around. BHP Billiton (NYSE:BHP) is the obvious core holding for copper as well as other commodities. However, the issue of how much Australia will tax companies like BHP is still up in the air.
If we had to pick one copper stock at the moment, we would choose Southern Copper (NYSE:SCCO). This well-positioned company has operations in both Peru and Mexico. The company also mines zinc and silver (two other critical metals), as well as gold, but its major product is copper.
Of course, we can't overlook Freeport McMoRan (NYSE:FCX), the world's largest copper producer, which is currently trading at less than 10X earnings.
The only thing you need to be careful of is the fact that all commodities are volatile, no matter how scarce or valuable. Price corrections are inevitable. In 2008, for instance, copper fell from $4 down to $1.50. We expect copper to set new highs before oil does, however. Remember the old adage about buying dips and selling rallies. However, the volatility is a fair trade-off considering commodities are the only sure-fire way to make huge long-term profits over the next 10 years.