Distinction Between Hard and Soft Assets

There have been numerous recent articles talking about inflation. Investors have finally noticed that over the past year or so certain commodities have risen at a faster clip than others. In general, specific sectors benefited from this inflationary spiral where there have been few exceptions pertaining to specific companies within the sector.

Metals and mining has been the sector to be in for the past six months as predicted in 'Mining is Shining' and here (take special notice of the comments posted on the Seeking Alpha article). It would be true to say that energy has done relatively well as well, however, the whole trick is to find the lead sector that is poised for the largest increase. Keep in mind that when prices rise not all sectors benefit from the inflationary spiral. The difference is between 'hard' and 'soft' assets.

Hard assets are those that are the basic inputs early on in the economic chain. For example, coal and iron ore are hard assets. The inflationary inputs associated with the cost of mining coal are of low value in relation to the final selling price of the product. Oil and natural gas, in most cases, would be considered hard assets as well. Assets become 'softer' as they proceed down the economic chain. The further away from the source, the harder it becomes to translate the inflationary process into a profit. There is a hieratical natural sequence of events; has always happened throughout all previous cycles and is repeating today. Only towards the end of the cycle does 'softer' assets play catch up.

It is still too early for the next step or phase to fully benefit from the cycle. The next in line to benefit from coal and iron pellet inflation would be steel. Currently, profits won't keep pace with the input costs though their time will come soon enough. Though it may be a bit premature to start riding the next leg up of this inflationary wave and there might even be some better entry points ahead, it is still time to consider building a position in the steel makers. Materials and construction as a sector needs to be carefully dissected for the next wave. Manufacturing in general has been bid up for the most part and may present better entry points in the near future. We are not the only analysts who see this coming so some companies such as U.S. Steel Corp (X) may have gotten a bit ahead of themselves.

Pundits will attempt to discourage you touting the recession and the likes; in the end of the day, these companies will benefit enormously from the cycle. As an investor, both revenues and profits will continue to increase if for no other reason than higher prices. When looking at a P&L statement, there is no mention as to how many tons were produced or sold. In other words, if last year 10 units were sold for 100 yielding a profit of 15, the following year - due to 'the recession' - only 8 units were sold at 140 yielding a profit of 25. Total units can come down while revenue and profits continue to soar in dollar terms. This means that even non export oriented companies should benefit. Companies that export as well, well they should benefit doubly so. Just to spell out the pun, we are looking for a double for a number of companies, over the next twelve months.

By sector, amongst the companies to keep on your radar are as follows:

Metals & Mining:

• Alcoa Inc (AA)
• Allegheny Technologies (ATI)
• Peabody Energy (BTU)
• Cleveland-Cliffs Inc (CLF)
• Consol Energy Inc (CNX)
• Freeport Mcmoran (FX)
• Mechel Steel Group (MTL)

See latest comment on SA article above as it applies to MTL as well. Also see original MTL article here.

• Newmont Mining Corp (NEM)
• Nucor Corp (NUE)

For a more complete alphabetical listing of the Metals & Mining sector, see here.

For a comprehensive list of the Materials & Construction sector, see here. (As above, list is sorted by letter.)

For a comprehensive list for the Manufacturing sector, see here.

Disclosure: Clients and associates are long a number of above mentioned stocks.

Caution: Sectors are general in accordance with Hemscott classification and need further filtering.

Comments

[Marol:]

A suggestion. I almost missed this article as I assumed "soft" assets were food, etc. Maybe a more descriptive title for those of us who are not in the know.

2008 Apr 28 07:29 PM

[Greg Pinelli:]

The inflationary inputs at the early stages .."hard"....are low...so are you saying that the return on inputs there is high?? You might have a very hrd time convincing an oil/gas major paying $400K a day for an offshore platform his inflationary input is low..but what the hell...All you're doing is writing a semi-literate (generous..not hard) article that's main objective is selling your newsletter..which must be a real treat!

2008 Apr 28 09:31 PM

[kotika98:]

blah....blah...blah...... coal and oil are hard assets, but MTL, BTU, XOM and all the others are paper assets by definition!

2008 Apr 28 11:39 PM

[investorslive:]

BTU big correction, thoughts about a long?

www.investorslive.com/.../

2008 Apr 30 09:04 AM

[CrossProfit:]

Marol,

Suggestion noted, thank you.
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Georealsit,

1) The increase from 80K to 270k or from 130/170k to 300/400k for rig/platforms would be meaningful for platforms producing 25,000 bpd or less. For platforms producing 40,000 bpd or more the increase from $55 per barrel to $110 per barrel more than covers the difference.

As stated accurately above "Oil and natural gas, in most cases, would be considered hard assets as well"; emphasis on 'most cases'. The majority of (actually all) platforms in the $400k range produce 40,000 bpd or more.

2) What newsletter are you referring to? The CrossProfit site is free without advertisements as well.
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InvestorsLive.com,

Nice site. BTU is a long term long in our opinion.
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kotika,

From our understanding of your comment, you seem to miss the point of the article. Perhaps you would like to expound a bit.

CrossProfit

2008 Apr 30 03:30 PM

[sunrises:]

Hi CrossProfit:

what is your opinion of MTL today?

2008 May 21 01:49 AM