Not all Metals are Created Equal (Part I)

Oftentimes I talk to investors, even sophisticated ones, and I realize that they treat metals as a group. Particularly in the subset of base metals, most point out the price action of copper and conclude that all base metals are in a raging bull with no signs of slowing down.

Close examination of correlation between various metal prices reveals a very different story, as we shall illustrate. (most charts here are from my friends at Kitco.com)

Phases of a market:

There is nothing new in Wall Street. There can't be because speculation is as old as the hills. Whatever happens in the stock market today has happened before and will happen again. (Jesse Livermore, Reminiscences of a stock operator)

Each market invariably goes through different phases of a bull. Starting with bottom, accumulation, rise, mania, rolling over, crash, sucker's rallies, and then it starts all over again. People can attribute various reasons along the way for the rise and crash. The fact is price patterns are repetitive and can be observed time and again. Let's start with oil:

Mania

Does oil seem stretched and entering a short term mania phase? Yes. I wouldn't go short, but I would certainly put a tight stop if I were long.

Rolling over

Copper seems to be rolling over and unable to convincingly overcome the $4 level. $200 oil (possible, but not too probable in my opinion) could propel copper past the $4 level. Conversely, a correction in oil could break copper back to $3 in a hurry.

Crash

Lead staged a spectacular crash in early 08 as prices went from $1.80 to now 80 cents in under 6 months.

Sucker's Rally

Nickel resembled Lead, except the peak was established in mid-07 instead of early 08. Since the $23 peak, Nickel has staged several sucker's rallies and seemed to be settling down at the $10 level.

Bottom-Accumulate

Zinc peaked ahead of Nickel at over $2 in late 2006. Since then many have lost their shirts calling for Zinc's bottom. Given Zinc peaked ahead of lead and nickel, it will likely be on recovery mode faster with less risk of downside from here.

Accumulate - Rise

Gold has been on a steady rise since the bull began in 2001. Throughout the bull it has stayed above 200 day moving averages and yet it exhibits parabolic action, as oil did; consequently, the chart suggests the blow-off phase for gold is yet to come.

Fundamentally, while gold is not as cheap as zinc when measured in oil, nonetheless, based on historic relationship, a $130 oil calls for a gold price that is substantially higher than today's $900/oz.

The ratio of Gold to Oil from 2006 to present (sitting at 6 currently). The chart is showing an extreme bargain of gold relative to oil. If the ratio were to restore to the peak in 1999 of 26, today's $130 oil price will equate to a gold price of $3380/oz.

Here is a chart of where I see various metals markets are:

Correlations between Price and Inventory Unclear

Some accuse me of being overly technically oriented and ignorant of fundamentals. Fine, there are some that attribute base metal price action to inventory levels. If such a relationship is held true, zinc should not be trading at roughly 1/3 of its 2007 high of $2.2/lb, because the difference of inventory levels between now and then is negligible by historical standards. In fact, inventory levels have never been a good forecast for future metal prices.

Buy Low - Sell High
To borrow the overused Buffett line, "buy low, and sell high". This is particularly applicable in commodity investment since metals such as zinc will never be made obsolete in my lifetime. Against rapid currency debasement and $4 trillion held at central banks of emerging-growth countries around the world, my view is:

• Oil and Copper - risky investment
• Gold and Silver - Good value and entering a blow off phase.
• Zinc, lead, and nickel - Current prices will prove to be extreme bargain (particularly zinc at 80 cents) looking back 2-3 years from now.

Metals investment was the focus of my workshop at the Cambridge House Investment Conference in Vancouver (June 15-16). For those interested, the write-up of the conference and my workshop presentation can be accessed here.

In part II, we shall examine how various resource equities (energy, base metals, precious metals) fared against the respective underlying commodities. Stay tuned!

Comments

[Georealist]

I have a problem with large parts of your analysis...and the conclusions...
1. Oil has not been a "mania." The South Sea Bubble..Tulip's in Holland....even money losing technology stocks of the late nineties and early 2000's might be termed manias. Look at the chart for oil and gold...corrections operating very nicely within the Bollinger Bands...neither with a parabolic rise...and considering oils basic fundamental use structure and monopoly over certain forms of critical energy I'd hardly put it in the class of tulips.
2. A distinction needs to be made between oil/nat gas and oil/nat gas equities..We could well see avery startling divergence between the two...There is NOTHING governments can do to apidly increase the immediate supply of the physical product..yet there is everything they can do to ruin companies that produce and service the industry.

[ozzy43]

This analysis seems to rely on the fundamental assumption that peak oil is a non-event. That is, it relies upon the presumption that we're not entering a completely new paradigm as regards global energy supplies. Perhaps this is accurate. But if the peakers are right - and I think an analysis which draws this conclusion is at the least plausible - then all of this analysis rests on flawed assumptions about the future state of the markets, and indeed the world.

[Engineer]

I agree with geo and ozzy. Also note the 'y-axis' in all the graphs above. These graphs show value relative to the $US. What has the $US done over the same time period???? A large part of the so-called 'bubble' in commodities has been illusionary - it is merely that the unit of value they are measured in has become diluted.

[James V]

I like the gold/oil ratio chart, this was quite good.
I will be quite interested to see how the markets pan out going forward.

However I think Copper is actually getting ready for its next move up and is just testing dynamic breakout line.

I personally think that the dollar is going to get smashed so I expect a lot of commodities priced in dollars to go up.