I jotted down some notes from the Don Coxe call this week, thought it might be of interest:
Don Coxe
November 28, 2003
Chicago
Charts: BHP Billiton, Rio Tinto [should have included Alcan]
Comment: “The Big Cap Boys Get Bigger”
I want to talk about what could be the next stage of activity within the mining stocks.
Today is a significant day in market history because USD index today for the first time broke through the level that it had back in the currency crisis related to the Long Term Capital collapse in 1998. that was the beginning of what was going to be the huge refloating of NASDAQ which lead to the triple waterfall. So I didn’t plan the time of the call to be so perfect for this but we actually broke through 1.20 on the Euro and seventy-seven cents on the Canadian dollar overnight.
Notwithstanding all the other reasons why we might have dollar strength what we see is this pattern of dollar weakness unfolding. Here in the US, we were told the dollar would be strong as long as the US economy was stronger than other economies. So we get 8.2% GDP growth in the 3rd quarter, corporate profits up 30%, we get blowout numbers like the Chicago PMI, durable goods, far ahead what’s being done around the world, outside China, and the dollar keeps breaking through to new lows.
The pattern of the dollar bear market is really well established. Think what might happen if we actually had a quarter where the US was growing at the same rate as the rest of the industrial world.
The Canadian dollar breaks through to a new high on a day that it announces roughly a 1% GDP gain – roughly 1/8 of the US, yet the Canadian dollar goes to a new high. So much for those who say you can explain currency activity on the basis of relative economic growth rates.
I really should have included Alcan in my chart because Alcan may surprise us in this cycle by being on the leading edge of what’s happens. The Pechiney takeover was well-timed and what they’ve done is made themselves an aluminum company on the scale of Alcoa.
What I’m thinking is likely to happen here is that - because of the enormous increase in value that’s occurring to the capitalization of the big mining companies - that once they become confident that this global economic recovery is really going to continue (and remember, mining company executives who are in their jobs are cautious indeed, having blundered in the past, having believed that economic recovery was going to last), when that happens though, then I think what you’re going to see is a real stage of mergers and buyouts and bids for small companies and then mergers with big companies because it’s not clear that any of these companies really are in a position to control any of the metal markets.
Now if Inco were to merge with Falconbridge or to buy out Norilsk that would be different, but I don’t think those are likely.
But when you look at, for example, just to name a stock, Noranda, the current holders may have somewhat different ambitions, you wonder if at some stage something might happen there. I’m not speaking from internal knowledge at all, I’m simply saying that this is one of the stigmata by which you judge a new phase of faith that occurs in a market cycle.
We will start to know whether we are nearing the end of Movement One of this sonata form that I talk about, when we have a couple of big takeovers. The Pechiney was the first one but I think that there will probably be a couple of others and that will be a sign of confidence but it will also be a recognition that just going out and building, or exploring and developing themselves isn’t going to meet any of the demand between the years 2005 and 2010.
If you project forward anything like the current rate of global economic growth, what this means is TREMENDOUS shortages on a sustained basis and then we’re talking about cash flows that are potentially enormous.
I realize of course that all of this is contingent upon the continuation of the global economic recovery. Nobody thinks we are going to have sustained 8% growth in the US. That was due to a lot of special factors in the 3rd qtr, most particularly the tax refunds and the effect of all the mortgage refi that was done when interest rates were at 40 year lows and also to a big pickup in Pentagon spending.
But having said that, what we’re starting to see in this country is improvements in a lot of the other economic indicators. But as I say for metals, what this country does isn’t really important anyway. What really matters is what happens in Germany, Japan and China and India.
And so I really think that the evidence that things are going to get better there is important and I would argue that the breakdown of the Mastricht treaty this week, where France and Germany said that the growth and stability pact really doesn’t apply to them is a huge development. You may say that this has been signaled, they’ve been violating it for a couple of years anyway. What they’ve basically said is “The law that we wrote doesn’t apply to us, just other people, other countries.”
That’s good for the price of gold because it signifies is that this recovery is not going to be choked off by old style economic Puritanism and there is still a huge constituency out there that believes that deficits cause inflation. I’m still of the view that deficits only cause inflation if Central banks choose to print money to monetize the debt. But we’ll let that pass because monetarism is now out of favor. What’s clear is that what you’re going to have is faster economic growth in Germany and France and Italy then we would have if they were constrained to 3% government deficits.
Now in Japan, yeah, you get good news followed by bad news but the fact remains that the evidence is that the banking system is in the best shape it’s been in, in some time. Not that the banking system deserves anything more than junk bond status, but there certainly are signs of life there.
Meanwhile, we’ve got the meeting coming shortly between the Chinese Premier and Bush. Bush has behaved strangely in provoking China with two tiny pinpricks of attack on brassieres and on TV sets. And so, not clear what’s the background to that except he’s probably trying to undercut the Democrats as they head into those two key primaries which are coming up next month, the Iowa caucuses and New Hampshire.
I might comment that that is the theme of the issue of Basic Points which goes to press this afternoon. Not that I like to burden you with politics but I think it is time to do at least one issue of Basic Points on the question of the forthcoming Presidential elections and whether it matters to investors how they turn out.
My view is that yes it does matter if only because the Democrats have during their lead up to this turned so wildly protectionist. So far away from Bill Clinton as to say that they’re not members of the same universe, let alone the same party. So, Bush’s little bits of protectionism are nothing compared to what the Democratic candidates are proposing, so I think yes it does matter. And since they’re united in saying they’d roll back the tax cuts, then yeah, that’s also important too. Because this US economic recovery would stall out in a hurry if there were a huge tax increase.
Whether you like Bush or love him or hate him, as an investor, given what are the stated policy planks for the candidates, it becomes a matter of significance to investors who wins the election. In particular, if Governor Dean wins, given that he’s supported by the ultra left in the party, that would send out quite a signal. I think you’d be looking at gold far above $500 in the event of something like that unfolding, which I‘m certainly not predicting.
Now, let’s get back to the base metals then and the assumption that one way or another we’re going to have an expansion of global trade and the global economic recovery will continue. We’re faced with the fact, still, that the total market capitalization of all the mining companies is still so tiny relative to their importance in the global economy and to the way they operate as a measuring stick for inflationary pressures and indeed demand pressures in the global economy.
So assuming that we’re going to, in this cycle, go to new high prices for most of the base metals, then what we’re talking about is the upside potential for these stocks is still enormous. And it makes sense therefore, for managements who accept this viewpoint, that that’s what’s unfolding to try to acquire another company now, rather than waiting. The price can only go up.
This is of course also true within the gold industry. Not that there’s that many well-developed small gold properties and gold mines around. When you look at the price of the exploration gold companies, what you can see is that investors are putting in a big bet in them that these companies are going to be the subjects of bidding. I can’t predict which ones will go and which ones won’t, but I think that a portfolio taking a basket approach within both the base metals and the golds, between the bigs and the smalls is going to work out very, very well over the next 12 to 18 months.
It now looks as if the global economy has such a wind at its back that it’s going to go on for some time.
We also have the phenomenon that within the energy field, that these stocks still are trading at incredibly low multiples. In fact, I think I cannot recall a time when oil stocks have traded at such a discount to the S&P. There may have been other times but I don’t remember it. That is on earnings.
You’ve got stocks like Encana trading at single digit multiples. Well, this is the 8th straight quarter where Wall Street expected a collapse in oil prices and it didn’t happen. So at some time, maybe we’re going to get some kind of pullback but if you notice the statistic that China accounts for 1/3 of the total increase in demand for oil this year in the world, what you see is that regardless of what the politics of OPEC might be, or regardless of how much they manage to get out of Iraq, that what you’ve got is a lot of demand out there as against available supply. And so we’re still in a position that if something really goes wrong we’re looking at enormous prices.
Now, I’m not predicting a collapse of Saudi Arabia or any of those other things. But, what I am saying is that when you can buy the shares of the companies that are really eminent in producing what is the preeminent commodity - that’s a good investment. And we still have the phenomenon that a handful of the listed oil companies produced more earnings, gains, that is, more dollars growth in earnings year after year, than all of the technology companies put together. And yet the tech stocks are up 40%.
So, the market greets with ululations of joy, any evidence of improvement in tech earnings and not only yawns but scowls at growth in earnings for the oil companies. So what I’m suggesting in Basic Points is for investors, that those who want to invest in earnings should buy the oil and gas stocks. Those who want to invest in hope and hype should buy tech stocks and in the near term, we’re probably going to do well on both.
At some point there will be a divergence here, but clearly talking about the wind at their back, the wind from these shills and mountebanks at the moment turns out to be bigger than the wind from profits. There’s no sign that NASDAQ is going to roll over and start going back to where it was at the time the Dollar index was where it is today.
What does this continued breakdown in the dollar imply? It’s going to cause even more problems for global investors investing in US stocks and in particular it’s going to be causing more concern for Canadian investors and I’m certainly getting lots of calls about this. They’re saying “Gee I’ve got this big exposure in US stocks and do you really think the Canadian dollar is going to stay above seventy-five cents? Answer: yes. How high could it go? Well, let’s take eighty-five as a target. What does that do? What do you need in profits on your US stocks if you’re a Canadian, to make money?
Back in the 90s what you could do as a Canadian retail investor or institutional investor in balanced funds was buy lots of US stocks. Even if you underperformed the S&P, what you delivered was great returns in Canadian dollar terms. Now it’s the reverse. What you’ve got to do is get spectacular returns relative to the S&P to deliver great returns to Canadian investors. I regard this as a trend that’s so clearly established and you’ve got to allow here, for the fact that in quarters going forward the relative economic growth rates in Canada and the US are going to be closer to each other.
Against that there’s the argument that so many Canadian industries are going to be in serious trouble because of the higher dollar. First of all, there’s a lag effect on that. Secondly, I’ll go back to it, that global investors buy assets denominated in strong currencies in preference to buying assets denominated in weak currencies.
I don’t think you should assume that even the Canadian resource industries – and I gather that the economist at one of our competitive organizations in Canada was warning people against investing in Canadian resource stocks – I disagree, strongly. I believe that global investors will want to acquire assets denominated in Canadian dollars just as they continue to do with the Canadian banks and I look at my own favorite bank stock which obviously I have a personal interest in and see how it keeps touching new highs at least in US dollar terms. For an American investor, I come back to it, 15% tax rate on dividends, you’re getting dividends in a currency that keeps going up in value. That’s a good deal.
Before we get to the questions, I’d like to just touch on one other issue which people keep raising with me, which is how can you feel so confident given that terrorism is still out there and there’s still a chance for some major terrorist attack that could product the kind of sell-off we had with 9/11?
My answer to that remains the same. First of all, the United States is now much, much harder to attack than it was. Yes, people keep coming up with evidence that people have been able to smuggle paper cutters into airplanes and so forth but it’s no longer as easy as it was and you’ve got that luck on your side. It’s a harder target.
It’s significant that the terrorist attacks that we’ve had in the last 18 months have been outside the US, not in. We keep getting warning of a massive Al Qaeda attack which is going to be aimed at destroying US communications and all these things and maybe they’ll find a way of doing it.
Gosh knows if a Filipino hacker can disable a large part of the world’s computer systems with an I Love You type message then maybe these people will be able to do that. But I don’t believe that it will be enough to derail the recovery unless it’s something of the scale of 9/11 itself.
What we’re seeing more and more of is that these attacks seem to be by small fringe groups either affiliated with Al Qaeda or small cells that are able to attack a synagogue or blow up something here or kill somebody there…nothing of the sheer audacity, scale and brilliance of organization that we saw with 9/11. I think that this is one thing you’ve got to give Bush credit for, even those that want to attack him as being the worst thing since Darth Vader, that it is tougher for them.
So I take the view that you should be optimistic here and assume that next year the total global economy will be stronger than today.
I notice that the Brazilian stock market went to a 36-year high yesterday and Brazil is the 2nd or 3rd biggest of the developing world stock markets and economies – so the pattern is there.
Emerging markets continue to do well. Resource stocks continue to do well. Dividend paying stocks continue to do well. And tech stocks continue to do well. Obviously I think that one member of that group is gradually going to be dropped from the winner’s list but it hasn’t happened yet and it’s not going to happen between now and year end.
The next thing I would expect is that what we will see is some kind of buyouts or mergers which will mean that the total valuation of the stocks remaining in the group will rise as people assess what strategic buyers should pay for them. That’s it, any questions? |
