Latest from Coxe...
Since one of the major themes of the call this week was a review of the base metals story, I thought I should post this here as opposed to the Woodshed where it usually appears. I also thought that some people might appreciate an on topic post, just for a change of scenery. The base metal stocks have been ripping lately, Teck and First Quantum, to name two, are making new 52 week highs and nobody wants to discuss it. I find this highly encouraging.
Don Coxe
November 26, 2004
Chicago
stockcharts.com[w,a]daclyyay[pc50!c100][vc60][iub14!la12,26,9]&r=5727
Chart: BHP Billiton
Comment: “The Biggest of Them All Does a Big Stock Buyback But Doesn’t Put The Money Into The Ground”
Highlights
I'd like to begin by getting back to the base metals before reviewing the Dollar story, which is the focus of the current issue of Basic Points.
Base metal story remains a very big one. Focus on BHP because it is the biggest of all and is doing a massive stock buyback which is a way of giving the stockholders the money that you’re making. Signals that this industry is not going to do what it did in the past, commit itself to massive expansion when times were good.
Chip Goodyear runs BHP, came out of Standard Oil of NJ and grew up during the time that oil prices plunged in the 1980’s. What he learned from that is that commodities are very cyclical. He watched his father’s friends go into genteel poverty, early retirement or worse. A big lesson for him which has had a big influence on the way he manages things. Learned that things are cyclical.
So BHP has enormous gains in earnings and they do have some major capital projects but these were on the drawing board for a long time. They are NOT keeping the money in the treasury or just boosting the dividends, they are having a big buyback as a means of getting money out to stockholders quickly.
The lesson for investors is that the industry is still ruled by those who were so seared by the experiences of the 80’s and 90’s that they are not going to create oversupply. The best investment opportunities come from an asset class where those who know it best, love it least because they’ve been disappointed most.
Phelps Dodge got a big price today, over $100. Not bigger than BHP, but big. It has finally responded to rising copper prices. It was $60 in May. What this says is that the investing public also had the fear that any sign of increased capital spending was a sign to get out of the stocks. Mine re-openings announcements and capital expenditure increases were a signal to some investors to get out.
Always dangerous to say it is different this time but in the case of the base metals, I really believe it is different. The industry has completed a triple waterfall crash, we now have an industry where the price for the products is set byChinawith help from India. What we have there is that the addition of people to the middle class of the kind that consume metals will be on the order of 3-4 times as great over the next 20 years as what occurred after WWII which gave us the last big mining boom.
Much better fundamentals than ever before in terms of a long-term compounded rate of growth in demand for the product. But the market cap of the companies is still very, very modest and the companies are run by people who are battle-scarred and we have investors out there who have looked at the charts and the history of these stocks and have concluded that it is time to sell them now.
Takes a long time to bring on new capacity. Secondly, total world demand is continuing to rise.
Stories that are negative on China continue to proliferate. Amazing all the stories that say China is on the edge of collapse. Ever since China boom got underway what we’ve had is a new cottage industry of experts on China who tell us that China is about to collapse. Banking system is about to go bust, ships are backed up in the ports, government is raising rates – all to suggest that the whole country is going to go bust.
½ trillion of FOREX reserves and that is such a big difference with other third world economies that got into fast growth rates and got overextended and went bust with bad banking systems. Those countries had huge external debts denominated in Dollars.
This time,Chinahas very modest external debts, gigantic FOREX position, one of three largest central banks in the world. Challenge is to keep the currency value down!
When you look at what is driving demand for base metals, it comes from a growth that is very much within the growth rate that Deng Xiaopeng began. Because we were starting with such tiny numbers, it didn’t look big for a while. But now it’s gigantic so we have all these people saying it’s out of control and going to go bust. Can’t rule that out as a possibility but when you look at the low multiples on these stocks and look at the fact that for China to go bust they would have to disgorge themselves of these exchange reserves, which are in Dollars, what that would mean is driving the Dollar down hard, driving your gold holdings up.
Stories of a China collapse are proliferating again, but now the market is taking them in its stride. Inco is at 38 ¾. Base metal group now is looking much, much better. Still think that we’re talking about a tiny small capitalized group in relation to how important it is to the Asian story and the global economy story.
I just don’t see how China can go bust given their enormous exchange reserves and given the built-in advantages that they have, which is, that all they have to do is raise the value of their currency. If they do that, they get all the money to do all the bailing out they need to do.
China has lots of problems, no doubt, but not of the kind that should steer you away from these base metal stocks. The BHP buyback instead of a big capital spending program shows that the big miners are not getting carried away.
It is questionable whether Chinese acquisition of Noranda will go through, but that deal was priced too low. Chinese acquisitions of resources will become the norm rather than the exception.
Next Stage of the Dollar’s Devaluation
I’m a little worried about this because when I started it wasn’t even a Page 16 story and now it’s a Page 1 story. [Don’s Rule of Page 16: You neither make nor lose serious money on a story that’s on Page 1, you make or lose serious money on a story that’s on Page 16 that’s on its way to Page 1] People who were least interested before in what was happening with the Dollar now realize that there is a problem and it’s a Page 1 story now. Does this mean that the move in gold stocks is over for now?
The Rule is a guideline rule. A story can stay on Page 1 for some time. Subtext: Providing the basic story was something truly huge was going to go on and that therefore even if it did get on the front page then as long as the front page story wasn’t the original one, predicting where it was going to go, you still had room.
In case you think I’m weaseling out of this, we spent four years – those of you who have been loyal to these calls and have read Basic Points – believing that oil prices were going to go way up and that the experts had it all wrong. What we found is that the oil stocks didn’t start to make their move until oil had already made an enormous move and was getting on to Page 1 because there was such a perception gap out there. The perception gap was the shared belief of the oil companies and The Street, that oil prices were about to collapse.
So you had the oil companies massively selling forward in their futures operations to take advantage of what they thought were gigantic prices for oil. “Wow! $34, we gotta sell our production forward”. And their investment bankers were in some cases making it an absolute legal requirement for getting financing that the oil companies lock in these “absurdly high” prices for oil.
So what we had then was a delayed reaction, a perception lag, that even though the story was there, the story was still in the process of unfolding. The oil stocks have been in a race to catch up with their earnings potential because the prices of the commodities have kept running faster and faster ahead. So here we are with oil at 49.44 and some of these stocks are still coming to new highs.
So, although the story is on Page 1, the story is on Page 1 of the commodity itself, the story as to people’s willingness to assign a valuation to the oil companies, for prices even of $35, $36 – that hasn’t happened yet.
So that’s my way of saying then, what’s going on with the Dollar is still the early stages because although people are talking about what’s going to happen to the Dollar, the kinds of numbers that I’ve been using, 1.60 on the Euro and par on the Canadian Dollar, these kinds of numbers, there’s certainly nothing like a consensus emerging on that although there is more discussion on it.
In terms of the gold stocks, which I suggest is the way you play this, no, no, we’ve got a huge perception lag. The gold stocks aren’t back up to where they were in December of last year, as a group. And so, you can recall that I went neutral on the golds early in this year because what we had was a situation of enormous enthusiasm at that stage and we had big, big gatherings where the goldbug investment letters were speaking to huge crowds, a sure sign of a mania, a small mania at least, the kind that scared me off because I had actually attended one of these and that gave me the feeling that no, I didn’t want to be recommending these stocks, compared to the other commodity groups.
What’s fascinating now is that although the Dollar is going to levels that a lot of people thought it couldn’t have gotten to, what we don’t have is anything like a mania for the stocks. They’re up substantially and they’re one of the best performing groups in the market over the last six months but they aren’t up anywhere near as much as the bullion.
Now, people will say, “Ah yeah, but the stocks lead the bullion, so what the stocks are telling you by their somewhat insipid performance compared to the bullion is the bullion’s move isn’t for real and gold is going to fall”.
I grant you that where we’ve big moves in gold that are not correlated to big moves in the Dollar itself that that guideline, that slogan, that mantra worked, pretty well. That the stock moved before the bullion. Well now we’ve got gold trading at pretty lusty levels. It’s no longer the figure of $500 that we’ve used as a target, no longer looks unreachable. And this is with the Dollar Index at 81.90. Now that’s quite a move this year. The Dollar Index was 92 back in May and we’ve broken 82 now.
What’s happening to the Dollar is far more dramatic than what the gold stocks have shown and therefore there’s a perception lag, and I think I’ve got an explanation for it.
It is, that the true goldbugs still regard gold as a hedge against runaway inflation. And we got the commodity inflation alright, but we didn’t get the pass-through into runaway inflation. And when you look at the money supply growth numbers for the advanced industrial world, they aren’t of the kind that would suggest that we’re going to have runaway inflation, which would make $500 gold inevitable because you’d be looking at 6 or 7% inflation. So the idea that you could have gold going up simply because it’s trading inversely to the Dollar without triggering inflation is very tough for goldbugs. Because you’ve got the two things that they say would produce inflation, namely, soaring commodity prices and a falling Dollar.
I still believe that what’s happening is that commodity prices are going up and we’re simply redistributing the growth and income from secondary producers and service industries to primary producers, but we are not adding hugely to the inflation situation in the world.
Therefore my argument is that the gold stocks are still the place you should be focusing while staying with the other commodity groups, that there still is a lack of widespread understanding in there about why you want to own them. Not because of inflation or growth in money supply but because of the devaluation of the Dollar.
The Dollar devaluation is the undoing of a bubble and is a process of returning to normalcy.
Gold stocks are still cheap.
--
Don Coxe Profile from the BMO websites:
Donald G. M. Coxe is Chairman and Chief Strategist of Harris Investment Management, and Chairman of Jones Heward Investments. Mr. Coxe has 27 years experience in institutional investing, including a decade as CEO of a Canadian investment counseling firm and six years on Wall Street as a 'sell-side' portfolio strategist advising institutional investors. In addition, Mr. Coxe has experience with pension fund planning, including liability analysis, and tactical asset allocation. His educational background includes an undergraduate degree from theUniversityofTorontoand a law degree from OsgoodeHallLawSchool. Don joined Harris in September, 1993.
Don Coxe Weekly Conference Call – Current
jonesheward.com
Basic Points – Archive
Basic Points is a monthly publication of opinions, estimates and projections prepared by Don Coxe of Harris Investment Management, Inc. (HIM) and BMO Harris Investment Management Inc.:
harrisnesbitt.com
|
