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Nesbitt Burns Institutional Client Conference Call for March 11, 2005
Don Coxe
Chicago
“Big Metal Finally Thinks Big Cycle”
Charts: BHP Billiton and Noranda
Good afternoon and welcome to the conference call which comes to you from Chicago. The topic today was faxed out to you on the charts of BHP Billiton and Noranda.
To us, this is a historic week and I want to talk about that, two historical events.
First of all, the title of this is “Big Metal Finally Thinks Big Cycle”, so I regard the two major corporate announcements of this week, BHP Billiton’s purchase of WMC and Noranda’s deal on Falconbridge as opposed to Minmetals, what I really find significant is that both of those deals by companies who had announced previously for years the exact opposite policy, they both said it was a long cycle now based on China.
That’s big, big-time news, because having recently talked to about a total of thirty investment managers, this is personally, in their office, in Toronto and in Manhattan, what I see is that there’s a big feeling out there that “Yeah, it’s nice to have made all this money off these stocks, but they’re at the top for their cycle and this game is just about over.”
Well, you recall that last week I took strong issue with this viewpoint, I did not expect to have confirmation of my viewpoint from Chip Goodyear and Derek Pannell of Noranda. So let’s go through the significance of the BHP one first, which to me is truly gigantic.
You know, you’ve been hearing so much from me about Chip Goodyear over the years and about BHP Billiton, but since obviously the roster of attendees on the call changes week to week, let me review it.
Chip Goodyear has been in the mining industry since he went first to Lonmin and then now to BHP Billiton, which is itself a merger between the old Broken Hill Proprietary and Billiton, and he grew up in Houston during the oil crash. He watched his father’s friends either commit suicide or go into genteel poverty of early retirement. He made a vow, that first of all he didn’t want to go into the oil business, but secondly that going into a commodity business he wasn’t going to be in any production facility that couldn’t make money at the worst price that commodity had seen in at least a decade. Because he said “It’s a short cycle business. Prices always regress.” That policy has meant that he’s been a seller at both Lonmin and at BHP. Not a buyer.
He develops his own high grade properties – and he’s got a huge portfolio of them – but he does not go out and buy other companies and the properties he develops are very high grade indeed and they’re profitable even at very low prices for the metals.
Now he goes out and buys WMC, scooping Xstrata. And this was really a shock, because this is uncharacteristic behavior. And he announced, this time it’s because of China, it’s a long cycle. Then, the next day, when we had taken it as a matter of course that the only options Brascan had on the table were to sell Noranda to Minmetals or just to look for a bigger price, they take it off the table and put together this merger between Noranda and Falconbridge. I applaud the management for doing that, I believe that selling Noranda now would have been a huge mistake. And so I’m pleased about that, but once again, they justify it on the basis of a long cycle.
Now this again is huge because that holding of Brascan’s in Noranda dates back to _____(?) in 1982 when Jack Cockwell had it in the portfolio for Peter Bronfman and I know all about that because I was with the brokerage firm that was involved in a lot of those transactions back in the ’80’s. They bought with the triple waterfall already starting to descend – they didn’t know that and I didn’t know that back then, it took me another 15 years to get that thesis in place – but now, they’re saying “Nope, we’re going to sit this one out. Our company is going to be worth more.”
And I am very pleased by the response in the marketplace to this. Noranda’s gone to a new high. But if we look across this week, across the big metal companies, BHP Billiton, down about a buck from it’s all time high but after a huge price that they paid like that, I can understand the market pulling back a bit.
And then we look at Rio Tinto. Rio Tinto touched an all-time high this week. And Freeport McMoran has been rallying very strongly; it’s not at an all time high because they’ve had this huge cave-in problem at their property in Indonesia – and the stock had gone down to as low as twenty-nine bucks last year, so what it is, is a new recovery high for it and it’s within a couple of bucks of it’s all time high. And Inco is at, at least, a ten year high on my chart. Cleveland Cliffs Iron Ore…all time high. Phelps Dodge, at least a twelve year high.
I’m strongly of the view that when they write the history of this market that the historians are going to say that this week was the week when the serious investors got advice from the real experts of the industry that it is different this time. That it’s not a three year cycle. And that means that you value these companies based on reserves in the ground. That’s what they’re doing. That’s what they’re doing with WMC, that’s what Noranda’s doing with Falconbridge and I believe that’s what you on the call should be doing as you look to build up your own portfolios.
So this is one of those times when I just say “Gosh, it couldn’t have come at a better time.” Because once again, the China crash stories are proliferating. I thought that industry, which was a mushroom industry, had gone the way of mushrooms…but they’re back again. So I was having to deal with this, with people sending me stuff about the China crash theory again.
It was about this time last year that they were really developing a head of steam and so I’m thinking “Oh gosh are we going to go through another period of time in March, April and May when these stocks go down even while metal prices are holding up and even while their earnings are doing splendidly? Just because they convince the doubters that they better take their profits now before they evaporate?
For those of you who are skeptics on the call, and are thinking “Okay, I want to be able to make sure I show my partners that I managed to sell at an all-time high”, good luck to you because you got your chance to do it! Matter of fact, hang up the phone now and make your calls…so you don’t have to worry about sitting through the weekend. You’ll be able to say you sold at the top.
But there’s always the possibility that this is not the top and that the current supply/demand for these metals is so much in favor of the supply side and that it’s going to be so long before we’ve got substantial new resources coming onstream. So frankly, the best argument you’ve got on your side is another commodity: crude oil.
And at fifty four dollars and a half – by the way, this is one of these cases where the people who were saying we had a commodity top were in the position of saying both oil and the metals had reached a top at the same point, when in fact the best argument you’ve got, if you want an argument, for why the metals might be in trouble, is $55 oil, because so many of these emerging markets have pegged themselves to the Dollar, which means they’re getting creamed by high oil prices.
And so, no question also the US economy is going to be suffering somewhat from it. And the bond market has finally taken note of it. We got 4.53, we’ve broken through the 4.50 level on the 10-year Treasury note. What you can argue then, is for the first time, what we’ve got is the fears of commodity inflation actually being reflected in the valuation in the bond market.
And we got the Dollar going down, again, just after we were reassured that that rally in the foreign currencies against the Dollar last year, that’s all over. And we had all these congratulations being passed around from people at the Barron’s roundtable when one of their experts said he had gone long on the Dollar because there were all these fools like Warren Buffet who were shorting the Dollar and he was being congratulated because there was this rally in the Dollar.
Well, we’ve recouped that again.
So, put all this together and you’ve got a case that maybe we’re going to have a slowing economy, which would not be good for the base metals.
Let me reiterate then, the commodities story, which is that the reason you own these is because they are assets that through extended economic cycles are going to outperform most other assets. And that doesn’t mean that they always move up together or move down together. In fact, if oil goes through sixty bucks, that isn’t good for the price of copper or the price of nickel. I don’t know what the point is, frankly, on oil, where it does produce enough of a rise in interest rates and enough of a choking of demand that we get some pullback, modest perhaps, in copper, nickel, lead, zinc and aluminum.
If the only commodity stocks that you own are the Inco’s and the Phelps Dodge’s of this world, you’d like to see $30 oil. I don’t think you’ve got much chance of seeing that. So, at all times we’ve stressed that you need to have diversification in your portfolio. And the emphasis that I have does shift around week to week somewhat, partly on the stories out there, partly on my sense of where the best value are at any given point in time. And I’ve been emphasizing the mines lately, the base metals, because when you get these sialogic* P/E ratios like seven and a half on Phelps Dodge and ten on Inco, you say “Gosh, it’s time to really emphasize these stocks.”
What I discovered though in my meetings, particularly in Toronto, was people saying “Well, the whole commodity boom is bound to crash.” Instead of saying “Well, the oil may continue strong but that will produce a sell-off in the rest of them”, which is to me an easier case to make. Not that I want to make it, but I think it’s better.
My own feelings are that the falling Dollar is the key to these other things going on, because as the Dollar falls it has the effect of liquefying the global economy, providing it isn’t totally offset by big inflation. Let me explain the way it works.
First of all, emerging markets, a huge amount of their debt is denominated in Dollars. Secondly, in the corporate sphere worldwide, everybody has debt in Dollars because they have Eurodollar liabilities. Eurodollars are what they use to move their resources and inventories around the world. So therefore, when the Dollar falls, what it does is it’s good for debtors. Not good for those who hold Dollars, we don’t worry about them. What we worry about is the people that owe liabilities in Dollars.
So the fall of the Dollar has a stimulative effect on, shall we say, somewhat lower quality credit worldwide and the corporate sector to a significant extent worldwide. And therefore, what I’m saying then is, as long as the rise in the price of oil is to some extent at least being offset by a fall in the Dollar, then the global economy doesn’t have to slow down.
Now of course, the problems for the US economy and the Chinese economy, so that’s two of the big three, from rising oil prices – and particularly for the Chinese economy – is a different matter and we could devote a whole call to that, I don’t intend to spend time on it. All I’ll say is this, that if you have a diversified portfolio of mining and oil stocks, you are fully hedged. Whichever side wins, you’re in good shape, you’re not going to get killed on the other side.
Now this is the fifth anniversary of the top for NASDAQ, which came yesterday. And oh boy, it was fun partly because Wall Street barely observed it. I’ve been writing some notes for the red book and I said it was given about as much attention by Wall Street as Stalin gave to anniversaries of the birthday of Peter the Great.
Now actually Wall Street didn’t want to draw any attention to this because it was largely culpable for this. If Wall Street hadn’t been so stuffed to the armpits with shills and mountebanks, then the behavior of the shills and mountebanks of Silicon Valley wouldn’t have caused so much trouble.
And particularly since Wall Street still has roughly the same cast of characters. Amazing, you know! Amazing the forgiving nature of Wall Street! You can look at the people that were the worst ones, for pitching these stocks, five years ago, and they’ve still got good jobs and they’re still prominent.
So Wall Street is remarkable in the sense it’s shameless. Those people...not one of them should have a job. And there they are. And so you can understand why Wall Street did not choose to draw attention to this fifth anniversary.
Now I’m going to draw more attention to it, of course, in the next issue of Basic Points. Not under the heading of triumphalism, but I don’t want this to go down the memory hole in some Orwellian formulation, where the financial community just sort of acts as if it didn’t happen at all. I still regard NASDAQ’s current level as absurdly overpriced, but in case there’s anybody on this call who thinks that we have some kind of new mania in the commodity stocks to compare what we had to the tech stocks, look what happened this week in the amount of coverage that was given up to and after Intel’s pre-announcement about what it’s activities were going to be for the quarter, it’s margins and it’s top line revenue.
[mocking] This was a much bigger event, much bigger, than BHP’s acquisition, than the Noranda merger, that’s news that certainly wasn’t a big deal for Americans. As far as CNBC is concerned these were stories that were just shoved down into the system. But the financial press…much, much more attention was paid to Intel’s story than to the commodities story. Now it’s true that oil gets a lot of publicity, but that’s under the heading of bad news. There’s no cheerleading section on CNBC and in the financial media for higher oil prices. They are just regarded as a curse.
So, to the extent that there is coverage of the commodity action, it is under the heading of Something We Should Be Unhappy About. But, of course, if Intel announces a 2% improvement in its margins, that is an occasion for dancing in the street all the way up the street.
So I don’t believe at all that Wall Street has fundamentally learned from its experience. And I know that the whole story of past triple waterfalls is that if you don’t have true repentance, the next time around the punishment is even more vicious. That’s what happened to the Japanese. They refused to, after the first gigantic sell-off, say that anything was wrong. And that’s one reason why they went to such incredibly low lows.
So I think that’s going to happen with NASDAQ, so I feel more confident than ever that we’re going to go through the old lows that we reached on NASDAQ the next time we have a real downturn. I don’t know when that will be.
If this fifth anniversary had been the occasion for public apologies, public crepe hanging, then I would say maybe those old lows will hold. But, no, it’s just like if you got a prosecutor out there who’s trying to get the mafia and if they don’t catch them, the hunt goes on. And in this case, the Mafiosi are still as brazen as ever, still out there in their jobs. So, we will not see the bottom until those people become unemployed. So, the fifth anniversary of NASDAQ is not only an occasion for savoring the fact that markets ultimately work, it’s an occasion for preparing yourself for the fact that the forces of punishment have yet to be activated.
And therefore, there is some blood to be shed in the next few years in this sector.
[Bond market discussion, Don is re-considering his position here.]
As far as the mining stocks are concerned, historic week. This is one we’re going to look back on. As far as the commodity story generally, the idea that we’re in a new bubble is something that only shills and mountebanks should try to maintain. Third, that we are getting evidence finally of some kinds of cost pass-throughs showing up. The real evidence, though, will not come until China revalues the Renminbi, whenever that is.
And finally, I didn’t mention it, you know my affection for the gold stocks, the breaking down of the Dollar anew means that the gold mining stocks are a good place to be. They’re part of that diversified commodity portfolio; they’re essentially your bad news friends.
That’s it, any questions?
* sialogic, from sialgogue: A drug or other agent that increases the flow of saliva.
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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 the University of Toronto and a law degree from Osgoode Hall Law School. Don joined Harris in September, 1993.
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