Bob, thanks for the table and the report. I started buying base metal stocks in Jan/Feb this year (Stephen O pointed the way). I don't know if you listen to Don Coxe, but I have a transcript of last Friday's call. He's got some very good insights on the base metals, imo:
Don Coxe
10/17/03 Conference call
A New Kind of Recovery
[chart of Phelps Dodge]
I wanted to talk about this theme because, although you say “You’ve been talking about this obsessively for the past two years”, I wanted to talk about this theme because I really believe that this story is getting legs and is even bigger than I thought it was a few months ago.
The reason I chose this weekend for it is because this is Bush’s week in Asia. I’m not expecting anything concrete to come out of this, what it amounts to is some sort of pilgrimage to that region of the world…if we’re going to have a unique kind of recovery…this is the one that’s going to lead it.
So if we go back to previous recoveries you will see that the recovery in the:
90’s was lead by the US
80’s was lead by US/Japan/Europe
70’s was a lousy decade
60’s The first one where Asia was significant
50’s was US and Europe
The question about this one being lead by the new East Asia Co-Prosperity Sphere, if this is in fact going to be the case, then it’s going to mean such a different investment climate. Although I’ve chosen this to be the theme, I’ve done an entire Basic Points on this.
In reading and in talking to people I realize that there’s still a lot of people out there and in following the day to day moves of these stocks I see that there’s a lot of people trading these stocks or reacting on the basis of US economic news. If we have good news during the day, then we seem to have money coming into the Alcoa’s and the Phelps’s and the BHP’s and the Inco’s. Now I’m not knocking that, obviously, because I’m recommending these stocks or this group, but I want to do is that you do the right things for the right reasons.
The US recovery in itself is not a reason to buy these stocks, at least, not at the levels that they’ve moved to. It WAS, maybe six months ago. Given the huge moves that these stocks have made, then even if we were going to get six or seven percent GDP growth in the US next year (I don’t know anybody who believes that) it wouldn’t justify putting a lot of money into these stocks except as trading vehicles. So therefore I’m left with the fact that what is priced into them now is two things.
First of all, the metals themselves, ex-nickel, have simply moved to offset the depreciation of the US dollar. They’re doing what commodities should do, as long as their supply and demand are in balance, which is that they will rise real terms. The fact that this is occurring is a sign that we are in a different kind of environment, because this did not occur during the triple waterfall years for inflation hedges. They had their rallies but they always went to new lows. It didn’t matter too much what was happening to the dollar.
So the first argument then is that they’re just simply doing what they should when you’ve got a fundamentally sound situation for the metals. But you see we haven’t had a fundamentally sound situation for so long that that in itself is big news.
But the real argument here is the argument that we’ve got this new middle class in the East Asian co-prosperity sphere, which, 350 million strong now, headed for half a billion by the end of the decade average incomes right now in the Portuguese level, by the end of the decade their average incomes will be headed towards the Taiwans and the Singapores and Koreas. And those countries are equal to the average of the entire Euro zone.
So, what we’re talking about here is a once in a century type event, in which you have a group of people, hundreds of millions strong, who move from a quasi-subsistence existence to advanced middle class in a few years.
And how you play that, there’s various other ways you can do that, but this technique of overweighting in the metals is a surefire way to do that because it means they’re going to acquire durable goods.
Well you say “You’ve mentioned this on so many other calls, why talk about it again?”
It’s because I’m still not convinced that there is agreement out there on this part of the argument and therefore the arguments that people are giving and the earnings forecasts that I see from Wall Street for next year, correlate on the basis of the US with some allowance for Europe.
But, you see, I’m trying to make the case that there is a high, not conclusive, probability that this is really going to be a dramatically different recovery and that Japan is going to participate in it and Japan is going to participate in it as one of the driving forces of the economy of the mainland. Now that’s different because Japan, in previous recoveries, simply drove from itself. It was isolated out there and certainly its relations with China were terrible its relations with Korea were terrible and there was rivalry with Singapore and Taiwan.
What we’re talking about here is that there’s a recognition by that part of the world, they’re better off to deal with each other to move goods back and forth in the equivalent of a NAFTA zone where you get parts of a car in Windsor Ontario and Michigan that move back and forth maybe three or four times before the finished car comes out. Something like that is unfolding in this EAST ASIAN CO-PROSPERITY SPHERE.
The fact that Japanese stocks are doing what they are, we’ve gone through the 11,000 mark on the Nikkei and what’s happening in Japan now is just really impressive. We got the election coming up three weeks from now in Japan and it looks like Koizumi is going to get a big endorsement. They’ve let the Yen move down, which means move up which is one of the things that makes these explanations more difficult, but the fact that it broke 110 was truly significant and the fact that it’s not trading below 108 now is probably just because of Bush’s arrival within that zone. I think it’s going to head down towards par.
Meanwhile what we see is the Japanese auto companies really doing well. In this country now, Toyota has moved up to the number three slot, of selling cars. Chrysler is no longer in the Big Three. Meanwhile Nissan is actually growing faster than Toyota in this country. So I think that we’ve got a new kind of global strategic vision in this recovery which we didn’t have in previous recoveries. The Globalists were really the Americans and to a lesser extent, the European multinationals.
This time what we have, the reason why China does not have a gigantic trade surplus, is because of massive imports of machinery and equipment. Very advanced equipment coming from the US, Japan and Germany and they’re being brought in there of foreign direct investment from foreign multinationals who are doing operations in China which means that gradually the Chinese recovery is being taken over as being part of the production phase for global multinationals as a group…which is distinctly different from the fact that India, which is growing at five, to six, to seven percent, that’s being done overwhelmingly by Indian companies.
Now, there’s different models and right now the China is the one that’s making it work because what the Chinese government is doing is creating the infrastructure and environment for the foreign multinationals to come in with their brands, their management and their technology and use Chinese labor and resources to produce.
So, if in fact, this recovery then, is the first free-trade-driven inter-zonal recovery where what you have is sort of master plans by the great global multinationals, then it cannot be something where the US economic indicators are the most important thing.
Now remember, in previous recoveries that we had – leaving out the ‘90’s, which were a special case because that was basically technology, in the previous recoveries we had so many trade barriers that you couldn’t have this kind of global vision by the multinationals. But now what’s happening is that we are moving rapidly into trading zones, more or less free trade with each other separating out parts of the process and moving them around.
This is a different kind of recovery. That means that this could be a recovery that is well sustained even after the economic stimulus that got it going is withdrawn because it will be a recovery in which what we have is advanced management techniques driving it and it won’t just be a few companies based in the US and Europe, it will be a huge number of multinationals including the Japanese companies will be doing things differently than they did before.
Before when it was producing in Japan to sell to the world and then being forced to build plants in the US and Europe, this time Japan, Inc. will be operating around the world. If you assume that this kind of thing means a better, more efficient and productive type of economy then what you have to assume is that there is going to be a much bigger demand for metals in this than we’ve ever seen in a recovery.
The combination of the new consumers that need durable goods plus the multinationalism of the organization structure of this in a way we haven’t had before. So the US economic numbers are important but we’re not talking about something here that is crucial to it once it’s gotten going. The economists have ratcheted up their forecasts for third quarter US GDP which is the one where we got the full effect of the tax stimulus plus the low interest rates. 5 to 5.5% numbers. That is what has driven the Dow and NASDAQ up as high as they’ve gone. Which is people saying “Well I’ve just got to get in to the recovery.”
In particular, asset allocators are now faced with a stark choice. Do you keep a high commitment to bonds, with the benchmark duration given that we’re going in to this recover with interest rates that are the lowest in decades? In other words, that there’s an endogenous risk for you in holding bond exposure this time that there wasn’t in the 90’s. Certainly of course not in the 80’s and certainly not in the 70’s. Your coupon doesn’t do much for you if people decide that they want to move money out of bonds of if inflation comes back at all. And so what I think asset allocators are faced with is a new kind of challenge.
Back in the 90’s you could keep bond exposure even if you were investing heavily in the NASDAQ because interest rates were still falling and you were getting really agreeable returns. You were getting 8-11% returns, year in year out, but now what we have is off these bases where we’ve got interest rates down where they are – we’re up 4.38 on the 10 year Treasury note, now that’s up hugely from 3.11 but it still doesn’t give you much of a margin of error if we are going to get let’s say over the next 12 months 4% US GDP growth. And given what’s been happening in commodities and given what’s happening with the dollar, you aren’t going to have 1% inflation, that’s not going to be the case. It’s going to be higher than that.
So, I have a feeling that what’s been happening here is that we’ve got some truly nervous asset allocators that are saying even at these multiples I may be safe in stocks than in bonds. I am not arguing that. But what I am saying is that the risk/reward ratio is better in stocks than in bonds. Well, you say “Do I change my assets mix?” the answer is “No”…so why not?
There are things that can still go wrong with this. Most importantly what can go wrong is some kind of terrorist attack again. I don’t know how to quantify it but it just seems to me that they’ve been lucky in finding these ones that they have. I’m not yet convinced that the response is brilliant and although winning in Iraq was good for winning in Iraq I’m not sure it dramatically improved our chances for winning the war on terror except as an indication that you play with the USA and boy you got problems.
And Afghanistan, I just have the feeling that they’re collecting again there in the remote regions. I think about, as a reader of Lord of the Rings, about what happened in Murkwood when the Rangers were no longer able to patrol it and the baddies re=congregated. So I’ve got that worry and I’m also still not convinced that US corporations have the profitability to support much higher stock prices, notwithstanding any sales increases.
In other words, I’m wondering whether we’ve just squeezed the system enough, fired enough people and become more productive with technology so that we can handle vastly more than the demand that we’re likely to have, which means that I just don’t see that we’ve got upside earnings leverage for the market as a whole in a big amount.
That’s how we get to the so-called deep cyclicals, because they’ve got upside earnings leverage and it’s not the automobile companies now because they’re not going to have a lot of leverage because they’re just nothing out there that’s going to produce demand for 19MM cars/year. Even if they gave them away, along with tickets to Cub games. Now next year that’s not going to be much of an inducement anyway in this city [Chicago].
So, what I’m afraid of is that what we’re going to have is a fairly good US economy but without the kind of response in earnings and that it’s therefore not going to justify much higher prices as a whole, which means in my view you’ve got to make more of an emphasis than you would have otherwise for going into the deep cyclicals. I would actually argue that you’re better off with a big overweighting in the deepest of deep cyclicals which is the base metals. Because they have got upside leverage.
The mines are in balance now with the demand for the products and as demand comes through, we’ve got lots of room, you know. If you say “Gee, well we’ve had quite a run up in these metals”, yeah, that’s true but let’s…if we take any kind of long-term charts for the metals, what you realize is that what’s happened to date isn’t that huge.
You know, even if we rule out the move that copper had in 1988 because that was heavily manipulated by Japanese and Chinese trading houses where we got it up to a buck ninety a pound actually, which is really incredible, but it got to a buck fifty a pound in 1995 and so where it is now is still cheap. And zinc which is sitting at under .40 a pound, look it’s traded above .70 in 1997 and 1998. In other words, there’s room. Nickel of course, has enormous potential upside leverage because this is a metal that has traded as high as eight bucks in the past and so I just feel that this is a clear-cut case.
Although there’s only a few stocks you can buy and although they’ve moved a lot, I really want you to go through the piece this week, I think it’s a great story. |
