February 2008 HRA Dispatch
Dichotomies
David and Eric
Coffin's
Hard Rock Analyst Journal
Mar 3, 2008
Sell on News?
This long standing maxim seems
to be in full force as the US debt concerns deepen. Not that
all news has been good, but even where context would auger future
gains it is only negatives the market is seeing at present.
Efforts by the great and good to catch up to the reality that
a major housing and debt based downturn is underway in the US
certainly aren't helping. Fed Chairman Bernanke reporting to
his Congress that the economy will weaken further impacted the
markets on Thursday, and IMF head Dominique Strauss-Khan amongst
others has declared emerging markets decoupling from the US economy
a dead idea. Hmm.
China has just announced its
January trade surplus is some US$15.88 billion, up by 50% over
the year earlier period. For the full year 2007 the total surplus
was up almost 50% at some $262 billion. This is in spite of
obvious slowing in overall US consumer demand for the past four
months. Obviously a continued slowing in the US can begin to
dent China's exports, but China has dealt with the same rising
costs for resource inputs as the rest of world by becoming more
flexible with its cost base to maintain its growth of exports.
We expect the upward adjustment
of the Yuan, signalled by last autumn's noises about adjusting
the Yuan's currency basket, to accelerate further. That helps
satisfy a rising hue in the US for better trade terms, and also
reduces the cost of resource imports and therefore costs into
China. Lower exports cost will, in due course, help spread China's
growth around its domestic economy and up-shift consumption in
China. That is what the IMF and the G7, those mature economies
that don't decouple from each other very easily, are actually
looking for from China. Good of them to notice it is underway.
So are we saying that the great
and good are simply wrong in stating that decoupling is a dead
concept? No. Obviously if the entire "developed economy"
goes into a deep recession it will hurt everywhere. The heads
of developed economies' various regulatory bodies have no more
idea how big the debt bomb actually is then anyone else. They
are trying to scare the ultimate lenders, those job sapping "emerging
economies" that were storing wealth before Romulus was suckled,
into bailing out Wall Street. We have no problem recognizing
that as scary, so we continue to be cautious about jumping into
the deep end just yet. But the decoupling we talk about is specific
to metals.
From pre cycle base levels
oil is trading up 900%, nickel some 650%, copper over 500%, and
even lowly zinc is up 300%. We are a full six quarters into the
US housing crisis (signalled by copper's drop from $4 per pound
in mid'06). European zinc smelters want to increase charges
by 75%, citing more concentrates supply to justify this.
There is some new mine supply. But China reversing long standing
tariff enticements that overpaid for zinc concentrates also helps
the cause; a new export tax on finished zinc from
China is expected to halve its export of the metal this year.
Given metal producers are cash flush for the first time in seventy
years, do you think really they will drain that cash by supplying
zinc at loss due to short term demand weakness? We don't.
Mono-line insurers are the
current béte noir as we noted in the last
Journal. Warren Buffet has offered a profitable (for him) way
out and the regulators sound like their patience with Wall St
is rapidly evaporating. We're surprised it's taken this long.
Since they created the mess its only reasonable they cut come
cheques to help clean up the mess. If the combination of Omaha
vulture capital and Albany strong arming can resolve that crisis
the market should stabilize for a while at least.
Anything else we should be
paranoid about? Well, as long as you're asking, there are those
Credit Default Swaps and Credit Swaps waiting in the wings.
These make a lot of people nervous thanks to sheer scale; the
best guess as the current amount of outstanding swaps is close
to $50 trillion. How ugly might that get? No one knows
- that's the problem. It's important to add that these derivatives
were designed as hedging instruments so (we hope) most of that
big total is swaps that will effectively cancel each other out.
That's the theory. Given how many outstanding swaps seem to
exceed debt instruments created in recent years you have to suspect
someone is using them to leverage up. Cynics point out with more
than a little justification that assumptions about other markets
having little "dumb money" involved proved to be highly
optimistic. This market is a "gray area's gray area"
so the odds of getting any meaningful answers or market statistics
are slim. We just have to hope it doesn't blow up on us. Stay
tuned.
With all the market fears and
nasty economic stats floating around January and early February
were particularly unforgiving on the base metal side. Two producers
on the list, Lundin Mining (LUN-T) and Teck Cominco (TCK.b-T)
have both been harshly dealt with by the market after reporting
weak fourth quarter results. This was partially due to weaker
zinc prices and also to one time changes. As we noted above
a receding economic tide would "drop all boats" but
the market is marking down producers like these much more than
the metals themselves. The next month or two should tell the
tale when it comes to base metal prices. There will either be
rapid inventory build-ups and price drops or the prices will
continue to stay at least level. If they do, we can't help but
think these companies will get rediscovered as it dawns on traders
they could sustain high profits and low P/E's for some time.
On that basis we think you should have LUN and TCK on the shopping
list (on weakness) if the markets get through the quarter without
coming apart further.
Juniors have been on ice since
the start of the year. Some discovery stories are trading well
but market participants are holding back from anything less liquid
until there is more clarity on the direction of the major markets.
We've maintained for some time that there could be another down
leg on the major indices so we can't blame people for caution.
All that said, continued strength
in the precious metals complex should start drawing buyers in
again soon. Gold could consolidate short term, but events in
the broader markets and increasing assurance that the Fed will
cut further continues to underpin prices. The only short term
event that might rally the dollar is some sort of legislated
fix of the mono-line insurer crisis. If that happens and gold
is sold down consider it a good entry. There is little chance
of the greenback getting rescued longer term. Credit issues
in one form or another will be around for some time to come but
one can already sense that traders are getting tired of hearing
about it and reacting to it less. It seems like this could go
on forever but then the same has been said about many other crises
over the past couple of decades. It seems silly to say "the
market has no memory" but it does explain greed overcoming
common sense with such tedious regularity.
The preceding article was sent
to HRA Dispatch subscribers on February 17th 2008
David Coffin
& Eric Coffin
Editors HRA Journal
email: hra@publishers-mgmt.com
David Coffin
and Eric Coffin are the editors of the HRA Journal, HRA Dispatch
and HRA Special Delivery publications focused on metals exploration,
development and production stocks. They were among the first
to draw attention to the current commodities super cycle and
have generated one of the best track records in the business
thanks to decades of experience and contacts throughout the industry
that help them get the story to their readers first. Please visit
their website at www.hraadvisory.com for more information.
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