Lead Bull Market
There is no denying the fact that we are in a long-term secular bull market for nearly all commodities. And the transformation our global economy is undergoing is unparalleled to anything we've seen in modern history. An economic supercycle has emerged in which a vortex of demand is sucking in commodities with relentless fury.
As suppliers feed the powerful spiraling current, they continue to struggle to meet demand as even record-high prices can hardly stand as a deterrent in suppressing its force. And the industrial metals that are indispensable in their role in building this economy are beginning to take center stage among the commodities investors.
These industrial metals, or base metals, provide the brick and mortar for virtually everything, structurally and mechanically, that our growing world commands to not only advance but exist within today's level of commerce and technology.
From the investment and speculation perspective the most popular of these base metals is copper, with nickel, zinc and aluminum following close behind. And lagging this group is inarguably the least glamorous of all the base metals, lead. For many folks lead is just plain boring and perhaps still garners negative perceptions surrounding its noxious past.
Lead has been a forgettable metal since the 1970s and 1980s when the lead market underwent radical changes. Because it was discovered that lead's toxicity in various products presented the risk of lead poisoning, lead's use in paint, solders and water systems among many uses was greatly diminished. Even its use as an additive in gasoline was discovered to have various environmental drawbacks further curtailing its utility. An onslaught of new environmental regulations indeed phased out many of lead's historical uses.
Lead truly got a bad rap and for years has been weathering shifting dynamics. But though this metal has been seemingly pushed aside and forgotten, it has risen from adversity to become one of the hot commodities of this bull market. And regardless of its past, investors are starting to realize that this nonferrous metal still serves as one of the most vital commodities in today's economy.
Lead still has a myriad of applications. And the average person probably most associates these applications with pencils, batteries, fishing sinkers and X-ray-machine garb. While even though pencil "lead" is actually comprised of graphite, clay and wax and contains no lead at all, the rest of these examples are indeed some of lead's everyday uses.
Aside from the grand pencil misconception, I've personally gone through enough car batteries over the years (the alkaline batteries used to power your flashlights and kids toys are actually comprised of zinc and manganese dioxide), donated countless pounds of fishing weights to the bottoms of lakes around the world, and have been known to frequently don stylish lead vests as a result of my reckless adventure days, that surely lead cannot be a dying commodity.
Well aside from the latter two ethereal uses, there are a vast number of industrial uses for lead that include its use in ceramic pigmentation, glass, plastics and ammunition. But these uses and all the rest are trivial compared to lead's use in batteries. Lead-acid batteries command three-quarters of lead's consumption. And without lead-acid batteries, the world as we know it today would be vastly different, in fact quite archaic.
Virtually every form of transportation uses lead-acid batteries in some way, shape or form. As starting batteries, the power burst from lead-acid batteries is used to start engines. As deep-cycle batteries they are used to provide long-lasting power to a multitude of accessories that require power. And of course lead-acid batteries play a hyper-critical role in backup power for the industries that power our world.
Even though various minor uses for lead have been phased out, its use in batteries has been accelerating at a rapid pace and has caused demand to outpace supply. In fact, according to the International Lead and Zinc Study Group (ILZSG), 2007 is expected to be the fifth consecutive year in which there is a supply imbalance in the lead trade. The ILZSG forecasts a shortage of over 50,000 metric tons, and I believe this is a very conservative estimate.
As a result of this imbalance, the price of lead has skyrocketed in recent years. In lead's 10-year chart you can see how sensitive market pricing is to these supply deficits. With 2003 being the first year of this supply deficit, the price of lead reacted sharply as it broke out of a multi-year consolidation to begin its march higher.
From its low in 2002 of around $0.18 per pound, lead has rocketed over 550% to its recent high. So with lead shattering its all-time highs and nearly tripling in just the last year or so, it has truly been a hot commodity. Gains like we've seen in lead are simply breathtaking, but are they sustainable and where will support take shape?
Well ultimately it comes down to fundamentals. Once a balance between supply and demand occurs, prices will stabilize. And there is plenty of lead in the earth's crust, so there is certainly not a scarcity issue. In fact, the mined supply of lead has grown steadily over time. In the last 10 years lead miners have increased their output by 15%. This supply increase is meager though and has not been sufficient to meet increasing demand.
But it is hardly reasonable to blame the miners for the supply shortcomings. With the rising lead price it would behoove mining companies to produce as much lead as they can. But because of the nature of mining, the miners cannot simply turn a spigot and increase the flow of lead out of their mines as demand warrants.
Increasing the production volume of any mineral extracted from the earth is tedious and expensive. This is to be expected, but interestingly growth on the lead-mining front has been nowhere near the growth of the other metals. This is due to a number of factors, but the simple fact is lead is an unloved metal that is typically just a leftover mineral for the miners.
In actuality, most of the largest lead mines in the world are not primary lead mines. The lead that comes from these mines is typically a byproduct of higher-priced minerals within the same ore body such as copper, zinc and silver. And because lead is among the cheapest of the base metals measured by weight, a lot of it has to be processed in order to make money.
So when mining companies explore for their next mineral deposit, lead is not usually a primary target. But now with $1.00ish lead, a price that is right behind that of zinc and aluminum, the tides may soon be changing for how mining companies approach the exploitation of this base metal.
On the geopolitical front, lead can be affected just like any other commodity. Case in point is issues one of the world's very few primary lead mines has been dealing with. The Magellan mine in Australia provides about 3% of the global mined supply of lead and has been under duress this year struggling with delivery and regulatory issues. With lead's already tight supply, its impact has been felt by the markets.
And one of the reasons prices can be so reactionary to supply disruptions is because of the limited above-ground supply of lead that is available to cushion these types of problems. Several months ago I wrote about base metals stockpiles as measured by the London Metal Exchange (LME), the world's largest nonferrous metals exchange. And I found that looking at stockpile levels, especially in a historical context, can really provide support for this bull market.
From its 2002 high near 200,000 metric tons, LME lead stockpiles have dwindled to levels as low as 30,000 metric tons in just the last few months. An incredible 85% drop in stockpiles in just five years really has warranted drastic price increases as consumers chase after a shrinking supply.
And based on the annual consumption of lead, the LME only houses about 2 days worth of consumption in its warehouses. Even ILZSG estimates of all global lead stockpiles combined only tallies to about 11 days worth of consumption.
Because the lead stockpile levels have been so alarmingly low, you can see that there has been a strong inverse correlation with its price. And I believe speculators have added a risk premium to the price of lead that will likely remain there until stockpile levels are built back up.
So where is the demand coming from, and how long will it continue to outpace supply? Once again I believe we need to look to Asia for the answers. According to the ILZSG, the global demand for refined lead metal will rise by 4.1% in 2007. And this rise in demand is supported by China's estimated increase in lead usage of over 12%.
China's lead consumption growth has been shouldered by the growth of its automobile industry. It is now the world's second largest market for auto sales behind the US and is the third largest auto maker. And the China Automobile Industry Association expects 2007's auto output to grow by 15% over last year while many other analysts foresee 15% sustained annual growth for at least the next 5 to 10 years. Many analysts also predict that China will likely overtake the US in these categories in the next 10 to 15 years. A lot of lead-acid batteries will be required to fuel this auto growth.
But even with amazing numbers coming out of China in regards to its booming auto industry, the most striking numbers surround its growth in individual car ownership. Up until recently, private car ownership in China was only a dream for the average Chinese family. Only in the last ten years or so has a private citizen even been permitted to own a vehicle. Up until recently, the few cars on the road belonged to the government.
Well with China's fast-growing economy and growing shift toward capitalistic tendencies, more and more of its citizens have disposable income and are able to fulfill their dreams of becoming car owners. And a recent report out of Beijing supports this as individual sedan car ownership in China grew by a whopping 33.5% last year to 11.5 million.
Now there are a number of reports on totals for individual car ownership in China, in which some include small tri-wheel cars and low-speed hauling trucks. The numbers I've seen range from 15 million to 50 million total individual Chinese car owners. Considering China's population of 1.3 billion and the massive influx of people moving to the big cities, even an aggressive total of 50 million individual car owners amounts to less than 4% of its population owning cars.
I believe 2% is a more accurate number for those private citizens that own vehicles. But considering that in the US individual car ownership is conservatively estimated to be 80% with the UK coming in at around 45%, China has a lot of room left for growth. If China was to increase its individual car ownership to only a quarter the level of the US in percentage terms, this would equate to 250 million more cars, which would likely mean 250 million more lead-acid batteries.
The China factor is very important to watch and can be used as a weather vane for the lead markets. Not only is its auto industry very robust in its growth, but it has a fair amount of control over the economics of this metal. Interestingly, even with China's huge consumption of lead it actually ranks as a net lead exporter. China is by far the world's largest lead producer by volume, but as its consumption grows, reduction of exports to keep the lead for its own use will likely have a major impact on the markets.
And lead-acid batteries are not likely to go anywhere either. In fact, there is new technology being developed that may soon open up the hybrid vehicle market to lead-acid batteries. Since the conventional lead-acid battery is so bulky and heavy and doesn't quite have the longevity of the nickel metal hydride battery currently used in most hybrid vehicles, this is a market that hasn't really been open to lead.
But new technology is making it possible to create a lead-acid battery that should soon be able to compete with the NiMH battery without losing any of the integrity this battery provides. If this technology hits the markets as a competitive alternative to the nickel battery, it should get accepted with open arms as lead is vastly cheaper than nickel.
And even with lead at a record price of over $1.00 per pound, demand for this metal is not expected to subside. There really isn't an economical alternative for most of its uses and it is not the environmental problem it used to be especially considering its excellent recycle rate. Over 97% of battery lead can be recycled, and in brand new batteries off the production line, about 60% to 80% of their contents contain recycled lead and plastic.
According to the ILZSG, 2007 lead demand is expected to be about 8.3 million metric tons while mine production is expected to yield about 3.8 million metric tons. But even with the battery recycle rate in the Western world over 90% helping to fill the gap between mined lead production and demand, a structural deficit still exists that the mining companies have not been able to fill.
As I mentioned, the global miners are now starting to really recognize how lead can impact their bottom lines. But much like silver, most of the world's largest lead producers are senior mining conglomerates that do not get their primary revenue streams from lead. Instead lead revenue at primary copper, zinc or silver mines serves as a byproduct credit to lower the operating costs for the primary metal.
But even as a byproduct credit, those mining companies that do not hedge their lead have enjoyed much better profits as they pull this metal from the ground. And outside of futures, the best way to gain exposure to lead's bull market is by buying the stocks of the mining companies that bring it to market. Since there are very few primary lead plays, we are able to get this exposure from mining companies that are diversified in their mineral extraction yet are exposed to lead's upside.
At Zeal we have been recommending diversified and hybrid mining stocks to our subscribers that are able to leverage the gains of the hot base metals markets including this wonderful lead bull. Some of these stocks serve as excellent long-term investment-grade plays that should multiply many times over in this secular commodities bull. And many others serve as near-term speculative plays that have vast potential over the near horizon.
The bottom line is lead is one of the hottest commodities in the markets today. And it is continuing to soar as seen by its recent all-time highs this week. Some of the speculative fervor may burn off in the near term if global stockpiles stage a notable build, but the strategic fundamentals of this metal call for a secular bull market that should run for many more years as the global economy driven by China continues to upgrade and expand.
And many of the mining companies that survived the bear-market years of the 1990s are now thriving as their lead and other base metals are selling for record-high prices. The beautiful thing for us investors is many of these mining stocks are still relatively undiscovered by the greater investment public and are very cheap measured by their fundamentals.
June 29, 2007
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