Investing in base metals

Doug Casey - Wed 06 Sep, 2006

...I am still expecting a greater correction in base metals than we've seen so far...

 
 
- Base metals are called that because they oxidize, corrode and react easily. The primary ones we're concerned with are: copper, nickel, lead, zinc, aluminum, and iron.

- Their inherent value lies in their industrial uses, not as money, like the precious metals — though silver is an interesting hybrid, being both an industrial metal and good for making small change as money. Compared with precious metals, base metals are plentiful in nature and therefore much cheaper, of course.

- The exploration question is not generally one of finding them, but one of finding enough of them concentrated in a large enough deposit to make them profitable to extract for a substantial length of time. Eventually, their fortunes are tied to the state of the world's economy — the fundamentals of supply and demand.

Investing in precious metals: Supply, demand and prices

- As we go to press, copper prices have recovered somewhat from this summer's correction, in part because of a possible labour strike at Chile's Escondida mine. This is characteristic of all base metals; numerous factors, including political and labour unrest, and even floods, affect the supply of base metals.

- In addition, cranking up supply in the short term is usually impossible; the process of prospecting, exploring and developing a mine takes many years, sometimes decades. The scale of most base metal mines is huge — they take an enormous amount of financing, require endless environmental permissions and need extensive infrastructure.

- These factors make it very difficult to balance supply with demand in the short term (meaning, up to a few years), creating frequent cycles of price increases when supplies tighten, followed by corrections when new supplies come online.

- On the demand side, Asia, particularly China (see the chart below), has stayed in high gear, requiring prices to go up to match demand with supply. Some day soon, India will join the arena. The result has been rising prices, which has been good news for companies like Falconbridge and Teck Cominco: both have just announced near-tripling of profits.

- Base metal prices during the last couple of years have risen faster than the price of precious metals, generating a lot of interest and excitement, even among mainstream investors. That's a sure sign to a contrarian of at least an intermediate high... though that doesn't mean they can't go higher before they correct.

- In fact, I wouldn't be surprised if they went to the sky, given price-insensitive demand and fixed supply and the involvement of hedge funds in the metals market. But any spike like that would be short lived, and for now I still see base metal prices as having gotten far ahead of themselves.

- In addition, I am bearish on the US economy and am not sure that even China can pick up all the slack we see coming, especially with so much of their economy going into exports to the US. At the same time, continually high prices have prompted everyone with assets that can be put into production quickly to move in that direction, so there could be a short-lived supply glut as that inventory of near-to-production assets come online.

Investing in base metals: The dreaded crystal ball

- In the longest term, I believe that all commodities — even including gold — will drop to near zero. Barring a new Dark Ages, that's the inevitable result of advancing technology. But that's still decades off, for the most part.

- In the nearer long term (over the next decade or so), I am bullish on commodities, believing that we are in a super-cycle that corresponds to the 20-year bear market for commodities that started in 1980.

- In the medium range (3 to 5 years), I am also bullish, as anything that can be quickly dusted off will have been, and new discoveries will take longer to bring online. In the short term (zero to 12, maybe 18 months) I see a high probability of economic woes leading to a major correction. That will be our time to re-enter base metal plays aggressively.

Investing in base metals: Are we just guessing?

- Not entirely. Consider the data from the futures market: • Copper for delivery in 27 months is US$5,590/tonne vs. the current US$7,260
• Nickel: US$16,675 vs. current US$27,350
• Zinc: US$2,293 vs. current US$3,125

- Furthermore, the higher prices have brought enough new supply online that base metals are not actually in a state of shortage at the moment.
 

Investing in base metals: Company stocks

- Consequently, I am holding off on buying any new base metal company stocks, unless the company has something of such extraordinary potential that we don't want to wait, or if a company also has a lot of precious metals, which hedges my base metal bet.

- But aside from hoarding precious metals, you can profit even more from the emerging commodities bull market by investing in the little-known sector of junior exploration.

- Right now is the perfect time to get into these underreported—and often undervalued—stocks. It's the Shopping Season, the summer period during which the juniors spend their time digging and drilling, and very little news comes out of this corner of the stock market. Many investors confuse no news with bad news, and share prices are taking a nosedive.

- Not forever, though. Once the summer is well and truly over, share prices will rise again—bringing smart speculators a much-appreciated windfall.


Regards,

Doug Casey
for The Daily Reckoning