Donald Coxe: When Supply Finally Exceeds Demand \from another board:
- My thanks to a subscriber for this excellent Global Portfolio Strategy report by the ever-colourful Donald Coxe for BMO Capital Markets. It is posted in the Subscriber's Area but here is the opening:
The commodity stock rally that began nearly five years ago was one of the two great bull markets of the Bush economic recovery.
The other, of course, was housing.
As in past Triple Waterfalls, the long economic rally also delivered a dead cat bounce to the asset class that was still in the early stages of its long-term collapse. Information technology stocks rose from their slough of despond. However, despite the best efforts of today's kings' horses and men-the Shills & Mountebanks-it turned out that putting Humpty-Dumpty back together again was too big a challenge: Nasdaq still languishes at 1998 levels, and hordes of US pension funds that sought to atone for years of over-optimism by betting big on one monstrous win are queuing up for bailouts by the Pension Benefits Guaranty Corporation.
The commodities bull market, which Wall Street chose to minimize until the profits from $60 oil and $3 copper became too big to overlook, has been the object of derision, disdain, and-in the case of oil-despair. Oil's rise has been treated as a bad-news story for consumers and the global economy, which has meant it has stayed on Page One. Oil industry profits also got there, but only because demagogic politicians pilloried Big Oil's CEOs, alleging that their inflated compensation packages were responsible for soaring gasoline prices.
Commodity stocks entered their bull market after 9/11 at a 4.8% weighting in the S&P and they've barely managed to double that weight, despite spectacular earnings gains. The stock market never re-rated them: their p/es declined sharply in absolute and relative terms. In particular, those base metal stocks that did not become objects of takeover bids have been trading at homebuilder multiples. This picayune valuation reflects widespread Street warnings about the two bubbles-housing and commodity. With their single-digit multiples, the metals and oils are characterized as this decade's versions of the tech bubble by those who ne'er professed fear of bubbles when techs traded at triple-digit multiples.
My view - Of the two great bull markets mentioned in the opening, I would say that the US housing boom owed everything to the Bush administration's economic policies and Greenspan's Fed. And the former Fed Chairman commenced the partial deflating of that bubble before retiring last March.
The industrial commodity bull run owes far less to Bush and the Fed, although the latter supplied its share of liquidity. Instead, the seedbed for a recovery by resources was the 21-year prior bear market, which took prices to record lows in real terms for many of these industrial resources. And some of the fertilizer for the flowering of this seedbed appeared in the form of a synchronized global economic recover for the first time in many years. However the growth in demand turned Jurassic as one large-population underdeveloped nation after another, led by China and India, abandoned primitive economic experiments for capitalism. I maintain that this conversion on the road to Damascus, repeated to a greater or lesser degree on other continents, will produce by far the biggest and longest boom in industrial commodities and precious metals that the world has ever seen.
And what of house building and mining stocks?
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Email of the day (1) - On Timothy Guinness' view of natural gas:
"I have just listened to Tim Guinness on a conference call and asked him whether, given the collapse in US Nat Gas, he was looking to build up his exposure to US Gas plays.
"If I understood rightly, he said that a model he runs suggests that the excess storage built over this year would be accounted for on the demand side by substitution alone at these price levels. He sees US Gas at $7-8 next spring and having reduced exposure last autumn is looking to up the fund's weighting to gas plays."
My comment - Thanks for this insight. Timothy Guinness is highly experienced, not given to hyperbole and a great fund manager. I suspect his forecast on natural gas prices is conservative.
My personal portfolio: Stop raised on stock market futures position, and this trade has been increased - Details and charts are in the Subscriber's Area.
Email of the day (2) - On ECTs:
"A question regarding ETCs. You stated that this will be a positive for commodities in the future. However, an observation that I would ask your opinion on is that today's investment arena seems to react immediately in creating vehicles to allow smaller individual speculators to have access to whatever seems to be attracting publicity and is the "hot play of the month". Examples would be gold ETFs, the silver ETF, an assortment of instruments in the FX market such as credit default swaps, and now ETCs. Supporting your thesis of supply-demand imbalance 100%, do you believe these vehicles can have the effect of creating more volatility and pushing prices up far too quickly, just to see them have hard corrections as opposed to a rational trending market. I know there has been much discussion and disagreements in the financial world about how much of the previous commodity run was due to hedge fund or other speculative party's involvement. I guess this might be similar to the "Economist" cover story contrarian play."
My comment - It was actually Eoin who commented on the ETCs and posted charts in the Library but you will not be surprised to hear that we agree on this subject and feel that your initial premise is absolutely correct. The financial industry can only really market products that are fashionable at the time. Consequently a flurry of new investment vehicles allied to a specific area is almost certainly a contrary indicator, for at least the short term. I don't know to what extent the ETCs will catch on over the longer term, as there are competing instruments, but suspect interest will develop slowly, at least until the underlying commodities have completed their current medium-term currections. These would not have commenced when the ETCs were in their planning stages.
Additional Commentary by Eoin Treacy
GaveKal US Equity Strategy: Reviewing Our Bullish Stance on US Equities - Thanks to a subscriber for this bullish report by Steve Vannelli and Clay Allen which covers a number of important issues concerning investors at present. The full report is posted in the Subscriber's Area but here is a section:
The catalyst for further market gains and sector rotation will, we believe, continue to be ebbing commodity prices, particularly energy prices. This week we learned of the demise of two hedge funds who had over-extended positions in natural gas contracts (Amaranth and Motherrock). These events could lead one to believe that the recent plunge in energy have little to do with fundamentals, and everything to do with the unwinding of highly speculative, and leveraged, positions.
But Amaranth and Motherrock's demise also bring us back to a point we have made repeatedly in the past year: there are today a lot of people involved in the commodity space who might not really belong there. Commodities have been the epicentre of massive speculative capital flows in recent years. As we wrote in Are Washing Machines an Asset Class? and Will the Malthusian View on Oil Carry the Day?, the intellectual foundations upon which billions of dollars have poured into the commodity space look shaky at best. As this view gains greater acceptance, more stories like Amaranth's may yet come out. There is a massive amount of money balanced on the head of pin.
If we are correct that oil prices will continue falling, then the US stock market has, most likely, much further to run.
Another very important development has been the recent very sharp drop in long bond yields (which has taken almost everyone by surprise).
The recent rally in US Treasuries challenges the consensus belief that the twenty year bond bull market is ready to be buried; as shown above, the twenty year bull channel is still very much in force.
And this is important for US stocks. Indeed, as can be seen below, peaks in yields (major and interim) were associated with many major rally starting point in the last 25 years: 1982, 1984 (mid-cycle slowdown), 1987, 1990, 1994 (mid-cycle slowdown), 1996, 2004…. Will 2006 prove the exception?
My view - Oil's fall from near $80 to today's $61 will have a positive effect on company balance sheets and will help to keep inflation under control in the medium-term. The bond markets are also already starting to price in a US rate cut some time early next year, urged on by the expected slowdown in GDP growth. However, will these be the main positive conditions motivating the expected rally for 2007 through to 2008?
Oil (p&f, monthly, weekly, daily) remains in a secular bull market. Yes, it has fallen 25% from the peak and a couple of energy related funds have run into trouble, but the fact remains that demand is growing faster than replacement and refinery capacity remains under pressure. The current correction has broken the integrity of the three-year uptrend, implying that the recovery, when it begins, may take longer than other such recoveries. However it does not imply that oil prices are going to fall back to the lows seen in 1998. That possibility could only result from a global depression, which would wipe out demand from emerging markets and no one, to my knowledge, is predicting that.
This section continues in the Subscriber's Area.
Eoin's personal portfolio: one equity index position stopped out at a profit -This section continues in the Subscriber's Area.
Iberian Utilities Soar as Takeover Battles Heat Up - This article by Kristian Rix for Bloomberg covers some of the main reasons the Spanish market has outperformed over the last couple of months. Here is a section:
Shares of Iberdrola SA led Spanish and Portuguese utilities higher after building companies bought stakes in Spain's main utilities and E.ON AG increased a takeover offer for Endesa SA, the country's largest power company.
Iberdrola shares rose 13 percent to 37.80 euros after builder Actividades de Construccion y Servicios SA failed in its attempt to get a 10 percent stake in the utility. It bought 6.3 percent at 37 euros per share, the builder said today.
Spanish utilities are at the center of merger activity in Europe after the European Commission ordered Spain to remove roadblocks it had set up to stop E.ON, a German company, from taking over Spain's main power producer, Endesa.
"Anything is possible now," said Gonzalo Lardies, who helps oversee about $203 million at Metagestion in Madrid.
Gas Natural, which made a bid for Endesa last year, climbed as much as 2.97 euros, or 10 percent, in Madrid investors speculated it may take part in a merger with either Iberdrola of Endesa.
"There is speculation that Gas Natural may be involved in a merger with Union Fenosa and Iberdrola or even a link-up with Repsol,' Lardies said.
My view - Spain and Switzerland both broke up to new highs for the year on August 29th and have continued to lead Developed European markets since then. Spain, in particular, has benefited from significant merger activity in its utilities sector with Iberdrola, Gas Natural and Endesa now subject to speculation.
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Email of the day - on income trusts:
"It shows up as either Toronto, or Canada:WTE.UN (a lot of the Canadian trusts have the .UN suffix). It is Westshore Terminals Income Fund, and is still sort of resource-based, as it derives its income from handling coal shipments. (You can Google it to find out more). A lot of these trust have been hit by the sell off in resource stocks, although there are some that have held up. You may know that there are also a lot of US Royalty stocks e.g. Permian Basin, San Juan Trust or, of course, the Prudhoe Bay Trust. It was new to me until I started investigating! A lot of infrastructure plays (e.g. Amerigas, which I think gets an income from renting out its propane storage tanks and infrastructure to domestic users, and lots of pipeline trusts) seem to go for trust status as a way of flowing through their income to investors. I guess this is the same motivation for the REITs, which Gordon Brown is looking to introduce in the UK. I think there are considerable tax-benefits (although these may evaporate, I guess, if they get over-bought!). In terms of oil and oil exploration companies, it makes sense for them to capitalise their finds, and use the funds to carry on exploring. On the other hand, the investors who buy into the trust get a steady (although probably "wasting") income from their investment.
"There are loads of these in the US and Canada once you start to look for them. I haven't encountered the healthcare trusts yet, but your other correspondent has now pointed me in that direction, and I shall certainly give them the once over.
(Also, a final word of caution, some of these trusts (although none of those mentioned above, as far as I am aware) have been tarred with the brush of Ponzi-finance schemes, whereby the distributions are dependent upon luring in an ever-increasing supply of new investors. I haven't encountered anything of this nature, and have only found apparently bona-fide trust, but it is still important to research these thoroughly, and to take a view on the soundness of the underlying assets and there likely cashflows.)"
My comment - Thanks very much for the information and cautionary note. I have added Westshore Terminals Income fund, Precision Drilling Trust, BP Prudhoe Bay Royalty Trust, San Juan Basin Royalty Trust and the Permian Basin Royalty Trust to the Chart Library.
This section continues in the Subscriber's Area.
Email of the day - On long-term outlook:
"I am a big fan of your service. You mentioned numerous times that 07 and 08 were going to be good years for the global market. Looking at Dow, currently at 11,669, which is not that far from all time high of 12,000.
Does this mean that we are going to see Dow reaching new highs in 07 and 08?
"Aren't we supposed to be in a bear market with contracting P/E ratios and rising yield? What happened to the previous secular bear market of the 70s, where Dow 1,000 was the glass ceiling? It does not seem that this secular bear market would be the repeat of its predecessor.
"What is your take on 2009 and 2010? I believe they are going to be bear markets. We will see bigger corrections than the medium term correction we just witnessed, but to the lesser extent than the bloodbath of 2001 and 2002."
My comment - Thanks to for email which airs an important question. Can I refer you to Comment of the Day on September 15th and David's answer to Email of the Day 1 - On long-term outlook, books and inflation-adjusted metal prices. I found this by putting 'secular bear market' into the Search engine.
Today's interesting charts - The inflation adjusted charts section of the Chart Library helps to put the secular bull market for commodities in perspective.
Australia - strong upward dynamic from the bottom of the range. Today's move changes the profile of the index which had looked like it was starting to roll over to a much more bullish outlook. It would now need to sustain a close below 4,900 to offset potential for additional upside.
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