With many thanks to TheSlowLane from SI's "The Woodshed" board for the transcript. (Link below)
(Link to audio of CC located below text)
Don Coxe Feb 25, 2005 Chicago
“The New Millennium Is Good For Mines”
Thank you all for tuning in to the call which comes to you from Harris Investment Management in Chicago.
The chart that we faxed out was the Toronto Stock Exchange Mining Index. A dramatic chart from the middle of ’03, ever since then, the upside. Our comment was “The New Millennium Is Good For Mines”.
This weekend is the beginning of the annual Nesbitt Burns Resources Conference and I’m going to be down there as I’ve been for the last few years. I thought it was a good time to review this group and to also tell you that the next issue of Basic Points goes to press this afternoon. It’s a two part issue. One part is an analysis of the Social Security trust fund, which is part of the reason why Social Security is in trouble and it’s an analysis that it’s because of a bizarre investment policy that they have.
I am not aware that this has been written up anywhere by anybody and it hasn’t come up in the debate. It happens to be a subject where I testified before the US Senate Finance Committee about it, so I know something about the subject matter. I thought for those readers that are interested that this very detailed discussion could give them surprising information.
The other half of it is about investing personal security for the New Millennium. I include the mining stocks as part of the retirement portfolio.
What I wanted to do today was to talk about a conceptual view of these stocks. I had the advantage last week of seeing major institutional clients in New York City and the week before that on the West Coast. What I realize is that there - in regard to the mining stocks - is still a major perceptual problem about what kind of investments these are.
As you know, dating back to July 2003 when we came out with our first major call – we had been endorsing these stocks but really got keen on them in the summer of ’03 and followed up with various Basic Points since then on it. The story of course, is essentially a China and India play. We’ve had to deal with the fact that the stocks have been priced largely by what the various experts and self-appointed experts on China had to say about the economy. Which has meant that the performance can be disconcerting at times, as it was starting this time last year really, until the middle of last year when they were very disappointing.
So let me take you through the idea, which first of all, if you’re familiar with my thoughts, in each decade since the ‘60’s, what works best and worst in the first five years of a decade works best and worst in the second five years. So just reviewing this, in the first five years of the ‘70’s, just about the only place to make money was in commodities and commodity stocks, particularly the gold and oil stocks. And the worst thing to own was long-term bonds. Back then when I was building an investment management firm I used the tag line at conferences “The proper holding period for a long-term bond is the amount of time you hold a hand grenade after you’ve pulled the pin.” It worked that way in the second half of that decade.
The next decade the worst asset class for the first five years was commodities and particularly gold and oil stocks. The best was long term zero coupon bonds and then in the stock market most groups, particularly the financials and the consumer stocks.
In the ‘90’s the worst asset class was Japanese stocks, the best was tech stocks, although even better was 30 year Japanese government bonds, zero coupon bonds. And the worst again was commodities and commodity stocks. And that was the first five and the second five years of the last millennium.
In this millennium so far, the best things to own have been the mining stocks, the oil stocks and now we’ve been getting good action on the food stocks. And then, also the great dividend paying stocks have been coming on strong, the first five years of this millennium. Those groups will continue to outperform. Long-term bonds have done surprisingly well, but that’s because of the worst asset class, which is, of course, tech stocks. And we’re in the early stage of their triple waterfall crash so that’s not going to change.
The mining stocks, what has changed I think – and this is the concept that I really want you to understand – is that the market still looks on them as being momentum stocks where you must sell them on peak earnings and a single digit multiple is appropriate. So, for example, as recently as a week and a half ago, both Phelps Dodge and Inco were selling at eight to nine times earnings. Inco’s a little higher than that now, probably 10 to 10 ½ times earnings and Phelps Dodge is getting up there to maybe close to ten times earnings.
But what I heard from institutional investors in New York was that’s appropriate. Because these are deep cyclicals and they’re not entitled to high multiples on peak earnings. Well, what I want to do is emphasize that I believe the market is mis-pricing these stocks because it is using the performance of the last twenty-five years. Now ordinarily that’s a big enough database for anybody. Hell’s bells, Long Term Capital Management was able to attract billions and billions of dollars of investment from everybody including the bank of Italy on the basis of six years of data. So twenty five years should be enough.
Well, it isn’t. Not when you add something to the whole story. And the story is that they had a triple waterfall crash. It began along with the other commodities, it intensified once the Berlin Wall fell, which took away the only non-economic cyclical component of demand – namely military hardware – and it meant that the Soviet era mines, those gigantic mines, would now be dumping their stuff out on the world markets.
So, virtually the bottom was reached right after 9/11. And the reason for that of course was that we had a new war on. But they didn’t do much until the middle of ’03 and of course since then they’ve been sensational. With the fact that we had a four month pullback last year, we’ve more than made that up.
What I want to do is develop a new metric for these stocks. And the metric is this, that what drives the price of the industrial metals is not the GDP in the OECD countries, it is the net new middle class dwellings in the world. I’ll repeat that, the number of net new middle class dwellings in the world.
Because when you get a middle class dwelling, what you get is a housing unit that has indoor plumbing, electricity and basic appliances and in addition, a reasonable percentage that will continue to grow of those will be people who own cars.
That’s what creates demand for metals.
Once you’ve got all of that, then scrap becomes a big component of the whole demand for raw materials.
And so what we needed to create this kind of boom was two things. What we needed was to create demand for metal that would draw down existing inventories of both virgin metal and scrap. And then secondly what we had to have was a sustained growth component which was not tied just to a capital spending cycle or a sudden burst of economic growth, something that has a long-term component to it and we’ve got those features.
The scrap feature of this is something that I think requires some special comment. Because, you see, a lot of the problem that people have in evaluating reserves in the ground is that there’s a lumpiness as to what happens to a pickup in demand for the metal and what happens to the price of newly-mined metal. And a big part of that is because of the availability of scrap.
From talking to a client of ours who is a very major scrap dealer and who’s expert in dealing with the sales to Asia of different kinds of metal scrap – they’re very good at getting in to the landfill sites and separating them out – what’s really happened is that we have drawn down an amazing amount of scrap that has accumulated over a long period of time. That’s why we had the phenomenon that at one point last year, steel scrap was selling for what hot rolled coil had sold at a year before. And that’s almost unheard of.
The United States’ roughly second largest export to Asia is scrap, which includes steel scrap and various other kinds of metal scrap. The biggest volume export from the United States to Asia is used newspapers which is another form of scrap, you might say, but that’s a different kind of product.
My argument is this: not only have we run down the inventories on the London Metals Exchange, the Comex and the Shanghai Exchange of the industrial metals by something like 70% over the last two and a half years, but in addition, we have drawn down a significant amount of our scrap inventory.
Although we’ve had huge price increases for the industrial metals, this week alone, we saw highs dating back to the ‘80’s in some cases, for nickel, aluminum and copper and zinc. What we must realize is that we drew down massive inventories of metal and scrap. For example, we drew down the entire finished goods inventory of Norilsk, which is the world’s largest nickel producer, which is the old Alexander Solzhenitsyn mine of the Gulag.
Therefore, it is my view that if you assume a compounded growth rate going forward in China and India, then what we’ve done is we’ve not only used up the output of the existing mines, we’ve drawn down inventories that have been there that accumulated over quite a period of time, but we’ve also reduced to a degree that I can’t measure and probably nobody else can, the competition from scrap because scrap was so readily available for a while that a lot of that went out and competed with virgin metal.
This is all up against the obvious argument that I got from everybody, which is “Oh well, look, they’re going to be bringing all these new mines on, so forget it, this is peak earnings.”
Well, and everybody had pointed, particularly when I recommended Inco, to the fact that Inco’s bringing on Voisey’s Bay next year and Goro only a couple of years after that. Ha!
But Inco’s compounded growth rate of sales of nickel to China, has been about one third in percentage per year, since the new millennium began. Ha! I mean, we’re talking here of a situation, where if you take the new addition, you take the two Inco mines, the BHP mine, WMC and if you add in Falconbridge’s, what we’re still looking at is that as long as the OECD don’t go absolutely into the tank and as long as China and India keep growing and as long as they keep adding middle class units at a big rate - which includes such things as kitchen sinks, which means stainless steel and/or aluminum - then what we’ve got is a sustained growth in demand. And we’ve seen this before.
Because the consumption of metal in pounds per person that we’ve seen from both Taiwan and South Korea from the time that they both broke out, which is in the ’60’s in each case, is that although there’s big cyclical swings in the demand, it’s an upward curve that lasts through the cycles because of the big thing, which is the addition of new housing units. Which is not as cyclical, of course, as heavy industry or major capital spending booms, where you have tremendous demand for steel for construction, that kind of thing.
Who knows how many net new middle class housing units are being built in the world. Obviously I don’t have that statistic. But, what you can say is, that as you look at income growth in China and India and third world countries for that matter, is that a lot of that is going to be reflected in new housing units. And so, this is what I regard as the sustainable amount of demand.
Because when people point out that two years ago that 45% of Chinese GDP was capital spending and this last year it was down to maybe something like 35%, they say “Well that’s not going to be sustained, so therefore metal demand won’t be sustained.”
Well, that’s a good argument. But I’m much more interested in this compounded growth of dwellings. Because what that does mean is sustained growth. And China has certainly used up most of the scrap they have around. And whereas China used to be an exporter of zinc, obviously that’s changed, too, just because the growth in demand produces this swing factor. We saw that in oil, too, where the International Energy Agency was so far behind the curve on oil prices because they were still looking back to the Euro and China was an oil exporter. Amazing.
My argument, then, is that you should own these great companies, because if you add together the market capitalization of all the big publicly traded mining companies in the world – we’re looking at two dozen of them – they’ve got a combined market cap somewhere less than Microsoft and Cisco. And yet these are the companies that must somehow find, develop, mine and sell the basic ingredients required to create new members of the middle class in China and India, which is, by any reasonable estimates, we’re talking hundreds and hundreds of millions of people.
Now remember the big mining boom in the ‘50’s was the boom associated with the new middle class in North America and Europe after World War II and that was something on the order of 60 to 70 million people. And that produced a sustained mining boom that lasted for 15 years. This time it’s going to be immensely bigger, but we’ve harvested the low-hanging fruit and bringing on new mines is such a big job – yes there are some old mines that can be de-watered and that’s happening. But, I think we’re dealing with a situation where a long-term investor, that is somebody let’s say in their 60’s that is looking forward to retirement, should be considering that oil reserves in the ground in secure areas of the world (and how many times have you heard me use that expression) is an asset that will grow in value through each economic cycle.
Yes, if we have a recession, these prices are going to fall. But the stock market is going to fall anyway if we have a recession. So here you’ve got a stock group that is trading at something under 50% of the market multiple, which is tied to the most powerful economic growth force that we’re going to see in our lifetime, which is hundreds of millions of new middle class people on the march. That, to me, is a big, big concept.
Having developed that theme, which is developed in detail in Basic Points, let me just comment that the oil stocks have obviously just continued to soar ahead and set new records and I’m most pleased to see how well the oil sands stocks have done relative to the rest of the group. No change in my view there that it’s the concept of secure reserves in the ground.
And as for those who’ve been upset that Shell had to write down it’s Alberta oil sands properties held through Shell Canada because of this bizarre rule of the SEC, that is…Cambridge Energy Associates has written a proposal to the SEC, which is backed by Big Oil about the way to calculate the reserves.
But they use now this this amazing thing, what the price was for bitumen at year end. And because of the fire at Suncor, which meant that the supply of daluin(?) needed to get that gunk to flow into a pipeline, the price of bitumen collapsed in a matter of a few days. And the price of daluin sold far above the price of Saudi light.
So this was just a short-term event, but it meant that by the SEC rules, that Shell Canada had to write down its reserves as being uneconomic. That will get sorted out.
[Canadian budget discussion, changes in regulations allowing Canadians to invest a larger percentage of their assets outside the country.]
Market Data 
Markets 
AI
