Thank you all for tuning in to the call which comes to you from Chicago. As we said, this call will primarily be focusing on reflections on the BMO Nesbitt Burns Global Resources Conference for 2005, which was in Florida over the weekend and through Wednesday. When I look at my screen today, you might conclude that everybody who attended that conference who is an investor, had rushed back to their desk and put in massive buy orders for base metal stocks.
It’s a little more complicated than that, but let me, sort of, just stream of consciousness-wise talk to you about what came across to me in my three and a half days at the conference.
First of all, this has been the biggest. There were 700 people there, way up from previous years. Virtually every mining company of significance in the world was represented. It was an amazing conference.
I was told by executives of the mining companies that this is now one of two events in the world that they try to attend…it’s on that scale. So my congratulations to the people at Nesbitt Burns research and investment banking who put this conference together.
The first thing that comes out of it is that notwithstanding the fact that they were a happy bunch, this was not a conference of runaway wildness and enthusiasm. I think I kept my status as the most optimistic speaker at the conference and probably by a pretty wide margin. I’ve been that way for four years at these conferences.
I still am of the view that the mining industry, that is, the producing mines, the big ones, are still a cautious bunch. They’re still using, in their internal forecasts and in the analysis of the value of orebodies, numbers like 3.50 for nickel and eighty-five cents for copper. Nickel today is seven dollars and forty-two cents and copper is trading at 149.80.
I’d also to address the point that Sherry Cooper made in the morning notes today about the excitement and about how she’s having people stopping her at airports to ask what she thinks of commodities and referring to Jim Rogers’ book. A little personal background there…Jim Rogers and I spoke together in Chicago in the mid-90’s. And he was telling everyone in the audience to rush out and buy commodities. I took the exactly opposite view, I said that there would be a day for commodities, but not yet.
So, what Jim Rogers has written in his book is pretty much what he’s believed throughout, that there was going to be this shortage, but I felt that we were still in the triple-waterfall collapse of commodities and that the base metals and precious metals were going to still reach lower and lower lows. I didn’t turn bullish on the group until 2001, 2002. And so, I congratulate Jim Rogers on once again showing his ability to make a lot of money on something, not only of the commodities but on a book.
But I would like to sort of distinguish myself on this by saying that this is a very different rationale than the one that we had in the Seventies and early Eighties and that Jim is one of those few survivors from that period. Most of those who had those kinds of views got wiped out.
What we have still is a pretty cautious crowd, in general, among the major companies. Remember my maxim, that the best investment opportunities come from an asset class where those who know it best, love it least because they’ve been disappointed most.
That is one of the reasons why we’re still looking at a situation where stocks such as Inco and Phelps Dodge are trading at single digit earnings multiples. You will know that we have a mania when those stocks start trading close to the multiple in the broad market. At the moment, what we have is although the stocks have soared as much as they have, the earnings have done better. So they’re cheaper now than they were.
Now this isn’t true of all of them. BHP Billiton, which you’ve heard me speaking about for three years now, almost every month, at thirty dollars and a half is starting to trade up towards a mid-teens multiple. Although that is a multiple we’re going to have to adjust because with the iron ore contracts they’ve signed and with the prices for the metals that they produce and with the huge returns they’re getting out of oil and gas, I think it will turn out that their multiple will be back down towards the 11 or 12 range. Still well above that of some of the other major companies.
Let’s distinguish enthusiasm from mania. Enthusiasm is simply…if we’re going to have a triple waterfall for this group and I don’t believe we’ll have it, we’re still at Stage One, which is the Enthusiasm Stage. This is where tech stocks were in 1994. By then they were already attracting a following because great things were happening as it became apparent that everybody was now going to have a PC. After all, it was as recently as 1978 where the President of Digital Equipment said that he didn’t see a market for more than 60 home computers in the United States. And Olson was regarded as one of the great giants of the industry.
That caution was starting to go away by 1994. 1991, Intel had a multiple of eleven times earnings, they’ve had 71 as its multiple at the peak of the mania but by 1994 it was still a teens multiple.
So, let’s distinguish the enthusiasm…and there’s three phases up in a triple waterfall: enthusiasm, faith and fanaticism. I would put this the equivalent of the enthusiasm stage in the NASDAQ type tradition or the Japanese stock market. To put that into perspective then, I would put this back…NASDAQ was 900 back then. Still up substantially, but it had a long, long way to run.
Now I don’t think we’re ever going to have another triple waterfall like that one. So I’m not suggesting that this implies that Inco is going to trade at 60 times earnings. But we still have a situation where a substantial proportion of all the believers were actually in attendance at the conference, in terms of investors. That’s why so many of the faces were familiar and so many of them are people who tune in to this call.
We are a minority group. I can tell you this after my week speaking with institutional investors in Manhattan, that there is still a lack of enthusiasm in the sense, or anything really extreme at all for the base metals or even for the oils for that matter.
Part of it is because of the demography of the business. You have two kinds of investors. Those who believed in these stocks and got beaten up…and they’re people like me with some grey…and then young people who never knew in the Eighties and Nineties a good time to invest in them and they learned all about technology stocks and they all owned Blackberries and so for them these are faintly speculative, somewhat dubious companies.
I, for example, at more than half of my meetings in Manhattan, met people who didn’t know about the Alberta oil sands companies. They knew of Suncor but they didn’t know there was anything else. Now that has been rectified to some extent, but I don’t want you to believe that just because you’re seeing Inco trading at 42 and 3/4 now and Freeport McMoran up close to 43 and Phelps Dodge, 107.90 that what we’ve got here is a top.
For a top, what you have to have is not just a lot of enthusiasm and a lot of commentary and being stopped for discussion. But, what you’ve got to have is a valuation which is way out of whack. What we still have is The Street is using very low commodity prices for the various forecasts. So, therefore what we don’t have is a situation…if, for example, we had a forecast for the oil stocks based on $50 oil, and that was The Street consensus, then you could well make the case that that was a near-term top. Nobody’s using those numbers.
Similarly, in the case of the mining stocks, if we had a situation where people were using $8 nickel and $1.75 copper in their forecasts, then it would be time to take some money off the table. But that’s not the case, the figures that are being used for nickel are down around five bucks and in the case of copper down around 1.10, 1.20.
These stocks are actually cheaper and that’s the point…if there’s nothing else you understand from this call, you mustn’t think that just because I spent three and a half days with miners and investors in mines who have enthusiasm for the stocks, this is after two decades of decline and disappointment. What we’re still at is the stage of the relief rally which is “Hey, it isn’t going to get worse suddenly as it did”.
And to show that, we take Inco, which, as we opened the conference, was trading at about ten times what it would earn without it’s two new huge mines that it’s bringing on in the next two years, Voisey’s Bay and Goro. In other words, the market was assigning a zero value to what will prove to be the most profitable nickel mines in the world. One of which will be starting to come on stream later this year and the other will start the following year, so we’re not talking about something off in the future, nor are we talking about something that’s going to flood the market with nickel.
Inco’s sales to China of nickel last year were up 34%...that’s an improvement! They were up 32% to China the year before that. The inventories of all the base metals are at low levels. Scott Hand of Inco simply said there will not be enough nickel from all sources that is scrap and newly mined metal and drawdowns of inventories to meet the demand this year.
Next, I would like to address the question “Yeah, but what happens if there’s a recession?” And indeed, if there’s a recession, these stocks are going to get hurt and the prices of metals are going to fall and the price of oil is going to fall. But what you actually have if you own the oil stocks and the mining stocks here, is a low P/E investment in global growth, a huge discount to the P/E in the rest of the stock market. And if you think the Dow will be selling at 10,900 with a global recession and that therefore the mining and oil stocks are too risky, well, first of all I doubt you’re tuned in on this call. But, to me, what you’ve got to say is that to the extent that you are invested in a broad market portfolio, you are making a bet that the recession isn’t going to come up in a heck of a hurry. Otherwise, what you do is have a lot of cash, you’d have a lot of gold mining stocks and you’d have stocks that are there only for their dividends, the great dividend paying stocks.
Now that kind of portfolio is justifiable, but I believe strongly that you should compare the mining and oil stocks to the broad stock market, where even most of the financials are going to get hurt if we have a global recession. And they will trade probably only on their dividends.
So, yes, these stocks are much more levered to economic growth than other sectors of the market, but if we’re going to have a global recession coming up here, we’re going to have wipeouts in a lot of industrial companies. I still regard them as the cheap way to stay invested for where the growth is, which is lead by Asia, and you can avoid, then, the pitfalls of direct investment there.
The Chinese stock market is a disaster area. If you look what’s happened to it since the new millennium began, what you would figure is that China’s been torn apart by civil war. And yet this has been the engine of global economic growth. So, what you do when you buy an Inco, a Phelps Dodge, a Freeport McMoran, a CVRD, a Noranda, an Alcoa, an Alcan, a Rio Tinto, a BHP, what you do is you get a call on growth in India and China, China primarily.
Because, what do they sell directly to them, the price of their products is in effect set at the margin by the burgeoning growth in that part of the world.
So, you get to invest in the safe parts of the world, in terms of where the stocks are listed and their management practices and you get to have a tie to the fast growth area of the world without taking the kinds of risks in unattractive stock markets in terms of governance and all those things.
Separating out which are the most attractive companies is not the function of these calls. All that I’ll tell you is that this was – in terms of enthusiasm level – it was the base metals that predominated, although some of the gold mining companies had really fine stories about what new mines they’re going to be bringing on and that they’ve got their hedge books under better control. In other words, the gold stocks as a group, which have really underperformed over the last 12 months, are looking much better valued now than they did at this time a year ago.
Now, of course what’s held them back has been the fact that the Dollar which had been falling, started rallying at year end and rallied very strongly through January. And that banged down the price of gold and it really hurt the gold mining stocks.
Well we’re getting a bit of a slump in the Dollar today and we’ve got the Canadian dollar back up over eighty-one cents. What happened to the Canadian dollar was not only the fact that the US Dollar was stronger, but there was almost a panic reaction to the Federal budget in Canada which took the barriers off for pension funds and RRSPs to invest outside Canada. And there was a feeling that this was going to lead to a massive capital flight. Well, to me a massive capital flight from Canada right now would be the second stupidest thing to come out of Canada this year. The first of course was the decision of the government to double-cross the US on missile defense.
But, for Canadians to dump their money out of the country now, just because they can do it, given the attractions of the Canadian stocks and Canadian bonds relative to US stocks and US bonds, this would be poor timing, to put it mildly.
On balance then, what I think is that the near-term excitement in the resources area is going to become concentrated in the oils. The oil sands stocks are certainly now starting to get the kind of attention that I’d have liked to seen from them some time ago. Within the mining group, it looks like all the metals now can share in it.
The aluminums had a pretty sad year, Alcan and Alcoa, compared to the nickels and the coppers and the zincs. But the story that we got from Alcan and Alcoa – now these are big, big companies that do more than just haul stuff out of the ground. After all, the real value of bauxite is tiny in relation to what a ton of aluminum sells for. Aluminum is, as I’ve told you for the fifteen years I’ve been doing these calls, is congealed electricity. So therefore, it’s the energy cost that goes into it which is the key item in aluminum pricing, not the raw bauxite.
The metals that have done best for you as investments are those where they are metals that are contained in sulphide and lateritic deposits and it’s simply a matter of digging them out of the ground, crushing them and smelting them.
I heard presentations by and read presentations by dozens of smaller mining companies and this is reassuring to me. We’re going to get a speculative market in small-cap mining stocks – it’s already bubbling in Canada – but again, I look on this as the early phase. This is the equivalent, going back to the Fifties, of what was happening in 1950 and 1951, but that didn’t peak out until ’56.
So, again, the fact that there’s more enthusiasm here, remember, that we were down to a stage where the only people left who followed the mining stocks were people who were either the Jimmy Rogers of this world who said “They’re going to come back sometime and when they do I’m going to make it big” and congratulations to them for keeping the faith, or they were people who had to be in them, just because they were big institutions, Canadian institutions that had to have exposure. Or they were people who said “Things have gotten so bad, they can’t get any worse.” One of the things you learn in a triple waterfall is, one of the most dangerous of maxims is to say “Things are so bad, they can’t get worse.” It doesn’t work out that way.
I still regard these as groups for increased emphasis within your portfolios and I’m particularly impressed by companies that are diversifying their production out of high currency countries of the world – Australia and South Africa. South Africa in particular, and Canada to a lesser degree.
The irony here is that, in the case of Phelps Dodge, what you’ve got is so much production in the Dollar zone so that it’s winning in every possible direction and the stock is reflecting it.
The iron ore story is truly amazing. During this last week, we’ve had three sales of iron ore, long-term sales contracts, two to Nippon Steel and one to Ostinor [?] in Luxembourg where 71½% price increases are priced in.
This is quite remarkable and I guess one of the things I’m going to be looking at over the next month for the next Basic Points is the thought: at what point does $49 or $50 oil, $1.50 copper, $7 nickel and $75 iron ore create inflation? I would say the only one of those that I think could start triggering something, at the moment, would be the iron ore component because it’s tied in with the gigantic increases for coking coal. Fording Canadian Coal Trust comes up every day on the market down here as one of the hottest stocks.
So if you’ve got a combination of coking coal plus iron ore and scrap prices strong; steel is so ubiquitous whereas nickel and copper are not big items so we may finally start to see some inflationary impact here. You notice I’ve left out oil out of this and the reason I have is because we’ve managed to have the huge part of the move which is from 30 to 50 without inflation coming back and maybe it’s just a delayed response and maybe I should be skeptical about the new consensus, which is that high oil prices are disinflationary, but anyway, we’ve dodged a bullet of massive size, actually, almost a nuclear bomb effect, on the markets, without seeing significant returns of inflation.
So maybe what we need in order to create inflation psychology is the addition of these other things that people haven’t focused on. After all, coffee rose last year in price more than oil. It was only when Starbucks announced a price increase that a lot of people noticed it.
Put it all together before the question period, this conference was a sign of an industry which is coming back but doesn’t quite believe it yet. Yes it’s being more aggressive, but it’s being cautious and the kinds of people that are running these companies now are people who are not going to bet the shareholders bucks on big new mines until they see that this is not a short cycle. One of the biggest companies there distributed a chart which showed that we were at a peak for metal prices, using an historic chart.
So that kind of thinking, as long as it’s around, makes me very confident. That’s it. Questions?
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