The Race for Resources
Our friend Frank Holmes, U. S. Global Investors writes:
The world watched in awe as American swimmer Michael Phelps became the most decorated Olympian of all time. I’ve read he’s been training in the pool for an average of 6 hours a day, 6 days per week, which equates to about 30,000 hours since age 13 and about 10,000 calories burned during a training day. It’s inspiring to see the incredible results of his tremendous sacrifice and commitment.
Investing in global markets requires the same sort of stamina, especially at times like this week, when the month’s reading on the manufacturing industry was not encouraging.
However, I believe there are encouraging pockets of strength to energize and inspire investors.
For example, we’re coming up on the anniversary of the first stimulus move that kicked off the global easing cycle. On August 31, 2011, Brazil unexpectedly cut rates by 50 basis points, and since then, ISI says 228 stimulative monetary and fiscal policy moves have been initiated across several countries, including the Philippines, China, France, and Colombia.
In June and July alone, there were nearly 70 moves—the most since the world began this massive easing.
Generally, by the time central banks make a fiscal or monetary easing move, economic deterioration has already occurred. Even with these moves, it still takes several months for the stimulative measures to take effect and work their way through.
But while the world wades in the shallow end of the pool waiting for the economy to warm up, Asia has taken a deep dive into the energy space as they’ve recently announced acquisitions of Canadian resources companies.
In my presentations, I’ve discussed how resources companies have significantly underperformed their underlying commodities. During 2009 and most of 2010, the performance between oil and the S&P 500 Oil & Gas Exploration and Production Index was closely correlated. By the middle of 2011, oil and oil stocks started to separate, with crude continuing to rise while stocks deteriorated. Even with the recent drop in oil prices, oil stocks have continued to lag.
I’ve also discussed the strikingly similar trend occurring between gold and gold stocks. There’s been a spectacular pop in gold stocks recently, but it hasn’t been enough to catch up to gold’s performance.
The disparities mean that the cheapest resources are not found in the ground—they’re listed, and it’s been confirmed by recent energy company acquisitions.
Chinese oil company CNOOC put in a bid of $15 billion to purchase Canada’s Nexen. This was at a 61 percent premium to Nexen’s share price on July 20, according to Bloomberg. As you can see below, not only did the takeout announcement close the gap, now the company is outperforming the price of oil.
If CNOOC’s deal is approved, the state-run oil giant gets even bigger, gaining access to significant energy stores in several areas of the world, including Canada, the Gulf of Mexico, Colombia and West Africa, as shown below.
With a rapidly growing middle class and rising urbanization, Chinese leaders know they need to fill their country’s tremendous energy demands and are continually finding innovative ways to keep their country powered. CNOOC’s acquisition is one way China continues to acquire not only the resources needed to power the country, but also the technological innovations that come from countries with free markets and lower barriers to entry. According to The New York Times, China “has been garnering advanced production technologies to better draw oil and gas from nontraditional areas like deepwater fields and hardened rock formations.”
The other announcement came from Malaysia’s state-owned and natural-gas giant Petronas, which will purchase Canada’s Progress Energy Resources Corp. Petronas is one of the largest producers and shippers of supercooled LNG fuel in the world. According to the Vancouver Sun, the company is “anxious to increase its market share in Asia, where analysts expect demand to surge 75 percent by the end of the decade.”
After Petronas’ original bid was announced, Progress increased 74 percent—a record gain for the company, says Bloomberg. As shown below, Progress now dramatically outperforms the underlying commodity.
Ready to be a Buyer like Asia?
If you’re contrarian investor, there may be an additional reason to jump into the market today. According to research from J.P. Morgan, institutional investors have become extremely negative, as hedge funds “essentially short the market,” meaning that their expectation is that stocks will fall.
J.P. Morgan looked at the rolling 21-day beta of macro fund returns compared to the S&P 500 Index returns and found that the ratio is at an extreme level of -0.26. Research shows that the last two times the ratio fell this low—in September 2010 and February 2012—stocks rallied. In 2010, the S&P 500 climbed 26 percent in five months; in 2012, stocks rose 8 percent in two months.
These signs the market is sending out make it an especially attractive time to “mine” for investment opportunity. In July, we began to see energy stocks and oil get recharged, as the energy sector in the S&P 500 was the second best performer, increasing 4.17 percent and crude oil rose 3.68 percent. Unlike the start of an Olympic race, in investing, there isn’t a signal sounded to let you know when to dive off the starting block into the markets. Just make sure your portfolio is poised to participate in the race for resources.
USGI also included these comments on the gold market:
Strengths
- Central bank buying of gold continues to be a strong theme. This week the Bank of Korea, which has the world’s seventh biggest foreign exchange reserves, announced it had purchased 16 metric tons of gold last month, increasing reserves to 70.4 tons. Central banks and the International Monetary Fund (IMF) are the largest bullion owners with 29,500 tons at the end of last year, or 17 percent of all mined metal, World Gold Council data shows. Central banks have been net buyers for two straight years, the Council said. Purchases this year will probably exceed the 456 tons added in 2011, the Council estimates.
- Although gold was down for the week we think the price action was positive. Gold was down somewhat when the strong ADP jobs number came out on Wednesday morning, and then gold initially declined further after Federal Reserve Chairman Ben Bernanke held off on announcing new stimulus measures. The selloff did not last long before buyers came back in and scooped up the metal. The simplistic trade of shorting gold on no new Bernanke announcement for another round of quantitative easing has become quite crowded.
- Although global gold mine production has fallen -2.9 percent year-to-date and has registered year-over-year declines for eight months running may sound like bad news, and it has been for certain gold producers, this is certainly a positive for those companies that have maintained or grown their production. Despite the 11 years of consecutively higher gold prices, gold production has been flat and this should bode well for higher prices in the future.
Weaknesses
- Kinross Gold replaced CEO Tye Burt this week. This is the second senior gold company CEO to have been removed by their boards in the past month. The replacement CEO is J. Paul Rollinson, a long-time associate of Mr. Burt. Mr. Rollinson is also a former investment banker, with a geology and engineering background. In general, analysts lamented that they would have preferred a high profile manager with a proven track record of operating and/or building mines and/or turning companies around.
- Standard & Poor’s has downgraded Barrick Gold from “A-” to “BBB+” with a negative outlook. The rating agency’s negative outlook on Barrick “reflects our view that the execution risks surrounding Pascua-Lama could potentially stretch the company’s credit measures and free operation cash flow generation beyond the levels we have assumed within our base case scenario.”
- The Indian market is still seeing no relief as the rupee remains weak, the arrival of the monsoon season has been disappointing and the multi-state electric grid collapse last week caused widespread blackouts across the region, obviously curtailing near-term economic activity.
Opportunities
- Nick Holland, CEO of Goldfields Ltd., recently addressed the Melbourne Mining Club and covered a 35-page presentation surveying all the things that gold miners have been getting wrong over the last decade and offering a few ways to solve some of them. Nick Holland pointed out that one theme has run through the presentations of large gold producers at investor conferences over the last 15 years is that production is going to increase and this will result in the company increasing its earnings. Nick notes that if the gold industry had actually met all its production promises over the last five years, then it would not have dropped output on a compound annual basis by 2 percent between 2006 and 2011. Unfortunately gold miners have not met their production promises and investors have become skeptical.
- Nick also highlighted that gold miners need to think differently about costs. “Who are we trying to kid? We don’t kid the investors because they know how much cash we really generate after everything is accounted for. The sell-side also understands this. The only people we’re kidding are governments and communities, who, not surprisingly, say, okay, you’re making super profits, please pay up. And before we know it we have windfall taxes, higher royalties and so on. We’ve got to change the lens through which we and the world view this industry, and start talking about what it really costs to produce an ounce of gold. I don’t care if we call it NCE or something else, but to talk about cash costs only is not telling the full story.” We view this type of examination of the industry as a strong positive for management to take full notice of a nd start delivering on what the investor is expecting from gold mining companies.
- Bank of America Merrill Lynch noted that while the Federal Open Market Committee (FOMC) did not take any easing action at its current meeting, under its forecast, the economic data should weaken enough by the September 13 FOMC meeting to convince most Fed officials to support more QE and extend the forward guidance then. But the call on further Fed easing remains very dependent on the path of incoming data. We think only a small portion of recent gold buyers entered with the expectation of a Fed move this week but it is more likely a greater number are looking toward the Jackson Hole meeting at the end of August, and then the September FOMC meeting as key entry points into the gold market.
Threats
- While most governments are outright buyers of gold, Vietnam’s government has a different view on gold. The problem is nobody wants to use their local currency, the dong but instead more and more rely on gold to settle transactions. The Vietnamese people have a huge affinity with gold, but the country’s government is taking major steps to restrict the gold market and the practice of replacing the dong with gold in transactions. These restrictions included banning gold as a medium of exchange and issuing seven directives which are designed to reduce “goldization” the practice of replacing the dong with gold in transactions.
- David Rosenberg, of Gluskin Shelf, pointed out that U.S. investors withdrew a net $11.5 billion out of equity funds in the prior week according to the Lipper data that includes ETFs, the sharpest outflow in two years. Taxable bond funds attracted over $3 billion and that brings the year-to-date tally to $151 billion as the secular shift in investor behavior towards income-generation continues apace.
Baby boomer investors looking forward to retirement have been burned by the tech bubble, the housing boom and ensuing credit crisis. Much of the shift in money flows has been to extreme risk aversion and government bonds have been the choice for the safety. Unfortunately, the market has the uncanny ability to move in a direction that will disappoint the most investors. It is unlikely, given the rising debt burden of governments, that the masses will be rewarded for seeking safety in bonds for the next five years. Under owned assets which are out of favor, such as gold, deserve some consideration for portfolio diversification.
August 3, 2012 (Source: U. S. Global Investors)
