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ยป What a volatile few weeks for the resource sector
Date published: 21/05/2011
What a volatile few weeks for the resource sector
Prices for many commodities suffered the worst few weeks in recent memory with oil prices falling below $US100 per barrel, gold falling below $1500 per ounce and silver plunging to $35/oz – although prices have since recovered somewhat. Corrections like these are always opportune times for us to put market movements into perspective.
The shakeout has taken a particular toll on smaller-cap holdings. This is understandable, given the flight from risk by investors at times like this. It’s important however to bear in mind that investment selections should be based on a longer-term strategic viewpoint. This means an acknowledgement of underlying market volatility, without being distracted by it.
The important thing is to always take a deep breath, take a step back and put these sorts of market movements into perspective. Given the market’s extraordinary recent strength, as highlighted by the performance of silver compared to gold above (up 114% over the past year), correction was understandable, inevitable and in most respects a good thing.
We’ve seen a lot of speculative “hot” money in the commodity space over recent times, piggy-backing on strong sector fundamentals.
Some claimed commodity prices have been fuelled solely by this speculative money, which is incorrect. The sound fundamentals for commodities in terms of strengthening demand and supply-side challenges are what has driven commodity prices for the past decade, and will continue to do so for the next decade.
Don’t be fooled by the sudden influxes and withdrawals of speculative money from the resource sector. Speculators have seen the opportunity to profit from one of the greatest economic expansions in history, which has provided fertile ground for sizeable swings in commodity prices.
Silver was one of the best (or worst) examples, with the precious metal rallying by almost 80% from its low in late January to its recent peak in late April, a period of just three months! Clearly this was unsustainable and something had to give.
I stated earlier this year that “whilst we’re hugely positive on gold and as a consequence silver, we’re not as wildly bullish on price as some of the silver pundits out there. Price calls of $US400 per ounce in the near future by some wild silver bulls are quite ludicrous and impossible to justify, merely setting some investors up for inevitable disappointment.”
We’ve seen an almost immediate rebound in commodity markets, although I suspect a full recovery to pre-correction levels might take a few months to materialise. I expect investors to most likely take a breather for the next few months, after taking some profits off the table. The northern hemisphere summer is typically a quiet period for commodities, so I anticipate a solid recovery during the second half of 2011.
It’s important to bear in mind that very little has changed in terms of the long-term bull case for commodities. The issues specifically comprise US debt woes that are fanning inflation, emerging markets consuming more in terms of raw materials and energy, and supply-side concerns that put a big question mark over our capacity to keep up with burgeoning demand.
I’m sure that in a few months time we’ll look back and see the correction of the past few weeks as a great buying opportunity.
For a better perspective on the real state of play in the resource space, we can look past the volatility in precious and base metals and focus on what’s been happening in the bulk commodity sector. Interestingly, iron ore and coal have done a superb job of weathering the recent commodity downturn.
A study of the bulk commodities also helps dispel the myth that it’s been fund buying that has inflated the cost of commodities over the past decade. The two largest increases in average prices from 2001 to 2010 were in non-exchange traded commodities, iron ore and coking coal, with gains of more than 560% and 400% respectively, according to independent data provided by Bloomberg. By comparison, the three weakest performers were exchange-traded metals palladium, aluminum and zinc.
Some of our resource sector heavyweights are very attractively priced at present with BHP and Rio Tinto trading at around 12 times historic earnings. Given these companies have a significant component of earnings certainty, with a large chunk of earnings comprised of bulk commodities (iron ore and coal) that haven’t really eased in price, they represent great value. Given debt levels are also modest, these stocks are financially secure.
I was recently interviewed by both Bloomberg TV and CNBC TV with respect to my views on the outlook for commodities. One of the questions I was asked related to a commentator that compared the current situation with respect to commodities to that of the dot-com crash.
I pointed out the two scenarios were entirely different, with the current commodity boom based on sound fundamentals related to continuing and inevitable world growth, whereas the dot-com boom involved companies and business models built on the shakiest of foundations (if any foundations actually existed in the first place).
It’s a matter of keeping everything in perspective.
For more information, or to discuss your specific situation, please contact me directly.
Gavin Wendt
Founding Director & Senior Resource Analyst
MineLife Pty Ltd
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