Super Cycle Caveats

This story features BHP GROUP LIMITED, and other companies. For more info SHARE ANALYSIS: BHP

This story was first sent out as an email to paying subscribers on Monday.

By Rudi Filapek-Vandyck, editor FNArena

There is no such thing as a Commodities Super Cycle.

This may look like an odd statement to make, especially since Commodities Super Cycle has become one of the most often used terms in financial media reports and stockbroker research, so allow me to explain.

At around the time that the internet and technology boom was peaking, and the twentieth century morphed into the second millennium, it had started to dawn on some economists and financial markets specialists that a new era for basic materials was about to commence. It would still take a few years, until the second quarter of 2004 to be precise, before financial markets genuinely, and gradually, started picking up on the new trend.

I still vividly remember the public discussion, back in late 2003, whether BHP Billiton ((BHP)) shares at $9 were an absolute steal, or not.

Asia was awakening. A new middle class was rising. Soon the world would change forever. To summarise all that was happening into one simple catch phrase someone came up with Super Cycle, the Commodities Super Cycle, and the world ran away with the concept.

So far, so good. The same BHP Billiton is currently among the most profitable companies in the world and its shares have risen as high as $50 since then, while loyal shareholders in Rio Tinto ((RIO)) have equally seen the value of their shares that were on offer at $32 back in 2004 rise to as high as $150 earlier this year.

Both companies, if not merged into one entity sometime next year, should be looking forward to another year of strong profit growth, something potentially in the order of 80-90% (depending on whose forecasts one relies upon). This while most other listed companies, be they banks, insurance companies, technology service providers or internet ad sellers, seem happy if they’d manage to grow their profits for shareholders by single digits, low double digits at the most.

Surely, what we are experiencing here is the true meaning of Commodities Super Cycle. And it’s going to last “forever” if we can rely on insights from the likes of local Aussie mining legend Owen Hegarty, or at least for another 15-20 years were we to rely on the forecasts by world famous George Soros and others.

But look deeper and what you will find is that generalisations usually don’t work, and commodities are no different. When it comes to investing -longer term or shorter term- jumping on board of the general concept of the Commodities Super Cycle, without paying attention to the defining details, seems but a guaranteed recipe for financial disaster. To put it in a simple manner: it is easy to translate Super Cycle into Super Investment Losses. In fact, it is so damn easy that many thousands of investors have already shown you how to do it.

Here are a few examples.

In early 2006 shares of Australia’s pre-eminent aluminium company, Alumina Ltd ((AWC)), rose to nearly $8. They subsequently fell but bounced quickly back to $8 again in the second quarter. After that, the shares spent most time trading below $7, until a strong surge in the first half of last year took them to nearly $9. After that it was down, down, down to below $4, with one intermediate spike in May-June this year. Whatever the amount of money you would have invested at the wrong timing in 2006, it would have mostly brought you headaches, and financial losses.

Not everyone bought Paladin ((PDN)) shares below $1. In the second quarter of 2006 Paladin shares surged to $5. More than two years later, that’s where they still are. In between they surged above $10 -twice- in the first half of 2007; but let’s not even go there, if you bought Paladin shares two years ago on the premise that it looked like a very promising long term investment, your only consolation today would be that at least your investment decision hasn’t cost you anything (the company doesn’t pay out any dividends).

There are many, many such examples without having to mention companies that effectively ran into serious problems, such as Minara Resources ((MRE)) whose share price has collapsed from highs above $7 (last price $1.55).

Super Cycle? What Super Cycle?

How can we rhyme this with the examples of BHP Billiton and Rio Tinto previously?

If you look closely at what has happened over the past five years, you’ll instantly agree with me there’s no such thing as one Super Cycle for All Commodities. Well, there is, if one takes into account all nuances that come with the concept, but this does still not imply boom time for all commodities at the very same moment.

What is being painted as one big, long lasting boom for all commodities is in fact an amalgamation of non-parrallel, non-interlinked smaller cycli for certain sets of inter-connected base materials. The early years were predominantly base and precious metals driven, but significant shifts in momentum have subsequently created significant differences in between what we tend to cluster together as “commodities”.

But if the past five years have shown us anything it is that there seems to be a general pattern in how each of these individual commodities tends to go through their own cycle. First a commodity is being pulled out of hibernation, followed by a strong price build up; what comes next is a temporary phase of investor euphoria; then the bubble quickly deflates, with prices falling deeper than anyone thought they would. After all that, a more gradual growth pattern seems to kick in, much more subdued than what we saw in the earlier phases, prior to the peak.

Observation number one to make is that even after the price correction/deflation the price remains at a multiple of what used to be standard during the hibernation period – this is why the term Super Cycle seems appropriate. (Think nickel, zinc, lead, but also uranium).

Observation number two is that share markets are quick in pricing in peak prices into share prices, with the result that timing is key for anyone looking to financially benefit from the commodities investment theme. This holds even true when one sticks to juggermauts such as BHP Billiton and Rio Tinto. An example: BHP Billiton shares have now twice peaked at $50. The first time was about one year ago. If you’d had bought at that time, even when convincing yourself you were in this game for the longer term, today you would still be sitting on more than 10% in paper losses, dividends recieved over the period not included (and not once did you have the chance to sell at a higher price, or even close to your purchase price, until briefly in May).

Now you know why shares of BHP Billiton have risen back above $40 (and Rio Tinto back above $120) – while there is always an element of big (= safer) versus small (= riskier), the recent results season has reminded investors the pendulum inside the commodities spectrum left base and precious metals a while ago already and has swung towards energy and bulk commodities this year. And quite decisively so.

BHP Billiton and Rio Tinto are both riding the wave of big price increases for bulk commodities. Their strong growth profile -takeover or no takeover- for the current year seems all but guaranteed. And BHP has the luxury of also having direct exposure to the other leader in the sector this year: crude oil.

However, if history is our guide, these new leaders in the commodities universe will at some point equally reach their peak, and subsequently correct, and then a much more moderate growth rhythm seems to be following next.

Just as an example: we all know that analyst price forecasts are just that, forecasts, but they can nevertheless serve as a guide. After one more year of significant growth, current forecasts anticipate growth is likely to remain strong but will nevertheless moderate in the year thereafter. The following year (two years from now) could see negative growth.

Bottom line: nothing lasts forever, not even in a Commodities Super Cycle (which is not what you thought it was). Better enjoy it as long as you can.

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