Commodities | May 26 2006
By Chris Shaw (Tokyo)
The last few days of volatility in commodity markets has caused a number of investors to lose faith in the commodity story, but giving up on commodities could prove a costly mistake in the view of Andrew Garthwaite, equity research analyst at Credit Suisse Investment Banking in London.
Speaking in the broker’s e-magazine, Garthwaite notes the focus continues to be on mining companies in the resources sector and oil producers as against oil explorers, though the preference is for the mining sector compared to oils.
Garthwaite further explains the preference is for mining companies compared to actual commodities thanks to a number of factors, one being they are relatively cheap given the average for mining companies is a reserve life of two to three times their P/E ratio.
Additionally, actual commodity prices are well in excess of the prices used to calculate earnings in broker models, so even if there was a pullback in prices for the metals earnings are unlikely to be impacted significantly. As an example Garthwaite points to the copper market, where he suggests copper stocks are discounting the copper price down to US$3,000/t, when the physical price is closer to US$8,000/t.
Even assuming current prices are not sustainable he expects average prices should remain high, as for commodity prices to weaken significantly he estimates global industrial production would have to decline to below 2% compared to more than 7% currently.
He also discounts the supply side response argument, pointing out delivery problems, labour disputes, high depletion rates and the high cost of new production mean the supply response may only be about half of what is expected in the zinc and copper markets.
In response to the commodities bubble scenario Garthwaite points out inventory positions for a number of metals remain quite low, while speculative positions in the copper market are still net short, which indicates it is as much fundamentals as speculative buying that has helped drive prices.
Zinc and copper remain his preferred picks among the base metals sector, while he likes platinum in the precious metals.