Rudi's View | Nov 07 2012
By Rudi Filapek-Vandyck, Editor FNArena
Legendary investor Jim Rogers is now an old man who likes to chat about the joys of two growing up daughters and about his adventures when he was traveling around the world, twice; once on a motorbike and once with a modified beaming yellow sports car.
But when Rogers shows up at investing or mining conferences, the audience is more anxious to hear about his views and predictions for the world, for opportunities and investments and, most likely, for investment opportunities in commodities.
After decades of (literally) fame and fortune, Rogers' all-encompassing view today comes down to one simple, straightforward prediction: global governments have become addicted to the apparent virtues of their money printing presses; they will use it more and more, and more, and more.
It's the ultimate political heaven: in the short term it looks like all evils and wrongs are being dealt with, while the real effects won't be known for a much longer time but by then, such is the dynamic of democratic government, there will likely be another government in power instead.
Rogers' active investment career spans many decades, during which he became a wealthy man. Yet, today, he does not own one single government bond, not one single share on a stock exchange and no investments in real estate. He put all his money in commodities. He never sells, only wants to buy more.
Because of his macro-view, Rogers is convinced the last investment asset left standing will be hard assets; commodities. Under a worst case scenario, he believes, commodities will lose less of their value than shares and bonds and paper currencies and properties. Under a best case scenario, commodities are yet to experience a genuine rampant investment bubble.
Guaranteed outperformance, that's how Rogers sees it. Both his daughters speak fluent Mandarin and already have their own investment portfolio which contains of -you guessed it- 100% investments in commodities.
Rogers admits he also has some shorter-term positions in a handful of currencies, but only for a limited time. Ultimately, he believes, all paper currencies will suffer from the loss in confidence that will come, at some point during this process.
For investors looking to build up their own commodities investment portfolio, Rogers has one piece of advice: pick the five that are the furthest away from their all-time peak in price. Then start your research. Pick the three that are most likely to move back up again.
His current favourite is sugar. Do you know sugar is currently priced some 75% below its all-time peak from the 1970s, he lectured the audience at a recent mining conference in Singapore. And guess what's in the pockets of his jacket: a silver coin, a few gold coins and a handful of sugar sachets from the coffee table in the back of the room.
Take a few for yourself, he tells the audience. It's free!
Rogers' tongue-in-cheek investment advice lays bare the counter-intuitive truth behind successful investing in commodities: big profits are made from bottoms but most investors only get interested closer to the top.
When asked about his most favourite country to invest in, again that same base principle stands out as Rogers names Myanmar in Asia and Angola in Africa. The first one is a 70 million population in a resource-rich country previously known as Burma, that has for decades been isolated from the rest of the world because of a ruthless military dictatorship. The second is a former war-torn ex-Portuguese colony rich in oil and gas reserves, plus largely unknown quantities of metals and minerals. And oh yes, he likes North Korea too (big changes coming, he predicts).
Most investors are lured into the world of commodities via promises of strong demand growth. Taking guidance from the demand side can seem lucrative for short time-spans, but it has proved an ill-guided strategy for longer term horizons. Aluminium is an excellent example with strong demand growth in years past anticipated to be followed by ongoing strong demand in the years ahead, yet the price has hardly moved if we exclude the daily and seasonal volatility that is very much typical for commodities and worse; expectations are for relatively stable price averages in years ahead.
On the other end of the spectrum we find a thinly traded metal such as tin for which annual demand grows by no more than 2%, yet many experts continue to list tin near the top of their lists of sector favourites. Nobody favours aluminium over tin.
The enigma that is the price outlook for commodities is tightly intertwined with the supply side for each particular base material. Supply is not the only factor in the game, but it certainly has proved a more reliable indicator than any other factor over the years past. Global supply of aluminium remains abundant with China the key culprit while supply for tin continues to lag, easily explaining the differences in price outlook.
The (in)ability of the supply side to catch up with demand, growing strongly or not, is the reason why price action for commodities has diverged so much post the initial China rallies of some eight years ago. With all that talk about a Super Cycle and with mathematical models pointing towards truly mind-boggling statistics, investors were excused for thinking this was going to be a long-stretched uptrend of unprecedented proportions, but we have already seen the downside and it has caused quite some havoc for investment returns and asset portfolios the world around.
The euphoria from years ago is now gone, but what exactly does this mean? Gradually lower prices? Sharp price falls ahead? Mean-reversion to longer term averages? A multi-year sideways trend? One final blow-off top? Surely with the unprecedented rise of a new middle class in Asia, this time the underlying dynamic for commodities has to be one of this time really, it's not going to be simply the same as every single precedent from the past?
In my personal view, we will continue to see "accordion moves" for prices of commodities as demand and supply dynamics will continue to push markets into revolving deficits and surpluses. This will make price movements less universal and more market-specific. It will likely also translate into shorter-sharper price cycles in general.
Ultimately, it's best to view commodities through cycles of feast and famine, whereby each phase provides the fertile grounds for the opposite phase to follow next. During times of feast, high prices invite more investments and ultimately all that new supply will push the market into surplus thus causing a new period of famine for the producers in the market. This is when production is curtailed, producers go out of business and investments stop.
The emergence of "Chindia" will continue to heavily impact on the outlook for commodities, but it hasn't (and won't) change the feast-famine dynamic that is so characteristic and so obvious from the past.
There is one other key element that makes investing in commodities different from the past and that is the increasing influence of investors and speculators as more and more investment products become available, leading to a larger and more dominant participation from alien investment funds. Market researchers at CRU have tried to distinguish the various elements that have been responsible for the price settings of copper, widely regarded as the bellwether for industrial metals and minerals. Their study has delivered quite surprising outcomes.
What would the price of copper be without investors and speculators actively flooding the market? According to CRU's assessment, copper market fundamentals can explain a price for copper of around US$6000 per tonne via-a-vis an estimated marginal cost level for production of US$4500/tonne. The metal is currently trading around US$7600/t and CRU believes financial participants are responsible for the price gap ("premium") which in this case is around US$1600/t.
Copper's market fundamentals today look better than eighteen months ago, offers CRU, when the price reached as high as US$9000/tonne. Back then, market fundamentals only justified a copper price of circa US$5000/t which means investors and speculators at that time created an extra premium of no less than US$4000/t.
The irony from CRU's analysis is that while market fundamentals for copper have improved since, the price has fallen sharply because of a smaller premium priced in by investors and speculators. Go figure.
This easily explains why making accurate forecasts on commodity prices is such an incredibly difficult task. Apart from trying to predict the dynamic between demand and supply, forecasters now also have to consider what investors might decide to price in or out in addition, and for how long. Viewed from a different angle, this also shows the inherent sentiment-leverage built into commodity prices.
CRU's multi-year outlook for commodities is not expressed in terms of future price estimates, but merely as a barometer of underlying market fundamentals, ranging from hot to freezing cold. Shorter-term, money flows and sentiment from financial market participants do have the ability to distort or ignore the balance between supply and demand, longer-term there's no denying supply and demand will ultimately shape price and outlook for all commodities.
Here is, as a reminder, the most recent CRU update on commodities:
For companies operating in sectors that are no longer enjoying steady price gains, the challenge to continue creating additional value for shareholders will increasingly become more difficult. A recent study on Economic Value Add (EVA) by analysts at Citi highlighted just that with Citi projecting only four out of a total of 16 precious metals producers globally are likely to increase value for shareholders in the years ahead. The situation looks hardly more promising for miners in bulks and other metals and minerals.
Citi's study includes the market observation that, over time, share prices tend to converge with EVA, highlighting the challenge for investors seeking long term exposure through equities markets. This takes us back to commodities guru Jim Rogers who believes that "great stock picking" is a necessity to successfully exploit the Chindia theme through the stock market.
Of course, predictions for future value add and share price developments can vary dramatically according to price values entered in today's valuation models and there's little doubt Rogers would use higher projections than analysts at Citi, but this should not cloud the underlying issue that commodities will always be commodities, Fed printing and Chindia notwithstanding.
(In late October I attended the inaugural Asian Mining Indaba conference in Singapore. This story was inspired by presentations at the conference. It was published in the form of an email to paying subscribers on Monday,5th November 2012.)
Good news for FNArena subscribers: colleague Greg Peel has just finished an in-depth market update on rare earths elements (REE) which has been published in e-booklet format, for FNArena subscribers only.
(Do note that, in line with all my analyses, appearances and presentations, all of the above names and calculations are provided for educational purposes only. Investors should always consult with their licensed investment advisor first, before making any decisions.)
