2018 Outlook – And it is only just starting #74

January 25, 2018 | Dawes Points |

Key Points

  • Brilliant year ahead for resources
  • Bond market peaking creates critical watershed
  • Global inflationary pressures building
  • Economic Boom broadening
  • Equity markets now playing catch up
  • Gold and silver now ready for major move
  • Resources commodities iron ore, copper and aluminium strong
  • Oil and gas (+LNG) rising as energy bull market resuming
  • Big caps wonderfully cheap
  • Mid caps proving production and earnings paths
  • Small and micro caps provide numerous opportunities
  • Small cap oil and gas stocks outstanding
  • Expect lots of M&A across the resources sector
  • Key stocks BHP.ASX RIO.ASX FMG.ASX WPL.ASX NST.ASX NCM.ASX SBM.ASX PSA.ASX LNG.ASX OSH.ASX

Call me to discuss ways of participating bdawes@mpsecurities.com.au +61 2 9222 9111

The Dawes Points Global Boom™ is now in its fourth year and has been accompanied by robust GDP growth in Asia and US and now Europe and Japan are fully fledged members of this expanding club. Also, China has just announced an uptick in growth in Dec Qtr 2017 to 6.9% annualized.

Equity markets around the world have been showing enthusiasm and, quite frankly, rational exuberance as earnings growth accelerates and as new projects are being unveiled daily everywhere.Global trade is expanding again with major drivers in transportation, housing, construction and technology.  The list is ever-widening.

The 3000-4000 Dow points surge called in early Sept provided 3000pts by end Dec and 4000 on 12 January and 4500 by 23 January. So much more coming over the next decade.

The top of the channel has been hit by the Dow 30 so it will probably need some consolidation before moving higher. Other individual stocks have only just broken through their top channels so more upside is still coming and the US Banking sector is not overbought and still well below previous highs.

The Australian market has been playing catch up but the Resources Sector is giving it underlying strength and will propel it higher in 2018.

Commodities are looking strong and resources equities are starting to take off with gold now likely to move sharply higher after breaking the 2011 downtrend and providing enough retests, good bye kisses and fake-outs to deserve to go higher now. Gold has gained US$100 since early December and now has US$1350-70 as the major resistance. Pullbacks and consolidation may be expected but it just may be more powerful.

Oil is in its next channel and should achieve US$80 (WTIC) and US$86 (Brent) in 2018. Demand side drivers, especially China where consumption is expected to surge again, are reducing the inventory position and supply side issues like no growth in Non-OPEC output and flagging US tight oil output.

Iron ore will surely provide the U$100/tonne target set by Dawes Points early last year.

Resource sector stocks large and small are having a wonderful start to 2018 and can be expected to provide a magic year.

Keep the buy and hold mentality close to your nose. Fortunes are made by being patient, not by furious trading.

This graphic is showing the long term trends and is notable how well BHP did from 2000 to 2008 when the S&P500 went nowhere.  BHP out performed the S&P500 over 12 years, has had a correction and is now moving on to outperform for another decade.

RIO is a few months ahead of BHP but BHP should get a benefit from the rising oil price and should catch up.

Again, keep in mind the time frames involved here. At least a Decade. Not a few months.

Long term Dawes Points readers might recall the early 2016 discussion anticipating the `bifurcation’ in markets with the bond markets, the bureaucrats, the public sector, snout in the trough politicians and the media heading for trouble while the backers of industry, raw materials, Asia and gold were heading in another direction.

This bifurcation has been clearly underway. And in three dimensions.We are moving upwards in a new direction. They are stumbling down an old and treacherous path.

Dawes Points continues to focus on the Flow of Funds concept for markets. 

Follow the money.

The vast amount of capital tied up in bonds and also in cash has been tied up with the left bifurcation and, in anticipation of the demise of this defensive sector, is now flowing out.

And flowing to the Resources Sector and tangible assets and infrastructure.

(Did you note recent ECB comments that its policy settings were for continuing downturn. Now inappropriate. The boom is happening there as well. Some clearly worried EU bureaucrats.)

China has indicated an acceleration in GDP growth with 6.9% recorded for the Dec Qtr. The equity market is going to respond positively to that in 2018.

As with China, the other emerging economies are also performing and receiving strong capital inflow. Some repatriation of safe haven capital and some is new investment.

Emerging Markets surging after nine years of consolidation.

The outlook is powerfully positive.

These long term trends are so useful and inspiring.

Take the bond markets. This is for US Ten Year T Notes. Almost 80 years of history in a single market and asset.

Long term trends. Generational and hence easily ignored by each generation.

Here, from 1946 to Sept Qtr 1981. 35 years of rising bond yields.

Then until Sept Qtr 2016, 35 years of declining bond yields.

Another 30+years of rising bond yields is now in train.

Bond yields and bond prices get a bit complicated when the coupon ( ie the income component of a bond) differs from the actual prevailing interest rate environment and bond yields.

The price of a bond itself is also complicated but the overall price is declining and a big fall is imminent. This is the 30 Year Tbond and you have seen the 10 Year has already fallen sharply. The 10 Year Price Index will include 30 year bonds from 1997 when rates were 7% and 20 Year bonds from 2007 when rates were 5%. These would now be trading at a premium to their issue price but are now falling back to par value as maturity comes closer.

Before we go on, note how equity markets are rising as bond yields head higher.

Now look at the yield on 30 Year T Bond. A major compression feature ahead of a strong surge in yields to probably 3.25% and then targets to 3.75%. Nothing much in 0.5%-1.0% in interest rates rises but it will have a major impact on bond yields and a significant decline in bond prices at a time of low coupons.

Note that yield on 10 Year T Bonds have already jumped. Likewise for 3 years and all along the yield curve.

Note that weaker TBonds are not necessarily a call for a weak US$.

The DXY US$ Index is very narrow with just six components and is terrible given it is 57% Euro, 13.6% Yen and 11.9% Sterling, 9.1% Canadian $, 4.2% Swedish Krona and 3.6% Swiss Franc. The CNY and A$ don’t figure in this index. This US$ Index may be ready to weaken. Or may strengthen.

But look at this broader US$ Index. Doesn’t look so bad at all. Note that the US$ is very strong against currencies of many smaller nations.  The proverbial s**tholes are still weak currency states.

Also note how gold is rising with higher interest rates. And with equities. No Fear Trade here.

Can you imagine the current anguish of those believing that rising interest rates will make markets in stocks, commodities and property fall.  Imagine their short positions in all these markets over the past year. Ouch.

I have called this global boom for almost four years now so have given it a trademark

–  The Dawes Points Global Boom™.

I hope you agree that this is a fair assessment of things.

The Wave Pattern graphic below was first presented on 1 December 2008 at Mines and Money London that happened to coincide with the major 2008 lows in commodities, resources stocks and most things China. The major equity markets kept falling until early March 2009 but the earlier upturns here in resources with gold leading gave strong confidence for the future of world economy despite the extreme pessimism at that time.

The previous 8-10 years had been a good bull market but as long term readers would know, there was little participation by institutional investors and very little public retail interest. It was an excellent Bull Market that few believed in and hence the Disbelief leg.

The Subprime/Lehman Bros debacle in 2007/08 created that sharp Pessimism leg that was the GFC.

The Hope rally was encouraging with gold running to US$1923 in September 2011 however the resources rally petered out earlier in 2011 leading into the Despair leg that gave us an 80% fall in most gold sector indices into the lows of late 2014 in Australia and late 2015 elsewhere.

MPS Dawes Points Wave Pattern

The key issues to focus on here are the time cover of these trends.  Ten years Disbelief. Five to seven years of Pessimism/Despair. Now we have at least 10 more years of Optimism.

This pattern can be clearly seen in the resources sector indices and in commodities.

The big driver is GDP growth. Underestimated and disbelieved by so many commentators.

GDP growth (and Industrial Production growth) is good for commodities and growth in China is the best growth.And it is accelerating again.

Commodities have been priced for recession and resources companies have cut back on exploration and new capacity development. Particularly in energy.

The CRB Index has a heavy weighting in energy so this should be very strong over the next few years.

The shorter term is providing evidence for a sharp move soon.

Commodities were covered in more detail in Dawes Points #73 2017 Year in Review but the 2018 Outlook is still the same.

Record consumption demand still flowing through, restocking of inventory required, limited major new capacity coming on stream and, well, just no inventory.

Higher prices are inevitable and the outlook still suggests the supply/demand imbalance will be with us for several years.

Higher prices are just inevitable.

The producers of resources commodities are generating very robust cash flows on balance sheets that are now quite favorable.

The big commodities iron ore, copper and oil are really helping the bigger stocks. All are moving higher. So is aluminum with its 63mtpa and rapidly growing consumption level.

The big stocks still appear to be very cheap and here BHP is on its way to test the previous high A$50 (US ADRs US$75) and perhaps this year. Just repeating targets from 2016.

RIO is looking strong too. Aluminium, iron ore and copper here will send RIO up to US$75 and up 150% to my target from 2016 (100% from early 2017).

Here is a link to my 16 Jan 2018 CNBC Asia interview on RIO.

https://www.cnbc.com/id/15840232/?video=3000686687&play=1

FMG is here too. Brilliant company with debt reduced and strong cash flow despite the discount for low Fe iron ore.

Energy Outlook

Energy is having its own resurgence thanks to robust demand and to supply side concerns. Inventories have fallen considerably.


Source: HFI Research

Oil consumption is likely to hit 100mmbopd in the Sept Qr of 2018. That is 36bnbbl pa. The largest oil field in the US was Prudhoe Bay at 16bnbbls recoverable. Australia’s largest was Kingfish at just over 1bnbbl. Oil will remain tight for many years yet.

Energy consumption is all about Non-OECD countries increasing their energy consumption while OECD has been flat due to stagnant economies and energy efficiencies. OECD is growing too now!

BP does it differently with some more detail but the picture is growth in China and India and in lots of `other’.

It is also useful to note the relative sizes of each source.

Fossil fuels aren’t going away anywhere soon!

MPS Energy Consumption by Fuel Type

Energy will be covered in more detail in the near future but the basic position is quite clear.

Energy is the lifeblood of all economies.

Demand is rising and LNG is already assuming an important role again in Asian energy imports. WPL looks quite exciting. And also Oilsearch.

These larger companies need to be part of every portfolio.

The Oil and Gas Sector on ASX is quite unloved and doesn’t even get a sniff of an index.  This MPS index of 11 small explorers/producers shows a lag between oil prices and stock prices.

These stocks are down 80% from an arbitrary 1 Jan 2007 basis and almost 90% against the oil price so should provide outstanding returns to astute investors.

The market for many of these companies is the East Coast of Australia where decades of government and bureaucratic bungling and pandering to half baked ideals of special interest groups have put the entire well being of 80% of the nation at risk.

Shortages can be overcome by increasing supply. So simple.

Talk to me about them.

Gold Outlook

Gold continues to be looking positive and an appropriate switch is underway from T Bonds into gold as part of the great bifurcation. Which safe haven would you prefer?

Gold itself is readying for another test of US$1350-1370 before launching a more powerful upmove. This may still take another three to six months to break through. Or maybe the coming week!

Gold in A$ has travelled sideways for three years now but it has bounced off the long term uptrend and is still heading toward a A$2000 target within the next year or so.

Gold stocks in North America have been trading constructively but have been net flat in 2017.

The largest global gold stocks have had to unwind a lot of debt after some expensive new projects and mergers but improved cashflows and better balance sheets are making these stocks quite attractive again.

In Australia the ASX XGD is leading the world resources industry, as it did from Dec 2014.

The short term trend of gold stocks vs Gold is calling for a resolution soon.

A similar wedging is apparent for these gold stocks against the S&P 500. Together these graphics suggest a VERY strong outperformance by gold stocks.

And gold and gold stocks are important in the direction of the A$.

Look at this long term correlation.

Within all this the A$ looks very robust.

The very long term is bringing about a change. To make A$ holders wealthier.

Summary

It is very clear that The Dawes Points Global Boom™ is well underway and the trends are coming into place that will last for quite some years.

The broader resources sector has some excellent performances in 2017 and should continue into 2018 and beyond.

This graphic of the ASX 300 Resources is at a critical juncture and a solid break above 4400 (now 4174) will unleash some massive buying that will take all these indices to new highs within two years.

ASX S&P 300 Resources  2004- 2018

Equity markets around the world are acting as the barometers of improving economic prosperity in the years ahead as the vast savings in cash and bonds are redirected into equities, property and commodities.

The markets have been indicating all this for these past four years and the markets have often been at odds with the commentators. Dawes Points has held true through all of this and we are looking at further outstanding returns to our portfolios.

The year ahead will provide even better returns for resources sector investors starting with the major companies with strong revenues, balance sheets, earnings and dividends.

The mid cap sectors will also perform well and should be at the forefront of M&A activity.

The hundreds of small to micro caps offer outstanding value if you know how and where to look.

These will also be the targets of the M&A and once mid caps are comfortable with their own cashflows they will be looking for growth opportunities.

Talk to me if you want to participate.

Barry DawesBSc F AusIMM (CP) MSAFAA

+61 2 9222 9111
bdawes@mpsecurities.com.au

Dawes Points #74
25 January 2018

I own BHP, WPL, FMG, NST, OSH, PSA, LNG

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