And so it has all come to pass

Key points

And so it has all come to pass. The views expressed in Dawes Points over the past 18 months are now firmly on course. The efforts of Wall St and local investment banks to talk everything commodities and Australia down has failed and they will fail spectacularly further as 2014 unfolds.

The world economy is growing and commodity demand continues to rise. A financial world focussing on `the Fed’ and `tapering’ and believing that pulling the monetary levers in just one country will determine economic outcomes elsewhere in the world is failing to watch the fundamental human aspirations and the laws of supply and demand.  And the most recent wailing about `failing emerging markets’ is yet more wailing from those just looking for troubles.

Dawes Points has continually focussed on the markets and data that can be monitored, measured and assessed.  The markets have consistently indicated a global economy very different from the views of most of the economic commentators.  Market reality is coming to the fore.

Certainly a broken clock is right twice a day but the evidence has been as clear as day that no depression in the US was happening, no collapse in the European banking system has occurred, no collapse of China has taken place and the concerns about Turkey do not make for a system crisis in emerging markets.

The key points above are very clear.  Commodity prices are moving up again after about three years of consolidation.  The move up is from a much higher base than many previous declines and the structures of supply and demand are unlike any other in modern economic history.

The ASX Gold Index had fallen 80% from its April 2011 high into a December 2013 low while the A$ gold price fell just 5% from A$1408 to A$1339/oz.  Today it is A$1490.   To say that again just note that at the time of the high in the ASX Gold Index at 8499 it was A$1408 and now XGD is 70% lower.   Go figure.  But then again just remember the BS from the DS at GS with their sub US$1000/oz forecasts last September.

How can consensus thinking be so wrong.  Why did the ASX Small Resources fall 70% from April 2011 to last June’s low?  Where is the collapse in commodity demand/prices?

It is just sentiment and the prolific opinions of financial media and its bed fellows in financial institutions.  How can it be otherwise?  
Now just look what the markets are saying.

The Dawes Points three “Fasten Seat Belts’‘ calls of 15 Oct (ASX Metals and Minerals 3184 +3.6%),  11 December (3181 +3.6%)  and 17 Jan ( 3346 +6.7%) seem to be on track with that index rising to recent highs of 26.7% from the 2653 27 June 13 low.  And the ASX Gold Index at 2618 is up 54% since that Dec low.

China now consumes more than 45% of most resource sector commodities. The US is now less than 10% in most commodities except for energy. Other countries are showing marginal rises in consumption so the pressure continues to be on supply.

The pontifications of almost all things Wall Street is for lower commodity prices, lower gold and weaker currencies against the US$.  Pontifications and propaganda to protect the US bond market where these banks have large long positions and to defend the US$. As has been said before:- Defending the indefensible and protecting the unprotectable.

These terrible twins of the US$ and the Treasury Bonds are suggesting a serious change in the flow of investment funds from safe refuges and paper assets to the real economy and inflation hedges.  Yes, inflation.  Is anybody here old enough to remember the bad old days?  The Moses Principle is applying here. After 40 years wandering in the Wilderness by the Israelites with nothing, the Promised Land of `flowing with milk and honey’ in  er..er ..Palestine was found.  Forty years was enough to squeeze out memories of a better life in Egypt or anywhere else for that matter and to bring the Israelites to expect very little to be given from life.  Small gains seemed miraculous because the then collective wisdom knew no different.

So many of the current investment communities have known only three decades of falling interest rates and bond yields to reflect their experience.  Too many erstwhile mini Warren Buffets looking for `sustainable cashflows from well run businesses’ to notice that the landscape may be changing.

The `Moses Principle’ applies here.  Outside of common wisdom.  Outside of common expectations.

The 30 year bond uptrend is broken. The world is `long’ bonds as True Believers to the tune of US$80 trillion. But the fundamentals are rancid. Who, apart from `the Fed’ will be buying this paper junk in the next few years.

The US$ Index has just had a Friday close under 80.  It failed to make it into the upper channel and now has closed below both 50 and 200 month moving averages. Expect a move down in 2014 to about 3-5%. Maybe more.

The weaker US$ will stimulate capital outflows to everywhere else.  Expect higher equity markets and commodities and gold.  And also a stronger A$.

Mitchell Johnson was the Panzer and the Maginot Line is being outflanked.

The bond market is de facto currency with a coupon. Strains appearing in bonds and with the US$ breaking bad below 80 last week all isn’t looking good for the `strong dollar’ thesis.

And whilst all this is happening note this extraordinary pessimism at the exact bottom of the market!

Just review some recent commentary from these Wall Street gurus and their sycophants here in Australia:-

In a recent AFR article :-UBS spokesman… `But he warns it’s going to be another tough year for resources.

“Our expectation is commodity prices will probably track sideways, pretty much, but they’re still healthy commodity prices, But companies that will be able to generate strong free cash, reduce their debt and know where the market perceives they will be able to return cash to shareholders will be the ones that do better this year.” he says.

A recent review on Bloomberg 11 Feb 2014:-

`Commodity prices rose almost fourfold in the decade through 2011 on Chinese demand. The Standard & Poor’s GSCI Index of 24 raw materials posted the first drop since 2008 last year as bear markets extended from corn to gold to copper.

Citigroup Inc. says the so-called super-cycle of rising demand has ended and

Goldman Sachs Group Inc. said last month a reversing cycle will eventually drive raw materials into a structural bear market.’

Morgan Stanley’s chief metals economist recently left the bank after almost five years in the role to start his own research and advisory group. He understands, but possibly not the bank. He said `The collective memory of the financial industry, particularly in relation to commodity cycles, appears to me to be shrinking if not disappearing altogether..’

Pontifications because the banks think they know better.  They of course have big trading arms and balance sheets that allow active participation (we wouldn’t say manipulation would we!) in some small and illiquid markets but pontifications are no substitute for knowledge at the coal face.

So despite the talking down of gold, oil, LNG, copper and natural gas the markets themselves are talking a different language.

And the language is almost from a different planet and is about shortages.  Have a look at these LME inventories that were mentioned last month.  Sure, Shanghai inventories are rising but the real evidence is that there is little spare metal now.

Rapid declines in inventories but prices are still being held back with copper and tin being in backwardation where future prices are lower than current spot prices.  The markets are still pessimistic.

LME Metals Inventories

LME Metals
000t
Jan 2013  June 2013 Feb 2014 % change
On Jan 13
% change
On June 13
% of Jan inventory drawn down in Feb 2014
Copper

320

665

276

-14 -58 -12.2
Zinc

1220

1061

761

-38 -28 -10.9
Lead

320

198

202

-37 +2 -3.0
Tin

12

14

8.06

-33 -42 -9.3
Nickel

139

187

271

+95 +45 +1.5
Aluminium

5210

5435

5311

-2 -2 -2.1

Copper, zinc, lead and tin show very low inventories and reflect lack of new capacity.  Can you name two ASX stocks outside of BHP and RIO that produce each of these `old fashioned’ metals.  Not as racy as gold or iron ore so mostly forgotten.   Aluminium and nickel have high stocks but as always the best thing for low prices is low prices that cut output. So maybe a change could come through for these two as well.

Now have a look at gold.

The COMEX has access to about 7moz of eligible gold sitting in vaults around the world. This gold is known to COMEX but only gold that is `registered’, is in 100 oz bar form of high standard purity and ready for prompt delivery can be used for meeting delivery notices for the 100oz contract.  Much of the gold is on kilo, 10 kilo or other bar form and is not suitable for delivery without remelting.

Recent open interest in the futures showed over 100 contract oz for each oz of gold registered for delivery on COMEX.  With Asian demand now greater than global mine production the potential is there for a short squeeze.

The change in trend for gold looks very constructive.  Downtrends of gold prices in a number of currencies are now broken and price are turning up.

With iron ore, the big build up in iron ore stocks in China might just be a furphy.  86mt at 20 coastal ports in China against 850mtpa of imports is still only 33 days and is 35% fewer days than two years ago.  The new large coastal steel mills get almost 90% of their iron ore feed from imports.  The old small scale inland steel mills get less than half from imports.  The current low iron ore price is closing down environmentally unfriendly old inland steel capacity along with their high cost low grade magnetite mines.  Potentially over 400 million tonnes of domestic iron ore production is in danger of progressively closing down should prices fall further.   The mining, crushing and grinding of magnetite is energy intensive and in a competitive market for energy, power bills must be paid or the power goes elsewhere.  At US$120/t probably 30% (120mt) is currently cashflow negative.

The most commonly used number is for 20 ports and is 86mt.  The larger number for 40 ports adds about 14mt but this is only 750kt per additional port and probably just a tiny 200kt for many.  The 20 ports figure is more significant.

So this graphic of port stocks doesn’t suggest oversupply, but rather tight inventory here in the commodity the market loves to hate.

Let’s see what iron ore does over the next month or so to see a clearer direction.  I still am sticking to my forecast of new highs in iron ore in the next few years.  Today, about 130m tonnes of Chinese iron ore concentrate production is underwater.

The oil market is saying the same story.  Peak oil has been with us since about 2006.  Where is the new oil coming from?  The idea that the US will provide vast new production is considered to be delusional.  That has been stated here previously.

What does the market say?  Brent is a global price and seems ready to jump higher.

Higher oil prices in the US are likely now after the breakout last week. West Texas is enduring an increased supply from shale oil (tight oil) but it’s market is still building up and anticipating a sharp upside move.

What does the US oil and gas industry say?  Gearing up for new highs in E&P stocks.

And drilling activity is saying US$5/mmbtu is not enough to boost gas production.  A tight market is expected for another few years.  Gas rig activity continues to drop.


Gas rigs are getting better productivity and more efficient with horizontal drilling so fewer rigs are needed but gas prices are saying something more.  Recent prices above US$6/mmBtu suggests this figure is not enough to make money in dry gas in the US.

Don’t worry about Asian LNG prices. Oil-indexed prices will probably be here for a while yet and US exports might not be so great after the first few new export LNG projects.

This doesn’t look to me like a market about to collapse. And US natural gas prices look suspiciously as if they might run much higher yet.  The sharp run up has invited profit taking but this shows strength to me.

The big ASX resources stocks have reported strong results from iron ore and oil and gas in particular.

Strong results, undergeared or better balance sheets and lots of free cash for dividends.  After the recent five year Resources Sector investment binge of A$400bn, capex is tapering off and balance sheets are being rebuilt and cashflows are being redirected towards shareholders.  In the 1970s and 1980s it was usual to expect 50-65% of earnings paid out as dividends.   We should see it again.  (How long will it be before the commentators start pushing companies to go on the acquisition trail or expand output again?  Two years max?).

So the next stage of the boom is underway, ASX resources stocks are rising and capital raisings are picking up nicely.

The Dawes Points Portfolio is up 7% (pre dividends) against the XMM which is 2% higher (before recent dividends).

Whilst the heavy weighting in the large caps slowed the portfolio (pre dividends) some of the smaller stocks have done very well. Stock picks AQA, IGO, ERA, DLS, WSA, NST, ORE, MAU and BLK have done well whilst LMB has been and continues to be spectacular!

The next stage of the Resources Boom will be focussing on the 230 undeveloped projects that are in the hands of mostly junior companies.

The story is the same.  The stock prices are far more advantageous and the opportunities are almost boundless.  Has there ever been a time in Australian stock market history that Resource Sector stock prices were so divorced from reality?

Disclosure: I own LMB, BHP, DLS, BLK, MAU, NST.

Barry Dawes
3 March 2014
BSc FAusIMM MSAA MSEG
Follow me on Twitter @DawesPoints

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