Yet more news on Small Resources Companies #71

October 25, 2017 | Dawes Points |

Key Points

  • Most global equity markets making new highs
  • Bond market about to have a sharp fall this quarter
  • Commodity prices looking very robust
  • Resources stocks returning to rightful prominence on ASX
  • MPS Portfolios well positioned for this coming uplift

The acceleration of the US equity market has brought renewed enthusiasm to almost all equity markets and the local All Ords finally broke through 5800 after a long consolidation.

This has all been flagged for the past few months but the important initial upthrust has now taken place. The next few weeks should see some serious short covering and a strong move in all these equity markets that will take the resources sector to new highs in a surprisingly short time.

The resources sector has seen the battery raw materials sector (lithium, graphite, cobalt and nickel) provide good gains amongst the leaders but the mood is spreading to companies with assets in industrial metals, mineral sands, rare earths, iron ore and petroleum. Note that uranium is stirring again. Much more to come here.

Gold is moving upwards with some zigging and zagging but all seems well with much better times coming again in 2018. I still expect to see new highs in the XGD (ie doubling) by third qtr 2018.

The limited funds in the market at this stage are seeing some switching out of gold into some of these other sectors but this should be only temporary.

The Pilbara gold conglomerates story can only get better as results come through later this quarter. The concept is exploding across the Pilbara and the `me too’ players are out in force so we need to be careful but also watchful because the area in the Fortsecue Basin is very large.  If the concept proves correct this is potentially the world’s second largest concentration of gold after the 160,000t Witwatersrand in Sth Africa. No closed minds allowed here.

Of course this will boost activity in the gold sector but there might not be many players in the actual ASX XGD Gold Index in the near term.  However, should Novo Resources be listed here and Kirkland Lake most certainly will then it will impact the XGD in 2018.

It is certainly pleasing to see the Dow Jones Industrial Average perform so well as this shorter term graphic was suggesting. I cannot recall seeing this feature of a market pushing against an upper channel line like this but it certainly was telling something. The move should accelerate.

The Super Bears didn’t notice this action so it looks like October will pass without a crash and the 30th anniversary of the 1987 Crash was just a celebration.

But accelerating into the next channel is worth noticing because these channel changes have a habit of alternating and displaying quite the opposite character to that of the previous channel.

Over eight years trading within a congested 4000 pt range could just give way to a very sharp and free upmove. The DJIA has already added 1550pts since early Sept and accelerating into the next channel should give us another 2500pts by year end. Will it do this? I think so.

Australia has finally woken from its torpor and should pass through 6000 this week on its way to above 7500.

The character of these markets and these clear trends shown in the indices are reflecting the underlying economies and they all indicate another extended period of prosperity for at least another ten years. Leading economies around the world are just having a great time yet appear to not be over extended and changes to taxation rates in the US just cannot hurt.

USA, Europe, China, India, Japan. All in synchronised economic expansion.

Of course these equity market moves are not occurring in isolation.

The key principle of investing is the flow of capital. This time it is flows of capital from cash and bonds into equities and commodities.

Cash has been highlighted previously and there is certainly a lot on the sidelines.

Capital into equities, and particularly into new equity (IPOs, rights issues and other capital raisings), funds capex and new jobs.

The Fear Thesis has kept hundreds of billions of capital in cash and near cash. No wonder the Australian economy has been so sluggish.

A surging stock market should now have a major impact on the local economy and keep in mind that a strong resources sector helps bring in foreign portfolio investment. Investment that buys shares from locals and increases local money circulation.

The so-called Mining Boom of 2010-14 was really restricted to the major stocks owned by the large pension funds so individuals saw very little of those benefits. It will be very different now.

The flow of capital should be from the US$100tn that was tied up in the bond markets.

That is now coming out as bonds are sold or just not rolled over by those just seeking safe refuge for capital rather than long term income.

The bonds are weakening and seem to finally be ready for the next leg down.

Note that this is happening just as equity markets are surging!

So much for `rising interest rates send stocks lower’!

And also note that higher interest rates are pushing up US banking stocks which are outperforming the S&P500 after 14 years of underperformance.  Again, so much for `rising interest rates sending banking stocks lower’!

Here in Australia the banking sector is having some heartburn with this although can’t be sure as to what it really means!  Is it following the bonds?  Don’t hold any local banks here.  Do you?

Commodities continue to do well for the resources sector and copper is an excellent proxy for the story with most metals.  The Channel Analysis works well with copper and the bullish calls from Dawes Points over the past couple of years have come to pass as prices move nicely with the channels.  The US$3.70/lb looks easy now but US$6/lb is coming.

The strength in gold, copper, iron ore, coking coal, aluminium, lithium, graphite, cobalt, zinc, lead and silver have helped the ASX 300 Resources Index (54 stocks) to regain its 2015 highs on the way down from the 2011 highs but the current 3650 level is firmly indicating that an upward move through this will give a very rapid retracement to 4000 (+10%) then to 4400(total +20%).

Market share is now back over 25% of All Ordinaries weekly turnover.

Small Resources (recall this index has 38 stocks with a combined market cap of A$42bn with 15 stocks capped at over A$1bn (including 5 >A$2bn!)) is showing much higher leverage and is coming with a probable 50% gain for the next year.

Market share of turnover is growing and is over 5% again.

Both of these indices seem to suggest that a sharp upmove is imminent.

The reason behind it might be just the global equity markets and the cash on the sidelines but gold is likely to have an important input here.

Whilst the immediate short term for gold is not quite so clear, the long term indicators are very robust and suggest a major move could come at any time now.

There are simply hundreds of small quality resources companies out there and to find them is one thing but to play them is another.

The best advice is to have a core portfolio to ride out the cycle and to add to it as further opportunities arise.  Which they will do in spades.

The best returns come from choosing well early and just sitting it through.

Have a look at these portfolios from the last boom from 2003-2011:-

October 2004 Portfolio  +432% in 36 months and +430% over 44 months.

Structured model portfolio with no trading.

Structure provided liquidity and dividends as well as allowing 68x gain in SMM in the riskiest end of the sector.

The July 2005 Portfolio provided 103% in 12 months and 261% in 22 months.

Clearly not every stock provided positive returns but the portfolios did what they were supposed to do – give high aggregate returns with income and liquidity.

Let’s look at some portfolios for now:-

Portfolio A

A$100,000 in a conservative diversified portfolio for income and capital growth.

Stock selection will be revealed in a month or so!

Portfolio B

A$100,000 in 24 equally weighted small cap stocks across a wide variety of sectors.

Stock selection to be revealed in a month or so as well.

The overriding comment is to `heed the markets, not the commentators’ and the market character is that extreme value exists against the 3,300m people in Asia who just want better lives. And our resources!

Are you onboard?
Barry Dawes BSc F AusIMM (CP) MSAFAA

 +61 2 9222 9111

Dawes Points #71
24 October 2017

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