Tag: Coal

What if … a rising gold price forces a short cover rally ???

by Barry Dawes

What if ... a rising gold price forces a short cover rally ???

Key Points

  • US equity markets at all time highs again
  • Asian markets still surging
  • Gold price jumps from recent 54 month lows
  • Gold stocks surging from 10 year lows
  • Coal market turning?
The US equity markets have continued to make new highs on strong earnings and economic data and on improving employment sentiment measures.  The stocks performances in the US are encouraging their counterparts in Europe and Asia along, as the various market indices also hit all time or new rally highs. Economic data in the US, Europe and Asia are encouraging but are generally at odds with what has happened with the out of favour basic industries and commodities.  Growing GDP and Industrial Production usually is good for commodities and the supply/demand pictures for most commodities are generally in balance, but there has been obvious new supply in commodities such as iron ore, coal and oil that has coincided with a short term slowing in demand from some quarters and the recent surge in the US$ has encouraged some market players to conclude that commodities must fall more.  But if the recovery is now quite clear should there be further falls? Market action is now suggesting that the 44 month decline (basis CRB CCI) in commodity prices may now be bottoming out with agricultural commodities generally making lows in September, industrial commodities (LME metals, nat gas) in October and oil, coal and precious metals in November. # gains from November lows Interesting to see that agricultural commodities fell about 15% to make their lows in September while the USDX rose 4% and subsequently recouped all their losses while the USDX rose.  Industrial commodities made their 6-12% lows in Oct and then rose with the USDX.  Precious metals and oil made lows in November and sharp gains have been made since those lows. The markets have had at least 44 months to play the bear side and now the world is fully convinced that war, plague and debt will continue to cut demand, China will slow down sharply and Europe will be in recession for ever.  And of course that the silly mining industry will continue to increase supply. But what if?   What if the Dawes Points view that the US is doing very well as indicated by a strong stock market and GDP data and that positive attention might now be paid to commodities as demand is seen to no longer be falling? Short cover rally anyone?  Note the very positive action in the US equity markets this week. What is a Short Cover Rally?   Well, some traders have sold assets that they hope to buy lower and make a profit.   If you are `short’ in futures or securities markets you have to buy them back or face unlimited losses.   Other have sold and gone to cash.  Others have just not bought so are underweight or underrepresented.  To cover `shorts’,  stock needs to  be bought back.  Underweight investors need to add to positions and then new money comes in.  Can be explosive.

What could this short cover rally actually mean?

First, there should be a bottoming in gold which is a proxy for all things commodity.  Did we get that last week when, as the last Dawes Points suggested, that gold was being `hammered into an important low’?  Demand is so strong and physical metal is hard to find.  Coins have been sold out from the mints. The extreme low valuation positions of gold equities give a lot of credibility to that possibility of an important low.  Platinum also made a key daily 'reversal' of making a new low then closing above the previous day's high on Friday. Higher gold might solve a lot of problems. Then other commodities should start to improve.  As shown above, sugar, wheat, corn and soy beans have already jumped well off their lows.   The LME metals and natural gas are higher today than in their October lows. Oil may have also made a very important low last week after a 32% fall since July, and note that the oil majors Exxon, Conoco and Chevron made their lows in mid October, a month before this low in oil.  US Lumber made its 2014 low in June and now could be very strong as housing starts continue to pick up. Iron ore looks to be still weakening through oversupply. I was amazed at this graphic.  Housing starts have fallen so much that it will take years to catch up to the need for another 1.5 million new units per year. The Philadelphia Housing Sector Index made an 11 month low in October but has bounced back to almost make a new all time high. Housing starts The industrial sensitive stocks and mining stocks should start to rally as short positions are unwound and bought back. Alcoa, Boeing, US Steel  and Caterpillar are all bouncing.  BHP, RIO and Freeport have improved from recent lows. Then the bond market needs to reassess itself.  Those holding low yielding bonds will be asking questions about how they will be able to sell them.  And where will the money go? And where will all the cash sitting on corporate balance sheets go?   Where will the bank deposits go?  Probably chasing real assets.   These numbers were discussed in the last Dawes Points. The amounts of cash and bond holdings are way bigger than equities today.  A short cover rally could ignite a much stronger market response.  What will the remainder of the year bring us? I understand many `value investors’ have reduced equity holdings in the US.  These may be forced to change their views, especially since the Dow Theory is now bullish. Where will the US$ sit in all this?  Where will the A$ go? You know my views.  Now, let the markets do the talking.

Let’s talk commodities

Commodity prices should be all about supply and demand, and these factors are far more important than the level of the US$.  Since the beginning of 2012 the USDX has risen 10% and the CCI has fallen 20%.  Since the latest 10% rally in the USDX since 1 July, commodities, as shown by the CRB Index (basis – CCI), have fallen 12%.    Not much of longer term correlation and the relative performances of agriculturals etc as noted above doesn't give much to rely on. At the margin, lower prices increase demand for commodities and reduce supply.  This is happening now.  Individual commodities have their own market patterns and the September lows of the agriculturals may be telling us something here. The industrial production data for China was >8%pa for Sept Qtr and India is looking at a GDP number in 2015 at >8%, higher than China.  These two great nations are important keys in commodity demand. Demand for gold from China and India has most recent data running at extraordinary high levels and has kicked the gold price up an important US$50/oz. The world is generally short raw materials and despises gold.   Gold shares hit a low last week and the ASX Gold Index was down to 83% below the April 2011 highs. Australian investors, however, are significantly underweight resources shares.

What about Equity Markets

The US markets are making new highs again today in what can be called a `bull hook’ -  the left side of an inverted parabola that then just surges! Many of these US stocks are truly remarkable given their earnings and their strong performances over the past few years.  The Dow Jones 30 Industrials have done well as has the S&P 500 but don’t forget that the Wilshire 5000 shows great strength in its breadth. Looking at the breadth and gains of these stocks it is hard to see how the market place could be negative on the US economy.  It is worth reviewing the Dow 30 to see what is there now. Gains by Dow Jones 30 Stocks    Market cap US5.0 trillion  PER 15.75x
14 Nov 2014 US$ 4 years 3 Years 2 Years

2104

Communications
AT&T

35.90

22%

19%

6%

2%

Verizon

51.50

44%

28%

19%

5%

Consumer
Disney

90.80

142%

142%

82%

19%

Home Depot

98.24

180%

134%

59%

19%

Coca Cola

42.73

30%

22%

18%

3%

MacDonalds

96.21

25%

-4%

9%

-1%

Nike

95.50

124%

98%

85%

21%

Proctor & Gamble

88.11

37%

32%

30%

8%

Walmart

82.96

54%

39%

22%

5%

Financial Services
American Express

90.67

111%

92%

58%

0%

Goldman Sachs

189.98

13%

110%

49%

7%

JP Morgan

60.28

42%

81%

37%

3%

Travellers

102.43

84%

73%

43%

13%

Visa

248.84

254%

145%

64%

12%

Health
Johnson & Johnson

108.16

75%

65%

54%

18%

Merck

59.07

64%

57%

44%

18%

Pfizer

30.34

73%

40%

21%

-1%

United Health

95.11

163%

88%

75%

26%

Manufacturing

 

 

 

 

 

Boeing

128.86

97%

76%

71%

-6%

Caterpillar

101.34

8%

12%

13%

12%

Du Pont

70.80

42%

55%

57%

9%

Gen Electric

26.46

45%

48%

26%

-6%

MMM

158.85

84%

94%

71%

13%

United Technologies

107.45

36%

47%

31%

-6%

Petroleum
Chevron

116.32

27%

9%

8%

-7%

Exxon

95.09

30%

12%

10%

-6%

Technology
Cisco

26.32

30%

46%

34%

17%

IBM

164.06

12%

-11%

-14%

-13%

Intel

33.95

61%

40%

65%

31%

Microsoft

49.58

78%

91%

86%

33%

Average

 

70%

59%

41%

8%

Dow Jones 30

17634

52%

44%

35%

5%

Russell 2000

1173.81

50%

58%

41%

1%

Some of the performances of these stocks are extraordinary and it is just about only the basic industries that have done badly in 2014. (IBM is the exception with its crazy stock buy back programme!).  This table is worth spending a few moments on. As the economic numbers improve it should be these activity sensitive stocks that do better.  And resources stocks. Asian markets are continuing their surges and Australia will eventually be following.

Gold

This has been discussed in Dawes Points but the extreme low levels for gold stocks are telling us that the lows for gold are probably very close (and probably behind us). The 23% rally from the lows here is probably signalling a major change. Also, gold in other currencies looks ready to continue the long term uptrend, especially in Yen. Gold is now all about demand from India and China.  This demand is unprecedented and will change the way gold is viewed.  Much higher prices are coming.

Resources stocks in Australia

The activity and optimism obvious in recent trips to China, Singapore, Kuala Lumpur and Bangkok contrasts greatly with the deep pessimism in Australia and the holdings and activity in resources stocks are well down on long term averages.  You might say they are hated.  Certainly despised. Some fund managers no longer hold BHP. It is now only 6% of market turnover- down at least 50%. Mining and Mining is down 50% or more.  Ignored. Small Resources.  Irrelevant. Gold.  Clearly despised at just 1.5% of turnover!

 A turn coming in coal?

A final note.  If gold is despised then coal is truly hated. But just look at these.  Maybe a turn coming in coal. A coal ETF had an October low. Coal stocks in the US are looking to turn up after long declines. Walter Energy Consol Energy Let’s hope this all happens.

Resources Boom Continuing

by Barry Dawes

Fasten Seat Belts Even Tighter - Now Enjoy the Ride

The US is not in another Great Depression (stock market at all time highs and ground breaking new technologies are changing the face of the US), Europe's banking system has not collapsed (German and UK stock markets at all time highs) and China's economy has not slumped.  The Resources Boom is not over.  The super capex boom might be trending down but the revenue gains are really only starting. Gold is now starting the next upleg.  Global resources stocks are responding.  You need to be on board. And despite most commentary, commodity prices are not falling but are stabilising and many are rising.   I note, too, a growing sense of underlying excitement developing in the whole sector. But the conventional wisdom has it otherwise. How often have you heard that these falling commodity prices will send resources stock prices lower along with the A$ in a long term downtrend that has no end in sight and that resources stocks are a most unattractive asset class.  And they don’t pay dividends, always are diluting shareholders by wanting more money and the management is rubbish.   Just lifestyle companies. How could this particular groupthink have eventuated? Where have all the thinkers gone today?  Is Australia made up of a new generation of wowsers and bureaucrats?  Regulators and bean counters who need the structures of ASIC and APRA and FoFA and FWA to tell people what to do and how to do it?  And then asset allocators with no real world experience dictating asset portfolio structures that are fixed by looking in the rear vision mirror.  And we are talking real money here.  A$1550bn in super fund assets. You all know the comment about generals still fighting the last war (particularly if they were the victors!) with a vested interest in maintaining their empires and structures so that strategies and tactics will be played out in a reasoned and rational manner. All applaudable reasoning.  Yes, the generals can show the politicians their crack polished troops and noisy toys so the politicians can tell their electorates that all their taxes are being spent on the right stuff so that if any of those XYZs get up to mischief as they did in `98, we will be ready. The Maginot Line of fixed fortifications was built at great financial cost by France in the 1920s and 30s to prevent an expected resurgent Germany, likely to be unhappy after the lop-sided Treaty of Versailles, invading across their long border.  A brilliant piece of engineering and long term planning over almost 20 years.  But the Germans with theirBlitzkreig (lightning war) simply skirted around through the mountainous forested Ardennes region of France and Belgium and outflanked the French and captured Paris within a six week campaign.   Fixed structures, mobile attackers. And more recently, the England cricket team arrived on our shores to continue the dominance shown in the three previous Ashes series over the seemingly rabble team and to maintain its high ICC ranking.  Mitchell Johnson has so far `outflanked’ them and their current thinking is scrambled over consideration of attack (with exactly what?) or defend (and admit defeat?).   Of course, in the end, what will be will be. So let’s come back to the main game.  Investing and making money. Investing is all about increasing wealth through balancing return against risk.  A compound 3%pa gain over inflation (real return) gives 34% pretax over 10 years.  Capital is maintained and Samuel Clements’ (Mark Twain) quip of the return of his money being more important than the return on his money, is respected.   And we are all painfully aware of the past 32 months giving the ASX Gold Index a 79% fall (and worse for smaller stocks) and making the return of our money only just a flicker of hope in a nightmare of despair. So this is all wonderful as asset allocators check the MSCI rankings and weightings and take into account JP Morgan/Goldman Sachs/Morgan Stanley/UBS/Deutsche Bank/etc  views on interest rates and currencies.  The eternal US$ up, Euro down, A$ down, commodities down (gold definitely DOWN), interest rates low and a large dollop of bonds (especially US Treasuries) required for safety and income in a very difficult world.  And avoid small caps and anything illiquid and just say NO to any investment that requires any additional pre-cashflow capital. Yes.  Everyone is set for the great extension to the US Great Recession and as China falls over and those Euro-sclerotic European banks and economies just roll over and die.  Everyone is set for the next ten years at that 3.0% pa pretax return.  And don’t alter that spreadsheet. But then there is Murphy’s Law, or as the great everyman’s economist Don Stammer would say, the X factor, to come into play.  Don probably isn’t following Mitchell Johnson at the moment. So the first graphic in this edition refers to the world’s second largest asset market (currency is first).  The global bond market is around US$80trillion with about 50% being US with US T bonds being about US$17trillion with municipal government, mortgage debt and corporate bonds making up the rest.  The numbers are difficult to precisely define as some double counting seems to apply but I am sure you get the drift. Anyway the first graphic refers to yield on long dated US Treasury bonds from an earlier major cycle low in 1942 and the 39 years of rising bond yields (and falling prices).  After the peak in yields in Dec Qtr 1981 there has been over 30 years of declining bond yields (and rising bond prices).  You have seen this graphic before but it is just as relevant as ever. Graphic 1 US long Term Treasuries Yields 1940-2013 The wowsers have had a great time.  (In another world this might have been Revenge of the Nerds).  And they obviously think there is more to come. No inflation and the Fed will bail us out so let’s just keep it going.  And this is one big slow moving ship of state type market that will take a while to turn.  It has been on this course for over 30 years so it has its own momentum. Looking at the past thirty years in price, however, it seems some ominous signs might be developing in the long term trend.  The uptrend line is being approached with a certain precariousness.  The absolute high in 30 Year T-Bonds occurred in July 2012, well over a year ago.  The bonds might bounce from here but if we check again with the yield perspective these rises in yield make the probability that the precarious is indeed precarious. Graphic 2 US 30 Year Treasuries Price Index 1980-2013 Yields in more recent times are rising here and the trend line break, support and `goodbye kiss’ on the trend line and subsequent rise, suggest higher yields are coming. Graphic 3 US 30 Year Treasuries Yields 2009-2013 Is that Mitchell Johnson out there or is it that a Panzer I hear? Apologies if this T-Bond stuff is repetitive in Dawes Points but this is history unfolding right before your very eyes as they say.  Stuff you can tell your grandkids.  `I was there when it happened’. So anyway we were talking about the renewal of the Resources Boom. Two new graphics.  Resources Sector capex and total exploration.  The Resources Industry in Australia has spent a cumulative A$418bn in new capital expenditure since 2000 and A$94bn in FY2013 alone.  Mostly on iron ore, coal and LNG projects. Graphic 4 Resource Sector Capital Expenditure 2000-2013    Exploration has been at an average rate of over A$2000m pa for minerals in the past six years (over A$13bn in this period) and A$4,000m pa for petroleum (over A$25bn).   Looking at the markets you would consider nothing has been discovered or developed.  Who is fooling whom? Graphic 5 Resource Sector Exploration Expenditure 2000-2013 Cumulative A$418bn in resources sector capex on new capacity.  Which the wowsers say won’t make any return.  Lifestyle companies.  Rubbish management.  No dividends.  Oversupply at the market top. And these are the resulting production forecasts. Iron ore and coal. The results of this will be some impressive production and export numbers for iron ore and coal. Over 500mt iron ore in FY13 and on its way to over 800mtps by FY2018. Graphic 6 Australian Iron Ore Exports 1965-2013 – BREE forecast to 2018 And 300mt of coal and more than 400mt in FY2018. Graphic 7 Australian Coal Exports 1968-2013 – BREE forecast to 2018 And  LNG. Graphic 8 Australian LNG  Exports 2000-2013 – BREE forecast to 2018 Prices for iron ore have been well above most commentators' expectations in FY2014 and coal is also better.  LNG exports should also rise by about 200% by FY2017. The net result in export revenue could be like this. Graphic 9 Australian Resources Sector Export Revenues 2000-2013 – Paradigm forecast to 2018 And these revenues are at roughly today’s prices and US$0.95 on the currency. If commodity prices are higher, and not lower as almost every commentator has incorrectly suggested, the numbers could be much higher. You know the story, A$54bn resources sector exports in FY2004 and ten years later A$220bn.  And the big three iron ore, coal and LNG alone will provide an increase of A$80bn by FY2017 to take it over A$300bn.  Quick check on operating margins for iron ore and LNG gives at least 50%, coal less but others OK.  40% EBITDA margin is A$120bn.  Some rubbish management.  Some lifestyle company. About A$60bn after tax. Traditionally resources companies paid out over 60% of their NPAT as dividends.  A$36bn in fully franked dividends.  >A$700bn grossed up at 5% yield.  Market cap of A$600bn on PER of 10.  Assuming prices don’t rise and some other smart alec starts talking about it being a long term growth sector and should have PERs expanding.  And higher commodity prices would bring growth in dividends.  Come on all you Warren Buffets disciples.  Do the maths. Of course, not all the investment is by ASX-listed companies but BHP, RIO, WPL, STO, FMG have contributed mightily. And have a look at this.  Over 200 more projects identified by BREE as feasibility studies or better.  Needing your money to develop them.  Hundreds of companies with projects.  Most trading at a few per cent of the project NPVs.  Just waiting for capital. Graphic 10 Australian Resource Development Projects 2003-2013 And it is your capital that is needed.  Not huge swags of foreign equity and debt. The A$1,537bn in bank deposits including A$547bn in term deposits, and A$595n in savings and building society accounts.    And around A$1550bn in superannuation (some double counting here of course).   And here I am sitting in Shenzhen, China, seeking a few million for some ultra cheap mining project that should achieve minimum IRRs of 30% while the wowsers are jumping for joy over bank dividends that are paying 5%. These are true alternatives to having ALL of your money in the banks and Telstra.   These opportunities are just begging for attention and funding. The A$1550bn tied up in Australia’s superannuation funds has mandated inflow of over A$100bn and an investment time horizon of at least 20 years.  Yet it is seemingly exceptionally `risk averse’ and seeking 3 month returns.   A major rethink is needed here.  Some recent ABS stats indicated that A$1.8bn in superannuation taxes (sorry, `contributions’) were paid by the mining industry in FY2012.  How much came back to it in investment over FY2013?  A$1.8bn out, not much back in. Some Australians might feel that they have missed out on the benefits of the boom but they haven’t really, because corporate earnings prior to 2008 provided substantial boosts to government tax revenues and allowed repayment of debt and gave reductions in tax rates.  And the best benefit any government can deliver is economic policy that produces a strong currency.  At US$1.00 the A$ makes you 25% wealthier than at US$0.80.    Cheaper food, cheaper energy, cheaper cars and cheaper TVs etc. And cheaper holidays. A 25% stronger currency is far better than a 25% pay rise.  Think about it. But a stronger A$ should also mean that interest rates should have a downward trend.   A strong currency should force governments to cut their public expenditures, firstly to reduce any borrowings and force cuts in interest rates.  Secondly to reduce the size of the least productive sector of the economy. A strong currency makes everyone wealthier. And this is the latest update on the long term trend for the A$.  Just pulling back to test support on the long term downtrend of the 90 year variety.  A powerful message here.  If the A$ gets above parity to confirm this thesis we will be in for decades of strong currency. Graphic 11 Long term US$/A$ Exchange rate 1913-2013  Now having had a look at this data and I think you might agree that the best for Australia is yet to come! And resources stocks are unloved, despised, underowned, down 80% from their highs, back to the levels of a decade ago, cheap and just rearing to go!. I will close with this busy graphic that just might be confirming that gold is now getting serious about renewing its bull market.    The low was back in late June 2013.  The rally could be very sharp now but the high will be many years away in this extraordinary bull market. Graphic 12 Gold bull market about to surge    11 December 20013 Shenzhen China Barry Dawes B Sc F AusIMM (CP) MSEG MSAA