 Base Metal Stocks:
A Bull Market Beyond Expectations
Kenneth J. Gerbino
Archives
Kenneth J.
Gerbino & Company
April 1, 2005
I believe the base metal stocks
are going to extend their bull market for a long time and well
beyond the consensus "group think". There will be corrections
along the way but these stocks should surprise everyone over
the next few years. My reasoning follows below.
Precious metal mining stocks
should be in everyone's portfolio but I also think it is a good
idea to have some exposure to base and other metals (copper,
zinc, nickel, lead, chromium, aluminum).
In order to understand a major
change that could take place in an investment sector one can
gain insights from a major change that took place in another
sector.
I remember twenty years ago
when Intel was producing computer chips, which at the time had
become like a commodity item. From 1985-1995, Intel sold for
only 7-12 times earnings because of the then "commodity"
aspect of chips and the fact the computer industry was at that
time a cyclical industry. By 2000, Intel was selling for 60 times
earnings because of the Internet, laptop and cell phone usage
explosion (mega-trends creating a new electronic marketplace
with a more sustained demand for chips). Even today, after the
tech stock wipeout, Intel is still selling for 20 times earnings.
A similar usage explosion
has now started in base metals. The corresponding new mega-trend
is Asian and Indian base metal demand. Base metal stocks are
now selling at only 5-8 times cash flow. Old time base metal
investors are locked into the past thinking of the cyclical nature
of the industry. Three billion Asian and Indian people say "no
way". Any structural or sustained demand for these metals
could increase cash flow multiples to 12-16 times or more. This
has significant implications. It means that even if the prices
of these base metals go down by 25-35%, because of the multiple
expansions, the base metal stocks will still be buys.
Even with just 2-3% growth
in Asia and India (current growth rates are 8-9%) a steady demand
for resources will create a more sustained and structural market
for these metals. A steady demand would change the "cyclical"
aspect of base metal demand and this would be reflected in higher
cash flow multiples and higher stock prices. Tight supplies also
will help stock values.
The latest data from China
shows that 82% of their capital spending is on housing and infrastructure
(roads, power plants, railroads, sewers etc.). Even with only
2-3% growth, China's capital spending should be a long-term positive
non-cyclical factor to metal demand, as these infrastructure
projects will last for decades as huge rural populations enter
their new economic world.
In the more established economies,
capital spending is more cyclical because people are buying cars
and TV sets and washing machines based on the economy, which
can go up and down. But newly industrializing countries do not
stop building roads and power plants when their economies slow
down.
Infrastructure projects are
usually not cyclical since they have State backing and many times
are not curtailed despite poor economic conditions. In the current
age of debt financing and printing money by world governments,
it would be hard to imagine politicians considering canceling
a power dam or major highway because of a slowdown in the economy.
It will not happen in China or in India. The projects in the
U.S during the great depression and many projects in Asia during
the Asian meltdown are good examples of large state projects
that continued despite all. Therefore one can expect a robust
demand for base metals for a very long time even with substantial
slowdowns in India and Asia.
China will attempt to talk
down their economic growth and try and get the hedge funds and
speculators out of the metal markets so they can buy cheaper
on world markets. But with 82% of their capital spending on housing
and huge infrastructure projects any economic slowdown will still
require a sustained demand for these metals.
Because of this change from
a cyclical nature of base metal demand to a more structural and
smoothed out demand, the valuations and cash flow multiples for
the base metal producers I believe could have a possible dramatic
shift upwards. Also it is just a matter of time before they start
paying out solid dividends.
Asian analysts are missing
the boat on the compounding of metal demand. Demand growth of
plus 10% for a given year, followed by a major slowdown to only
3% in the next year is still bullish. When you do the math you
start with, lets say, normal demand of 100,000 tonnes of some
metal, that then goes to 110,000 tonnes (10% higher) and prices
respond upwards. Now in the next year, if you go down to only
a 3% growth rate that means you are now increasing demand from
the 110,000 tonnes by another 3%. That means demand
in year two is 113,300 tonnes. That's still more demand
than what caused the price to go up in the first place.
If 110,000 tonnes created a price rise, then a 113,300 tonne
demand the following year will certainly do it again unless supply
turns up from somewhere and in the mining business this means
5-10 year lead times. Even a slowdown in Asia and India is bullish
for the metals.
Cash flow multiples should
also increase for these mining stocks due to two other long term
inflation inducing economic mega-trends we have
discussed many times (global money printing and increasing debt
levels).
At the recent The Bank of Montreal
Nesbitt Burns annual institutional mining conference every CEO
from the base metal companies that presented had the same story;
demand was very strong and not letting up and that warehouse
supplies globally of many basic metals are very low. They see
significant supply squeezes for the next 2-3 years.
BHP, the largest natural resource
company in the world right now makes more profits from
base metals than any other business sector including
petroleum, coal, steel materials, or diamonds. BHP is currently
bidding $7 billion for base metal producer WMC. Xstrata ($6.5
billion mining giant) was also bidding about $6 billion. These
big conservative mining companies know their industry and I believe
they see sufficient evidence that a new base metal decade is
coming to this world.
Some junior companies with
quality base metal, or massive sulfide deposits and other important
metals may also be good buy out candidates for other resource
companies as these juniors develop their projects.
A new "materials"
centric world is unfolding for billions of people who desire
a better lifestyle and are demanding it Technology, education,
globalization, and communication, are driving this desire. This
is a huge unstoppable mega-trend. The resource sector will be
a solid investment theme because of this and companies in the
base metal and precious metal sectors should experience well
above average growth.
March 2005
Kenneth J. Gerbino
Archives Kenneth J. Gerbino & Company
Investment Management
9595 Wilshire Boulevard, Suite 303
Beverly Hills, California 90212
Telephone (310) 550-6304
Fax (310) 550-0814
E-Mail: kjgco@att.net
Website: www.kengerbino.com Copyright ©2004-2016 Kenneth J. Gerbino & Company. All Rights Reserved.
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