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Fundamental View on Metal MarketsLarry W. Reaugh The resource industry and market review I have prepared are the result of several queries from investors and associates in the past few months about my feelings and beliefs regarding the current debacle and what the future holds. Unfortunately, most of us will be affected on one level or another. It is my belief that the world always or ultimately operates on the fundamentals of supply and demand. To reinforce this, my understanding of the demand from the BRIC (Brazil, Russia, India and China) countries has always remained positive. These countries will continue their modernization regardless of the recession we are experiencing in the West. That leaves the supply side - the question is: What has been happening to disrupt the supply of metals? Taking a cross-section and focusing on mine shutdowns and cut-backs in production, I had two huge surprises. First, I was astounded by the proliferation of new producers in the past 1 - 3 years. Second, I am shocked by the rapid response to the downturn reflected in the number of recent production shutdowns. Over the past few weeks, while conducting research for this piece, the number of shutdowns has accelerated considerably. Also, major small and mid size producers are cutting back their production in all metals. The immensity of that combined extinguished supply demonstrates that a tilt in the supply/demand equilibrium is just around the corner and a spike up in commodity prices is not far behind. In 2003, I conducted a supply-and-demand analysis for molybdenum. As a result I moved to create a pure molybdenum company and to achieve the advantage of a head start towards production. I have been involved in the stock market and the mining industry for the past 45 years. In that time, I have never experienced such a terrible meltdown in the markets. Even the stagflation of the 1970's would be welcome at this point in time. The value of my mining stocks during the mid to late 70's neither went up nor down but remained at pretty much the same prices, as compared to today where my portfolio is down by 80% to 90%. Although most markets have lost 60% to 80%, resource stocks particularly, have been hit hard. My entire working life has been in the resource sector, so that will be the focus of this editorial. The majority of the forecasters on commodities today are predicting a several-year bear market in the prices of metal commodities across the board. My fundamentalist point of view, resulting from hands on research, is the exact opposite of the popular consensus for several reasons:
I have been steadfast in my belief that all commodities are strictly governed by supply and demand with the exception of LME-traded metals which are heavily influenced by speculators, funds and large investor trading. My theory about a bounce-back in metals was reinforced when researching a large cross-section of current and near-term producers, in conjunction with a list of several operators now on care and maintenance which currently influence or could influence the supply of all categories of metal. For those of you interested, I have compiled a list of companies which currently have some of their mining operation on care and maintenance that may be obtained from: http://www.reacompanies.com/list. This list is only the tip of the iceberg of what is happening in our industry and focuses only on North American listed stocks where the situation here at home is only a reflection of what is happening worldwide. The total analysis involved over 100 companies but I have only listed those companies which have actually shut down or those that have put some of their mining operations on care and maintenance. Remember, this is only a glimpse what is happening out there. Due to safety regulations, China alone will be shutting down 6,000 of its 16,000 coal mines over the next 2 years. Forty-five out of seventy-five copper/ cobalt producers have shut down in the Democratic Republic of Congo (DRC). Shut downs are also widespread in Australia, South Africa, South America and India, etc. To me, the conclusion is obvious - those companies which have recently commenced production or have advanced projects on stream to go into production are being severely punished by the market with some market caps decreasing as much as 90% to 99%. There is no avenue for them to raise money to streamline operations in order to turn the corner on new production. At the present market stage bridge loans are a particularly difficult scenario with which to deal and any company having to repay those bridges is at severe risk of failure. It is a 'damned if you do and damned if you don't' scenario. My sympathies go out to those companies as I understand the hard work and focus required to bring on new production today. The old adage of having production to see you through the lean times has not held up this time around for a vast number of companies and appears to be a liability rather than an asset for most of them. The above list reflects only 20 companies which have shut down production - to think of the total number boggles the mind. The entire resource sector has been ravaged with the share prices of junior explorers down 95% to 99%, intermediate producers down 60% - 90% and some majors down close to 85%, especially in the steel industry. The total resource sector has had approximately $1.5 trillion knocked off of its market cap, with household names like U.S. Steel losing 85% of its market cap in the past 6 months. In my opinion, the way all categories of mining stocks are now viewed by the investment bankers and the investment community will change radically as follows:
The following is a snapshot comparison of some of the commodity price losses in the past 6 months:  Through previous observation and current research I have identified certain trends which indicate that prices will again head north in the next 6 - 18 months and eventually break most historic highs. This commodity Bull will break all previous cycles as the BRIC countries continue to modernize their infrastructure. The massive amount of metal supply that has been extinguished in the last 6 months will very quickly have a positive effect on metal commodity prices once again. Some of the benefits derived from the financial meltdown are as follows:
I have pretty much focused on base and minor metals in my review and it goes without saying that precious metals have a similar driving force and are experiencing closures as well. With gold being the exception, silver, platinum and palladium have a solid industrial base and will follow the direction of the base metals. Conversely, gold is the ultimate currency and will lead all metals out of this current recession. The disconnect between gold and other precious metals will become more evident going forward. My observation is that gold will play a much more important role as we become awash in all the world's currencies and seek value that cannot be destroyed by banks or governments. I believe the deck is stacked in favor of all commodities, surviving mining companies and explorers over the next three years. We will look back on the last two months of 2008 as the greatest buying opportunity of the century. My exercise in the synopsis outlined above was to source a course of action to direct my companies over the next 2 - 5 years. I am more enthused now about the prospects for our industry than I have been in the last 18 months. Caution is the direction I choose for the interim and as the market signals, I plan to become more aggressive in the future. I believe the shareholders deserve to know how their management and directors intend to move forward during these tumultuous times so I will be posting my observations on our website: In conclusion, I personally have been investing and continue to invest at these dramatically lower prices. Due to the current market my retirement has been postponed several years and I believe the only way I will be able to recoup is to take advantage of the current low share values. This is the tax selling season which creates further discounts from current low prices, definitely an advantage to the contrarian buyer. Look for companies that will survive the current market as these companies will be the strongest emerging from this recession. It's a new world out there but the emerging economies need our products. Daily, more and more casualties are appearing in our industry and this will continue until well after commodity prices once again head north. Mines can not operate at losses so supply will diminish much faster in this cycle, once more creating runaway prices in the next leg of the commodity Bull market. I encourage everyone to do their own due diligence as there are great opportunities in the market today with excellent projects, low-cost production and don't forget the junior companies that are trading at less than cash value. Dec 9, 2008 Larry W. Reaugh is not an investment advisor and any reference to specific securities in the list referred to in the article does not constitute a recommendation thereof. The opinions expressed herein are the express personal opinions of Larry W. Reaugh. Nothing in this article should be construed as a solicitation to buy or sell any securities referred to in the list or in the article. The author bears no liability for losses and/or damages arising from the use of this article. 321gold Ltd |
