Recently I have been reading and hearing about a commodities bubble. I disagree with the idea of commodities being in a bubble – some may occasionally become overbought and correct. Occasionally we will see profit taking and nervous nellies selling on the backs of the various naysayers. But what some are calling bubbles is simply demand outpacing supply.
"When the price of copper finally hit $2 a pound and started going above that, you started hearing people say, It's going to go right back down below $1 which is where it's been for decades. But more and more there came a point of view that this was a permanent increase in prices." Raymond Goldie, analyst, Salman Partners
The citizens of the worlds developing nations (China has one fifth of the world's population, India another 1.2 billion people) aspire to have what we have, the ease of travel, home phones, electricity, central plumbing, heating and air conditioning, cars, toys, consumer electronics and home appliances. The overall dominant global trend in the commodities sector is for increasing demand and rising prices because of a lack of supply.
Also I believe we're heading, over the next few years, to a very inflationary environment. With US President Obama promising trillion dollar deficits for years to come, with all exporting countries trying to keep their currencies weak to make their exports competitive and with Bernanke throwing money out of helicopters – once my anticipated inflation starts it isn't going to stop anytime soon.
The International Monetary Fund (IMF) recently published its report World Economic Outlook for October 2010 and in it they talked about commodity demand from emerging countries. "Because their growth is more commodity-intensive than that of advanced economies, the rapid increase in demand for commodities over the past decade is set to continue…the current era of higher scarcity, rising metal price trends and a balance of price risks tilted toward the upside may continue for some time."
Agricultural commodities are skyrocketing in price as well. Grain prices soared last Friday after the US department of Agricultural drastically revised estimates downward for the US corn harvest – they slashed a record 6.7 bushels an acre off the national harvest figures. This after projecting a record corn harvest as recently as August.
"Shocker may be an understatement. It's very out of character for the USDA to lower the corn yield so much." Jason Britt, president, Central State Commodities
The USDA will often revise (several times) its harvest estimates in October. But with the US corn harvest, at the time, barely 50 percent complete no one expected such a massive bushel per acre revision to the harvest numbers.
"The indication is that we'll just continue to move up from now. There is literally nowhere else in the world to turn to fill these supplies." Darin Newsom, senior analyst, Telvent DTN
Also consider the following:
- Population growth
- Scarcity of new resource discoveries
- Declining grades and ore reserves at existing deposits
- Decrease in arable land
- Lack of freshwater for irrigation
Investor interest is growing in the fertilizer sector. Anglo-Australian miner BHP Billiton recently made a $39 billion hostile bid for Canada's Potash Corp. – the world's largest fertilizer maker. China and the Ontario Teacher's Pension Fund are possibly getting involved and this author expects another higher bid to be offered, although as I write this none has appeared.
After last Fridays surprise announcement by the USDA shares in fertilizer companies soared.
To me it all means we are going to see much tighter supplies of, and higher prices for commodities going forward.
If I was looking for superior investment vehicles to take advantage of what I think I know regarding the future for commodities and precious metals I'd be looking at junior producers, near term producers and companies that are in the post discovery resource definition stage with the occasional green field exploration play thrown into the mix.
Why? Well besides the fact that I believe junior resource companies offer the greatest leverage to increased demand and rising prices for commodities there is a very real and increasing trend for Mergers and Acquisitions (M&A) in one of the few bright spots available for investors, resources – whether it's mining or agricultural.
Juniors, not majors, own the worlds future mines and juniors are the ones most adept at finding these future mines. They already own, and find, what the world's larger mining companies need to replace reserves and grow their asset base.
The following factors are driving the growing M&A trend:
- Consolidation to achieve economies of scale and pricing power
- Scarcity of large producing assets
- High demand in industrialized nations for metals and minerals
- V shaped recoveries in developing countries
- Expansion into new geographies
- Diversification of resource bases
- Overall return to risk
- Looser bank lending
- Higher commodity prices and better company cost management = larger operating cash flow
"As the potential for commodity scarcity escalates, M&A activity in the global mining sector will likely intensify, mimicking a 'global arms race. With few large targets in play and diminishing key resource reserves, we expect global miners will continue to scour the globe for projects and broaden their deal strategies." M&A in the Global Mining Sector – No Stone Unturned, PricewaterhouseCoopers
"The key to really understanding what's driving this globally is the pressure on food production around the world." Denita Stann, Potash Corp's director of investor relations.
- Rising commodity prices
- Soaring share prices because of outstanding drill assay results
- Increased excitement being brought to the junior sector by increasing M&A activity for junior "fish"
The soon to be a tidal wave of money coming into the resource sector is going to bypass the majors and roll right over the few surviving mid-tiers. This money is going to be looking for the greatest leverage to increased commodity demand, rising commodity prices and the potential for an extremely lucrative buyout.
In their No Stone Unturned report PricewaterhouseCoopers (PwC) said 1,732 deals worth $159 billion were struck in the record setting year 2007 – 1,324 M&A deals were struck in the first six months of 2010 for a total value of $104 billion. But the overall number of mega deals (+ $500 million) is way down with only 28 announced to date against 54 in 2007.
"Scarce opportunities for mega deals have prompted more senior miners to acquire junior mines and exploration companies earlier in their life cycle." PwC
"Many mining and metals companies are looking for acquisitions to fast track supply pipelines, driven by confidence in ongoing underlying demand in China and India. We are seeing a lot larger lists of potential buyers than there are assets available." Mike Elliot Ernst & Young's Global Mining & Metals Leader
Senior miners are buying junior and exploration companies earlier in their life cycle. New money is coming into the sector, bids are building and the asks are being taken out. Significant drill assay results are giving companies share prices a rocket ride when released.
It's an exciting time to be an investor in the junior resource market. Are there some quality junior producers, soon to be producers, post discovery resource definition, green field exploration companies and potential takeover targets on your radar screen?
If not, maybe there should be.
Richard (Rick) Mills
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Richard is host of aheadoftheherd.com and invests in the junior resource sector. His articles have been published on over 200 websites, including: Wall Street Journal, SafeHaven, Market Oracle, USAToday, National Post, Stockhouse, Lewrockwell.com, Casey Research, 24hgold, Vancouver Sun, SilverBearCafe, Infomine, Huffington Post, Mineweb, 321Gold, Kitco, Gold-Eagle, The Gold/Energy Reports, Resource Investor, Calgary Herald and Financial Sense.
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I only have two gold-related stories for you today. The first is a GATA release of a King World News blog featuring Jim Rickards of Omnis Inc. As always, anything Jim has to say, is worth the read… and this short piece is no exception. The headline states "Jim Rickards: Race between gold and new paper currency"… and the link is here.
Lastly today is this piece from yesterday's edition of The Telegraph that's courtesy of Washington state reader S.A. The headline reads 'Gold is the best asset class to be in'. After a 10-year bull run, conventional wisdom says it's too late to join the party. Is it different this time? The writer points out the obvious fact that unallocated gold [including pool accounts] leave investors exposed to counterparty risk… if the custodian goes bust, you can't reclaim the gold and will simply be a creditor. This is something that I've been going on about in this column for years… and I hope, dear reader, that you will take his words [and mine] to heart. This is a must read… and the link is here.
¤ THE FUNNIES
¤ THE WRAP
Inflation has now been institutionalized at a fairly constant 5% per year. This has been scientifically determined to be the optimum level for generating the most revenue without causing public alarm. A 5% devaluation applies, not only to the money earned this year, but also to all that is left over from previous years. At the end of the first year, a dollar is worth 95 cents. At the end of the second year, the 95 cents is reduced again by 5%, leaving its worth at 90 cents, and so on. By the time a person has worked 20 years, the government will have confiscated 64% of every dollar he saved over those years. By the time he has worked 45 years, the hidden tax will be 90%. The government will take [in purchasing power] virtually everything a person saves over a lifetime.– G. Edward Griffin
I note that both gold and silver are drifting lower in Far East and early London trading as I put the finishing touches on today's column. Volume in both metals [as of 4:09 a.m. Eastern time] is already pretty decent. The dollar is up about twenty-five basis points as well. As I've mentioned several times, both precious metals are overbought… and the dollar is oversold. A reversal of these conditions, regardless of whether they're warranted or not, may be in the cards. We'll see.
For the past month or so… and for whatever reason… I've noted that Tuesdays [the cut-off for Friday's COT report] have been big price movement days in both silver and gold. So far, they've all been to the upside… so I'm more than interested in seeing what today's price action will bring.
Not that it really matters, because as I've said many times, the ever-increasing prices for both gold and silver would hit the odd speed bump along the way… and it's important not to get panicked by the day-to-day price movements. I'll still be 'all in' regardless of what gold and silver prices do today, next week… or even next month. I'm just not smart enough to trade in and out of this market… especially at this point in time.
I hope your Tuesday goes well… and I'll see you here tomorrow.