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February 20, 2019

Global Market Comments
February 20, 2019
Fiat Lux

Featured Trade:

(THE NEXT COMMODITY SUPER CYCLE HAS ALREADY STARTED),
(COPX), (GLD), (FCX), (BHP), (RIO), (SIL),
 (PPLT), (PALL), (GOLD), (ECH), (EWZ), (IDX),
(WHY THE REAL ESTATE BOOM HAS A DECADE TO RUN),
(DHI), (LEN), (PHM), (ITB)

The Next Commodity Supercycle Has Already Started

When I toured Australia a couple of years ago, I couldn’t help but notice a surprising number of fresh-faced young people driving luxury Ferraris, Lamborghinis, and Porsches.

I remarked to my Aussie friend that there must be a lot of indulgent parents in The Lucky Country these days. “It’s not the parents who are buying these cars,” he remarked, “It’s the kids.”

He went on to explain that the mining boom had driven wages for skilled labor to spectacular levels. Workers in their early twenties could earn as much as $200,000 a year with generous benefits.

The big resource companies flew them by private jet a thousand miles to remote locations where they toiled at four-week on, four-week off schedules.

This was creating social problems, as it is tough for parents to manage offspring who make more than they do.

It’s starting to look like we are on the eve of another great commodity boom, the start of a long-term super cycle. China, the world’s largest consumer of commodities, is currently stimulating its economy on multiple fronts, including generous corporate tax breaks and relaxed reserve requirements. Get a trigger like a settlement of its trade war with the US and it will be off to the races once more for the entire sector.

The last bear market in commodities was certainly punishing. From the 2011 peaks, copper (COPX) shed 65%, gold (GLD) gave back 47%, and iron ore was cut by 78%. One research house estimated that some $150 billion in resource projects in Australia were suspended or canceled.

Budgeted capital spending during 2012-2015 was slashed by a blood curdling 30%. Contract negotiations for price breaks demanded by end consumers broke out like a bad case of chicken pox.

The shellacking was reflected in the major producer shares, like BHP Billiton (BHP), Freeport McMoRan (FCX), and Rio Tinto (RIO), with prices down by half or more. Write-downs of asset values became epidemic at many of these firms.

The selloff was especially punishing for the gold miners, with lead firm Barrack Gold (GOLD) seeing its stock down by nearly 80% at one point, lower than the darkest days of the 2008-9 stock market crash.

With both prices and volumes in a race to the bottom, the effect on profits was especially traumatic. Highly leveraged, smaller, undercapitalized firms have filed for bankruptcy in droves, such as the Western Australia-based Allmine Group (see http://www.allminegroup.com), a service provider.

You also saw the bloodshed in the currencies of commodity-producing countries. The Australian dollar led the retreat, falling 30%. The South African Rand has also taken it on the nose, off 30%. In Canada, the Loonie got cooked.

The impact of China cannot be underestimated. In 2012, it consumed 11.7% of the planet’s oil, 40% of its copper, 46% of its iron ore, 46% of its aluminum, and 50% of its coal. It is much smaller than that today, with its annual growth rate dropping by more than half, from 13.7% to 6.6%.

The rise of emerging market standard of living will also provide a boost to hard asset prices. But as China goes, so does its satellite trading partners, who rely on the Middle Kingdom as their largest customer. Many major commodity exporters themselves, like Chile (ECH), Brazil (EWZ), and Indonesia (IDX), are looking to come back big time.

As a result, western hedge funds are currently moving money out of paper assets, like stocks and bonds, into hard ones, such as gold, silver (SIL), palladium (PALL),  platinum (PPLT), and copper. A massive US stock market rally has sent managers in search of any investment that can’t be created with a printing press. Look at the best performing sectors this year and they are dominated by the commodity space.

The bulls may be right for as long as a decade, thanks to the cruel arithmetic of the commodities cycle. These are your classic textbook inelastic markets. Mines often take 10-15 years to progress from conception to production. Deposits need to be mapped, plans drafted, permits obtained, infrastructure built, capital raised, and bribes paid. By the time they come on line, prices have peaked, drowning investors in red ink.

So a 1% rise in demand can trigger a price rise of 50% or more. There are not a lot of substitutes for iron ore. Hedge funds then throw gasoline on the fire with excess leverage and high-frequency trading. That gives us higher highs to be followed by lower lows.

I am old enough to have lived through a couple of these cycles now, so it is all old news for me. The previous bull legs of super cycles ran from 1870-1913 and 1945-1973. The current one started for the whole range of commodities in 2016. Before that, it was down from seven years.

While the present one is short in terms of years, no one can deny how business cycles have been greatly accelerated by globalization and the Internet.

Some new factors are weighing on miners that didn’t plague them in the past. Reregulation of the US banking system is forcing several large players, like JP Morgan (JPM) and Goldman Sachs (GS) to pull out of the industry. That impairs trading liquidity and widens spreads— developments that can only accelerate upside price moves.

The prospect of flat US interest rates is also attracting capital. That reduces the opportunity cost of staying in raw metals, which pay neither interest nor dividends.

The future is bright for the resource industry. While the gains in Chinese demand are smaller than they have been in the past, they are off of a much larger base. In 20 years, Chinese GDP has soared from $1 trillion to $10 trillion.

Some 20 million people a year are still moving from the countryside to the coastal cities in search of a better standard of living and improved prospects for their children.

That is the good news. The bad news is that it looks like the headaches of Australian parents of juvenile high earners may persist for a lot longer than they wish.

 

 

 

 

 

Picking Up Freeport McMoRan

It is clear from the improving economic data from China that the hard landing scenario is off the table. This is great news for the producers of everything that the Middle Kingdom buys in bulk, especially copper.

If you like copper, you?ve got to love Freeport McMoRan, one of the world?s largest producers for the red metal. On top of these rapidly improving fundamentals, the stock yields a nice security blanket of a hefty 4% dividend. These factors explain the sizeable insider buying that has been taking place in the shares over the past month.

Finally, the technical picture is looking pretty positive. The chart is showing that an upside breakout is taking place, supported by a sharp turn up in the 50 day moving average. The 200 day moving average is not far above, settle up the possibility of a fabled ?golden cross.? This is universally positive for share prices.

This commodity is known in the investment industry as Dr. Copper, the only metal that has a PhD in economics. That?s because of its uncanny ability to predict the future of the global economy. Copper is now hinting of better things to come, along with the stock market, like a 3.5% GDP growth rate in the US next year.

The recent strength further is confirmed by longer-term charts for the Shanghai index ($SSEC), which is showing that a double bottom may well be in place. Will China permabear, Jim Chanos, finally get his comeuppance?

Copper was the first metal used by man in any quantity. The earliest workers in the red metal found that it could be easily hammered into sheets and worked into shapes, which became more complex and artistic as their skill increased. The ability to resist corrosion ensured that copper, bronze and brass remained as functional as well as decorative materials during the Middle Ages and through the Industrial Revolution to the present day.

Of the 16.7 million metric tonnes of copper produced in 2012, Chile was far and away the leader, with 5.4 million tonnes, followed by China at 1.5 million tonnes, Peru at 1.2 million tonnes, and the US at 1.1 million tonnes. This makes the Chile ETF (ECH) another great backdoor play in copper. As copper is a great electrical conductor, it is primarily used for electrical wiring, followed by the construction industry and shipbuilding, and the auto industry, especially in alternative vehicles.

It?s true that copper is no longer the dominant metal it once was. Because of the lack of a consumer banking system in the Middle Kingdom, individuals have been hoarding 100 pound copper bars and posting them as collateral for loans. Get any weakness of the kind we have seen this year, and lenders panic, dumping their collateral for cash.

The high frequency traders are now also in there in force, whipping around prices and creating unprecedented volatility. You can see this also in gold, silver, oil, coal, platinum, and palladium. Notice how they seem to be running the movie on fast forward everywhere these days? This summer, we probably got an overshoot on the downside in copper that finally flushed out the last of the weak holders.

This is why I am loading up with a bull call spread Freeport McMoRan. The gearing in the company is such that a 50% rise in the price of copper triggers a 100% rise in (FCX). More conservative ad less leveraged investors can buy the First Trust ISE Global Copper ETF (CU).

FCX 9-11-13

SSEC 9-6-13

COPPER 9-9-13

ECH 9-11-13

Map-Where to Find Copper

Where to Find Copper

Pennies

Reach for Yield with High Dividend Foreign Stocks

With the increase of globalization, investing in foreign stocks can be a smart move. Many Americans have low exposure to foreign equities in their portfolio believing that US stocks are safer and more reliable. However, investing in foreign stocks can help to decrease risk, diversify your portfolio, give you access to emerging markets, and deliver dividend yields that you can only dream about at home.

France Telecom (FTE), the largest telecom operator in France, is a favorite target of yield hungry hedge funds. Earlier this year, the company?s revenue and growth declined due to the entry of a lower cost mobile operator Iliad S.A. (ILD.PA). Iliad offers SIM-only plans, which bypass the cost of having to buy a new phone. In its first quarter ever, Iliad added 2.6 million subscribers, taking many from France Telecom and its competitors.

Although Iliad?s entrance into the wireless market was impressive, SIM-only customers account for less than 5% of total users. Despite the difficult competitive and economic conditions France Telecom faces, they have recently experienced large customer growth, as 320,000 domestic consumers have switched back to their mobile service.

Customer growth is occurring internationally as well, with strategic marketing campaigns targeted in Africa and the Middle East. In fact, their Africa and Middle East segments have become their key drivers of growth over the past year. France Telecom currently pays one of the largest dividends in the telecom industry, which was recently cut in November. Their dividend yield is an eye popping 13.10% and the company is selling for $11.60 a share. France Telecom is enticingly undervalued here.

FTE 1-29-13

Banco Santander (SAN) is the largest bank in the euro zone by market value. It has been instrumental in restructuring the Spanish financial system as the country plans to decrease the number of competitors to create stronger, more reliable institutions.

With its recent acquisition of the Spanish banks Banesto and Banif, Santander expects to save over ?520 million a year. Although Santander has cut its branches to 30,000, it has greatly benefited from the ?100 billion rescue plan provided by the European Union.

Thanks to the ongoing financial crisis in Europe, Santander?s stock has been crushed. Analysts expect to see earnings of at least $0.80-1.00 a share in 2013. The stock is trading at 9.65 times its forward earnings, which is low compared to the industry average of 17.35. Furthermore, the relatively cheap stock is trading at 0.75 times its book value in comparison to a higher 1.33 of most other Spanish banks.

While the banking sector in Spain saw an overall revenue decrease of 0.4%, Santander exceeded expectations, growing 3.7%. The company has projected steady revenue growth for 2013 and 2014. Their current dividend yield of 6.9% provides a nice cushion against any near term volatility.

SAN 1-29-13

CorpBanca S.A. (BCA) is one of Chile?s oldest and largest banks. The company has a strong presence in Latin America and is attempting to penetrate the U.S market as well. A recent ADR (American Depository Receipt) issue means more liquidity and more accessibility for U.S. investors. The company intends to use proceeds of the offering to buy out competitors in the region and to gain a stronger grasp particularly in the Colombian banking industry.

With a current GDP growth rate of 5.7%, Chile (ECH) is one of the fastest growing economies in Lain America and is one of the few countries that run a budget surplus. Due to mandatory saving systems established by most companies, Chileans save a sky high 21.6% of their income. Furthermore, Chile gives foreign investors the same rights as domestic investors, which adds safety to any. CorpBanca has a 31.2% profit margin and a quarterly revenue growth of 38.2% year-on-year.? Their recent dividend yield of 6.0% is expected to rise.

BCA 1-29-13

ECH 1-29-13

Veolia Environment (VE) is a multinational French company that provides water management, water supply, waste management, energy, and transport services. It is the world?s largest water company, operating in 77 countries with a market cap of $6.2 billion.

Through the Veolia Innovation Accelerator Initiative, the company works with the most promising start-up companies to identify and develop clean technology. Veolia is strongly involved with governments around the world to help preserve natural resources, develop alternative energy sources, and control environmental degradation.

Due to the European crisis, the company saw H1 2012 results weaker than expected. To fight back, Veolia has been undergoing significant restructuring which includes a partial buyback program of USD and Euro-denominated bonds. Veolia has become heavily involved in China due to the country?s miserable environmental conditions. It operates in 17 provinces, municipalities, and autonomous regions helping restructure water and wastewater services. Veolia?s large presence in China will continue to grow in the coming years, promising stable growth over the long term.

Veolia pays a dividend 5.90% off of today?s $12.85 price. With its involvement in countries across the globe and its ever-increasing presence in China, Veolia is likely to do well in the coming years.

VE 1-29-13

Alumina Limited (AWC) is an Australian company that specializes in mining bauxite, alumina (aluminum oxide), and the smelting of pure aluminum. (AWC) produces around 17% of the alumina in the world and operates in the United States, Brazil, Spain, Suriname, Jamaica, and Guinea. It is your classic deep cyclical play.

Alumina has great thermal conductivity, making it a primary component of electrical insulation. In its crystalline form, it is used in sharp cutting tools making it essential for many manufacturing and production materials. Alumina Ltd?s very low debt to equity ratio and its estimated annual earnings growth rate of 35.10% for the next five years have attracted investors who focus on basic material commodities. Their forward dividend yield stands at a solid 6.10% with a payout ratio of 220%. (AWC) is selling well below its book value. There is one cautionary note: it is unusually sensitive to economic conditions of its main customer, China.

AWC 1-29-13