Back in 1999 whenever tech stocks had a pullback or retreated briefly, the chorus of popular consensus was deafening in declaring that any weakness was a wonderful “buying opportunity”. This typical mania behavior didn’t start to abate until the NASDAQ was down 50% or so in late 2000 less than a year after its crash.

In light of the context tech stocks in 1999 provide, the sentiment in the commodities realm this week was quite amusing. After multi-day pullbacks in energy, precious metals, and base metals, every financial report I saw was wondering whether the commodities bull is over. From CNBC to Reuters, commodities bears were pontificating all over the place about why the end must be drawing nigh.

Yet any astute student of market history would have to laugh at the assertion that a commodities mania has been underway so therefore a bust must be approaching. Manias have very distinctive characteristics in terms of duration, gains, psychology, and fundamentals that commodities are not even close to approaching.

This commodities bull launched less than 5 years ago in October 2001. This is far too short of time for a secular bull to run its course and build the popular adoration necessary to ignite a mania. The 1999 NASDAQ mania, in contrast, was the culmination of a typical 17-year secular bull market in stocks. Manias just don’t happen early on in young secular trends.

Today in real inflation-adjusted terms commodities are only trading near early 1990s levels at best. In comparison the true stock mania in 1999 saw the US stock markets driven way up to all-time real highs. The idea of a true commodities mania when the CRB Index still remains two-thirds below its own all-time real highs is pretty farfetched.

Psychology during manias is fantastically bullish and no one can even entertain the possibility that anything other than a New Era of permanently high prices is upon them. But in commodities today psychology is still very bearish, as witnessed by the legions of experts this week who were ready to throw in the towel on this whole bull after a minor pullback. If you remember 1999, commodities psychology even in late January 2006 when this realm was surging was ridiculously dismal in comparison.

Finally true manias drive valuations to stellar extremes. The general stock markets were trading at 44x earnings in early 2000, all-time highs far exceeding even the valuations right before the infamous 1929 crash. Today many stocks of major commodities producers including oil and copper are trading near 7x earnings, just half the 14x traditional fair value. A mania at 7x earnings? Please. 7x is bottoming territory, not topping!

The popular notion making the rounds this week that a commodities mania has been upon us and is now busting is absurd when considered through the lens of market history. This young secular bull in commodities is painstakingly climbing the wall of worries characteristic of all early-stage bulls and is doing great. Yes, there will be periodic corrections such as we are witnessing in gold and silver today, but the global supply/demand fundamentals driving the long-term secular uptrend remain very much intact.

Despite the naysayers, vast opportunities to profit still remain in this awesome bull market, and I believe one of the most overlooked ones is in the base metals. While there is a true chemical definition for base metals, in general investment usage they are just common industrial metals that aren’t considered precious. My partner Scott Wright wrote an excellent essay last week describing the dazzling worldwide base metals fundamentals in force today.

Scott and I have been doing a lot of research in base metals as we layer in trades in elite miners, and there are five major base metals in particular that have really captured our attention. They are copper, zinc, nickel, lead, and aluminum. These are certainly not the only base metals opportunities though. Others include uranium, molybdenum, and a host of more exotic and lesser known elements like indium.

But even commodities investors today who are already well versed in energy and precious metals have still largely overlooked the big five base metals. Thus in a sense base metals producers are probably as much as a contrarian play today as gold miners were 5 years ago or oil producers 3 years ago. I expect massive profits to be earned in the coming years by investing and speculating in elite base metals miners.

Since base metals have largely escaped the limelight so far, there has been a dearth of technical studies on their price behavior. While I have studied gold, silver, oil, and gas in great depth technically, I hadn’t yet taken a serious technical look at base metals. I understood their general bullish uptrends, but I wanted to get a better feel for their volatility and how exactly their bulls have unfolded. Hence this essay.

The following typical Zeal technical charts examine copper, zinc, nickel, lead, and aluminum. In each chart the actual base metal price, its standard-deviation bands, and its key moving averages are rendered on the right axes. The left axes show the Relativity-based technicals of each base metal, or where they have traded over time as multiples of their key 200-day moving averages.

The base metals’ bull-to-date behavior has really been quite interesting. We’ll start with a look at copper, arguably the king of the base metals world. This underappreciated metal among investors is up a whopping 287% bull to date, compared to just 124% for gold. Fortunes will be won by investors in elite copper stocks.

Some of the biggest and best publicly-traded major copper miners have been trading at ultra-low valuations similar to oil stocks, around 7x earnings. It blows my mind that anyone would want to own a bubble like Google trading at 70x earnings when they could pay 1/10th that price for an identical dollar of earnings from an elite copper miner. Amazingly these dirt-cheap copper miners were sold this week like they were radioactive.

Why the copper-stock panic? Since early February copper is down from $2.34 per pound, an all-time high, to about $2.20. This trivial little 6% pullback apparently convinced investors that the sky was falling. For the investors that were spooked, their problem was a crippling lack of perspective. When the whole copper bull to date is considered in strategic context as in this chart, it shows just how spectacular copper prices remain today.

For most of 2002 and 2003, copper was trading in a tight and modest initial uptrend of about $0.65 to $0.90 per pound. Mining copper, not surprisingly, is not done overnight like building a website. It takes up to a decade to find deposits, secure permitting, build a mine, and then start producing. So every major copper mine on the planet today was planned and built in years past based on economic assumptions of far lower copper prices than we are seeing today.

In late 2003 copper broke out to the upside in what seemed like a radical and unsustainable spike at the time. Yet, after this huge surge which drove copper more than 50% over its 200dma it didn’t crash. Instead it consolidated sideways briefly and then started climbing higher in a brand new steeper and more volatile uptrend. And last year copper surged above this latest uptrend too in another breakout.

If you carefully compare both uptrends and their respective breakouts, they look fractal in nature. A fractal is a general price pattern that repeats itself at different scales. If this pattern holds again this time, we are unlikely to see copper correct or crash but instead likely to see it consolidate and grind sideways until its black 200dma line catches up with it. So far in this copper bull there is zero evidence to suggest it is volatile enough to crash as some investors this week seemed to fear.

And fundamentally this makes sense too. No matter how high world copper demand rises, supply just cannot be brought online instantly. Copper would have to stay at today’s levels for 5 to 10 years before mining companies could do the exploring and build the mines necessary to feed the world the copper it is demanding. The industrialization of Asia coupled with the declining production of copper as many of today’s major mines reach the end of their prime has created a situation that cannot be rectified overnight.

Even if copper corrected down under its 200dma, to $1.75 or so, mining copper would still be fantastically lucrative. Most of today’s copper mines were probably built assuming $1.00 or less copper. So if you spent 10 years in the 1990s building a copper mine in South America you may have production costs of $0.90 and have hoped for $1.00 copper so you could turn a profit. But since copper has more than doubled, all of a sudden you have a veritable profits gold mine.

If copper doubles from $1.00 to $2.00, your mining costs still remain roughly the same at $0.90. Yet your profits per ounce mined rocket heavenwards from $0.10 in the old price paradigm to $1.10 in the new price paradigm, 11x higher! Several years ago I wrote an essay about gold-mining profits leverage but the economics of base metals mining are structurally similar. When you are pulling any commodity out of the earth and its selling price rises significantly, your profits literally explode.

If copper recovers and starts meandering higher as it did after its last breakout pullback, the valuations of copper miners are going to drop even farther and early investors are going to make fortunes. But even if copper corrects dramatically to $1.75 or below, which doesn’t seem probable, copper mining will still be phenomenally lucrative.

Copper’s technicals look great and highlight the sheer irrationality of selling copper stocks today. The metal has been rising in a bull but has not gone parabolic nor shown tendencies to plummet blisteringly fast in its bull to date. It might correct down to its 200dma or a little lower but it will more likely just consolidate sideways and stay near $2. In either case copper remains a fantastic mining business in which to be involved.

Zinc is similar to copper in some ways technically, it too has had two uptrends and two breakouts. But it is different in other ways and certainly unique. While zinc’s overall bull-to-date gain of 230% is lower than copper’s, a greater proportion of zinc’s gains occurred recently so zinc may have a higher probability of correcting down rather than consolidating sideways.

Like copper, zinc’s performance in its bull to date has been spectacular, far exceeding that of gold and silver. Unlike copper, it actually had somewhat of a relative trading range in 2004 and 2005. Note that zinc tended to peak just under 1.30x its 200dma before consolidating and that its consolidations tended to end at 0.95x its 200dma. Out of all five of these major base metals, zinc had the highest potential for a well-defined relative trading range.

But its latest upleg, which saw zinc run from about $0.55 per pound to nearly $1.10, a double in just a couple quarters, blew the developing zinc relative trading model apart when it surged to nearly 1.60x its 200dma. This awesome rally is certainly the fastest seen in the last couple years in any of the major base metals. While it was a heck of a run, zinc is looking fairly parabolic these days. Thus it has a higher probability of suffering a correction than the other base metals.

Now if zinc was to plunge all the way back down to its 200dma, under $0.75, it would probably bounce near both that 200dma and the resistance line of its latest uptrend. And compared to recent years, even this $0.75 probable worst-case technical scenario would still leave zinc mining extremely profitable. In 2002 and 2003 the metal largely traded under $0.40 so even a corrected zinc would represent a double in revenues for mines compared to what they probably projected.

And if zinc starts behaving like copper or nickel and just consolidates rather than corrects, all the better. It still reflects the core thesis of this essay. Base metals, even if they do correct considerably, will still be trading at prices vastly higher than those of recent years. This makes base metals mining a great business that is likely to spin off huge profits in the coming years. New mines take up to a decade to get into production so supply cannot respond to high demand-driven prices very quickly.

Yet even with zinc still above $1.00, zinc miners were decimated this week as investors irrationally fled just like they did with the copper miners. Once again perspective matters. The only way to understand just how trivial the base metals pullbacks really were this week in the grand scheme of things is to consider them on a long-term chart like the one above. Owning mining stocks is about profiting on higher commodities prices and base metals will remain very high by recent standards even if they continue correcting.

Actually nickel is a great example of this phenomenon. As this chart shows, nickel rocketed up 302%, more than doubling gold’s total bull-to-date gains, from late 2001 to early 2004. While this metal did correct after its near-parabolic ascent, it then entered a massive consolidation at far higher levels than those of the early 2000s. New nickel supply could not outpace global demand so its price couldn’t collapse.

Even after its vertical surge in late 2003, nickel entered a new much higher and vastly more profitable trading range for nickel miners. While it had been trading from $2 to $4 in the early 2000s, in the last couple years it has been running from $6 to $8. Thus any nickel miner that built a mine betting on $3 to $4 nickel has seen its revenues double and its profits skyrocket. And I suspect this nickel precedent is a model that other base metals will now follow.

During a secular bull in general, and especially one that is physically supply-limited like commodities, major uplegs do not necessarily lead to symmetrical crashes even when they go vertical. Secular bulls are driven for supply and demand reasons and the only way the price of anything can fall over the long-term is if its supply exceeds its demand, it has a persistent structural surplus.

Yet this nickel chart suggests that nickel miners, while they couldn’t produce enough to drive a structural surplus after the 2003 spike, were able to produce enough to meet world demand between roughly $6 and $8. What seemed like ridiculously high nickel levels in late 2003 when the metal surged from $6 to $8 virtually instantly became the new accepted norm over the following years.

Odds are we will see something similar in other base metals like copper, where what today feels high in price terms will be part of a new higher trading range. Consolidations make price levels that once looked extreme soon feel normal and typical. They lay the crucial psychological foundations for future uplegs.

Once again the reason prices can stay high is because mining is just so difficult, capital intensive, and time consuming. If the nickel price went up 10x tomorrow to $70 it would still take years at best to bring new nickel mines online. You cannot just flip a switch and produce commodities, even if you already own a major undeveloped deposit. Unlike the virtual world of the tech bubble where the “supply” of web services could be ramped overnight, the physical world has huge and inelastic lead times which spawn persistently high prices.

Lead is up 260% in this chart and looks a lot like copper technically. It has had two major uptrends followed by two major breakouts and the metal consolidated higher rather than correcting after its first breakout. Odds are it will soon embark on a similar consolidation today, establishing a new higher trading range between maybe $0.50 and $0.70. Obviously it will be very profitable for today’s miners that had to survive $0.20 lead.

And although lead is probably the lowest profile of these five major base metals, it may have the most potential. Lead mining is hugely politically incorrect and no one wants a lead mine near them due to the pollution involved. This, in combination with low lead prices, has led to a world where virtually no new primary lead mines have been opened worldwide in several decades. Unlike copper, zinc, and nickel which have development-stage mines in their supply pipelines, lead is really hurting.

Now this wouldn’t be a big deal if no one wanted lead, but lead demand is likely to skyrocket globally. The primary reason is the lead-acid batteries used in automobiles. While the West is heavily populated with vehicles, the East is just getting started. Billions of Asians want cars and all those cars will need batteries. And if some of these new cars are hybrids or true electrics, lead demand will be even higher. Lead is essential to the industrialization of Asia.

But even if lead prices quadruple from here, it will not make it any easier to find new lead deposits, kowtow before some government long enough to get permission to mine them, build the mines and their supporting infrastructure, and finally bring new lead to market. It takes many years to a decade or more for commodities supplies to respond to prices, which ensures our commodities bull almost certainly remains quite young.

Aluminum is the last of the big five base metals. Its technical pattern looks a lot like copper too except it is shallower. Aluminum is only up 105% bull to date, less than gold. Yet it is still very illustrative of what we should be able to expect from base metals. Its first major upleg and breakout led to a consolidation in a new higher trading range, not a sharp correction or crash. Its current breakout will probably play out the same way.

When considering all five of these charts, clear technical patterns emerge. The most important in my mind is the fact that sharp surges that look nearly parabolic at the time lead to higher new base trading ranges, not crashes. This reflects a reality of world demand growth for base metals outstripping world supply growth. Since new metals supplies are so darned time- and capital-intensive to bring online, this creates vast opportunities for investors.

If we are less than a third or so into what ought to be another 17-year secular commodities bull like we have seen in history, then on balance commodities prices ought to continue rising despite periodic healthy consolidations to rebalance sentiment. And as each new mine is gradually built, its economics will be based on today’s prevailing prices and not tomorrow’s. Thus mining profits should multiply dramatically over the entire life of this Great Commodities Bull. And stock prices will ultimately follow profits.

So what’s an investor or speculator to do? At Zeal our strategy is to painstakingly research commodities producers to find the best of the best elite stocks. We examine companies fundamentally, technically, and try to learn all we can about their existing mining projects and future opportunities. We then buy and recommend our favorites in our newsletters. Please subscribe today if you want to ride this awesome commodities bull with us!

The bottom line is despite all the panic in commodities in general and base metals in particular this past week, there is almost no chance commodities have already entered a mania. The base metals technicals show prices gradually marching higher over years in response to global structural deficits. Each dramatic upleg like the ones in recent quarters is followed by a healthy consolidation at new higher price levels.

The best way to not get spooked by periodic pullbacks is to keep the big picture in mind, both technically and fundamentally. Base metals are essential and indispensable building blocks of our world economy and voracious demand out of Asia may strain supplies for a decade or more to come. The owners of the elite base metals miners are likely to earn fortunes before this fundamental imbalance is rectified.

Adam Hamilton, CPA
March 10, 2006

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