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Due to excessive pessimism and negativity in the markets - I have held off this article until I talk to some senior contacts and gather additional data in order to ensure I had a balanced view of what we may expect this year in the Australian precious metals and resource sector.
Time is slipping by to release this article as a 12 month prediction piece however, each few days, as I plan to release it the market tanks further – what an interesting lesson in mass behavior. Two nights back we had terrible news on property – sorry but that was so obvious it was ridiculous in the extreme so what could investors expect as the bubble popped. An estimated 1,353,700 housing units were started in 2007. This is 24.8 percent (±1.3%) below the 2006 figure of 1,800,900. Going back to pre-bubble times to 1995 was the last time we saw a similar figure – 1,350,500 housing starts.
Growth is slowing but it is still growth – the market is now jumping at shadows and has factored in a 1930 decline yet things are very different now – we have globalization. A new rule book is being written at this time and many will look back and kick themselves for current selling of resource and precious metals stocks – that is unless they buy them back quickly at lower levels. Remember this phenomenon is exactly the same in reverse - of the emotion that will send stocks to unimaginable highs and over valuation during a later gold rally.
Here in Australia the gold price is $AUD1007 per oz and silver is north of $AUD18.20 per ounce and these numbers are great – the shares are getting hammered though. I would like to state how absurd this has become and that this rout has now done it’s job – most smaller investors are totally shaken or scared away and may have lost faith in the metals bull market. The leveraged buyers must be close to wiped out – leverage is something I have never condoned. So this sector of our market can rise now and receive scant interest from shell shocked investors or the public at large.
Yesterday the Shanghai Composite Index lost over 5%, today 7.22% as panic spread to Asia – we are standing at a very precarious place right now and the total global growth has become more unpredictable for now however you can be sure it will be growth. Fortunately stock market sentiment ebbs and flows and does not dictate the economy. This article deals with global commodity supply, demand and the effect of current credit conditions on global GDP in order to assess the outlook for ASX Resource stocks in 2008.
I just witnessed a 14th day straight of falls on a market in a strong economy – Australia where we are having to put up interest rates to attempt to cool growth. Investors across the globe knee jerked over an expected write down at Citigroup last week and I think it had already been over factored into an over hammered local resource market here in Australia. These extended cycle extremes defy any sane logic and are caused by a total fear based aberration – so an Alice in Wonderland condition develops with Mad Hatters in abundance throwing out value stocks to eager buyers. More sadly the leveraged are forced to sell and, accept it or not, get a very hard lesson about risk and the new modern trading disease – leverage based selling. Spotting these events can make you rich if you can get set and stay the distance to the other end of the cycle extreme.
Focus
My interests and therefore business and articles cover gold, silver and base metals with the occasional mention of bonds, property and foreign exchange or other factors as required. Therefore my comments always have to be read in that context. This is my focus - I have been disinterested in industrials and other market sectors in general for the past few years because of the risk built into the financial system and the existence of various price bubbles such as housing. I even wanted to sell our family home a couple of years back as well but one irate wife stood in the way of that move J.
At present I am enjoying returns on silver bullion purchased at $US4.50 in the second half of 2003 and the benefits of a 10 year fixed interest mortgage which I “locked in” to the surprise of the bank staff 4 years ago. They “wished me luck” with a hint of mirth at the time and I just smiled to myself – it is a great privilege to be able to see the writing on the wall when so many are distracted or confused.
As I look forward in my analysis of current macro economic trends – the big picture stuff - I see major confirmation of a long term up trend in tangible assets, however we have been in a medium term correction for several weeks. There was a counter rally on our resource index which we called and also called the top in November. I have awaited a clear signal that the next bottom was in however I have not been able to do so as yet. I believe - short term - we are very close and very over sold at present but back to the longer term. Some stocks are already worth selling your house to buy but I hope your wife stands in the way of that one as you have to live somewhere. But seriously a fully franked 17% dividend yield on a resource stock – you have got to be joking!!!
Longer term
Once a rally exceeds two to three years it becomes more and more likely it will continue for one to two decades – and the current uptrend in gold began in 2001 which is now 6 years old. The first wave of the commodity bull is over and over the coming weeks we should see base formations on most base metals – this medium term correction is not far from over and most metals should range trade this year with steady or increasing demand combined with supply disruptions (and over estimations) amongst the volatility.
So far in recent times base metal supply response to additional demand has been pedestrian at best. This is because demand has been underestimated but more importantly as we go forward the projections may be over optimistic. I have followed the mining game for 20 years which is long enough to see that bringing a mine into production on time and on budget is quite a feat. However at a time like this we see uncertainty, funding constraints and sovereign risk becoming important issues and I see the latter as highly significant.
Mining giants are being forced into higher risk areas to replace reserves where the chances of major flooding, mine confiscation, surprise taxes or military unrest in some of these regions is far higher than comfortable for many investors. There are a multitude of Sovereign risk issues at hand. Then there is the major factor of over optimistic projections on production which fall short due to strikes, mechanical failure, inconsistent ore (hardness and or lower grade etc) and other unforeseen events – mining is a tough business.
Cost pressures will remain an issue and the rising cost of credit combined with lower sentiment on base metal prices may cause some projects to go back to the drawing boards. So I believe that many base metal supply projections will fall short and my conclusion is that demand will be higher than expected. Case in point once again - economic figures released by the Fed in the US the other night indicated “modest” growth at a lower rate than the previous lower rate of growth. Research we have outsourced confirms our belief that current supply projections are overstating the ability of the mining industry to match growing global demand in many base metals.
Silver and gold are most certainly in a supply deficit and no need to get too deep on this one – prices are rising for good reason and the potential new demand from investors increasingly becoming attracted to these metals will become intense at times. Jewelry demand will increase over the long term in Asia as incomes increase and potential Central Bank demand now looks set to eclipse any potential supply except in brief spates. I believe the bulk of demand will come from investment demand and as the prices continue to rise production will continue to fall – due to mine depletion and grade dilution that becomes acceptable during times of higher prices.
Demand Outlook China
Asia looks strong and apart from China there is little to no exposure to the sub prime credit problem. China is still expected to achieve a GDP growth of over 11% for 2007 and 10.8% in 2008 according to the World Bank so perhaps this is why the Shanghai Composite Index has been doing its own thing lately. Well it was until the housing slump worsened as this growth is more in doubt than ever – but China has continued to surprise over and over so once again this is unpredictable with the numbers currently to hand.
I am not using Purchasing Power Parity for this article because I want to look at growth to assess resource consumption in direct terms without factoring in potential theoretical distortions. Some economists believe the growth has been understated throughout the 90’s and early 2000’s – failing to factor all of the local consumption growth in the private sector – however I shall go with official figures. Any economist or investor that doubts there has been tremendous growth has not been to China or seen the price charts of copper, zinc and other commodities.
China has stated that it is not going to attempt to slow the process of urbanization of a further 300 million Chinese and that will take a massive amount of resources. They are still out and about taking advantage of current paranoia about global growth and the resultant effect on resource stocks – using off-take agreements and taking direct stakes in our resources sector. My conclusion is that the momentum of infrastructure roll out will not slow in Asia and any GDP slowing will only ease inflationary pressures that were too great anyway – so a positive in that sense.
To put Chinese growth in context we can use the 2006 GDP figure of $US1.32T and add 11.3% which is $US150B of additional business and resultant demand for 2007 – taking the Chinese GDP to $US1.47T for 2007. Add 10.8% on top of that and you get a potential $US157B of additional growth this year to $US1.627T. I would also prefer to add Taiwan to this figure and it adds an estimated $US385B as of 2007 making this resource hungry machine with over 20% of the worlds population worth $US1.82T (total potential additional growth this year estimate is $US180B).
That does not sound like much in the context of the $US500B recently added to the global slush of fiat currencies by the European Central Bank but it should give you an idea how big an injection of capital that actually is too. They are serious about fixing the present difficulties. Now add the plea in the US to add another $US150B which is nearly enough capital to offset the entire growth expected in China this year – but this is too simplistic. The Fed and ECB can create capital however they cannot control where the money flows – so a bubble is created again perhaps and in times of high inflation / low interest rates (negative real rates) the precious metals should fly.
But the thing about the Chinese GDP is not the gross amount – the true power is hidden within the nature of this beast. The US economy is huge at $US13.49T with an estimated $170B of additional business done in 2007 at an estimated growth rate of 2.2% - however it is an important point to understand that most of the US economy is service oriented. So only a relatively small portion of this growth is resource hungry – most unlike China and the rest of Asia.
Agriculture and industry account for 60% of Chinese GDP, power, transport and communications infrastructure are major components of the resource hungry development – economic components that will not cease because of housing credit worries in the US. A paradox is that natural resources are also under developed and this requires resources to develop them – trucks, machinery, rail and processing plants to name a few. The scale is unimaginable to most investors and indeed most investors have not embraced the precious metals or commodity boom as yet.
Highly sophisticated production facilities are still being installed to bring Chinese industry up to modern standards – even though significant progress has been made in this arena in recent years. But this process is not complete and in a sense once the first round is complete it is time to upgrade again - because it is an ongoing cycle.
Global Demand outlook
Can the relatively resource hungry GDP growth in the developing countries soak up any decrease in US resource consumption? How long can the boom in developing countries continue?? Well in the case of China this growth is still running off a low base – GDP per head is less than 25% of the USA levels and the Chinese are happy to rapidly urbanize a massive 300M people. 200 cities to house 1M people each are planned within this historic urbanization.
Now take Brazil with 188M people who have a per capita GDP of $8,800 by one estimate I found. Their GDP is reported as over $US1T and growing steadily at nearly 5% - their inflation rate is tame and their growth rate is steady but very strong at an estimated 4.5% for 2007 and 4.5% this year even factoring in the US down turn and current doom and gloom. They have massive resources and also come off a low base in developmental terms. Being a significant energy producer and a resource economy it seems to me that they will achieve or better the growth predictions for 2008 and also consume an ever increasing amount of resources over the next decade.
India is another fantastic story because of their powerful growth rate of 9% estimated for 2007 after reaching 9.4% in 2006. Will the estimate low ball the GDP growth as it did for China on most occasions in the last ten years. But she has 1.13 B people or 16.95% of the world’s population and now its growth is helping to feed China too as imports grow exponentially. Growth of 9% will add $US100B to new business done last year and estimated 8.4% GDP growth this year could add a further $US100B. She will never be another China but she does add to the demand equation.
I hope you are getting the picture by now – these figures factor in the down turn in the USA. I look at it this way – last year the global GDP was estimated to grow by 3.6% and next year the global economy will get even bigger – by an estimated 3.3%. This may be over optimistic and we have to wait for the numbers to trickle out through the year but I would be surprised to see a number under 3% for global growth this year despite the current sentiment.
This growth is expected to be maintained in the resource hungry developing nations and slow in the less resource hungry wealthy nations. Slower growth does not reverse consumption it merely decreases the rate of increase – think about that sentence if you need to as it is a senior bit of data for you to consider. I could go on and on this line of analysis but I think this covers my point – Russia and the Middle East are important to this line of reasoning and should also be added to this list as major players in this game. I am not factoring a big decrease in Japan or the Euro Zone in this analysis although they may slow - it had been factored into global growth.
Outlook For A Key Resource Economy
My partner in the GoldOz Weekly Newsletter, Colin Emery, is highly qualified and also covers technical analysis and macro economics. After 25 years in the elite end (in Management and senior trading positions for major international banks) of the investment and trading scene globally he has a vast level of understanding of these subjects. We usually see eye to eye on major issues but I still find his additional insights to be highly valuable as we watch stocks, metals and macro economic trends. His overall view and or specific comments are also expressed at times in my essays and I just wish to validate him for any additional insights I have gained from his perspective.
Last year I penned an article by almost the same name as this one, titled “2007 Outlook for a Key Resource Economy” and it is still available at (http://www.goldoz.com.au/102.0.html). In it I discussed money flows and this is critical to intelligent investing. Copper was discussed and importantly my call was good and I achieved this prediction thanks to technical and macro analysis – with confirmation from Colin. So enough you say… what about this year - which is the main subject of this article and your main interest I hope.
2008 Predictions
I do not pretend to be able to guess exact price levels and prefer to follow the market lead – and of course also prefer reading between the lines as a true contrarian. But as per former years you can follow the larger trends and factor current events on balance to arrive at “ball park” predictions. Extreme volatility can easily throw such predictions so any analyst that can pick all the metals this year is doing very well indeed.
This year we see zinc and lead in the same position as copper was this time last year. Zinc and lead have reached their base value at this time and there is a high probability they will range trade this year – mostly above this price level.
Nickel is likely to be at or near its price base area here however I am not as certain – but I can say that at current prices in AUD terms - each 1% of nickel grade is equivalent to approximately 14 grams per ton of gold to mine. So 2.5% nickel is equivalent to 35 grams per ton which is a very healthy level – any mine close to this nickel content is going to be robust and able to withstand these price levels and yet several have been hammered due to poor sentiment. This is another case in point where I would point out that mining activities and share prices are two different activities. Share price activity is a derivative of mining and can dislocate for periods of time before snapping back to more realistic share price levels.
Copper has settled in a range which is 3-5 times higher than just a few years ago – yep that’s 200% to 400% up on former price levels of $US0.80. I do not expect reduced demand growth in US housing to fully offset demand growth in global terms this year.
Gold and Silver in 2008
Last year I called gold almost spot on – I did get initially fooled by one false break out and some of the tops failed to reach the top price level but on balance it was quite accurate. I should have read my own notes more clearly because I had not expected a price break out before later in the second half of 2007 and I had even put it in writing in the article mentioned above so the false break should not have caught me by surprise – don’t you hate that.
The current fractal pattern in gold is unfolding accurately again so far - as a major up-leg which has many months to run and I watch this with both excitement and caution. A potential sell divergence looked to be forming however these can be duplicated on the way up so this is not a concrete indicator. In fact the continuation of this section of the rally may yet have reached sufficient RSI strength to avert this sell divergence signaling even greater potential upside. As this fractal has started with such strength there is a possibility of a very large run to $US1400 or more in this up-leg however the time count would make the top nearer to April 2009.
As lover of silver and the silver story – although I am far more conservative than some of the major silver analysts – I look to considerable upside price action this year. Price has only just broken confirming continuation of the gold rally and upside potential. Silver only began its bull rally in H2 2003 and tends to play catch up later in precious metal up legs – however this is not a hard and fast rule. But an initial peak this year should see silver reach in the order of $US20+ and I see a higher peak by April 2009.
In fact I can see a future of continued currency upheavals to a point where – like a car beginning to “fish-tail” and lose control - it makes wider and wilder swerves until it runs off the road completely if not handled correctly. So too with the currencies – economic figures and interest rate adjustments suffer from a lag time making the course hard to steer. An over correction here and an under correction there and things can get ugly as they are currently. Regulators and financial institutions failed to heed the signs of a loss of control – as they lost the plot in regard to over easy credit – and they failed to maintain control of lending to a point where we see pain and suffering as a direct result. At present I cannot call this with certainty.
Equity markets in the US may be staring at a giant bear trap and triple bottom formation as identified in our GoldOz Weekly Newsletter by Colin Emery. The jury is still out but too many of us commentators are too bearish and can only see the bad / are blinded to any good news… this has become a concern to me – too much negativity may have been built into equities at this time but only time will tell. For now I stick with gold and silver and continue to research the resource stocks in Australia because things are much stronger here – in fundamental terms.
I was sent a high profile Aussie Newsletter publication that did a special comment on gold and which reflected a large lack of understanding of not only gold but the whole gold sector here in Australia – this rally has not even begun by that standard. If you are currently in fear, had no cash aside for this drop or suffer from confusion in this market then perhaps a subscription to our GoldOz Weekly Newsletter and the calm advice of a highly experienced professional might assist you to profit and or sleep at night.
Broad analysis of the gold sector is once again about ready for update here at GoldOz so my PDF set is a bargain again – buy it now for only $AUD35 and you will get immediate delivery and a free upgrade by the end of next month. This allows for cross reference to spot the leading movers. Anybody who originally bought the first issue would benefit from the update as it is much bigger and more data is included including a brief on the last two quarters of news.
Good trading / investing.
Regards,
Neil Charnock
www.goldoz.com.au
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REGISTERED ADVISOR – WHO THE ADVICE COMES FROM IN THE GOLDOZ NEWSLETTER:
Colin Emery is currently a Branch Manger and Senior Client Adviser of a Stock Broking Company in Queensland Australia. Prior to his work in Share broking he spent nearly 20 years in Senior Management and Trading positions in Treasuries for major International Banks such as Bank Of America, Banque Indosuez, Barclays Bank, Bank Of Tokyo and Deutsche Bank AG. He spent a number of years as a Senior trader in New York, London, Singapore, Tokyo and Hong Kong with these institutions. He also was Global Head of emerging energy, emission and commodity products for the leading Energy and Commodities brokerage firm of Prebon Yamane Ltd – Prebon Energy for four years before moving to Cairns in 2003 to focus on the Stock market and Private consulting work. The private consulting and advisory work currently undertaken is with companies involved in Resources, Energy and Renewable Energy and Forestry.
Neil Charnock is not a registered investment advisor. He is a private investor who, in addition to his essay publication offerings, has now assembled a highly experienced panel to assist in the presentation of various research information services. The opinions and statements made in the above publication are the result of extensive research and are believed to be accurate and from reliable sources. The contents are my current opinion only, further more conditions may cause my opinions to change without notice. The insights herein published are made solely for international and educational purposes. The contents in this publication are not to be construed as solicitation or recommendation to be used for formulation of investment decisions in any type of market whatsoever. WARNING share market investment or speculation is a high risk activity. Investors enter such activity at their own risk and must conduct their own due diligence to research and verify all aspects of any investment decision, if necessary seeking competent professional assistance.
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