Bearish outlook for commodities
May 6, 2005
The gold price is holding up rather well. Except for a brief drop to $410
an ounce in late January the gold price has held itself above $420 this
year with a slight upward trend in place. For the past six weeks the gold
price has hovered around $430 an ounce.
The US dollar is still on thin ice, and when it falls through
the ice the dollar-gold price will resume a more aggressive upward trend.
My bet is still that we will see $700 to $800 an ounce within the next
few years. But I am much less optimistic about commodities such as copper,
zinc, or nickel.
Keep in mind that gold is not a commodity: it is money.
The price of gold and the prices of other metals do not have to follow
the same path and, in fact, I don’t think they will follow the same
path going forward.
Being the largest economy in the world, the health of the
US economy is of paramount importance. I, and many other analysts, have
long belabored the huge amount of debt in the US economy and how that
debt will one day come home to roost. Let’s take a look at some
recent news headlines from the Wall Street Journal.
“Slowdown at U.S. Factories May Herald Further Chill.”
According to a survey quoted by the Journal, the US manufacturing sector
turned in its slowest pace of growth in nearly two years. The manufacturing
sector has been slowing for five straight months.
I’m not going to rant about why the US economy is
in trouble. There are enough articles in the Commentary section on my
website at www.paulvaneeden.com on that topic. What I want to point out
is that we might be approaching the tipping point. It is quite possible
that the wobbles we are seeing now are the wheels coming off. More headlines:
“Delta Puts Figures to Its Pension Bill”
It’s no secret that the airline industry is in trouble. Ever since
9/11 they have been having a tough time and now, with the rising cost
of fuel, they are in serious trouble. But slow revenue growth and rising
fuel costs are not the only problems. One of the really big issues facing
the US economy, and not just the airlines, is under-funded pension plans.
Delta reckons that it has to pay $3.15 billion into its employee retirement
plans over the next three years. That is in addition to the $450 million
it will pay this year. Let’s put that number in perspective. Delta
had revenues of $15 billion in 2004 but made a $3.3 billion operating
loss. The total loss for the year was $5.2 billion. Shareholders’
equity in the company is a negative $5.8 billion. If you just add the
money that they have to pay into their employment retirement plans the
loss becomes almost $10 billion, and that’s assuming we don’t
have any more operating losses, which is a bad assumption to make.
It is not just the airline industry that’s in trouble.
Watch the auto manufacturers; they’re next. In fact, most of America’s
“Big Business” is in trouble. But investors don’t care.
The average price to earnings for S&P 500 Index is 19.2 and the price
to book is 2.8.
“S&P Downgrades GM Debt to Junk Status”
Talking about Standard and Poor’s, on Thursday they cut the corporate
credit ratings of General Motors Corp., General Motors Acceptance Corp.,
and all related entities to junk status. S&P also stated a negative
outlook, indicating that a further downgrade is possible.
This is serious business. It affects about $300 billion
in outstanding debt and increases GM’s cost of doing business across
the board. You might not have known this, but GM is the largest issuer
of corporate bonds in the US. A harbinger? Possibly.
It’s not just Corporate America that’s in trouble.
“Treasury is Considering Bringing Back Long Bond”
In August the US Treasury will announce whether it is going to start issuing
30-year bonds again. During the dot com bubble and the stock mania of
the late Nineties the US Treasury was raking in tax receipts from investors
who making a killing on the stock market. The oracles in Washington were
so impressed by the addition tax revenues that they decided to stop issuing
30-year Treasury Bonds. America’s Government was going to start
paying off its debt.
Of course, making future projections based on abnormal circumstances
is not prudent, and they should have known that the financial environment
during the late Nineties was unsustainable; Alan Greenspan said as much
in 1996 with his famous quote of “irrational exuberance” in
the US equities markets.
Instead of reducing its debt, the US Government is going
ever deeper into debt. Just this week the House of Representatives, without
voting, increased the US Government’s debt ceiling by $781 billion
to almost $9 trillion.
US interest rates have remained low to a large extent because
China, Japan, South Korea, and others, have been buying US Treasuries
with their trade dollars. But long term US interest rates have also been
kept in check because the Government was redeeming 30-year bonds and issuing
shorter term bonds. If the Treasury decides to reintroduce the 30-year
bond in August, don’t be surprised if 30-year interest rates start
rising. I have long cautioned that the US Budget Deficit is a virtual
guarantee that US interest rates will go up. The Government’s deficit
has to be met by issuing bonds. As the supply of bonds increases the price
of the bonds will decline, and interest rates are inversely related to
bond prices. So if bond prices fall, interest rates rise. By the end of
this year I expect we will see higher US interest rates across the spectrum,
not just on the short end, as we’ve seen in the recent past.
Of course, higher US interest rates are not going to help
Corporate America, or the consumers who are consuming more than they’re
earning. So none of this bodes well for the US economy.
If the US economy slows down the rest of the world slows
down as well. The European Central Bank has said that growth prospects
in Europe have only worsened since the Bank downgraded its forecast for
the year in March. And who do you think is going fuel China’s growth
if both the US and Europe are having economic troubles. Japan?
On this backdrop you can see why I am not bullish about
the near term future for commodities. I suspect the cyclical bull market
in commodities is over. China is not yet in a position to sustain its
economic development with internal demand. If export revenues stop rising
at the pace of the past decade then China is more likely to slow down
than to increase it’s rate of expansion.
Now, we should not forget that there is almost universal
pressure on China to revalue its currency upwards against the dollar.
As I explained in my commentary of February 10 (available at www.paulvaneeden.com
in the Commentary section), a revaluation of the renminbi will cause interest
rates to rise and the dollar to fall. The falling dollar will make the
gold price in US dollars go up and it will mitigate any decline in worldwide
commodity prices in terms of US dollars. So even though the price of copper
and other metals might be declining in many currencies, the price of copper
in US dollars could appear to be holding ground. Don’t let this
fool you. The bull market in base metals is not very likely to continue.
There are only two metals that I think have good upside
potential with acceptable risk: gold and uranium. I am, however, becoming
less optimistic about uranium. But that’s a story for another day.
PS If you would like to receive these commentaries
by email you can subscribe to them on my website. There is no cost either
monetary or otherwise. I do not rent or sell subscriber information and
I do not solicit either. The only thing you will receive are these commentaries.
Paul van Eeden
Paul van Eeden works primarily to find investments for his
own portfolio and shares his investment ideas with subscribers to his weekly
investment publication. For more information please visit his website (www.paulvaneeden.com)
or contact his publisher at (800) 528-0559 or (602) 252-4477.
This letter/article is not intended to meet your specific individual investment
needs and it is not tailored to your personal financial situation. Nothing contained
herein constitutes, is intended, or deemed to be -- either implied or otherwise
-- investment advice. This letter/article reflects the personal views and opinions
of Paul van Eeden and that is all it purports to be. While the information herein
is believed to be accurate and reliable it is not guaranteed or implied to be
so. The information herein may not be complete or correct; it is provided in
good faith but without any legal responsibility or obligation to provide future
updates. Neither Paul van Eeden, nor anyone else, accepts any responsibility,
or assumes any liability, whatsoever, for any direct, indirect or consequential
loss arising from the use of the information in this letter/article. The information
contained herein is subject to change without notice, may become outdated and
will not be updated. Paul van Eeden, entities that he controls, family, friends,
employees, associates, and others may have positions in securities mentioned,
or discussed, in this letter/article. While every attempt is made to avoid conflicts
of interest, such conflicts do arise from time to time. Whenever a conflict
of interest arises, every attempt is made to resolve such conflict in the best
possible interest of all parties, but you should not assume that your interest
would be placed ahead of anyone else’s interest in the event of a conflict
of interest. No part of this letter/article may be reproduced, copied, emailed,
faxed, or distributed (in any form) without the express written permission of
Paul van Eeden. Everything contained herein is subject to international copyright