2006-05-12
Commodities
This is the second installment of my investment series.
To put this discussion into context, I have to give a little background. The most important item to understand is that I am a proponent of the idea of commodity super cycles. What is a commodity super cycle? A commodity super cycle is the prolonged (measured in decades) trend (up or down) in real commodity prices, driven by the urbanization and industrialization of a major economy.
In the last 150 years, there have been two commodity super cycles. The first one occurred in the late-1800s to the early 1900s, driven by the dynamic growth in the U.S. economy. The second occurred in the post-WWII era in 1945 until about 1975, which was prompted by post-war reconstruction in Europe and later extended by the massive expansion of Japan. Even before reading Thomas Freidman’s book, The World is Flat, it was obvious that the next commodity super cycle would be driven by the rapid urbanization and industrialization of the two most populous nations that the world had ever seen, namely India and China. The migration of either of these countries toward an urban, industrialized economy could cause the building of a super cycle, however, they both are going through the process at virtually the same time.
How do you identify a super cycle? Usually, you can see a super cycle in the intensity of metal and other raw material use. The Chinese economy, while still smaller than the US, uses about three times as much metal. While some of that metal is turned into the crap we buy at Wal-mart, the majority of the demand is for building new buildings, bridges, roads, and other infrastructure that China needs as it modernizes and urbanizes.
The relatively low commodity prices that we enjoyed in the 1990s were a function of the fact that supply in virtually all commodities was completely sufficient to meet the demand of the world economy as it then existed. As we moved into the 2000’s, suddenly China and India exploded with growth and the existing commodity supply was no longer sufficient for the demand of the new, more robust and rapidly growing world economy.
Due to more global concerns about things like the environment and the fact that for many world commodities, the stuff that was easy to find has largely been found, supply is having and will continue to have a tough time catching up to the world demand. As everyone learns in basic economics classes, if demand exceeds supply, the price is going to go up and the companies and people that have some supply will benefit.
So that is the summary of how I am looking at the world here in the early part of the 21st century, and as such, it makes sense that I would put a significant portion of my portfolio into commodities. For the record, I think that all commodities, oil, unleaded gasoline, natural gas, gold, silver, copper, zinc, and eventually food related commodities, will continue to go up in price. If you were thinking that you were going to wait for the price of gasoline to go back down before you took that driving trip, I think you are going to be waiting a long, long time. I touched on the fact that I had concerns for the value of the dollar as part of my discussion of my foreign investments and my concerns for inflation play a part in this. If commodity prices continue to go up, that data is going to show up as inflation in the economic data and the Federal Reserve will continue to raise rates to attempt to slow the economy and cool inflation. The only problem I see is that we are going to be importing inflation (in the form of commodity prices) from China and India, so raising U.S. interest rates my not cool inflation pressures in this global economy. I am not a doom and gloomer, I just think we will see slower growth and higher inflation over the next five years, which will help erode some of the value of the dollar.
Anyway, this was supposed to be about investment thoughts. What can you do to profit from the commodity super cycle. Well, there are a lot of ways to do it. But I have done most of my investing in mutual funds that target commodity companies.
I bought three Fidelity Select Funds, Natural Resources (FNARX), Gold (FSAGX), and Natural Gas (FSNGX) in early 2004 and again in early 2005 to focus on three areas that I thought would produce favorable returns, and they have. Natural Resources, owns a diversified portfolio of natural resources, oil, metals, etc., while obviously the Gold and Natural Gas funds are more concentrated plays. There are a couple of other Energy and Paper select portfolios as well. The energy one has done very well year to date in 2006.
These portfolios have done very well, but I think there are still gains to come. I think most of the world is waiting for these high prices to pass and return to “normal”, unfortunately, I think we are going to have to adjust to a new idea of what “normal” is. As the world finds out that these are not windfall profits, the valuation on these companies will continue to rise.
I don’t own these companies, but I have been thinking about making an investment in these natural resource players.
BHP BILLITON LIMITED (NYSE:BHP) is a worldwide mining company that digs anything and everything out of the ground all over the world. The stock has done very well, but they should continue to do well as they have very large uranium deposits and long-term contracts with China to fuel what will be a growing nuclear energy need.
PetroChina Co. Ltd. (NYSE:PTR) is the largest oil company in China. I am not sure I need to say more. It trades at a PE multiple of less than 10x.
USEC Inc. (NYSE:USU) is more along the lines of my speculative bets that I will start to cover in my next updates. USU is definitely a story stock. Prior to its IPO in 1998 it was a government-controlled entity. The company runs the only commercial uranium enrichment plant in the US. USU supplies enriched uranium to over 150 electric utilities worldwide. There are 440 nuclear power plants world wide today and supply 16% of worldwide electricity (21% in the US). There are about 30 nuclear plants under construction worldwide and that number will be growing as commodity prices rise and you can get the same amount of electricity out of one pound of uranium as you get from 3 million pounds of coal. As we have seen in Iran, the US is not terribly worried about others having and using nuclear power, it is the enriching of the uranium that is an issue. Uncle Sam encourages buyers around the world to use the product of USU.
W&T Offshore (NYSE:WTI) is a Houston-based owner of oil and gas reserves in the Gulf of Mexico. I don’t know this story particularly well, but I am going to be taking a look. They have done an excellent job growing the business and could be the next Chesapeake (NYSE:CHK).
Three other suggestions, Mega Uranium, UGL Enterprises, and Microplanet Technologies, will be covered in my speculative write-ups.
I hope was this was as much fun to read as it was to write.
-- rockabillie at 2:21 p.m.