3 Commodity Plays That Shine Brightest

02/22/2012 8:45 am EST

Focus: GLOBAL

You know you're living in interesting times when exploration and production companies are a solid hedge against a destabilized Europe, notes David Chapman of Investor's Digest of Canada.

It isn’t a complete surprise the markets have been in rally mode, as most of us have been counting on the first quarter to be positive. If problems are coming, they could appear later in the year.

What might set the market back again? Europe’s continuing crisis, for one thing. Despite the appearance that it’s coming forth with solutions, all that Europe is really doing is postponing the day of reckoning.

Indeed, many analysts now agree that Greece could be forced to drop the euro, as could both Portugal and Ireland. And if the focus on the euro shifts elsewhere—even temporarily—investors could once again start worrying about the US, with its huge debt and its dysfunctional politics.

Finally, there’s the Iranian cauldron. One miscalculation, one accident, a bit of faulty intelligence—or just outright arrogance—could once again inflame the Middle East.

By late January, gold climbed 6.3%, while oil prices remained flat despite tensions in the Persian Gulf. Other precious metals also got off to a good start. Silver rose 13.5%, platinum 9.3%, and palladium 3%.

Any evidence the global economy is slowing down isn’t reflected in copper prices, which have so far jumped 11.1%. But gold stocks once again have been lagging. During the first three weeks of 2012, the TSX Gold Index rose just 1.4%. Gold stocks, slugabeds ever since the crash of 2008, remain undervalued in terms of bullion prices.

The market’s rise during January probably surprised many investors. Nor is the uptrend over yet, given that the cycles are positive for the first few months.

If there’s a serious stampede by short sellers to cover their positions, we could see a run toward the highs of 2007, or even one that touches them. Investors must remember that in all likelihood, we’re now experiencing a bear-market rally. And such rallies have a history of ending quickly—and badly.

If the broader market runs to the upside, the gold sector may be a strong beneficiary. As has been noted many times, it’s not that gold is rising, but that currencies are still crumbling.

A new round of quantitative easing, now apparently underway in Europe and rumored to be up next in the US, is a further expansion of the money supply. And although additional money in the financial system prevents stock markets from collapsing, it also results in a rush to gold as fiat currencies depreciate even more.

Last year may have seen record demand for gold. Demand in the third quarter was very strong, having jumped 6% year over year, while reports pointed to strong fourth-quarter demand too.

Silver was also in great demand. Meanwhile, demand for elements that are used in the high-tech sector, such as platinum and palladium, remains high.

Then, too, central banks—net purchasers of 330 metric tons of gold in 2011—put to rest any thoughts that such institutions sell, rather than buy, the yellow metal.

There are other things that could harm the US dollar. As America tightens the noose on Iran, that country has said it wants to be paid for its oil in currencies other than the greenback. Normally, all oil traded between countries is done so in US dollars.

Iran’s attempt to ditch the dollar could embolden other Arab oil exporters to do the same. Indeed, Libya’s late strongman, Muammar Gaddafi, was trying to organize a group of African and Arab nations into a trading bloc that would do business using Arab gold dinars, not US dollars.

The greenback could also suffer if China succeeds in organizing Asian nations to do business using its own currency, the yuan. Meanwhile, China has begun issuing debt that could be held as reserves by Asian banks. And China and Russia have already said they’ll do business in yuan and rubles.

All these actions not only threaten the US dollar as the world’s reserve currency, but lower the dollar’s value as well.

To compensate for the decline in the dollar’s value, there could be a rise in gold, silver, platinum, and palladium prices, as well as a host of other commodities. It’s for all these reasons that gold, as well as metals and energy stocks, could do well in the first quarter of 2012.

But trying to find just which stocks might perform well, especially junior plays, is always tricky. Juniors are traditionally more volatile than seniors—mainly because the risk is much higher.

Here are three junior plays that might be worth a look. For platinum and palladium, consider North American Palladium Ltd. (Toronto: PDL). North American Palladium, whose mines are mainly in Canada, explores and mines platinum group metals.

The company’s stock can be volatile, having hit $13-plus just before the 2008 crash and $19 back in 2003. Last February, it traded over $7 a share. Now trading at the lower end of its range, North American Palladium remains one of the few pure plays in its industry.

Another junior play worth looking at is Rio Alto Mining (Toronto: RIO). A gold, silver, and copper producer that has been riding a bull, Rio Alto has operations in Peru—its primary focus—as well as in Mexico, where it’s now developing a property in Nuevo Leon.

Following the plateau of its shares throughout much of 2011, Rio has started to climb again.

Another good junior play is Pace Oil & Gas Ltd. (Toronto: PCE). A mid-cap play in both exploration and production, Pace is primarily active in the Deep Basin of northwest Alberta.

In addition to a rapidly growing oil production business in the much-ballyhooed Peace River Arch, Pace also has operations in the Manville oil pools in southern Alberta, where it’s using advanced techniques. And the company holds undeveloped natural gas properties in the Deep Basin.

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