Conserve Your Resources

08/11/2008 12:00 am EST

Focus: GLOBAL

Eoin Treacy

Global Strategist, Fullermoney.com

Eoin Treacy of Fullermoney says that as commodities prices weaken, you need to look carefully before investing.

Q. Eoin, I've read that China's annual consumption of copper has declined from a 28.66% growth rate to 2.4%. What does that mean for continued growth in China and also for the global copper market?

A. China and indeed much of Asia and the Middle East are in a generational-long period where they have to build infrastructure from the ground up. The push for educating, housing, transporting, and employing large young populations requires massive investment, fueling demand for commodities across the boards.

The supply side was completely taken unawares by this demand following the 20-year crushing bear market that cut exploration budgets to the bone. That is now changing, as major mining groups compete for the best resources, particularly in politically stable parts of the world.

China continues to lead the world in terms of GDP growth, although it has recently manufactured a slowdown to combat rising inflation, generally positive for the economy.

Many commentators tend to equate copper consumption with economic growth, but I am skeptical of such a comparison. China has transformed itself into a major consumer and producer of many metals and has overtaken the US as the largest consumer in a number of markets. Their consumption affects commodity prices, but it cannot be relied on as the only indicator. Price action is the only clear arbiter of how supply and demand are interacting.

Copper surged in 2006 to almost $4, but has since entered a medium-term consolidation, which we define as lasting for anything from a few months to seldom more than two years. It is currently towards the upper side of its range and would need to sustain a move below $3.50 to question its scope for further [upward moves]. 

Q. China has also been a huge user of steel. Do you expect that consumption trend to continue in the next year?

A: Steel companies are a key beneficiary of the Supply Inelasticity Meets Rising Demand theme. As a rule of thumb, companies with the ability to increase their profit margins and pass on higher input costs to customers have an advantage over those that have to cut margins to maintain competitiveness. Steel producers are without doubt in the former category as are a great many other resource-focused companies.

Q. Are there any steel companies whose shares you would be interested in buying?

A. Arcelor Mittal (NYSE: MT), ThyssenKrupp (LSE: THK.L), Posco (NYSE: PKX), and US Steel (NYSE: X) all found support over the last few days and look like good recovery candidates.

While the steel producers appear to be in ruddy financial health, this is also good news for companies supplying iron ore such as Rio Tinto (NYSE: RTP), BHP Billiton and Companhia Vale (NYSE: RIO).

Q. Many markets, particularly Brazil and Russia, have had quite a run with commodity shares, yet a number of these stocks have sold off. What is your near- and long-term prediction for the commodity markets in these countries?

A. In markets, governance is everything, applying as much to the legislative branch as to the economy and rule of law. Russia has outstanding long-term potential, but is hampered by disrespect for minority shareholder rights at government level. Recently, the market found support, and a move below 1900 would be needed to question scope for some further up side. Over the medium- to longer term, I expect Brazil to outperform, assuming governance remains static.

Brazil is blessed with large reserves of basic commodities and is a major food producer. This market has remarkable long-term potential, but it may underperform its global peers, in relative terms, over the short term.

Q: What do you recommend and what are you buying?

A: At Fullermoney, we don't give investment advice and the only money we manage is our own. We make available to subscribers all of our own personal trades and investments. Personally, I am happy to play the commodity markets through futures because I like the leverage. I own BHP Billiton (NYSE: BHP), Frontline (NYSE: FRO), and JP Morgan India Trust (LSE: JII) and I also have a number of positions in Chinese banks. My colleague David Fuller holds Blackrock World Mining Trust (LSE: BRWM) among other commodity investments.

Q. Do you have any last thoughts on the best way for investors to participate in the global commodities markets?

A. I would always wish to back relative outperformers and when investing in equities, choose those companies with the ability to increase their margins.

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