Commodity Stocks: Wait 'Til Next Year
07/06/2010 4:15 pm EST
No secret that commodity prices have plunged on fears that global economic growth is fading. Or in the case of China, slowing from near 12% annually to something like 8% or 9%.
And no secret that the prices of commodity stocks have plunged as well. Shares of copper, gold, and molybdenum producer Freeport McMoRan Copper & Gold (NYSE: FCX) are down almost $30 from their April 5, 2010 high as of the close on July 6. That’s a drop of 33% in three months.
But commodity producers, especially copper producers, are starting to talk about a actual commodity shortages in 2011 because commodity producers are responding to current low prices by slowing expansion plans or putting off opening new production completely.
Commodities ride a wild boom and bust cycle—especially in a world where demand and supply are so closely balanced. Yes, it now looks like 2010 will be a commodity bust year. But that could put commodities and commodity stocks in position for a boom year in 2011.
For investors, the commodities story may be one of “Wait ‘til next year.”
The commodity futures markets aren’t showing any belief in a 2011 boom. They’re sunk in pessimism. Copper futures on the London Metal Exchange price in a scant 1.2% increase in the price of copper by the end of 2011. (I’m concentrating on copper because recently, it’s the metal that has shown the strongest correlation with rising and fall projections of economic growth.)
But first, Goldman Sachs (NYSE: GS) and, more recently, copper producers Codelco and Freeport McMoRan have warned about shortages in 2011. Goldman Sachs has projected that copper prices will be 23% above the level predicted by futures prices by the end of 2011.
Both copper producers have pointed to the same problems. Costs in the industry are rising as more and more companies are forced to mine lower-quality grades of ore. New finds with higher-quality ore were extremely rare before the global economic crisis, and the crisis hasn’t done anything to improve the geology of mining. A number of mining companies have recently either lowered their production forecasts or missed production targets completely in the last quarter or two. For example, BHP Billiton (NYSE: BHP) in April reported that its first quarter production in 2010 had dropped below production in the first quarter of 2009.
Average ore grades have fallen about 26% (in their concentration of copper) over the last two decades, according to estimates from Deutsche Bank (NYSE: DB). Australia’s Macquarie Bank calculates that the 2011 shortfall could be the largest since 2004.
Over the last two decades, copper producers have made up for the declining quality of ore by expanding their mining activity. Each truckload of ore may contain less copper per ton, but the companies were filling more trucks.
But with financing hard to get in the aftermath of the global financial crisis and everybody worried about falling demand, companies have been making the big investments required to expand ore production. Chile’s state-owned copper miner Codelco isn’t shy about making its point: The company needs to see higher copper prices before expanding production.
All this sets up the strong possibility of another supply shortage in 2011 if demand stops falling and actually inches upward. And that’s exactly what Morgan Stanley (NYSE: MS), for one, is predicting. Copper demand will climb 6.4% in 2011, the company projects.
I think it may still be a little soon to invest in copper stocks. (For some thoughts on timing, see this post.)
This all, to my mind, adds up to rising copper prices in 2011. But I wouldn’t wait until 2011 before I started to build positions in those stocks.
Full disclosure: I don’t own shares of any company mentioned in this post