4 Areas Revved Up for a Resources Boom
By Frank Holmes
CEO and Chief Investment Officer
U.S. Global Investors
Commodity returns vary wildly, as experienced resource investors can attest and our popular periodic table illustrates. This inherent volatility can spell opportunity for the nimble investor who can look past the mainstream headlines to identify hot spots. Our global resources expert, Brian Hicks, CFA, identified four we believe are revved up for a resources boom.
1. Plenty in the Tank for Energy Stocks
Because of the previously low expectations of global growth and oil demand, energy stocks have been shunned by investors and have languished in recent years. In fact, according to Goldman Sachs, oil equities held in the Energy Select Sector SPDR ETF have underperformed the broader market by 32 percent since 2008!
Global energy stocks have also suffered: In a comparison of the price-to-book valuations of the MSCI World Energy Index to that of the MSCI World Index, the ratio is at a level we haven’t seen since the late 1990s and early 2000s. Back then, crude oil plummeted to a very low price of $10 per barrel.
Today, with oil hovering around $100 a barrel and improved economic conditions in the U.S., energy stocks appear to be a tremendous bargain compared to overall stocks.
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When it comes to natural gas, the cold, snowy winter has caused inventories of the commodity to rapidly decline. As the U.S. is experiencing the coldest winter in 13 years – some parts of the country have had the coldest weather in nearly three decades – natural gas inventories have been drawn down to levels we haven’t seen in 10 years.
Still, Old Man Winter hasn’t been persuasive enough for companies to respond with supply.
Based on data from the research firm IHS, 384 gas-directed rigs were online in the lower 48 states to refill storage and meet new demand coming online from the industrial sector in 2013. However, looking ahead over the next few years, the rig count is going to have to rise dramatically “as the gas market tightens in late 2014 and 2015,” which is a tremendous opportunity for investors, says IHS.
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Before rig counts can increase, higher natural gas prices are needed to incentivize operators to invest in natural gas. Based on last quarter’s earnings reports, many major producers, such as EOG, Southwestern or Pioneer Natural Resources, are not planning on increasing their natural gas budgets. Bill Thomas, Chairman and CEO of EOG Resources, explained his reasoning that is part of the collective thought process across the industry:
For the sixth year in a row we are not [trying to] grow EOG's North American natural gas production. This is reflective of our view of low returns on natural gas investments. We won't drill any dry gas wells in North America during 2014 because we don't see a change in the gas oversupply picture until the 2017-2018 time frame."
As we come out of this winter season, the complacency toward adding to rig counts may amplify the deficit in natural gas inventories.
2. U.S. Chemical Industry Has a Competitive Edge
One upside to the low natural gas prices in North America is that it equates to relatively cheap feed stock for U.S. chemical companies. Whether it’s Asia or Europe, gas prices outside of the U.S. tend to be benchmarked to the higher price of crude oil.
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Along with the global economic recovery, natural gas is giving the U.S. a competitive advantage. We’re seeing chemical companies coming back to the states, creating jobs, expanding exports out of the U.S., and helping the nation’s current account deficit.
3. Shipping Companies at a Possible Inflection Point
The prices to ship commodities around the world have been hovering around the lowest we’ve seen in five years. However, demand for shipping is starting to overtake the supply of new ships, which bodes well for shipping companies.
Take a look at the chart showing the Baltic Dry Index over the past five years. The index is made up of various sizes of carriers including the Baltic Capesize, Panamax, Handysize and Supramax indices and measures the price of moving raw materials by sea. Primarily, these vessels transport iron ore and grains, i.e., wheat, corn and soybeans, which are especially vital goods for China.
To keep its population of 1.3 billion fed, China needs to import millions of tonnes of wheat, corn, rice and soybeans. As this demand is recognized, shipping companies should benefit.
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4. Alternative Energy Could Get You More Green
In China, residents have been dealing with increasing cancer-causing pollutants and vehicle congestion on roads, and public discontent is rising. This winter, as pollution grew to be 10 times higher than the acceptable rate, Beijing University students protested the conditions by putting masks on iconic statues.
The effect that pollution is having on China’s economy benefits certain industries, including renewable energy or clean energy, whether it's solar or wind power
You can see just how dramatic the investment has been over the last five years. Specifically, wind power and solar look especially attractive. Take a look at CLSA data: In 2009, the country had about 0.2 percent of the global market. By 2014, it’s estimated to grow to one-third of the global market.
China isn’t the only country with a growing renewable energy market. With the Fukushima nuclear reactors incident after the massive earthquake in Japan, the solar market is taking off there too.
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I just flew back from Asia, where I spoke at Robert Friedland’s Asia Mining Club and Mines and Money Hong Kong, with a special stop in Carslbad, CA on my way home to speak at the Investment U Conference. It has been an exhilarating week meeting with global entrepreneurs, mining executives and curious investors. I look forward to sharing their advice and insights with you next week.
Please consider carefully a fund’s investment objectives, risks, charges and expenses. For this and other important information, obtain a fund prospectus by visiting www.usfunds.com or by calling 1-800-US-FUNDS (1-800-873-8637). Read it carefully before investing. Distributed by U.S. Global Brokerage, Inc.
Fund portfolios are actively managed, and holdings may change daily. Holdings are reported as of the most recent quarter-end. Holdings in the Global Resources as a percentage of net assets as of 12/31/13: Energy Select Sector SPDR ETF 0.00%; EOG 0.00%; Pioneer Natural Resources (2.18%); Southwestern 0.00%
All opinions expressed and data provided are subject to change without notice. Some of these opinions may not be appropriate to every investor. MSCI World Index is a capitalization weighted index that monitors the performance of stocks from around the world. MSCI World Energy Index is an unmanaged index composed of more than 1,400 stocks listed on exchanges in the U.S., Europe, Canada, Australia, New Zealand and the Far East. The MSCI World Energy Index is the Energy sector of the MSCI World Index. The Baltic Dry Freight Index is an economic indicator that portrays an assessed price of moving major raw materials by sea as compiled by the London-based Baltic Exchange.
- Major market indices finished mixed this week. The Dow Jones Industrial Average rose 0.12 percent. The S&P 500 Stock Index fell 0.48 percent, while the Nasdaq Composite dropped 2.83 percent. The Russell 2000 small capitalization index declined by 3.51 percent this week.
- The Hang Seng Composite rose 2.23 percent; Taiwan gained 2.30 percent while the KOSPI advanced 2.38 percent. The 10-year Treasury bond yield fell 2 basis points this week to 2.72 percent.
Domestic Equity Market
The S&P 500 Index suffered modest declines this week but under the surface the market is churning as sector leadership is being reshuffled. The best performing sectors for the week are typically viewed as defensive with the exception of energy, which is inconsistent with the moves we are seeing in the bond market which appear to be moving forward with expectations of higher short-term interest rates.
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According to the Stock Trader’s Almanac 2014 springtime is a good time to own equities with the rally off the February or March low for the Dow Jones Industrial Average averaging 11.5 percent over the past 49 years. The Dow bottomed in early February and has rallied about 6 percent since that time, implying we are roughly half way through the spring rally if the seasonal averages hold.
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- The energy sector rose 2.52 percent this week as energy service and exploration and production companies were particularly strong. Oil and natural gas prices didn’t move that much so this change appears to be part of the rotation in the market as mentioned above. Strong performers included Noble Energy, Schlumberger and Baker Hughes.
- The technology sector led the S&P 500 in stock buy backs during the fourth quarter as the sector accounted for 27 percent of the $129.4 billion in buybacks.
- Symantec was the best performer in the S&P 500 rising 8.74 percent this week. The shares bounced back as last week the company unexpectedly fired President and Chief Executive Officer Steve Bennett and was the worst performing stock in the S&P 500.
- Since the post Federal Open Market Committee (FOMC) press conference last Wednesday the market has experienced quite a rotation from growth to value. High quality companies exhibiting strong relative strength have been hit hard, while traditional value stocks have experienced a price reversal.
- Certain industry groups have been hit the hardest. They include internet retailers, internet software & services, biotechnology and casino & gaming.
- Netflix was the worst performer in the S&P 500 this week, falling 11.61 percent. The company has fallen by more than 19 percent in March and is a good example of the market rotation mentioned above without company specific news.
- The current macro environment remains positive as economic data remains robust enough to give investors confidence in an economic recovery but not too strong as to force the Fed to aggressively change course in the near term.
- Money flows are likely to find their way into domestic U.S. equities and out of bonds and emerging markets.
- The improving economic situation could possibly drive equity prices well into 2014.
- A short-term market consolidation period after such strong performance over the past six months cannot be ruled out.
- Higher interest rates are a threat for the whole economy. The Fed must walk a fine line and the potential for policy error is potentially large.
- Potentially a lot of good news is priced into the market and the economy will need to deliver to maintain the positive momentum in the market.
The Economy and Bond Market
Treasury bond yields were mixed this week. The very short and very long ends of the yield curve experienced falling yields, while the belly of the curve saw yields move higher. The 2-year Treasury note is shown below and after a big move last week continues to creep higher as growth expectations continue to build. Short-term bond yields continued to adjust to last week’s comments from Fed Chair Yellen which spooked the market into thinking higher rates could be coming sooner than expected.
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- Fourth quarter GDP was revised higher to 2.6 percent as consumer spending and exports were better than initially estimated.
- Consumer confidence continued to improve as the Consumer Confidence Index reached a new multi-year high in March.
- The S&P/Case-Shiller Composite 20 City Home Price Index rose 13.24 percent on a year-over-year basis in January.
- Manufacturing data was modestly disappointing with the Markit US Manufacturing Index falling more than expected along with somewhat disappointing core durable goods orders in February.
- Housing data continued to send mixed signals with pending-home sales falling 0.8 percent in February for the eighth straight monthly decline.
- German business confidence weakened in March as the Ifo survey weakened.
- The Fed will likely follow a data dependent path for monetary policy and this week’s testimony will likely be refined in coming weeks.
- The IMF released a report recently highlighting the deflation risk in Europe. It is exactly this type of thinking that could spur additional easing policies from the ECB, especially as the Euro continues to strength and is approaching the 1.40 level vs. the dollar.
- There are many moving parts to the taper decision and while the Fed began the process it is very possible that tapering could be delayed if the economy stumbles.
- Several Fed officials tried to reframe Fed Chair Yellen’s comments from last week that caught the market off guard with regard to how quickly interest rates may be adjusted. The potential for miscommunication from the Fed has increased with the change in guard.
- Trade and/or currency “wars” cannot be ruled out which may cause unintended consequences and volatility in the financial markets.
- China remains a wildcard for economic recovery and the economy has shown some cracks in recent months. This is similar to how last year started and China found its footing, something similar needs to happen this time around.
For the week, spot gold closed at $1,295.27, down $39.43 per ounce, or 2.95 percent. Gold stocks, as measured by the NYSE Arca Gold Miners Index, declined 5.23 percent. The U.S. Trade-Weighted Dollar Index rose 0.09 percent for the week.
- China’s gold imports from Hong Kong rose in February amid increasing demand resulting from the country allowing more banks to import the yellow metal. Net imports for February totaled 109.2 metric tons, which added to the 83.6 tons in January, account for a 140 percent rise relative to the same period in 2013. Similarly, demand in Indonesia, Thailand and Vietnam totaled 300 tons in 2013, a 42 percent increase from 2012. Lastly, the Iraqi Central Bank purchased 36 tons of gold to prop up its reserves, marking the single largest purchase in three years.
- The Singapore exchange is looking to start a gold trading market that allows for physical delivery into the island nation. The news coincides with reports of gold ETF holdings rising; the SPDR Gold Trust announced an increase in holdings to the highest in three months. With gold prices back near the $1,300 level, an important threshold for price sensitive buyers, there is encouragement for sidelined physical buyers in emerging markets to resume buying.
- Osisko Mining reported additional drilling results from its Canadian Kirkland project at Kirkland Lake including a 105 meter intercept averaging 1.41 grams per tonne. Another recent drill report included a 128 meter intercept averaging 2.26 grams per tonne. On a different note, Dundee Precious Metals announced its Tsumeb copper smelter in Namibia will ramp up to full capacity next month after receiving government approvals.
- Gold traders are bearish as they expect the Fed to keep cutting its stimulus and raising interest rates as the economy strengthens. According to a Bloomberg poll, nine traders expect gold to trade higher next week, while 15 have said they expect gold to trade lower. The reason most frequently cited in the poll related to Fed Chair Yanet Jellen’s comments last week which suggested rates would rise in the U.S six months after the end of the bond buying program this fall.
- Platinum and palladium fell as striking miners in South Africa eased their pay demands. Despite this advance, a resolution to the work stoppage is not yet in sight as miners continue to demand onerous raises of nearly 100 percent over a four year period. It is estimated workers have forgone more than $403 million in wages since the beginning of the strike action.
- Standard & Poor’s downgraded Chicago-based Coeur Mining and Australia’s Santa Barbara. The rating agency argued Coeur’s higher debt load together with lower precious metal prices earned the company its new B rating. In terms of Santa Barbara, higher production costs, together with lower production volume, and execution risks in the cost saving initiatives have led to a deterioration of credit metrics. In similar fashion, Moody’s downgraded Hecla Mines arguing substantial near- term capital spending plans.
- During a presentation in San Antonio this week, Jefferies Chief Strategist David Zervos commented on gold and the equity market’s reaction to Yellen’s press conference last week. In his opinion, the Fed’s focus on driving real interest rates negative will continue, simply because high real rates deter investments. Just ask Japan which lost two decades while experimenting with high real rates. The Fed will likely raise nominal interest rates, but only when existing inflation can justify them; thus keeping real interest rates flat or negative. Yellen may have brought up the subject at this time because the Fed can see inflation in the horizon. Loan growth, as shown on the loan to deposit ratio below, drives money velocity. Velocity is one of the key components of inflation and was on a downtrend since 2008. This spike in velocity will act as a detonator to the unprecedented $4 trillion monetary base, thus spurring rising inflatio n.
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- If the threat of imminent inflation hasn’t hit home for you, David Rosenberg, Chief Economist at Gluskin Sheff, brings a cascade of money supply indicators that will have you thinking. According to Rosenberg, since the beginning of the year, M1 money supply has exploded at a 23 percent annual rate, 45 percent over the past four weeks. M2 has risen at 7.3 percent pace, while the M1 multiplier bottomed a month ago, boding well for velocity to pick up. In terms of loan growth, which has accounted for velocity missing in action since 2008, commercial paper and industrial exploded 19 percent. These are crazy numbers according to Rosenberg. The quantity theory of money says that based on the statistics above, inflation may not yet be present, but it is in your future.
- Indian gold imports will rebound in the second half of 2014 as a new government eases trade curbs and festivals and weddings spur demand, according to billionaire Indian jeweler T.S. Kalyanaram. Despite the curbs, India accounted for 25 percent of global demand in 2013 according to the World Gold Council, being surpassed by China as the largest gold consumer. According to Kalyanaram, India’s demand is nearly 50 percent greater than China’s, once you take into consideration the gold smuggling.
- Kinross Gold, the largest foreign gold miner operating in Russia today has asked Canada to take a balanced approach as it attempts to resolve the standoff with Russia following the annexation of Crimea. The news hit the wires after U.S. President Barack Obama said metal producers and miners in Russia could face sanctions.
- Hedge funds may hesitate from buying more gold after boosting their bets on the metal ahead of the Fed meeting that speculated rates may rise in 2015. A Bloomberg report shows that speculators and other money managers increased their net-long position to the highest level since 2012 ahead of the Fed meeting on March 19.
- ABN AMRO, the largest Dutch bank by assets, raised its 2014 gold forecast to $1,100 from $1,000 arguing changes in in currency forecasts and current market dynamics. The bank, however, left its 2015 forecast for gold at $800 as it believes the U.S. economy will accelerate and yields climb. This is the same bank that issued paper IOUs to investors holding physical gold in its vaults, claiming it was unable to deliver physical gold to clients any longer.
Energy and Natural Resources Market
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- Copper rebounded over $3 per pound this week, to post its largest five day gain in six months based on speculation that China will under take steps to strengthen economic growth.
- The benchmark West Texas Intermediate (WTI) crude oil price climbed above $100 a barrel, marking its second weekly gain on lower storage inventory at the Cushing, Oklahoma hub.
- According to recent reports, Indonesia has reached a deal over export taxes with U.S. mining company Freeport-McMoRan (FCX), allowing nearly $4 billion worth of annual Copper shipments to resume as early as next month. FCX halted concentrate shipments since January, refusing to pay an escalating export tax that FCX said breached its contracts.
- There is support for coal prices. The draw on domestic coal inventories at utilities eclipsed a 35-year record of 15.6 million tons during January, compared to a 10-year average of 5 million tons.
- In a Bloomberg survey, corn traders were the most bearish on their outlook for the commodity since the week ended February 14 in advance of a U.S. Department of Agriculture report that may show larger domestic inventories.
- Rio Tinto faces more delays on its $6 billion Mongolian copper and gold project after it was revealed that an agreement with the Mongolian government could be at least four months away. For more than a year, the partners have been unable to agree on a way to expand the Oyu Tolgoi mine.
- The U.S. Census Bureau released its 2012 Economic Census Advance Report this week, which highlighted strong job growth within the natural resources sector, as “Mining, Quarrying and Oil and Gas Extraction” grew faster than other industries, posting revenue growth of 34 percent over a 5-year period to $555 billion by 2012. Oil and gas alone saw payrolls increase by 60 percent to $15.4 billion.
- U.S. natural gas storage declined to 10-year low. U.S. natural gas storage for the week ending March 21 was 896 Bcf (down 49.7 percent year-over-year). Current inventories for natural gas are down 50.8 percent vs. its 5-yr average, according to the U.S. Energy Information Administration.
- Following year-over-year declines in 2011 and 2012, federal government highway awards in 2013 showed renewed signs, which typically leads to higher spending for road construction and infrastructure in the ensuing two to four month period.
- U.S. Steel’s President and CEO calls for imposition of duties on imports of Oil Country Tubular Goods (OCTG) from South Korea alleging the makers had fudged the facts by setting up networks of companies to evade U.S. laws and disguise the cost of producing and importing.
- A potential threat to copper pricing, China’s copper market is expected to experience a 400,000 ton surplus in 2014 as increases in production and imports outpace the growth in real consumption, according to Shanghai Metals Market.
- With the Greek economy expected to grow by 1.1 percent this year, the Purchasing Managers Index (PMI) in expansionary territory and consumer confidence having turned positive, it looks like Greece is turning the corner. As a result, money is starting to flow back into Greece, lured by the global reach for yield, sending the Greek 10-year bond yields down to 2010 levels. The conditions have allowed Greek banks to recapitalize, changing the lending landscape in a nation that has been starved of credit over the past 4 years.
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- Eurozone business activity slipped slightly this month, with the flash composite PMI reading 53.2 in March from 53.3 in February. Yet, the reading handsomely topped analysts’ consensus expectations of 52.6. The eurozone enjoyed its best quarter for business activity since the second quarter of 2011, according to Markit, with the PMI survey signaling a 0.5 percent increase in first quarter GDP after growth of 0.3 percent in the fourth quarter.
- Chinese Premier Li Keqiang’s comments on the importance of stabilizing growth within a reasonable range, amid deteriorating employment prospects, fueled market expectation of easing government policy in the second quarter. Coupled with anticipation of accelerating reform of state owned enterprises, Chinese financials stocks rallied throughout the week.
- Dedicated emerging market equity funds reported marginal outflows of $12 million for the week ended March 26, marking 22 straight weeks of outflows in dedicated emerging market funds. The cumulative outflow over the 22 weeks amounts to $51.2 billion. In regional terms, dedicated Asia funds reported marginal outflows while Latin America and Europe, Middle East and Africa (EMEA) funds both reported inflows.
- The HSBC China Flash Manufacturing Purchasing Manager’s Index fell to an eight month low of 48.1 in March. This was lower than expected and a third month in contractionary territory, as domestic demand slowdown continued after the Chinese New Year driven by moderating investment, cooling property sector, and continuous elimination of excess industrial capacity.
- S&P downgraded Brazil's sovereign rating by one notch to BBB- after five upgrades in the last ten years. S&P highlighted the deteriorating fiscal accounts and growth outlook as two important triggers for the decision. The downgrade opens the door for further downgrades to state owned companies, as well as downward pressure to highly levered sectors and companies in the local market.
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- Another reflection of Indonesia’s infrastructure inadequacy is that the country’s logistics cost accounts for 27 percent of GDP as of 2013, demonstrably higher than regional peers and developed counterparts. If Joko Widodo wins the upcoming election, a rejuvenated infrastructure building cycle should see benefits ripple through various economic sectors from construction to consumer.
- The Indian stock market, together with the rupee, rose sharply this week as foreigners stepped up purchases of Indian assets on speculation the election of a new government will hasten the nation’s economic recovery. Inflation has eased, according to official figures, and the government projects faster growth and narrower deficits resulting from better than expected collection from asset sales.
- Ukraine reached a preliminary deal with the International Monetary Fund to unlock $27 billion in international aid. As part of the agreement, Ukraine agreed to narrow the budget deficit to 2.5 percent of gross domestic product by 2016 and to raise retail energy tariffs toward their full cost. Similarly, the European Bank for Reconstruction and Development said that it would increase investments in Ukraine to 1 billion euros a year and would resume lending for state-run projects.
- A potentially persistent market style shift away from momentum and growth to reversion and value could hurt fund performance in the near term.
- The Philippines central bank raised the Reserve Ratio Requirement to 19 percent from 18 percent in an effort to curb excessive liquidity growth. While the central bank’s move will likely affect loan growth negatively, Credit Suisse analysts estimate stronger action from the central bank is necessary given the massive amount of liquidity that went into the banking system last year.
- In Thailand, the Constitutional Court has invalidated the results of the February 2 election and declared the election null. With this development there appears to be no prospect in sight for an end to the political standoff. The failure to form a new government may delay the approval of the fiscal budget, leading the finance ministry to cut its 2014 economic growth prediction to 2.6 percent from 3.1 percent.
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