The worst of the downturn behind us

By Barry Dawes*

MPS expects China will be far more resilient than the world expects and already the Shanghai Composite is up more than 50 per cent from its 2008 low. The last Outlook for Resources pointed out that this index together with Hong Kong and most resources stocks did not make new lows in 2009, unlike most of the other major indices around the world. China has also wisely begun stocking up on commodities to meet its growing raw material requirements associated with infrastructure spending. Copper and zinc are important but also watch for nickel and tin. China appears to be using up its US Dollar surplus to fund these purchases and it is also noticeable that Chinese companies are also looking around the world for resources projects from Western owners caught up in the global financial crisis.
Last month’s paper also focused on the US Dollar, US T-Bonds and the level of US Dollar cash in banks and in CMTs. The flow of money from cautious underweight fund managers into equities looks like it has some power to yet run and that US$9 trillion certainly won’t enjoy the current low interest rates. The US Dollar seems to be resuming its downtrend so equities generally should benefit and resources stocks in particular. The rallies should continue even if economic activity in the US is slow to recover.
The other factor with the weakening US Dollar will be a renewed interest in gold. It seems strange that gold stocks were amongst the best performers from the stock market lows in November and gold itself rallied to exceed US$1000 again but the excitement has waned as other sectors have caught up. The mid February highs in gold are now two months ago and in Australian Dollar terms gold is off by over 20 per cent from the record A$1550 levels. The market seems to be now suggesting that the fall from the highs is enough and that another gold surge should soon take place.
The choice in Australian gold stocks is remarkably limited given the record gold prices but a portfolio of some of the best value larger gold stocks is essential and then an astute sifting through some of the more speculative smaller (now very small after common 80-90 per cent falls in the December half of 2008) gold stocks should give outstanding returns over the next few months.
I have been fascinated by the performance of the Toronto Venture Exchange Index which fell about 75 per cent from around 2800 in June 2008 to a low below 700 in December 2008. This is a broad index of small developing companies across a wide range of industries but mostly resources. This index is now challenging 1000 and should be seen as a proxy for all small speculative resources stocks. The recent gains show that the rebound is international and that further sharp gains are likely as gold moves up.
Peak Oil is still with us so investments in energy stocks must be a key part of everyone’s portfolio. Oil, gas and coal will still provide good long term returns but the best long term opportunity must be in uranium for minimal polluting energy with perhaps the lowest strategic supply profile. Uranium can be flown in to power stations without requiring delivery by ships, trains or pipelines that may be subject to interference. Piracy on the high seas has become an issue again.
Uranium stocks around the world have also begun to move up with gusto and I think the quality plays will make new highs this year. The uranium opportunity is a very long term play with nuclear power likely to gain market share in electricity production from all other fuels and energy sources.
Finally the markets need to focus on market breadth whereby all stocks, particularly smaller stocks need to participate in rallies. From an MPS perspective, the last bull market period in commodities (from the lows in December quarter 1998 to the falls into December 2008) lasted 10 years and produced some outstanding prices, (oil at US$147/bbl, gold at over US$1000/oz and copper at US$4/lb) but oil and gold stocks in 2007 and 2008 were just not involved.
I think the next 12 months will see that market breadth as institutional and retail investors participate far more actively in the smaller stocks to a level more typical of these bull markets and so unlike the past few years. The markets are about money flows and anticipation rather than just GDP data and housing starts – let the markets tell you what is happening and follow the money!

* Barry Dawes is managing director, Martin Place Securities, a resources investment firm specialising in emerging mining, resources, energy and technology companies. Contact him at: bdawes@mpsecurities.com.au