Commodities: This is No Bubble!

Commodities are at 2008 bubble price levels, but demand remains supportive. This suggests much higher inflation to come. This is frightening given monetary authorities' determination to stoke still more inflationary fires! 

from Hellenic Shipping News:

Recently I have been reading and hearing about a commodities bubble. I disagree with the idea of commodities being in a bubble - some may occasionally become overbought and correct. Occasionally we will see profit taking and nervous nellies selling on the backs of the various naysayers. But what some are calling bubbles is simply demand outpacing supply.

“When the price of copper finally hit $2 a pound and started going above that, you started hearing people say, It's going to go right back down below $1 which is where it's been for decades. But more and more there came a point of view that this was a permanent increase in prices.” Raymond Goldie, analyst, Salman Partners.
The citizens of the worlds developing nations (China has one fifth of the world’s population, India another 1.2 billion people) aspire to have what we have, the ease of travel, home phones, electricity, central plumbing, heating and air conditioning, cars, toys, consumer electronics and home appliances. The overall dominant global trend in the commodities sector is for increasing demand and rising prices because of a lack of supply.
Also I believe we’re heading, over the next few years, to a very inflationary environment. With US President Obama promising trillion dollar deficits for years to come, with all exporting countries trying to keep their currencies weak to make their exports competitive and with Bernanke throwing money out of helicopters - once my anticipated inflation starts it isn’t going to stop anytime soon.
The International Monetary Fund (IMF) recently published its report World Economic Outlook for October 2010 and in it they talked about commodity demand from emerging countries.
“Because their growth is more commodity-intensive than that of advanced economies, the rapid increase in demand for commodities over the past decade is set to continue…the current era of higher scarcity, rising metal price trends and a balance of price risks tilted toward the upside may continue for some time.”
Agricultural commodities are skyrocketing in price as well. Grain prices soared last Friday after the US department of Agricultural drastically revised estimates downward for the US corn harvest - they slashed a record 6.7 bushels an acre off the national harvest figures. This after projecting a record corn harvest as recently as August.
“Shocker may be an understatement. It's very out of character for the USDA to lower the corn yield so much.” Jason Britt, president, Central State Commodities.
The USDA will often revise (several times) its harvest estimates in October. But with the US corn harvest, at the time, barely 50 percent complete no one expected such a massive bushel per acre revision to the harvest numbers.
"The indication is that we'll just continue to move up from now. There is literally nowhere else in the world to turn to fill these supplies." Darin Newsom, senior analyst, Telvent DTN
Also consider the following:
• Population growth
• Scarcity of new resource discoveries
• Declining grades and ore reserves at existing deposits
• Nationalization
• Decrease in arable land
• Lack of freshwater for irrigation
Investor interest is growing in the fertilizer sector. Anglo-Australian miner BHP Billiton recently made a $39 billion hostile bid for Canada's Potash Corp. - the world's largest fertilizer maker. China and the Ontario Teacher’s Pension Fund are possibly getting involved and this author expects another higher bid to be offered, although as I write this none has appeared.
After last Fridays surprise announcement by the USDA shares in fertilizer companies soared.
To me it all means we are going to see much tighter supplies of, and higher prices for commodities going forward.
If I was looking for superior investment vehicles to take advantage of what I think I know regarding the future for commodities and precious metals I’d be looking at junior producers, near term producers and companies that are in the post discovery resource definition stage with the occasional green field exploration play thrown into the mix.
Why? Well besides the fact that I believe junior resource companies offer the greatest leverage to increased demand and rising prices for commodities there is a very real and increasing trend for Mergers and Acquisitions (M&A) in one of the few bright spots available for investors, resources - whether it’s mining or agricultural.
Juniors, not majors, own the worlds future mines and juniors are the ones most adept at finding these future mines. They already own, and find, what the world’s larger mining companies need to replace reserves and grow their asset base.
The following factors are driving the growing M&A trend:
• Consolidation to achieve economies of scale and pricing power
• Scarcity of large producing assets
• High demand in industrialized nations for metals and minerals
• V shaped recoveries in developing countries
• Expansion into new geographies
• Diversification of resource bases
• Overall return to risk
• Looser bank lending
• Higher commodity prices and better company cost management = larger operating cash flow
“As the potential for commodity scarcity escalates, M&A activity in the global mining sector will likely intensify, mimicking a ‘global arms race. With few large targets in play and diminishing key resource reserves, we expect global miners will continue to scour the globe for projects and broaden their deal strategies." M&A in the Global Mining Sector - No Stone Unturned, PricewaterhouseCoopers.
"The key to really understanding what's driving this globally is the pressure on food production around the world." Denita Stann, Potash Corp's director of investor relations.
Because of:
• Rising commodity prices
• Soaring share prices because of outstanding drill assay results
• Increased excitement being brought to the junior sector by increasing M&A activity for junior “fish”
The soon to be a tidal wave of money coming into the resource sector is going to bypass the majors and roll right over the few surviving mid-tiers. This money is going to be looking for the greatest leverage to increased commodity demand, rising commodity prices and the potential for an extremely lucrative buyout.
In their No Stone Unturned report PricewaterhouseCoopers (PwC) said 1,732 deals worth $159 billion were struck in the record setting year 2007 - 1,324 M&A deals were struck in the first six months of 2010 for a total value of $104 billion. But the overall number of mega deals (+ $500 million) is way down with only 28 announced to date against 54 in 2007.
"Scarce opportunities for mega deals have prompted more senior miners to acquire junior mines and exploration companies earlier in their life cycle." PwC
Conclusion
“Many mining and metals companies are looking for acquisitions to fast track supply pipelines, driven by confidence in ongoing underlying demand in China and India. We are seeing a lot larger lists of potential buyers than there are assets available.” Mike Elliot Ernst & Young’s Global Mining & Metals Leader.
Senior miners are buying junior and exploration companies earlier in their life cycle. New money is coming into the sector, bids are building and the asks are being taken out. Significant drill assay results are giving companies share prices a rocket ride when released.
It’s an exciting time to be an investor in the junior resource market. Are there some quality junior producers, soon to be producers, post discovery resource definition, green field exploration companies and potential takeover targets on your radar screen?