Tue Oct 10th, 2006 at 04:14:29 AM EST
A famous Swedish fund manager once told me that the most important thing when it comes to investing in funds and shares is to only invest in companies and trades that you understand. If you can't understand how company X is supposed to make money, avoid it like the plague.
Now, I think I have some basic understanding of how energy markets are going to work in the coming years (peak oil basically) so I decided I should move some of my savings into energy funds now that the price of oil has fallen a bit. The only problem is that these funds often have quite a big part of their money invested in mining, metals and other commodities. And I have no idea how metals work.
So I decided I should try to find out.
from the diaries. - Jérôme
First of all I'd like to remind everyone that I am an amateur. I have no economics degree and almost no experience with shares and funds. I only have a strong faith in peak oil, know some basic economics and hope I possess common sense. You have been warned.
Let's first talk about oil and energy. Global oil production is going to peak pretty soon. Surely sometime between 2008 and 2020 and likely between 2010 and 2015. Peaking will first flatten and then lower the supply of oil. Demand for oil is currently increasing due to the rapid industrialisation of southern and eastern Asia and demand is also increasing in the USA and in oil producing countries like Iran. This demand increase will either continue or it will abate as the economies of these countries are cooled by rising energy prices. No matter what, the price of oil will increase and it will also drag gas and coal upwards.
Metals are different. The rally in metal prices largely depends on the above mentioned industrialisation. If the economic growth of China slows or goes negative it will really hurt the demand for metals. Making matters worse, metal costs are highly reliant on energy prices and on transportation costs (which are also reliant on energy prices). So a higher energy price both reduce demand for metals and increase costs. This is very negative for metal company profits and hence metal shares.
At the same time metal is a hedge against me being wrong on peak oil. If energy becomes cheaper and oil falls to $20 like some people say, this should heat up the global economy and push metals strongly upwards. But frankly I really don't think I am wrong about peak oil.
Furthermore, metal markets are cyclical. Before the current rally, metals have been in a 20 year bear market. Remember Julian Simon's bet? This makes metals fundamentally different than oil as metal reserves are very big and we won't see any peaking of extraction due to lack of stuff in the ground. Any lack of production depends on underinvestment, not geology, and production will increase when more money is invested which is the result of the current high prices. For a more in depth look on this optimistic view see The Sustainability of Mineral Resources with reference to uranium, a third down on the linked page.
The conventional wisdom on oil is exactly the same as the one described above for metal, but please let me utter the four most expensive words of the English language: this time it's different. Due to peak oil.
Still, opening new mines and building new smelting works and the surrounding infrastructure will take years and years and metals are hence probably a good idea in the peak oil time frame (5-10 years), that is if rising energy prices don't kill metal demand.
Let us look at some other scenarios. Let's say that the global economy tanks because of some other reason than high energy prices, like a bursting US housing bubble or trade imbalances or some of the other things I know nothing about. For example the big French bank BNP Paribas warned about that today (sorry, only in Swedish). This would be the worst possible outcome for energy and metals as demand for both would fall because of a weaker global economy. If peak oil arrives on top of that it won't be pretty for metals even though energy should head upwards again.
The best imaginable scenario is that peak oil arrives, slowly pushing energy prices upwards without throwing the world (and China!) into a recession and hence maintaining or even strengthening metal prices further.
Another important thing to consider is that the Chinese economy which is vital for metals is heavily reliant on exporting to the US, so any problems in the US will hurt China and then hurt metals.
There might also be other hazards I plainly don't understand (like interest rates or a collapse of the global financial system) so I'll leave them to others more competent, like the eminent readers of the European Tribune.
So what is my final view on owning metal stocks? I don't know. I don't know how metals will develop. I do know that the gentlemen in charge of Lundin Petroleum who very much believe in peak oil and finance ASPO also strongly believe in Lundin Mining. So maybe metals is a good idea. But energy is definitely a good idea. Maybe a little metal and lots of energy?
I'd like to end this speculation by repeating that I am an amateur. The research needed for the above article was done by reading a little in my economics textbooks and mostly surfing the web reading stuff and then applying peak oil and common sense. But I am sure at least half of it is wrong and that you all have many interesting things to add. And correct.
And yes, I know I need some charts. ;)