Category Archives: Commodities

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The Future Will Blow Your Mind. How Can You Take Advantage Of It?


  • Global GDP has quadrupled in the last 35 years and will probably do so again in the next 35 years.
  • By 2050 it’s expected there will be 10 billion people on earth and most of them will be living a western lifestyle.
  • While the forecasts are pretty certain, the issue is that the way towards those forecasts will not be linear. Investors should be careful not to get excited and jump into bubbles.

Introduction 

Investing is both complicated and simple at the same time. Today we are going to show the simple side of investing by analyzing a few factors that are almost certain and that will have a huge influence on your investing returns. By analyzing a few global demographic and economic trends we can see where the world will be in the future and connect that with our investments pictures, a scenario that is actually mind-blowing. Keep reading…

Global Population & Economic Development

A number that is essential for investors is the following:

figure 1 global population
Source: Worldometers.

 

What is even more important is that the population is growing and will continue to grow. Global population is expected to reach 9.7 billion by 2050. The biggest expected growth is in Africa, followed by Oceania, the Americas and Asia.

figure 2 global population forecast
Figure 2: The World’s population. Source: The Economist.

 

This simply means that the global market for companies and global demand will be at least 31% larger in 34 years. On top of the increase in the global population, the economic structure and growth forecasts for the majority of the global population are astonishing.

The list below shows the current top 15 countries by population and their respective GDP per capita.

figure 3 data
Figure 3: Population and GDP per capita. Source: Worldometers, World Bank.

 

Of the 15 most populous countries, only the U.S. and Japan have a GDP per capita higher than $10,000. Countries like Indonesia, with 260 million people, have to grow 10 fold to reach the Japanese standard while India has to grow 20 fold. Thankfully, all of these currently underdeveloped countries are growing at amazing rates.

figure 4 global gdp growth
Figure 4: Global GDP growth. Source: The Economist.

 

If we look at where the global GDP per capita average was 35 years ago we can only imagine where the GDP will be in 35 years with the explosive growth in emerging markets.

figure 5 glboal GDP per capita
Figure 5: Global GDP per capital in current US$. Source: World Bank.

 

If GDP per capital quadruples in the next 35 years like it did in the last 35 years, in 2050 we will have an average global GDP per capita of $40,000, which is higher than what Japan currently has.

A higher GDP will make many things available that are currently unavailable. Many people will want a car and we can only imagine what will that do for the car industry. Of the 15 countries mentioned above, only the U.S. and Japan have reached a level of car per capita saturation.

figure 6 cars per capita
Figure 6: Global cars per capita. Source: Charts Bin.

 

Cars, homes, infrastructure, software, hardware, travel, fashion, medicine, food and who knows how many more things that we can’t even imagine at the moment will be a normal in 2050 for the majority of the global population.

How sure can we be that this will become a reality in the next 35 years? Facebook gives us a clue. Their data shows the fastest growth rates in the Rest of the World and Asia which means that people there are more and more informed about a western lifestyle which will encourage them to seek such a life.

figure 7 daily users
Figure 7: Facebook’s global growth in daily active users. Source: Facebook.

 

We can clearly conclude that the world will be a much different place in 35 years, especially when we look at how different the world is now compared to how it was 35 years ago. Just to gather the data I’ve listed above would have taken me a year or longer to gather 35 years ago, while today I can go online and have everything in front of me in an instant. Globalization, a larger population and inevitable economic development are the trends that will undoubtedly influence your investments in the next 35 years.

What Investors Should Do

If you’re in it for the long-term, you have nothing to worry about especially if you are well diversified and have made smart investments. What do we mean by smart investments? The global growth discussed above is pretty certain, but what is uncertain is the linearity of it. Going back to figure 5 we can see that from 1995 to 2002 there was very little improvement in global GDP.  Only after 2002 did it explode. This means that the road to quadrupling global GDP will not be smooth.

An investor has to be careful not to overpay for an investment. Many people see the above numbers and get very excited. This is what creates bubbles. As we will have many recessions in the next 35 years, it is wise not to get too excited about the numbers above but to invest at maximum pessimism. Currently there is excitement about healthcare, social networks, and consumer discretionary, and negativism in agriculture, food, energy, mining and shipping. With the growth described above, there is more certainty that demand will grow for commodities than for social networks which is a perfect example of how investors get carried away.

Charlie Munger, Buffett’s investment partner, continually restates that investing should be like watching paint dry and that if you want excitement, take $800 bucks and go to the casino. All the inevitable economic and demographic developments are pretty certain, but will slowly grow into the forecasted numbers. If your investment horizon is long you can afford to be invested in the sectors that will surely benefit from the structural trends and wait for the booms. What you should avoid is to be invested in bubbles because those are the destroyers of long-term returns.

For more specific information about a sector that we believe has just reached a point of maximum pessimism and is trading dirt cheap, but is sure to benefit from the massive future growth in global GDP, click here.

 

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Commodities: Stick To The Fundamentals, Beware Of Speculation


  • Oil prices are increasing the number of rigs, putting pressure on prices.
  • Soros sold his gold, should you?
  • Iron ore is hot, but waiting until winter might provide better purchasing opportunities.

Introduction

Yesterday we discussed how Treasury Inflation-Protection Securities (or TIPS) are a great protection during times of inflation. Today we are going to take a deeper look into another great inflationary protection, commodities.

The general feeling is that commodities have surged since January, but there is a high level of divergence. This divergence in commodity price movements is due to speculation in some commodities and fundamental reasons in others.

Situation – Oil

Oil is currently trading at $46 per barrel which is 75% higher than it was at its low six months ago.

figure 1 oil prices
Figure 1: Oil prices. Source: Bloomberg.

The 75% price jump in oil is a clear indication of price speculation in oil markets because the demand is stable and well known. Speculators include the whole chain, from producers to retailers and future traders who can trade high quantities on margin. In such an environment, the only option is to make an educated guess about the long-term fundamental oil price and trade around it. As Russia and Saudi Arabia are in talks to stabilize the oil market, we could see the market push through year highs, but higher prices call for more global production. As oil prices stabilized above $40, the number of U.S. rigs increased for seven consecutive weeks and the global rig count also increased in July. More rigs mean more supply and further pressure on oil prices.

Investors should be careful with oil, production is very flexible and much of it is low cost which disables a higher level price stabilization. Therefore, oil is a pure trading play with fundamentals easily influenced by speculation.

Situation – Metals

As we discussed gold yesterday while discussing traditional safe haven assets, today we are going to focus on iron ore, copper, zinc and aluminum.

An additional warning for those long gold, George Soros, the legendary hedge fund manager that opened a $263 million position in Barrick Gold in Q1 has cashed out in Q2. Be careful not to get burned on gold as smart money is slowly leaving the playing field.

Iron Ore

Iron ore has had a wild ride this year, but its supply is much less flexible than oil and divergence from fundamentals can be easier to grasp.

figure 2 iron ore
Figure 2: Iron ore prices. Source: Bloomberg.

As iron ore is more predictable than oil, Morgan Stanley sees seasonal weakness ahead, increased supply due to the VALE S11D project, and suggests that prices might fall back to $40 again. Those dips are excellent opportunities to open a position in iron ore miners as when iron ore prices are low, their share prices also decline. By looking at the lowest cost producers, share price is the main risk factor as in the long run, big, low cost miners are unavoidable for global development. Companies to look at are Rio Tinto (RIO), BHP Billiton (BHP), Vale (VALE) and Glencore (GLNCY), but for lower risk it might be better to wait for winter.

Aluminum & Copper

Aluminum is only up 8% year-to-date, and copper is only up 3%. Both metals are a clear example of how commodities diverge. This divergence is what creates opportunity because lower prices tend to eliminate high cost production, limiting supply and pushing prices up again. The current price stability for aluminum and copper, and price increases for precious metals and iron, suggests that the 5-year commodity bear market has come to an end and things should slowly turn as we begin to run into supply deficits due to lower investments.

Aluminum and copper are closely related to global economic growth. An good aluminum play is Alcoa Inc. (AA), while with copper it’s good to look at the lowest cost producers.

figure 3 copper costs
Figure 3: Copper production costs. Source: Southern Copper Corporation (SCCO).

The production cost for the stock pick detailed in The Copper Goldmine—a report I wrote earlier this year, along with an update, that was sent to subscribers last Friday—was $0.92 per copper pound in Q2 2016, and is expected to be $0.52 for the company’s future copper project putting it among the lowest quintile in terms of production costs. To download this report, click here.

Zinc

Zinc is the superstar metal of the year. It has increased by more than 50% year-to-date and is expected to increase more due to the inevitable supply gap forming. More about the zinc supply gap here.

In addition to our above mentioned stock pick—which is transitioning from a mostly copper producer to a mostly zinc producer in 2017,—another good option to be exposed to zinc, copper and aluminum is the PowerShares DB Base Metals Fund (DBB) with equal weights for zinc, copper and aluminum.

Conclusion

Commodities seem to have reached a bottom, but global economic turmoil or China slowing down might ignite speculators to short metals on margin and put severe downward pressure on prices. Therefore, any commodity related investment has to be done with the notion in mind that 50% of it can quickly be lost.

On the other hand, the world cannot live without commodities and therefore it’s a good idea to be exposed to such an investment, especially to miners as their prices increase exponentially if commodity prices increase due to their fixed costs. Production costs are always the main factor in assessing how much can be lost when investing in commodities.

A good strategy with commodities at this point in the commodity cycle is to average down if commodities experience further declines and then ride in full the eventual upside. The upside is certain as global demand for commodities is expected to grow as a result of increasing demand from developing countries.

To sum things up, commodities are at or near their bottom. The upside impetuses to be aware of are growing global demand, limited supply and potential inflation, while downside risks come from an eventual slowdown in China or a global recession.

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Are Safe Havens Really That Safe?


  • Economic laws can’t be muted forever, and in the end always get their due, therefore it is good to look at other options to de-risk your portfolio.
  • Gold is too volatile to be considered a safe haven.
  • Diversification should be the best option to avoid losing everything in a market downturn.

Introduction

Economics is pretty straightforward. The first thing they teach you in ECON 101 is that the economy works in credit cycles. In a positive environment with low risks and low base interest rates, people borrow and spend. They buy a new car, go on trips, refurbish the kitchen and so on, which leads to economic expansion.

But there is only so much you can borrow, with two new cars in the garage of your new house you start feeling a bit tight and as all your main spending needs are satisfied, you start deleveraging. This leads to an inevitable recession.

Even if a recession might sound crazy at this moment in time, don’t forget that we have had 11 of them since 1945 with the average expansion cycle lasting 58.4 months and the average contraction 11.1 months. The current expansion is already 84 months old which statistically should have led to a recession, but the FED hasn’t allowed for a normal, healthy economic cycle to evolve and is trying to manage economic cycles. The more the economic expansion period is artificially stretched, the stronger the negative economic impact of a future recession will be. A good example to look to is the 2007-2009 Great Recession, which was the longest since the Great Depression.

The Japanese example perfectly demonstrates how monetary easing has its limits. Monday’s data showed that the Japanese economy expanded at an annualized rate of 0.2% in Q2 2016 despite government stimulus.

figure 1 Japan
Figure 1: Annualized quarterly change in Japan’s GDP. Source: Wall Street Journal.

As long term investors, we have to follow the main rule of investing which is not to lose money. Therefore, it is of essential importance to always be looking at risks, which I know isn’t as sexy as buying stocks, but it is what gives long-lasting and outperforming returns.

Among the many risks for investors, today we are going to focus on how safe traditional investing safe havens really are.

Investing Safe Havens

The definition of an investing safe haven states that the investment is expected to retain or even increase its value in market turmoil. The typical safe havens most investors consider are gold, U.S. treasuries—especially TIPS or Treasury Inflation-Protected Securities,—the Swiss franc, and defensive stocks. We shall discuss each of these below.

Gold

Gold is considered the ultimate safe haven asset, but due to its incredible volatility, I have a feeling that it’s retail investors who get burned by it, making gold a used-to-be the safe haven.

In wartimes, gold is the only worthy currency due to rampant money printing, however, we are hopefully not even close to a war, but are printing money like we are in a wartime. Even though gold is the ultimate hedge against runaway inflation, we may want to rethink it as a safe haven due to its volatility.

In the 1973-1975 recession, gold surged from below $100 per ounce to above $200 but quickly retreated to its previous level as soon as things got better. In 1980, due to geopolitical instability, gold surged to above $800 and again returned to the $350 levels in 1982. Gold notched up a bit in the 1987 bear market and in the 1991 recession, but did not move in the 2001 recession. In 2002, gold started its majestic bull run from prices around $300 to the highs reached in 2011 of above $1,800, only to retreat to $1,100 this winter. It has again surged to current prices of $1,350/oz.

figure 2 gold price
Figure 2: Gold prices since 1973. Source: Gold Price.

I wouldn’t consider an asset that fell 35% in the 2008 bear market to be a safe haven. Especially given gold’s volatility in the last 10 years, investors should know that gold at this point looks more like a speculation than safe haven investing.

That does not mean we don’t believe you should have some allocation to gold as a protection against an all out fiat currency collapse, just know it will be volatile.

U.S. Treasuries

U.S. treasuries carry two risks; one is the default of the U.S. government which is highly unlikely, while the other is inflation which is not so unlikely given the continuous monetary easing. Therefore, in order to really look for a safe haven, TIPS (Treasury Inflation-Protected Securities) should be examined.

If inflation hits 2% or more, 30-year treasury yields would give a negative real return. On the other hand, TIPS have a much lower yield, with the current spread at 162 basis points which is amongst the lowest spreads in the last five years but would keep giving you a positive real return in inflationary circumstances. The current difference of 1.62% is a lot, but protection always comes at a cost.

figure 3 tips vs yield
Figure 3: 30 year treasuries vs. 30 year TIPS – yields. Source: FRED.

The difference in yields demonstrated in the figure above is pretty high which suggests thinking about diversification in the safe haven bond portfolio. As the main rule of investing is not to lose money, TIPS should be considered.

The Swiss Franc

The Swiss franc (CHF) is similar to gold, when things get rough people flock to it, but you have to sell quickly when things get better. In August 2011 the CHF surged due to contagion fears related to the European debt crisis, but it quickly returned to previous values.

figure 4 chf
Figure 4: USD per 1 CHF. Source: XE.

The CHF is not a long term safe option as it is very volatile and does not provide long term protection.

Defensive Stocks

Defensive stocks usually perform well at the beginning of a bear market but are dragged downwards in later stages as investment funds get tight on liquidity. Defensive stocks can be found in the utilities sector and consumer staples. In the current environment, if you have two stocks with similar valuations and yields you might want to choose the more defensive one as it will limit your losses should a bear market arrive.

Conclusion

Talking about risk is always thankless, you become the grumpy fellow at the party while everyone else is having fun. But investing shouldn’t be about fun, it should be about creating sustainable long-term positive returns.

In this article we have discussed how some safe havens are not that safe due to their volatility and speculation around them, like gold and the Swiss franc. Being protected always comes at a cost which is relatively high when comparing treasuries and TIPS, but it is necessary as global monetary easing and stimulus continues.

The main conclusion is that you have to assess your risks for the returns you are getting. The S&P 500 is up only 4.9% per year in the last 24 months, so consider if those meagre returns are worth the risk of losing more than 20% if a bear market comes along.

The best protection should be diversification that includes TIPS, gold, defensive and growth stocks, domestic and emerging markets. If you continually rearrange the weights in order to minimize risks, you can for certain outperform the market with less risk.

 

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Incredible Investing Opportunity & Free Report


In lieu of an article from Sven Carlin, today we wanted to send Investiv Daily subscribers a ‘Thank You’ in the form of a free report and a special bonus ($49 value).

The Copper Goldmine was written by Sven earlier this year. The report details one particular small cap mining stock that we felt was a great buy, ready to make big gains. Included in this report is an in-depth overview of the company, an analysis of their fundamentals, a detailed look into the market for the primary metals this company mines (copper and zinc), and an explanation on why this company is uniquely positioned to make incredible new highs.

Additionally, we’ve included a special bonus report that takes a look at where the small cap miner discussed in The Copper Goldmine is now—we’ll give you a clue, it has been just over 6 months since the initial report was published and this stock is doing very well—and why it’s still a great buy today.

We hope you enjoy these valuable reports, and we hope that you, like us, look forward to reading Sven’s analyses on the market in each day’s Investiv Daily.

To download your copy of The Copper Goldmine, click here, and click here to download the bonus update report.

Sincerely,

Kristina Keene
Editor, Investiv Daily

 

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Will A Bet On Commodities Pay Now?


  • Iron ore prices are falling as supply continues to grow, while copper and zinc prices show signs of supply gaps forming.
  • Low exploration and discoveries indicate that metals will be winners again in the future.
  • The possibility of future inflation increases the appeal of commodities.

Introduction

Diversification is the ultimate protection against various economic factors, in recessions you might want to hold gold or treasuries, in inflationary times you want to be long stocks and commodities. Therefore it is very important to always know what is happening in each potential diversification sector.

Three weeks ago we discussed how aluminum is a bet on global transportation and while a supply gap is not the issue, productions costs are. In this article we are going to analyze what is currently going on with iron, copper and zinc. Before we analyze each individual metal, there is one very important trend in the mining sector which will affect all three metals, low prices which minimize exploration investments and new discoveries.

figure 1 discoveries
Figure 1: Expenditures and mineral discoveries. Source: Rio Tinto.

 

The low number of new discoveries means that sometime in the future there will be a new supply gap like the one we experienced in 2011. It is too early to call for such a situation now, but those are the future benefits of a well-diversified portfolio with commodities.

Iron

Let us start with the most mined metal in the world, iron. Iron prices have been declining since 2011 after hitting a 30-year high of nearly $200 per ton. Prices then bottomed out in December 2015 at $40 per ton, only to jump to $60 per ton in April 2016 and then slowly decline to the current price of $50 per ton. From an historical perspective, prices are still high, but it is important to analyze the current supply and demand situation in order to see if iron is a good diversification metal, especially as central banks target inflation.

figure 1 iron ore prices
Figure 2: Historical iron ore prices. Source: index mundi.

 

All the biggest iron ore producers recently came out with their Q2 2016 production reports, giving a clear indication of the trend in commodities. The results are mixed, Rio Tinto (NYSE: RIO) increased iron ore production by 10% year over year while BHP Billiton (NYSE: BHP) decreased production by 2% and Brazilian Vale (NYSE: VALE) decreased production by 1%. As all major producers are developing new mining projects—like Vale’s 90 million tons per year S11D—and are able to increase production if necessary, we cannot expect the formation of a supply gap in iron and a surge in prices similar to what we witnessed in 2011. Further, as major producers keep increasing production it will keep a lid on future prices.

In order to be diversified with iron, the best thing is to look at the lowest cost producers who are profitable at much lower prices.

figure 2 iron ore cost curve
Figure 3: Iron ore cost curve. Source: Metalytics.

 

The lowest cost producers manage to have positive cash flows even with iron ore prices below $40, which is still a possibility if we see more global turmoil or slowing in China. On the other hand, iron should be a relatively good hedge against inflation.

Copper

Copper has reached its seven year low in January 2016 with prices below $2 per pound, but the recovery has been much smaller than with iron. Current prices are at $2.20 and copper has been trading in the $2.05 to $2.25 range since March.

figure 4 copper prices
Figure 4: 10 year copper prices. Source: Nasdaq.

 

But copper is expected to enter a supply gap in the next few years as global copper grades are getting lower, big mines are being closed and demand is constantly growing.

figure 5 copper deficit
Figure 5: Expected copper supply gap. Source: Visual Capitalist.

 

A sign of how important copper is comes from the fact that both Rio Tinto and BHP Billiton base their strategic exploration on copper. In 2015, Rio Tinto spent 66% of its exploration budged on copper with 25 of 37 exploration targets being copper focused.

figure 6 rio tinto exploration
Figure 6: Rio Tinto’s exploration. Source: Rio Tinto.

 

A commodity that is already in a supply gap and is a great example of what can happen to copper, is zinc.

Zinc

Similarly to the above described commodities, zinc has reached its multi-year low in January 2016 with prices below $0.7 per pound. But, unlike copper, prices have quickly rebounded to the current $1.03 and the trend looks very positive.

figure 7 zinc prices
Figure 7: One year zinc prices. Source: Infomine.

 

The reasons for such strong performance are an increase in Chinese infrastructure spending, mine closures and a global increase in demand. With current zinc usage a few percentage points higher than production, we should expect even higher prices.

figure 8 zinc supply
Figure 8: Zinc supply and usage. Source: International Lead and Zinc Study Group.

 

Investing Opportunities

The lowest risk commodity investments are big miners with low debt levels and low costs.

Another option is to invest through ETFs that hold metal futures. Such an ETF equally spread in aluminum, copper and zinc is the DB Base Metals Powershares. Higher returns can be achieved by investing directly into specialized miners with low debt and low costs, giving a greater assurance of a profitable investment, however the risks also increase. 

Conclusion

Knowing how metal markets work, that near term supply gaps exist for several metals, and that prices are still close to multi-year lows minimizes risk and makes metals an attractive investment opportunity. But the main point of this article is that commodity metals are a protection against inflation since the metal supply is not flexible in the short term and fewer and fewer profitable mining operations are being discovered. With global central banks keeping interest rates very low, and increasing money supply, sooner or later inflation will kick in. Until that happens and metal prices rise, you can enjoy the high dividends miners are currently paying and have a well-diversified portfolio.

 

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This Commodity May Have Reached Its Bottom. Find Out What It Is In Today’s Article.


  • Fertilizer prices have been declining alongside food prices, but food prices are picking up.
  • Fundamentals give downside protection with some risk coming from short term earnings.
  • The long term outlook is positive with balanced markets and demand growth.

Introduction

In agriculture and horticulture, potash is the common term for nutrient forms of the element potassium (K). It is used globally for increasing agricultural yields and is an essential fertilizer.

From an investing perspective potash has been beaten down alongside other commodities but seems to be close to its bottom. This article is going to elaborate on an investing thesis for potash producers.

Current Situation

Two supply contracts, between the Belarusian Potash Corporation and two major Asian consumers, China and India, are very important for potash prices. At the end of June, India signed on to buy potash at $227 a ton which is the lowest price in the last decade and China signed on to buy at $217 a ton which is 30% less than last year. The low prices are not good news for potash producers, but those prices usually establish a global price floor. Other potash miners typically settle prices with India and China at the same levels.

The low prices are a result of current low food prices after a few years of favorable weather. This resulted in farmers putting-off increased fertilization and $50 billion spent in investments for increased potash production in the last ten years making supply 10% higher than current demand and bringing prices to multi-year lows.

figure 1 potash prices
Figure 1: Potash prices. Source: PotashCorp.

As potash prices are currently 50% of what they were a few years ago, potash stocks are also down more than 50%. However, if prices have bottomed an opportunity might be developing in this slump.

figure 2 potash price
Figure 2: Price movement of the Potash Corporation of Saskatchewan Inc. in the last 5 years. Source: Bloomberg.

Any improvements in the potash market would quickly give a boost to stocks of all potash producers.

figure 3 global potash producers
Figure 3: Global potash producers. Source: K+S.

Before we look at the fundamentals of individual companies, we are going to elaborate on the short- and long-term market outlook.

Market Sentiment

PotashCorp CEO Jochen Tilk stated in his Goldman Sachs basic materials conference this May that potash prices have bottomed and gave a cautious but optimistic view for the future. The basic drivers for potash prices are not contract negotiations, but rather the weather and planting, thus in the short term we can expect potash prices to be correlated to food prices.

figure 4 food prices
Figure 4: FAO food price index. Source: Food and Agriculture Organization of the United Nations.

Several agricultural commodities, such as sugar, soybeans, and coffee have seen significant increases in price this year after prolonged multi-year declines. This indicates that the bottom is likely in or near for most food based commodities. We therefore believe that fertilizer prices have also likely reached their bottom. As food prices increase, applying fertilizers becomes more attractive to farmers and demand increases.

Long Term Outlook

Food price correlations are also the main factor in long term potash prices forecasts. As the global population is expected to be around 10 billion in 2050, arable land is constantly decreasing while global calorie consumption is rising. Therefore, demand for both food and fertilizer should continually increase.

figure 4 arable land
Figure 5: Less land, more demand for food. Source: K+S.

On the supply side there is current overproduction, but as potash is a pure cyclical play, with a turnaround in food prices—also cyclical,—a change in the current oversupply might soon be possible.

By 2020 PotashCorp expects supply and demand to level out as demand is expected to grow in line with demand for food at a few percentage points per year. The current weak demand is expected to normalize with higher food prices, lower inventories and some mine closures.

figure 6 outlook
Figure 6: Potash outlook to 2020. Source: PotashCorp.

In a stable market environment, potash prices could pick up a bit which would be enough to significantly increase profits for producers, as most of them are profitable even with the current low prices and oversupply.

Fundamentals

For a fundamental analysis of the Potash market we are going to use data from the Potash Corporation of Saskatchewan Inc. (NYSE: POT), Mosaic (NYSE: MOS) and Agrium (NYSE: AGU), which are more U.S. oriented.

 PE RatioPrice to BookDebt to EquityGross MarginOperating MarginDividend Yield
POT14.81.70.4531.50%26%7.30%
MOS10.410.3818.20%13.30%3.40%
AGU13.72.20.7326.30%11.20%3.70%
AVERAGE12.971.630.520.250.170.05
Table 1: Potash Fundamentals. Source: Morningstar.

If we are truly at the bottom of the potash cycle, then the above fundamentals actually look very intriguing. With an average trailing PE ratio of 13, potash producers are almost 50% cheaper than the S&P 500. The same holds for their book values and dividend yields, with an exceptionally high dividend yield from POT. It’s exceptionally high because the payout ratio is 120%. In order to sustain the payout ratio POT is taking on debt, however, management is confident that a bottom is in place.

Risks

The main risk is that potash prices further deteriorate, although this risk is minimal as the price floor has been set with the Asian contracts. A further decline in potash prices could be caused by benevolent weather conditions, crop yields remaining high without the need for fertilizer, or low food prices which don’t make it economical to use fertilizer. Seeing that food prices are increasing, this negative scenario seems unlikely, but investors need to be prepared for it. Another thing to be aware of is that none of the companies identified above are pure potash producers, so proper due diligence and specific risks should be assessed before investing.

The second risk may come from the upcoming earnings declines. As the current contracts are 30% lower than last year we can expect lower earnings for 2016. This could put pressure on stock prices even if it seems that the bottom in potash prices has been reached. However, the market may have already discounted any further decline in earnings. More aggressive investors could establish positions now, and more conservative investors could follow the earnings reports  and if bad, with stock prices falling further, buy cheaper.

Conclusion

The potential rewards may outweigh any further downside risk since we have good companies with low PE ratios and high dividend yields, that are still profitable even at these low potash prices. They also have good supply chains in place and low cost production that creates an advantage in the market.

Investors should also remember that a drought in the U.S., or El Nino waking up and destabilizing global food production, would quickly increase food prices as well as the affordability of fertilizers, causing potash prices to rise.

An investment in potash looks like one with limited downside and huge upside potential with a nice dividend yield while you wait, which is something to think about during these long Summer days.

 

Disclaimer: Sven Carlin, the article’s author, is long K+S, AGU and The Mosaic Company, and may initiate a new position in any of the above mentioned companies in the next 72 hours.

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Aluminum: A Leveraged Investment Into the Global Economy


  • If the economy continues on its growth path, aluminum will enter into a supply gap.
  • After 5 years of losses, investors should be in for a treat.
  • The risks and potential rewards of investing in aluminum will be explained in this article.

Introduction

Aluminum is the third most abundant metal in the Earth’s crust and accounts for 8% of its mass. The mineral it is most commonly mined from is bauxite. The most widely known uses of aluminum are aircraft bodies and aluminum foil, but it has a multitude of other uses like window frames, beer cans etc.

Aluminum is a great element to watch in order to better understand the global economy as the supply is unlimited and its price depends purely on demand and production costs. Like any other metal, aluminum is cyclical and this article is going to shed some light on where we are in the cycle now, what the risks are, and introduce you to a few investing opportunities.

figure 1 consumption1
Figure 1: Aluminum consumption by industry (kt). Source: All About Aluminum.

Aluminum Price

The current aluminum price is below its historical average as prices fell along with all other commodities. The current price is $1,591 per metric ton.

figure 2 aluminum
Figure 2: Historical aluminum prices. Source: InfoMine.

From a price perspective, the above figure shows that aluminum is close to the bottom of its cycle. Prices are at the same level where they were in 1990 which is strange because inflation has lowered the value of the dollar by 83% since then and aluminum is a commodity and should therefore protect investors from inflation.

Supply and Demand

Supply and demand has been pretty balanced in the last decade with a slight tendency toward higher consumption which creates a market deficit.

figure 3 supply and demand
Figure 3: Aluminum supply and demand. Source: All About Aluminum.

Aluminum is expected to remain in a market deficit as global consumption is expected to grow by a rate of 4% per year. In total, aluminum consumption is expected to increase by almost 50% by 2025 due to rising utilization intensity and more diverse end-use applications. For example, car manufacturers are expected to use more aluminum because of it lightness.

figure 4 car usage
Figure 4: Use of aluminum per car. Source: Alcoa.

Ford (NYSE: F) uses an all-aluminum body for its F-150 pickup and we can only imagine where aluminum will be if all car manufacturers switch to aluminum. With more electric cars and their range issues, weight becomes more important and aluminum fits perfectly into that scenario.

In addition to cars, another example of why aluminum will be a wanted metal is that consumption in India is at 2kg per person while the global average is 20kg per person.

figure 5 consumption per person
Figure 5: Aluminum consumption per person. Source: Aluminium Association of India.

As for supply, the availability is not the issue as there is plenty of aluminum, but production costs are an issue. In such a competitive environment, scalability is important as high investments are necessary to develop feasible mining projects.

figure 6 aluminum prouducers
Figure 6: Major global aluminum producers. Source: Rusal.

In an environment where a few players dominate, production costs are essential for profitably producing aluminum. The current aluminum price is below the 4th quartile producers which means that 25% of global aluminum producers produce at a loss.

figure 7 cost curve
Figure 7: Aluminum production cost curve. Source: Rusal.

Currently, the reason for the low aluminum price is high inventory levels. As a quarter of producers are not profitable, this should bring a longer term market deficit.

figure 8 aluminum supply and demand forecast
Figure 8: Aluminum global supply and demand balance forecast. Source: Rusal.

If the above presented forecast realizes itself, aluminum investors will be in for a bullish ride.

The main risks are that aluminum demand will not grow as fast as expected and that the new developing projects will create a market oversupply. As transportation is the main demand growth factor for aluminum, any recession that would impact cyclical car sales would also have a negative impact on aluminum demand and consequently, prices.

figure 9 transportation
Figure 9: Aluminum demand in transportation in million metric tons. Source: Rusal.

Due to the high necessary investments to set up aluminum production it is difficult to be flexible and avoid huge losses if the price of aluminum falls.

Investment Opportunities

For those who are convinced that aluminum is the metal of the 21st century, there a lot of investment options. There are several different ETFs which have the word aluminum in their names, but that does not mean much as they consist of various assets. Only two ETFs are pure aluminum plays but they are very small and are at risk of being liquidated due to their low trading volume.

For aluminum exposure, a good ETF is the PowerShares DB Base Metals Fund which has equal exposure (33%) to aluminum, copper and zinc, and is based on the metals’ future contract prices. But as all of the three metals are expected to go into a supply deficit in the next few years, this ETF might be the best exposure to basic metals that an investor can get. You can read more about zinc here, and about copper here. The performance of the ETF has been terrible in the last 5 years which gives a great opportunity for a rebound.

figure 10 performance
Figure 10: PowerShares DB Base Metals Fund performance. Source: Yahoo Finance.

Another method for aluminum exposure would be to invest directly into pure aluminum producers like Rusal, Aluminum Corporation of China (NYSE: ACH) or Alcoa (NYSE: AA) but those investments necessitate a thorough analysis, not only of the systemic risks for aluminum, but also the specific company risks. A more diversified metal play that gets 31% of its revenues from aluminum is Rio Tinto (NYSE: RIO).

Conclusion

In short, it can be said that aluminum is a bet on transportation. This is not such a bad bet given that everything needs to be lighter to lower CO2 emissions or to save on energy consumption, and the developed world car number per capita still has plenty of room to grow.

The current car of the future, Tesla (Nasdaq: TSLA), is made mostly of aluminum, but the metal is still expensive in relation to steel for mass car production. On the flip side, it gives downside protection for aluminum as at lower prices, car manufacturers would make the switch to aluminum much faster.

As aluminum is such a base metal, the risks are related to the global economy. Lower demand for cars would really affect global demand and quickly erode the future expected supply gap. Therefore, aluminum is a metal that should be watched as it is essential for the world as we know it and portfolio exposure can be increased when the metal is cheaper and decreased when more expensive.

 

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BREXIT Aftermath: Where to Look for Returns & What to Avoid Now


  • The U.S. and Europe are overvalued, especially seeing the current political situation and economic fragility.
  • What’s about to hit Europe and the U.S. already hit emerging markets in 2015. There are opportunities in emerging markets now, but where?
  • Bonds seem the riskiest asset of all with no yield and huge potential downside.

Introduction

After last week’s BREXIT vote the markets have been in a free fall with a slight recovery yesterday. But savvy investors have been expecting this and it has been a recurring theme at Investiv Daily that stocks are overvalued. In such an overvalued environment it is normal that inflated asset prices take a beating at any sign of future uncertainty.

As one’s misfortune is another’s fortune, this article is going to elaborate on what to look for and what to avoid in order to limit risks and maximize returns.

The U.S. Stock Market

The U.S. stock market is fully valued and therefore the decline should not have come as a surprise. The S&P 500 has been moving sideways for the last year and a half and many are expecting a recession. In such an environment the risks are high and the potential returns very low.

figure 1 pe earnings
Figure 1: S&P 500 PE ratio and earnings. Source: Multpl.

With a PE ratio of 24 and declining earnings, the only way for investors to realize capital gains by investing in the S&P 500 would be through the formation of an asset bubble. With the current political turmoil, slower U.S. productivity, lower employment participation and strong dollar, this seems like a very unlikely scenario.

On the other hand, those factors might start a recession that could easily lower the S&P 500 to the average historical PE ratio of 15 which would cause a 1,300 point, or 35% drop. Therefore, the conclusion is that the S&P 500 carries a lot of risks with limited upside.

Emerging Markets

Emerging markets were the thing to avoid in 2015, but they still possess long term factors that should make them the long term investment winners, especially if bought at these depressed prices. Let us focus on Brazil as an example.

Brazil was hit by various corruption scandals and by the deepest recession in the last two decades. But, Brazil is still a young country rich in natural resources and on the road to becoming part of the developed world, minor setbacks are normal and should be used as an investment opportunity.

figure 2 brazil GDP
Figure 2: Brazil’s GDP in billions of US dollars. Source: Trading Economics.

Brazil’s GDP grew from $1,107 billion to $2,346 billion in ten years which still represents a yearly average growth of 7.7%. As the market has already factored in the chance of a Brazil bankruptcy, the risks and rewards of investing there are opposite from what they are in the U.S., as there is no risk of a U.S. bankruptcy.

Brazil’s current CAPE (Cyclically adjusted 10 year average price earnings ratio) is currently 3 times undervalued at 8.2, while the S&P 500 has a CAPE ratio of 24.6. The undervaluation is probably the reason why Brazilian stocks have behaved very well in the last few days. The Brazilian stock index is still in positive territory for the month and year to date. On top of the relative stability, U.S. investors could also gain from currency benefits as the oversold real is slowly returning to its real exchange value toward the dollar.

figure 3 usd brl
Figure 3: USD vs BRL in the last year. Source: XE.

To conclude, Brazil represents a young, resource rich country where it seems that all that could go wrong did go wrong last year. More positive news than negative news should now be expected. On top of that, it is one of the most undervalued markets in the world.

Europe

The situation in Europe is similar if not worse than the one in the U.S. To put it simply, the markets are in an asset bubble as the European Central Bank has been issuing huge amounts of liquidity with the hope of faster economic growth and some inflation. It succeeded for a while but the BREXIT issue will for sure have a negative impact on current economic growth when coupled with the overvalued markets, the risks outweigh the rewards.

The average PE ratio in Italy is 31.5, Netherlands 28.5, United Kingdom 35.4 and Germany 19. There is also the euro issue where any political turmoil could weaken the euro and lower investment returns for U.S. investors.

Europe should be avoided until asset prices reflect the real state of the economy and the political situation, thus far below current prices, at least 50%.

Gold and Bonds

It is uncommon to put gold and bonds in the same basket but as they both have practically no yield with negative interest rates on the most secure government bonds, it seems the right choice.

Gold is currently at its year high as investors look for safety. The problem with gold is that it has no yield and most investors come too late to the party as gold primarily appreciates at maximum turmoil as it has done in the past few days.

figure 4 gold prices
Figure 4: Gold prices in the last year. Source: Bloomberg.

If political turmoil persists and inflation arrives due to the high liquidity, gold might be the winner, but any signs of stabilization would negatively affect gold. It can be concluded that gold represents a good hedge and could be a part of a well-diversified portfolio. Investors that seek a riskier investment than gold itself could go for gold mining stocks that offer a dividend yield and potential growth, though gold mining stocks also come with much more volatility.

As for government bonds, the risks seem to outweigh the rewards. Yes, it is possible to make capital gains if interest rates further decline, but this defies logic as there is no point in holding negative yielding bonds. On the other hand, if yields increase bonds could fall tremendously as a 100% increase in bond yields should consequently lower bond prices by 50%. Therefore, the current situation with bonds isn’t what’s typically assumed about bonds—low risk with high rewards—as right now they are high risk with low rewards.

Conclusion

At this point, after a 7-year bull market and high liquidity provided by central banks, investors should be wary of being overweight in the same things that were good 7 years ago. Many analysts have forgotten how to analyze risk as we have not seen a bear market since 2009, but this is exactly the time when one should look at risks before rewards. High asset prices and low yields mean that investors do not see much risk and are willing to pay hefty prices, but this is exactly the kind of situation that can bring lots of investment pains.

Any signs of recession, the continuation of the decline in corporate earnings, and a shift from the current investor’s perception that central banks are still able to save the markets with additional intervention, could easily send the stock market down by 30%. Assess your risks, estimate the rewards, and position your portfolio accordingly.

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How to Prepare Your Portfolio For The Next Recession or Stock Market Crash


  • The risks of a slowdown are higher than the upside.
  • Fundamental trends are negative in advanced economies while emerging markets show higher growth rates and are cheaper.
  • It is important to create a diversified portfolio with uncorrelated assets.

Introduction

In an environment where it seems maximum potential for the U.S. economy has been reached, the St. Louis FED chief, James Bullard, has said in his most recent report that he favors only one interest rate increase through 2018, which would at best keep things stable. His view is further supported by the fact that the unemployment rate is sitting at below 5%, and the Personal Consumption Expenditures PCE inflation—measured by the Dallas FED—is at 1.84%, both of which signal that the economy has reached its maximum potential.

1 figure trimmed inflation
Figure 1: Trimmed mean PCE inflation. Source: FRED.

The scary part of the report is where Mr. Bullard describes how forecasts are made based on the current situation, which will most definitely change. What is difficult to predict is the direction of the change therefore, forecasts are bound to be incorrect and under the influence of various risks like a return to the normal Phillips curve influence where low unemployment triggers inflation, or a recession even if no current data indicates the possibility of one. Thus only an extremely positive scenario would trigger interest rate increases if fundamentals like inflation or productivity stay stable.

2 figure fed stlouis
Figure 2: St. Louis FED’s U.S. macroeconomic outlook. Source: St. Louis FED.

The conclusion is that practically anything can happen, and the FED has absolutely no idea as to where the economy will be in a year or two. Even FED Chairwoman Yellen admits that the 2013 expected interest rates of 4% for 2016 were too high and that an aging society and a slump in productivity growth will keep the subdued economic indicators persistent.

In such an uncertain environment, an investor should look at the best ways to protect his downside and maximize his upside.

Investment Ideas

Let us start with bonds where interest rates have been declining since the start of this century.

Bonds

3 figure bonds
Figure 3: 10-year government bonds yields. Source: Wall Street Journal.

As bond prices are inverse to bond yields, any increase in yields would precipitate bond prices, thus bonds are currently low yield and high risk. Usually considered safe havens in recession times, bonds currently do not provide such protection as it is better to keep cash than bonds with negative interest rates. There is the option of further bond price increases, but that is a highly unlikely scenario as bond yields are at historical lows.

The Stock Market

The S&P 500 is still holding well, but does not manage to break the previous highs despite having come close several times.

4 figure s&P 500
Figure 4: S&P 500 in the last 12 months. Source: Bloomberg.

The S&P 500 dividend yield is 2.12% which might look tempting when compared to the extremely low bond yields, but it is meagre when compared to the historical mean of 4.39%. A return to the mean would result in a drop of 50% or more of the S&P 500 index. The conclusion here is the same as with bonds: High risk, low returns.

But there is an option with stocks that should limit the downside. Dividend stocks that will not see their cash flows affected by a slowing down in the economy are always assets toward which investors run when trouble comes. Examples can be found in telecommunication, consumer staples and healthcare.

Emerging Markets

If the reason for economic stagnation in the developed world is an aging society, slow productivity growth and emerging markets competition, a contrarian thesis would be to invest into emerging markets.

Emerging markets have a relatively young population and are currently shunned by investors as too risky amidst a commodity price slump. But no matter the current issues, the World Bank expects emerging markets and developing economies to grow at rates north of 4% in the long term, while advanced economies are expected to grow below 2%.

Currently, advanced economies are preferred by investors as they regard them as secure, but long term structural trends are strong in place even if we do not choose to see them. What China has done in the last 15 years could be the same as India is about to do. Brazil will probably also return to growth someday.

The following figure will show that the current developed world impression of asset security is mostly funded by debt which is unsustainable in the long term.

figure 5 investment position
Figure 5: U.S. net international investment position. Source: Bureau of Economic Analysis.

On top of that, emerging markets are much cheaper than developed ones according to the Cyclically Adjusted Price Earnings (CAPE) ratio which takes into account earnings from the past 10 years.

figure 6 global cape
Figure 6: Global CAPE map. Source: Star Capital.

For long term investors, the less risky option might be to dig for good investments in emerging markets with positive demographics and a strong growth outlook. Currently those investments are out of favor, but this is exactly the environment where investments give the best returns.

Gold

Gold is a doomsday investment, it protects you against inflation and is the metal that surges in difficult times. Typically as the economy does well, stocks grow and gold declines because gold has no yield. The opposite happens in turmoil.

7 figure guardian precious metals
Figure 7: Gold and stocks cycle. Source: Guardian Precious Metals.

You can invest in gold by buying it physically, through ETFs or by buying gold miner stocks.

Conclusion

As always, good diversification should provide sufficient downside protection but a portfolio has to be diversified with uncorrelated assets.

If you have Ford in your portfolio and then you add some Caterpillar, that is not real diversification. Gold, emerging markets, cash, and quality stocks should enable a portfolio to weather economic hardships.

Don’t forget that after every recession comes a recovery, so be ready to increase your exposure to stocks when assets are cheap, even if everyone will be thinking that there is no tomorrow.

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Big Returns on Silver Could Be at the Finish Line, But Are You In for the Wild Ride?


  • Silver is both a precious metal and a commodity, which makes it a very interesting investment.
  • Silver prices jumped 26% year to date and the market has been in a deficit for 3 years.
  • In the long term, silver will continue to be very volatile but might present excellent investment opportunities for brave investors.

Introduction

Silver is a special metal as it is considered both a precious metal and an industrial commodity. Silver is used for solar panels, water filtration, jewelry, electrical contacts and conductors, LCD screens, x-rays, disinfectants and for other various applications. This makes silver have, unlike gold, a pragmatic use influencing the demand for the metal.

This article is going to provide an analysis of the current silver market, elaborate on the investment thesis for silver by assessing risks and rewards, and provide investment opportunities.

Silver has been battered alongside other commodities but what strikes is its volatility.

1 figure silver prce
Figure 1: Silver price per ounce. Source: SILVERPRICE.

Silver has much more accentuated spikes and busts than gold but they are positively correlated, so an investment in silver would resemble one in gold and add the benefit of a commodity.

2 figure gold
Figure 2: Gold price per ounce. Source: SILVERPRICE.

Supply and Demand

In 2015, silver demand hit a record high while mine production growth declined to its slowest pace in four years. This resulted in an annual physical deficit for silver of 129 million ounces, making it the third consecutive annual deficit. Even with the deficits, silver prices continued to fall up to December 2015 when silver reached a low of $13.7 per ounce because of expected higher interest rates in the US and slowing industrial demand in China.

As the situation in the US is not that good and demand from China did not fall as expected, silver has rebounded alongside other commodities to the current price of $17.25.

3 figure silver prices last 5 years
Figure 3: Silver price in the last 5 years. Source: Bloomberg.

It is interesting that as silver prices fall, demand for silver coins increases as coins are priced per ounce.

4 figure silver coin
Figure 4: Silver eagle coin as an investment. Source: APMEX.

Except for investment, silver demand has increased for jewelry and silverware bringing to a total increase in demand of 25% in the last 10 years.

5 figure silver supply and demand
Figure 5: World silver supply and demand. Source: World Silver Survey 2016.

Meanwhile the supply has increased only by 13.4% in the last 10 years. The fact that silver supply remained stable in the last decade, even with silver prices going above $40 per ounce, shows how small imbalances can make silver a very profitable investment, especially at these low prices.

Outlook

Silver has two purposes, it is a precious metal and therefore considered a store of value and protection from inflation. As inflation is something most of the millennials only heard about in school and the last years have been good for the markets, silver got the short end. But any turmoil in global markets or hint of inflation could spur the metal. The volatility of silver is further excited by paper silver trading as currently, according to the U.S. Commodity Futures Trading Commission, there are 64,790 short contracts and only 22,928 long contracts so more volatility can be expected if shorts have to cover or try to force the market down.

Increased demand from China and a weaker dollar influenced this year’s rebound and the question now is if this can be sustained. In the long term, the World Bank does not expect average silver prices to go much higher as industrial demand stabilizes and investment demand declines, but the forecast is opposite from what is really going on as more investment coins are bought with silver prices declining.

6 figure World bank outlook
Figure 6: World Bank long term outlook. Source: World Bank.

Long term downside risks to the forecast include stronger-than-expected monetary tightening and dollar strength. Upside risks include weaker global growth, financial stress in key economies, heightened geopolitical events, and stronger demand from consumers, central banks, and investors. As the Word Bank’s outlook is known to be the average, investors can expect both downside and upside risks that will make silver volatile in the long term.

Investments

One opportunity to invest in silver is through the iShares silver trust which follows the price movement of physical silver.

For more entrepreneurial investors, investing directly in silver stocks is a possibility but a limited one as silver is usually a byproduct from mining gold, zinc or copper. However, there are some potential investment that can be researched like Silver Wheaton Corp. (NYSE: SLW), Fresnillo Plc (FNLPF), Taho Resources (NYSE: TAHO), Coeur Mining (NYSE: CDE), First Majestic Silver Corp (NYSE: AG) and Pan American Silver Corporation (NASDAQ: PAAS).

Investing directly into mining stocks brings along other risks than just the above mentioned general risks related to silver, but can provide extra returns.

Conclusion

Silver gives two opportunities, one from being a precious metal and one from industrial demand. At current low prices, if you think the FED is not going to raise interest rates as the economy is not doing as well as it should, silver might be a very good investment.

It is impossible to know what will happen but we can be sure that silver will be volatile as short sellers will push prices down in a negative scenario and cover in a positive one. This makes silver a good diversification investment as it is uncorrelated to the general market or an investment for those who have the stomach to withstand large swings in prices.