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Stephen Leeb on the Key Importance of Oil and Energy
December 27, 2011 As we leave 2011 it should be clear to almost everyone that oil has regained its perch as the most significant commodity (not that it ever really lost it). Clearly, oil by a wide margin is the most widely traded commodity in the world -- and also by a wide margin, arguably the most important. But coming to the end of this year we find that despite the near record output by OPEC (some would characterize it as “maximum output” by OPEC), and slowing world-wide growth, oil prices are once again up to 3-digit levels. Oil and more generally energy have once again become critical issues. It seems very unlikely that our economy, even though there have been some signs of strengthening over the past month or so, is any position to survive a big upturn in oil prices. We’ve pointed out on many occasions that once the year-over-year change in the price of oil reaches 80% or more, the economy is under severe duress. Everything else being equal, this kind of analysis is based on oil and its use as a feedstock in so many materials and essentials of our economy. Probably nothing is more important in this respect as gasoline, and on this score it probably would not take an increase of 80% in oil prices to drive the economy into something of a tizzy. Indeed, with the recent closing of refineries on the East coast it is likely that, come this summer, gas is going to be considerably higher relative to oil prices than it has before. It’s even likely that $4 a gallon could end up being a bottom for gas prices rather than a top, and that would assume that oil is somewhere near where it is today. If oil continues to climb toward $130 or $140 a barrel, it’s not impossible to see $5 per gallon gasoline.
why aren’t they lowering interest rates? Why are they simply focusing on very targeted measures.2 More broadly. This obviously will further boost the consumer sector. But we think these numbers are dramatically understated. and make very dear commodities. Looking at how China uses various commodities. or any other form of energy. There are many implications. that economy appears to be growing at a reasonable rate. if China is in such trouble. If you look at the import data from China. is the lack of consumer spending to sustain an economy that is moving into a consumer economy. what stands out is that while commodities such as steel and cement find most of their uses in infrastructure and in . alternative energies. will have to be tried. just that – hopes.not only in the U.cheaper for China. The big rap against China. Beyond the evident shortage of oil the one we must stress is the fundamental question of how are we going to solve the energy problem. cheaper for Chinese consumers. such as oil. But in order to use renewable energies. you’ll see that imports there have risen dramatically in recent years. China no doubt ended the year on a soft note. so-called smart grids and many more power carrying cables are required -. Obviously. will make all commodities – and imports -. very big deal. recently hit a 17-year high)? A rising Yuan. of course. Furthermore. this in just one reason why energy remains a very. At best they may fill a very small portion of the gap. whether they involve non-conventional oil or renewable energies. Most of the pessimists cite that currently China only generates 35% of its economic activity from consumer spending. And hopes of nonconventional energy filling the gap are. incidentally. even quicker than the exports. including an increase in the value of the Yuan (which. It’s almost impossible to rationalize such an import data increase with anything as low as the 35% figure for the consumer sector of the China’s economy. to date. But despite slowdowns in manufacturing and the real estate sector. but across the world.S. besides the supposed overbuilding of infrastructure. This is a good point to segue to China for a moment.
There’s only so much of it in the world and. but throughout the world. even copper for that matter. . In any event. whether by Barrick or by a Chinese company. although we must admit that we might have to wait for 2013 to see it fulfilled.5 trillion investment over the next 5 years will probably be devoted to smart grids and other related energy projects. copper grades have been declining steadily. In this regard it’s interesting to note that despite the fact that many commodities have been relatively weak.3 construction of houses and commercial buildings. such as coal. is that copper is going to become regarded as a very scarce commodity. the need for copper is going to accelerate markedly not only in China. There’s a good reason for that: again we touch on the subject of smart grids. preparing for the next energy revolution in that country. and their mines and infrastructure in Africa virtually assure that any copper mined in those locations. China has already begun this massive undertaking. one commodity stands apart. One of the predictions we would make for 2012. and without using massive amounts of copper. which is part of the whole process of extending electricity throughout China – and perhaps more important. other commodities. at least in terms of price have held their own very well. It’s the one commodity in China for which energy-related usages are by far the largest share of total usages: copper. And all this is taking place in the context where most of the world remains stuck in a grid that just will not serve it in the 21st century. China clearly has the edge on us: their mines in Afghanistan. as most people know. There’s no way that you’re going to have an economy that’s running on a wide mixture of different energy sources without having a smart grid. Indeed a big chunk of their proposed $2. Nearly 40% of the copper China uses goes directly to the power sector. China is an exception. is going to find its way to China. but even China still has a long way to go in terms of grid development. in that it has already begun to create its grid.
if a scarcity that is so overt and so potentially serious in terms of rare earths has not moved our Congress to consider strategic stockpiles of those metals. but it’s controlled by a Mexican conglomerate whose decisions sometimes appear to favor the controlling group rather . which we think also includes copper. and probably the highest weighted metal. We can remind you that less than 15 years ago oil still traded in single digits. are rising. (SCCO). The line between sufficient copper and severe copper scarcity could be a very thin one indeed – and we fear it’s likely by the time we wake up to this situation. Southern Copper is a different story.4 Where could copper go in terms of its ultimate price? We can’t say. accessibility and ore grade decline and costs to mine. one percent growth today takes a lot more copper than one percent growth took oil 50 years ago. by most metrics it may actually be cheaper than Freeport. and the amount of growth you can get is a lot stronger. That is not a projection that copper could go to $100. which means ever declining margins. Our two favorites: Freeport-McMoRan Copper & Gold (FCX). for example. Clearly. has started to stockpile strategic metals – rare earths and others. even if growth is not accelerating as fast. etc. is that any portfolio has to include the hard metals as well as the miners. but bear in mind that in today’s world things are a lot faster. But in the case of copper we think there are at least several miners who are extremely well positioned. Clearly one lesson of 2011. and to the fact that China’s efforts to secure massive copper supplies (or as much copper as they can possibly acquire). We prefer Freeport because it has demonstrated that its goal is to serve shareholders – all its shareholders. Look at how Germany. transport and deliver product. One percent growth today takes a lot more copper than one percent growth took 50 years ago. which. and a scary one. along with Southern Copper Corp. it’s going to take a lot – and likely. as miners become harder pressed to increase production. are the two largest dedicated copper producers in the world.S. We begin our non-precious metal commodity portfolio with copper at its core. it might even be too late for the U. happen too late – for us to consider building such stockpiles of copper. You don’t have to take my word for it.
Yet the company is simply too tasty to pass up in terms of its fundamentals and captive market. so you could say that however much gold there is now. such as silver. We don’t necessarily believe this is going to be the case. By virtue of its geographic location in Kazakhstan it has dedicated supply routes to China. (ABX) which has announced plans to continue to acquire copper assets. trading below book value. Their large purchase earlier in the year in Africa should pay big dividends for them. which is clearly ending the year on an extremely sour note. with Freeport). We continue to view the action in gold as very much like that of a rubber band. with a P/E in mid-single digits (which is also the case. too. is a very scarce commodity. what’s to stop China from executing a “take under” (in deal parlance. But its industrial uses are not primary. for example. again with China a captive audience. The other company we would single out is Rio Tinto PLC (RIO). and also when he bought a copper mine at a time when copper was widely perceived as having far inferior long-term valuation metrics compared with gold. a move that was subsequently rewarded. Among larger companies that have stakes in copper. a situation where a company is sold at less than its market value). That’s why we’re sticking with Freeport as our core holding in this area. Gold. We particularly appreciate the courage its CEO showed on two occasions: when he removed the hedges on gold upon assuming his position at the company. as. But that’s not the case with copper. The stock is dirt cheap. incidentally. Why we would favor Rio over BHP Billiton Ltd (BHP) is because it mines more copper as a percentage of its total operations than BHP. Kazakhmys Plc (KAZ LN). we can live with.) Finally a few words on gold. Gold’s . and it also appears to have a larger stake in some of the precious metals. A smaller holding is the stock of a Kazakhstan’s largest copper producer. we would focus on Barrick Gold Corp. This is obviously a more speculative play.5 than the shareholders at large. and also supplies power. (Silver as we have written before is also very scarce and likely to become even more so.
It’s sort of last resort liquidity. As to whether the Fed will engage in a QE3: yes.S. Ironically. as in 2008. gold’s weakness will be more a sign of the need for QE3 than the end of a bull market in gold. the price could go as low as $1. if the correction in gold is comparable to what we saw in 2008. As far as gold goes. to prove merely ephemeral. This will not reflect a better world (unfortunately). . we still view that as extremely likely. once the printing presses start running again gold’s uptrend is likely to be chaotically strong. this last quarter of 2011 and perhaps the first quarter of 2012 or so will just be a small bump along a spectacular and very steep upward road. As we have pointed out before. Gold may continue to be weak into the New Year. not only because of the weakness in Europe.340. but a world desperate for liquidity.330 – 1. And need we remind you. but also because we expect the recent signs of strength in the U. our message to our subscribers is that you may have to gut it out a while longer.6 weakness now is simply a reflection of how strong it has been. especially for German and other European banks which have had a lot of trouble getting dollars. but in the end.