# Rocket science and disconnections



## rederob (19 January 2008)

1.	The US is in the grips of recession.
2.	The greenback is in freefall.
3.	Consumer confidence in Japan is an oxymoron.
4.	Eurozone countries are battening down the hatches.
5.	The allords is in tatters.
6.	Precious metals are at cyclical record highs.
7.	Hard and soft commodities remain in a bull trend.
8.	Emerging economies are not bleeding. 

The obvious disconnect is between received commodity prices and equities that produce them.
BHP’s price collapse during the week was a classic disconnection.  Its 10% price fall was met with little or no change to the prices it receives for its products.
Oxiana is a little easier to work out because it has a more limited product mix; base metals and gold.  True, gold prices came off the boil.  But its principal product, copper, rose during the week: And copper fundamentals remain at the best in many months.  Oxiania’s Golden Grove is predominantly a zinc mine, and while there might be a perception that zinc is poorly priced (relatively speaking), the  reality is that when OXR was trading around $4 the price of zinc was about the same as it is today.
Yet the kicker for OXR is that Golden Grove’s zinc costs are expressed against by-product credits – namely copper, gold, silver and lead – all of which remain strongly priced in today’s terms and look like holding up reasonably well in the short term at least.

Against this backdrop is USD weakness, and the fact that commodities are priced in USD terms.  Although this diminishes the profitability of our producers, another reality is that our dollar rallied strongly well before the allords went into freefall, suggesting our producers remain likely to report very good results for the December quarter, while still traveling well in the early stages of this quarter.

I am not suggesting you go out and buy our cashed up, low cost commodity producers next week, or even next month.  I think it is silly to think the present market carnage is near an end when it has really just begun.  So I expect bargains will “appear” every week, for some time.  Liken these bargains (for now) to buying a laptop computer: Great value and great price, but you could have got it cheaper had you held off a little longer.

My strategy is to wait for price/earnings multiples to go through the floor, then eke a little into the stronger commodities equities.  I don’t anticipate I will be buying at the lowest point of the market, but I also don’t expect our market will be in the doldrums for as long as many might think.  So long as I get back on board relatively cheaply, I will be satisfied.


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## 2020hindsight (19 January 2008)

rob - 
great post - but you are assuming that there is any logic in it - 
all the iron ore boys should be holding better you'd think  (well I thought lol - when I bought em - and rode it all the way down)

I think I'm a couple of years older and wiser than I was a month ago ...

lesson (for me anyway) :-   forget the present and future potential of the company's operations - the value of a share is what someone is prepared to pay (end of story)


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## So_Cynical (19 January 2008)

2020hindsight said:


> lesson (for me anyway) :-   forget the present and future potential of the company's operations - the value of a share is what someone is prepared to pay (end of story)




True and thats always the case...the 90% of holders in XYZ arnt the ones selling it down...its the holders 
that "have" to sell for whatever reason.

Our Market fundamentals remain strong....and come next quarter reporting that strength will be 
reflected in the SP's of many stocks.


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## ithatheekret (19 January 2008)

Very good post , I think P/Es are worthless gauges at present , value , quality and turnover are the only viewings .

I noted you mention Oxiana , I like them they have a hoard of cash and a nice bit of dirt . I find it funny that a cashed up predator like ZFX , could now be the meal , with a falling share price and negative markets , it's a prime take the money we offer you prospect , slight premium to market .

We have to remain cautious if we are venturing into small markets like commodities , there's not enough for everyone if you know what I mean , and sometimes you have to take what's offered . As long as your okay with this , go for it , but remember volatility and BS data can stuff your day/ week/ month up . Fortunately it can be judged on shopping ventures and the like , the rest is all market and seasonal factors .

I disagree with the point about emerging economies are not bleeding , only by way of noting it is the consumer that is suffering from the boom whilst traders trade it .


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## rederob (19 January 2008)

So_Cynical said:


> Our Market fundamentals remain strong....and come next quarter reporting that strength will be reflected in the SP's of many stocks.



Presently only zinc and aluminium are "weak".
Which means that irrespective of equity prices, the producers are making good money while the market plummets.  Even Zinifex is doing very well, despite its share price.  
Perilya is even better value for money and it will be my first market re-entry if it falls to $1.30 - which is my target price.  That will return a f/f dividend of about 6% which isn't bad for a company yet to hit its straps.


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## bvbfan (21 January 2008)

Funny now that OXR has a higher market cap than ZFX


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## rederob (23 January 2008)

ithatheekret said:


> I disagree with the point about emerging economies are not bleeding , only by way of noting it is the consumer that is suffering from the boom whilst traders trade it .



I'm not suggesting hey are not being impacted.
I am, however, of the view that their growth rates will be nowhere near as constrained as other economies.

Today's important disconnection was of gold equities and gold prices.  For example, if LGL's 13% decline was equally matched by POG, then right now POG would be at $750 rather than the $860 which it is presently.  EQI fell by 22%, which would have put gold back to the $600 range!

By the way, I wound down my price target on PEM to an even dollar.
I also have a dollar bid on Beach petroleum shares.
Which exposes me to the exorbitant sum of $10k in total if both orders are filled.

My trading strategy proper is to review the situation more closely when the allords fills gaps from exactly 2 years ago - around the 4700 mark - and re-enter strongly when the allords approaches 3900 (trigger point is below 4200).
In the interim, I will bid selectively on oil, gold and the odd base metal equity:  I have MRE and SMY in my sights given the short term fundamental improvement for nickel, and the very strong cashflows these companies continue to generate despite their falling share prices.


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## michael_selway (23 January 2008)

rederob said:


> I'm not suggesting hey are not being impacted.
> I am, however, of the view that their growth rates will be nowhere near as constrained as other economies.
> 
> Today's important disconnection was of gold equities and gold prices.  For example, if LGL's 13% decline was equally matched by POG, then right now POG would be at $750 rather than the $860 which it is presently.  EQI fell by 22%, which would have put gold back to the $600 range!
> ...




Yep PEM & MRE look good

*Earnings and Dividends Forecast (cents per share) 
2007 2008 2009 2010 
EPS 43.1 51.2 46.0 71.1 
DPS 11.0 8.2 10.1 11.8 *

*Earnings and Dividends Forecast (cents per share) 
2006 2007 2008 2009 
EPS 72.5 59.9 60.4 52.6 
DPS 57.5 35.0 28.3 30.8 *

thx

MS


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## rederob (23 January 2008)

2020hindsight said:


> lesson (for me anyway) :-   forget the present and future potential of the company's operations - the value of a share is what someone is prepared to pay (end of story)



Yes, but markets have a time frame.
Over time, markets mostly rise, and less occasionally fall.
When they do fall, they fall quickly; more quickly on average than they rise.
Falls "return value".
My stated strategy is to wait for the allords to fall considerably further, which I am reasonably confident will happen, as the US has a lot further to fall and we will get sucked down with it.
My postulation, and the reason I began this thread, is that there are market disconnections that both short and long term present qualified buying opportunities.
Inevitably, those equities that continue to earn strongly - and many Australian commodity producers are in this camp - will also rebound strongly.
There is also a smaller group that are cashed up and not leveraged to the US quagmire that may not yet be in favour, but will weather this storm and be well positioned for the next commodity bull.

Oil is the key?
Oil is a many pronged thorn at the foot of the US economy.  Oil import costs are going to continue to cruel the US deficit. And high oil prices are going to strain transport profitability, and increase manufacturing costs, thereby exacerbating the price differential between US made and Asian made products.  The US car industry was going to hell in a hand basket before the subprime crisis, and will now be decimated.
Despite the market turmoil of recent weeks, oil prices are still in the high eighty dollar range and showing very few signs of weakness. This suggests to me that the US is somewhat important to oil prices, but is no longer in the driver's seat.  What's more, it appears the market knows this now and will continue to bid up oil on any price weakness.
My suspicion is that there are 2 vital factors in play with oil.  First, irrespective of any spin from oil industry apologists, supply is at near capacity and there is minimal slack in the system. Secondly, OPEC have done their sums: They know there is little to be gained from spending trillions on ramping output to get lower received prices, when they can simply spend billions on improving efficiency (and producing much the same) while receiving higher prices.  Moreover, they fully realise the less they produce, they more they will receive, for longer!  Rocket science?


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## dhukka (23 January 2008)

Rederob,

I disagree there is a disconnect. I think equity prices are beginning to price in the pullback in commodity prices which will be inevitable in a global demand slowdown.  I think you can already see the pullbacks in commodty prices, a few of which are attached below. Also Australian mining profits have been declining for several quarters. 

That said I believe the commodity bull cycle has a long way to go but we are going to see a pullback in the medium term as global growth slows and deflation takes it toll across all asset classes.


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## rederob (23 January 2008)

dhukka said:


> Rederob,
> 
> I disagree there is a disconnect. I think equity prices are beginning to price in the pullback in commodity prices which will be inevitable in a global demand slowdown.  I think you can already see the pullbacks in commodty prices, a few of which are attached below. Also Australian mining profits have been declining for several quarters.



dhukka
My case is principally that there is a disconnection between the extent that commodity price declines are matched by equity price declines.  And that the equities will, therefore, represent greater value buying opportunities as a result.
There are sub-themes to the points you make that count equally to my argument.  For example, one of the greatest contributors to oz equities declining in profitability was a strengthening of the AUD in the second half of 2007.  Although that trend has not reversed to any meaningful extent, a more stable AUD means this factor will have less impact in the second half of this financial year.   
Perhaps more importantly, none of us are much the wiser about "fundamental supply and demand imbalances" as the base metals market has remained very tight for the past few years.  I say "importantly" because producers have been ramping up output for years and 2007 was supposed to be a watershed - the year that inventories would build substantially and metals prices fall back markedly as a result.
An important question needing answering is why, in the few charts you have posted, is there not a massive price crisis that matches global economic meltdown of recent weeks.  Copper, the "industrial" metal, remains more expensive than it was several months ago.  It should, instead, be the litmus test for industrial "recession".  More intriguingly, Comex copper inventories at US warehouse sites continue to deplete, albeit at small quantities.  Given the collapse in US housing it is hard to fathom this! Which is why I am reasonably confident that when the US gets back on an even keel, metals prices will go through the roof: 5 average US homes consume one tonne of copper during construction.


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## dhukka (24 January 2008)

rederob said:


> dhukka
> My case is principally that there is a disconnection between the extent that commodity price declines are matched by equity price declines.  And that the equities will, therefore, represent greater value buying opportunities as a result.
> There are sub-themes to the points you make that count equally to my argument.  For example, one of the greatest contributors to oz equities declining in profitability was a strengthening of the AUD in the second half of 2007.  Although that trend has not reversed to any meaningful extent, a more stable AUD means this factor will have less impact in the second half of this financial year.
> Perhaps more importantly, none of us are much the wiser about "fundamental supply and demand imbalances" as the base metals market has remained very tight for the past few years.  I say "importantly" because producers have been ramping up output for years and 2007 was supposed to be a watershed - the year that inventories would build substantially and metals prices fall back markedly as a result.
> An important question needing answering is why, in the few charts you have posted, is there not a massive price crisis that matches global economic meltdown of recent weeks.  Copper, the "industrial" metal, remains more expensive than it was several months ago.  It should, instead, be the litmus test for industrial "recession".  More intriguingly, Comex copper inventories at US warehouse sites continue to deplete, albeit at small quantities.  Given the collapse in US housing it is hard to fathom this! Which is why I am reasonably confident that when the US gets back on an even keel, metals prices will go through the roof: 5 average US homes consume one tonne of copper during construction.





Rederob, 

You make some good points and raise some interesting questions. I don't have an answer to why there hasn't been a capitulation in commodity prices in recent weeks.  Could it be that the markets are clinging to the idea that BRIC demand will put a floor under prices? 

How much of the price in copper, for example, is demand driven as opposed to speculation? When you ask that question about oil you can get a wide variety of answers. I don't pretend to know the answer I'm just throwing it out there.  I recognize you have your finger much closer to the pulse on these matters than I do. My views are based purely on what I see as a widespread deleveraging process across all asset classes as payback for the excesses of the past few years.


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