Will Commodities Recover From the Credit Crisis?
"Money is the lifeblood of the economy." This famous saying is easy enough to remember, yet how much easier is it to forget it when asset prices are pushed to unreasonable extremities. Consumers and investors alike are now being reminded of the veracity of this statement in a big way as the money panic rages on.
The term "credit crisis" can actually be broken down into two separate yet related categories. On the one hand the credit problem is a crisis in confidence. Confidence, after all, is the baseline requirement of any banking system. This is especially true for one as vast and reticular as the U.S. financial system. When confidence is lacking among participants in any credit-based financial system, money will become scarce and if the fear continues long enough, the wheels of commerce will grind to a halt.
The credit crisis can also be interchangeable with the term "money scarcity." At heart, a credit crisis is a lack of sufficient liquidity to meet the current demands of the banking system. Liquidity can become scarce either from lack of money itself or because those who have the money refuse to let go of it. The latter is a symptom of extreme fear, which answers to the crisis of confidence we talked about. The credit crisis raging in the U.S. and sweeping its way across other countries is a combination of both, but it's mostly a confidence crisis.
Earlier this year the commodities market was booming in spite the credit crisis. To some extent the credit crisis was feeding the commodities rally as hot money from hedge funds and retail investors alike were seeking maximum profits with minimal risk. Commodities were still benefiting from strong upward momentum and so they became the logical choice for money managers seeking to avoid stock market risk. Gold and silver especially benefited from this combination of momentum chasing and safe haven-seeking mentality. The price of gold briefly touched the psychological $1,000/oz. in March amid much cheering and wildly bullish sentiment. Meanwhile the price of crude oil was roaring ahead to prices deemed unthinkable just a few years earlier.
Unfortunately, most investors in these markets seemed to forget the old saying that "money is the lifeblood of the economy." That truism applies as much to commodities as it does to stocks or anything else of economic value. When the money contraction that is part and parcel of the credit crisis eventually took its toll in the commodities sector, the "hot money crowd" quickly pulled its money out of commodities and those lofty prices were quickly reversed. The oil price fell from nearly $150/barrel in July to a low of $90 in September.
That oil could lose nearly 40% of its value in just two short months is a testament to the severity of the raging money panic. It's also a testimony to the influence of the hedge funds and pension funds, whose large presence and tendency to chase momentum was responsible for much of the run-up in the oil price. A few months ago the oil bulls were spinning tales of oil supply crunches and heavy Chinese demand for oil. The rapid retreat in the oil price was clear testimony to the power of the speculative impulse over and above market fundamentals.
Now that the crisis in confidence has taken a hefty toll on commodities, many erstwhile commodity bulls are now staring in the face of huge losses. The corresponding impact on investor psychology is also enormous. Instead of wild optimism, investors are mostly depressed and wonder if prices will even begin to recover anytime soon. Investor sentiment has run from opposite extremes of the cycle in just a few short weeks and everyone seems to be "feeling it" at the bottom.
It isn't just commodity investors who are feeling the effects of the credit crisis. Commodity producers are feeling it, too. To get some insight into how the crisis is effecting natural resource companies, I've been conducting a series of interviews with the heads of various mining ventures, including gold, silver and uranium mining and exploration firms. As you might guess, some companies are doing better than others, yet most are struggling in various ways. The biggest challenge facing most of these companies is getting retail investors interested in the mining sector in the current investment climate.
Colin Sutherland is the president and CEO of Nayarit Gold Inc., a Canadian gold and silver exploration company headquartered in Nova Scotia. The company controls over 102,000 hectares of mining concessions, known as the Orion Project, in the State of Nayarit, Mexico. Nayarit is doing better than most junior mining companies right now, in large part due to the talent of Mr. Sutherland and his fellow managers. As a testament to his managerial acumen, he was recently featured on the Fox Business Hour television program. For Fox to feature a junior mining executive is rare indeed.
Sutherland was also able through his talents to secure an impressive level of financing from a major Canadian bank recently. His company is still looking for its "breakout" opportunity to capture the imagination of the natural resource investment world.
Mr. Sutherland is an incurable optimist when it comes to the commodities investment cycle. I asked Mr. Sutherland where he sees the price of gold in the months ahead. Here's what he told me:
"I see a recovery. Being in the business these last few years I know how difficult it is to develop deposits. But with what's happening right now in the resource sector the supply curve will be magnified at some point. Gold's going to continue to go up when you look at the fundamentals. After the election we may be in a position of [gold] approaching $1,200 maybe $1,600. Strictly fundamentally speaking I believe it's going to increase. We're only one-third into the commodities bull run. We'll see an exuberance develop in the next 6-9 months where [gold] approaches $2,000 because of the economic challenges out there. But when it smoothes out, new deposits will be more difficult to find. Purely economically speaking the gold price should stabilize between $900-$1,000."
Some would no doubt question the optimistic forecast of Mr. Sutherland, especially in the face of current monetary conditions. Yet others would agree with his outlook, at least in spirit.
Jim Williams is the CEO of Arian Silver, a London-based silver, gold and copper mining firm operating in Mexico. I asked Mr. Williams last week to compare the current crisis to former periods of difficulty he's been through in his long career in the mining industry. Here's what he shared with me:
"I've gone through three recessions in my career. The first was Black Wednesday in 1987. I was mining in Sudan back then. The second one was the Bre-X scandal in 1997, which instigated the Toronto Stock Exchange to tighten up, hence [more regulation]. This latest crisis is global and the banking sector has been massively hit. It's been a domino effect. Raising money right now for mining firms is quite difficult. Anyone who could raise money right now I'd take my hat off to them. We've only done non-brokered placings so far. Previously, I raised $3 million in 10-15 minutes on a handshake in London. I raised $3 million in May this year and it took me 5 weeks with a multitude of different clients. We're raising money with $1.65 million pledged from trustworthy people but I'm fairly upbeat. But it is very difficult. No one knows what's going to happening tomorrow. The U.S. dollar isn't just in the U.S., it's a tradable currency. China holds trillions in U.S. bonds and they can't just sell them or it will trash the dollar. They have to find a conclusion to this."
Mr. Williams notes that in spite of the often positive results that have released onto the market news wires lately, it has mostly fallen on deaf ears. Investors aren't too interested in strong fundamentals or positive results in this economic environment, a fact that isn't lost on most of the executives I've spoken to lately. As Mr. Williams observes, were it not for the credit crisis, the market would likely react with joy at the news many juniors mines are releasing. This answers to the old Wall Street assertion that how the market reacts to news is often as important as the news itself. More to the point, investors can sometimes lose sight of true underlying values when fear reigns supreme. But when the fear is lifted, the market eventually recognizes the value and rewards those companies who showed the best results during the crisis.
The market malaise in the natural resource sector will lift, and when it many of the mining firms that have been ignored by investors during the crisis period will be rewarded for their patient endurance through the hard times.
For every crisis, there is an opportunity. This fact isn't lost on foreign investors as the headline of a recent Financial Times article states: "SWFs invest $20bn in commodities." The article points out that sovereign wealth funds have invested almost $20 billion in commodity futures, confirming for the first time the presence of state-owned vehicles in the commodities market.
Then there's the hedge fund factor. According to the FT, hedge funds have lately spurned sophistication for perceived safety and have moved $100 billion into low-yielding money market funds. According to the FT article, Citigroup estimates that hedge funds have now placed $600 billion in cash, with $100 billion of this held in money market funds.
But as the FT points out, "Last week, those money funds became embroiled in the wider financial crisis to the point that the US Treasury was forced to offer a blanket guarantee on them as part of its attempts to prevent the spillover of the financial crisis into the $3,400bn sector." If nothing else, observes the FT, the presence of "hedge fund investment in money market funds shows how scarce attractive investment opportunities and safe havens have become."
On this score, we can be assured that hedge funds are watching the natural resource sector like a hawk and are waiting the first sign of recovery before returning and running up asset prices once again. The internal momentum indicators we look at daily will tell us when the moment has arrived before it becomes widely apparent to the investment world at large.
One of the root problems associated with the current malaise is the service-based nature of the U.S. economy. The very notion that a service sector economy can remain prosperous over time is being called into question, especially in light of growing global trade imbalances.
Robert Dultz is the chairman and CEO of USCorp, an up-and-coming junior mining company engaged in the exploration of gold in Arizona. When I spoke to him recently, he shared his thoughts on one of the key economic problems confronting the U.S.
Says Dultz, "To us, mining is like manufacturing - it brings wealth to a country. When you make something, that's wealth. If you take oil, timber, gas, iron, coal, silver, copper - all of that is real wealth. A country needs real wealth, they can't make it in services. A service economy is a servant economy, in my opinion. I believe what [mining firms] are doing here is of service to the economy at large and not just to the shareholders."
Arian's Mr. Williams goes on to address a top concern right now among natural resource investors. He notes that several investment firms in London have a mandate not to do any buying in the foreseeable future in order to recover some of their losses. This reactionary approach to the crisis isn't surprising, though it's hardly logical. Williams observes, "They have to redeem some of their funds by their clients. Clients will want to bail out if they're not making any money. The general consensus is that a week from now [the market] will be worse than now. It's doom and gloom out there."
Yet Williams takes the contrarian approach to investing at the bottom of the panic. "Why sell out now if you can afford to sit out the uncertainty in the times ahead, the stock will go back up eventually. If a $1 stock goes down 70%, why sell now? Gold has been so high - unnaturally high - and yet metal prices have been down for so long. All of a sudden the metals are increasing in price again. It will take a bit of a knock-on effect to get the juniors to move in accordance with those price increases, but it will happen. The more people get disillusioned with the dollar, the more they will turn to the [resource sector]."