A couple of weeks ago, copper reached a record high in Asia before news came that China, an increasing user of copper, is cutting imports.  The news sent base metals markets screaming lower. [See] 

Funny how each time we hit a new high, some news or rumor out of China cuts prices back, only to see them recover over the next days and weeks.  That may well be the case here, too, as only a few weeks earlier it was reported that the Chinese government had entered the copper market in London to secure long term supplies.  Should that not be considered a very serious expression of supply concerns?

Also curious in this regard is the fact that Chinese copper stores in foreign warehouses have, in some cases, been diverted to other Asian buyers as those prices soared beyond domestic prices.  This is not evidence of a global slowdown in demand, it's a minor and probably temporary shift, and the essence of capitalism in a still communist state (which we should celebrate).  Besides, it is unknown as to why prices may be softening in China, but interruptions in the electrical supply grid have been cited in the past.  If demand is softening, it can only be a blip on the long term demand curve.  You see, the need to rebuild and expand the electrical power grid once the Three Gorges Dam project is on line will directly and indirectly consume as much copper as the world can produce for years - not that it will happen all at one time, of course.   Then, there is the effort currently underway to provide cable television across the land.  These undertakings alone will spur new demand for copper intensive appliances just as the level of household disposable income is increasing nationally.

With that in mind, and before moving on to other subjects, let me say this yet again.  There are not enough raw materials on the planet to sustain growth in China and India without severe shortages (read inflation) springing up elsewhere within the world's developed economies.  Therefore, the investment story of the next couple of decades is not going to be real estate prices, it's going to be raw materials prices.  And the one sector likely to benefit the most will be mining shares, particularly the junior issues.

A major news story of this past month, though probably overlooked by many, was the U.S. trade deficit.  It was worse than expected and the worst on record - 732.5 billion dollars annualized.  So what happens in the markets?  The dollar goes up and gold goes down.  Is this rational?  Then, just yesterday we had a report about a slowing in GDP growth.  If we were not on dangerous ground already in regards to the trade deficit v. GDP ratio, we are certainly headed there now.

And does this not bring up questions about "rational market theory?"  If the market is "rational," and I doubt it is, then we are on the verge of a big bust in bullion prices and mining shares.  Otherwise one must assume the market has been asleep to the fundamentals.  One should note that spring is usually the most active and rewarding period for mining shares, particularly the junior mining sub sector.  Not this year.  It's a dud.  What's going on?

I my judgment there can be only one of two things causing this, or maybe a little of both.  1)  Mr. and Mrs. Market do not anticipate a rosy future for this sector, or 2) Mr. and Mrs. Market are preoccupied with other interests at the moment.

In the first scenario, it is true that mining stocks are general ascribed the powers of anticipating the direction of bullion prices.  So, as the theory goes, if the market expects a softening in metals prices, share prices will stall, or head down before bullion prices do.  Sometimes the clues for such thinking can be seen in the trend for interest rates.  The reasoning here is that interest rate hikes result in a slow down in economic activity (in the U.S.), causing in turn lower demand for raw materials.  Also, the cost of holding bullion, which pays nothing, appears to go up, causing a drain in investment as against the benefits of holding interest bearing instruments.  That's the theory, anyway.

As we have discussed here over the last few years, this type of thinking is out-of-date with the new realities of the market, though most participants in this country are still playing by the old rules.  In this regard, there are two important considerations to contemplate.  One is that as interest rates in the United States advance from cyclical lows, they are often just another symptom of inflation, at least at the beginning of a cycle.  In other words, interest rate increases early in a cycle seem to track inflation, not out pace it, and are often less dampening of price increases than most observers are prone to think.  That's because it takes a big move in rates over time to stop a trend in motion.  The consequence is that metals prices can actually advance most strongly during such a period, as we have been seeing.

An appreciation of this tendency has served astute investors quite well in the past, as the United States has dominated global markets for many generations.  It's different this time, I believe.  While the U.S. remains an important factor, the economic center of gravity is shifting to the Far East.  So, the model has to be adjusted for happenings in China and India.  Here is why announcements of recent interest rate increases here have resulted in downward pressure on metals prices in New York, only to see them driven back up in overseas trading.  The rest of the world doesn't care so much anymore what investor's here think, or what rules they play by.

But the market for mining shares in North America is driven here by Mr. and Mrs. Market, who appear to be preoccupied with investments in what they think of as more exciting sectors at the moment.  They have thus far not been observing the powerful forces at work in the international market for raw materials.  So, while these markets for metals appears to be in a secular bull run, the masses of individual investors who usually catch such waves by owning mining shares (as in the late 70's and mid 90's) have been missing, finding their excitement elsewhere.  In my opinion, this is the larger part of the explanation, with some additional influence from those still playing by the old rules regarding interest rates.  Seems Mr. and Mrs. Market will need their traditional slap across the face from an inflation scare, before we can expect them to change.

Otherwise, how does one explain the absence of small investors in this sector, when one sees some metal prices double or triple over a couple of years, when one reads of major mining companies reporting increased profits in percentages of three digits, when one sees storehouses of raw materials about to become completely empty?

I believe mining shares should be wildly higher than they are now.  I believe that the market is deluded by thinking rising interest rates in the U.S. will hurt the sector, and I am convinced the market is oblivious to the powerful shift in the global centers of demand for raw materials currently underway.  If I am correct, a sudden awakening, delayed though as it is, may result in the most powerful bull move mining shares have ever seen.  Call it a Super Cycle, if you will.

So, you ask, what's the diversion, what's keeping mom and pop investor focused elsewhere?  We gave space in the last letter to the real estate market, and have written about it often in the past.  It seems to get more hysterical with each passing month.  On my own block, and among the houses that border those streets on the opposite sides, there have been half a dozen sales in the last month - homes that were on the market for only a few days - and another half dozen homes that sold recently that are in the process of receiving various amounts of upgrades to be "flipped" back onto the market.  I know many readers here, regardless of one's location in North America, can acknowledge similar observations from their own neighborhoods, whatever the price range.  Additionally, I have reports for title and escrow companies of many clients financing multiple "second home" purchases at the same time, so easy is loan underwriting these days.

In our last missive, I parted with my own rule about not mentioning specific mining issues in these public writings by recommending Yukon Zinc (See). YZC holds an impressive polymetallic property just now entering feasibility with Hatch, Ltd. I mentioned the company as an extension of my discussions about selenium prices.  In that regard, this one-time nuisance in the refining of certain base metals continues to show impressive price advances, and is up $3.50 since out last report a month ago.  Mine concentrate now sells for US$62.00 per pound.

Even while precious metals have been in decline recently, and some base metals have shown prices softening, selenium, as nearly as I can tell, has shown only one week of lower prices in the last few years.  Otherwise, prices have been flat between weeks, to as much as 4 dollars higher. With one exception in the last couple of years, the amount of dollar adjustments has shown a tendency toward larger and larger price increases.  In quite a stunning move, selenium has left it's long term flat line price of $3.75 per pound in late June 2003, posting a price increase to date of 1,553 percent.  This annualizes to very nearly 850% per year.  To play this market, you should know that Yukon Zinc will be capable of producing up to 15 percent of world wide annual demand once their Wolverine project becomes a mine in the next little while (not to belittle the additional and impressive concentrations of zinc, lead, copper, silver and gold).

THE CHINA SYNDROME:
(News related to Asian influences on commodity and other international markets)

30/03/2005 - Copper demand looking brighter still. [See]

30/03/2005 - China dominates the market, says the world's largest nickel miner. [See]

31/03/2005 - Chinese imports cost less here, but China's growth hits you with "biflation." [See]

02/04/2005 - BHP demands 110 percent increase in iron ore prices paid by China. [See]

07/04/2005 - Soft landing predicted with 8.5%+ growth rates (and industrial growth from 9.3 - 10.2%).  Soft landing? [See]

07/04/2005 - As global growth slows, China booms - World Bank [See]

11/04/2005 - Copper hits another record.  Fear of shortages in China cited. [See]

12/04/2005 - "Copper Hits New High on Shanghai Shortage" [See]

12/04/2005 - "China and India have just entered the critical income range supporting rapid growth in resource consumption." [See]

13/04/2005 - Politics enters the Australian iron ore market, price gain settled at a 72% increase. [See]

14/04/2005 - ...but the issue of a surcharge remains, along with a possible sellers cartel in support of next year's contracts. [See] This story is showing flames now, and the issue will just get hotter and hotter as Asian growth dominates the market for raw materials.

28/04/2005 - Urban areas report an 8.6 percent rise in disposable income. [See]

28/04/2005 - 20 Chinese companies to be listed on Nasdaq. [See]

QUOTES FROM SELECTED READINGS:

"I don't know whether change will come with a bang or a whimper, whether sooner or later. But as things stand, it is more likely than not that it will be financial crises rather than policy foresight that will force the change.”   Paul Volcker - [See] 
"The Second Best Time to Buy Mining Stocks" -[See]

Some thoughts:
In the long run, escalating trade deficits always result in severe economic adjustments.
In the long run, unrestrained fractional reserve banking always results in a full fiat money system and later disaster.
In the long run, legal tender laws always end in economic crisis.
"In the long run, we are all dead."  John Maynard Keynes, the 20th Century's most influential economist/monetarist (and leading socialist).

End legal tender laws.  End government debt as an "asset"  for reserve banking.  End the Federal Reserve System. 
The cost of such adjustments will be quite painful, but no where nearly as disabling as the eventual cost of doing nothing.

"The study of money, above all other fields in economics, is one in which
complexity is used to disguise the truth or to evade truth, not to reveal it."
John Kenneth Galbraith

© 2005 Larry S. Levy
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