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Base Metal Stocks: A Bull Market Beyond Expectations

-- Posted Tuesday, 29 March 2005 | Digg This ArticleDigg It!

We enjoy listening to Beverly Hills money manager Ken Gerbino and not just because of his track record in mining stocks for the last three years. He talks in a simple way that we can understand. We asked him about base metals – and their amazing run over the last six months.  Could they be peaking? Ken laughs and tells us "Three billion Asian and Indian people say “no way”".  He believes there is a new paradigm of sustained growth in base metals from Asian demand - no more cycles - translating into increased multiples for base metal stocks. And for good measure, he mentions a few base metal companies he owns and why.  Ken, we always get our best readership from your articles.  Thanks for your time, and your permission to republish.



I believe the base metal stocks are going to extend their bull market for a long time and well beyond the consensus "group think". There will be corrections along the way but I believe these stocks are going to surprise everyone over the next few years. My reasoning follows below.

I believe precious metal mining stocks should be in everyone's portfolio but I also think it is a good idea to have some exposure to base and other metals (copper, zinc, nickel, lead, chromium, aluminum).

In order to understand a major change that could take place in an investment sector one can gain insights from a major change that took place in another sector.

I remember twenty years ago when Intel was producing computer chips, which at the time had become like a commodity item. From 1985-1995, Intel sold for only 7-12 times earnings because of the then "commodity" aspect of chips and the fact the computer industry was at that time a cyclical industry. By 2000, Intel was selling for 60 times earnings because of the Internet, laptop and cell phone usage explosion (mega-trends creating a new electronic marketplace with a more sustained demand for chips). Even today, after the tech stock wipeout, Intel is still selling for 20 times earnings.

A similar usage explosion has now started in base metals. The corresponding new mega-trend is Asian and Indian base metal demand. Base metal stocks are now selling at only 5-8 times cash flow. Old time base metal investors are locked into the past thinking of the cyclical nature of the industry. Three billion Asian and Indian people say "no way". Any structural or sustained demand for these metals could increase cash flow multiples to 12-16 times or more. This has significant implications. It means that even if the prices of these base metals go down by 25-35%, because of the multiple expansions, the base metal stocks will still be buys.

Even with just 2-3% growth in Asia and India (current growth rates are 8-9%) a steady demand for resources will create a more sustained and structural market for these metals. A steady demand would change the "cyclical" aspect of base metal demand and this would be reflected in higher cash flow multiples and higher stock prices. Tight supplies also will help stock values.

The latest data from China shows that 82% of their capital spending is on housing and infrastructure (roads, power plants, railroads, sewers etc.). Even with only 2-3% growth, China's capital spending should be a long-term positive non-cyclical factor to metal demand, as these infrastructure projects will last for decades as huge rural populations enter their new economic world. In the more established economies, capital spending is more cyclical because people are buying cars and TV sets and washing machines based on the economy, which can go up and down. But newly industrializing countries do not stop building roads and power plants when their economies slow down.

Infrastructure projects are usually not cyclical since they have State backing and many times are not curtailed despite poor economic conditions. In the current age of debt financing and printing money by world governments, it would be hard to imagine politicians considering canceling a power dam or major highway because of a slowdown in the economy. It will not happen in China or in India. The projects in the U.S during the great depression and many projects in Asia during the Asian meltdown are good examples of large state projects that continued despite all. Therefore one can expect a robust demand for base metals for a very long time even with substantial slowdowns in India and Asia.

China will attempt to talk down their economic growth and try and get the hedge funds and speculators out of the metal markets so they can buy cheaper on world markets. But with 82% of their capital spending on housing and huge infrastructure projects any economic slowdown will still require a sustained demand for these metals.

Because of this change from a cyclical nature of base metal demand to a more structural and smoothed out demand, the valuations and cash flow multiples for the base metal producers I believe could have a possible dramatic shift upwards. Also it is just a matter of time before they start paying out solid dividends.

Asian analysts are missing the boat on the compounding of metal demand. Demand growth of plus 10% for a given year, followed by a major slowdown to only 3% in the next year is still bullish. When you do the math you start with, lets say, normal demand of 100,000 tonnes of some metal, that then goes to 110,000 tonnes (10% higher) and prices respond upwards. Now in the next year, if you go down to only a 3% growth rate that means you are now increasing demand from the 110,000 tonnes by another 3%. That means demand in year two is 113,300 tonnes. That's still more demand than what caused the price to go up in the first place. Get the picture? If 110,000 tonnes created a price rise, then a 113,300 tonne demand the following year will certainly do it again unless supply turns up from somewhere and in the mining business this means 5-10 year lead times. Even a slowdown in Asia and India is bullish for the metals.

Cash flow multiples should also increase for these mining stocks due to two other long term inflation inducing economic mega-trends we have discussed many times (global money printing and increasing debt levels).

At the recent The Bank of Montreal Nesbitt Burns annual institutional mining conference every CEO from the base metal companies that presented had the same story; demand was very strong and not letting up and that warehouse supplies globally of many basic metals are very low. They see significant supply squeezes for the next 2-3 years.

BHP, the largest natural resource company in the world right now makes more profits from base metals than any other business sector including petroleum, coal, steel materials, or diamonds. BHP is currently bidding $7 billion for base metal producer WMC. Xstrata ($6.5 billion mining giant) was also bidding about $6 billion. These big conservative mining companies know their industry and I believe they see sufficient evidence that a new base metal decade is coming to this world.

Some junior companies with quality base metal, or massive sulfide deposits and other important metals may also be good buy out candidates for other resource companies as these juniors develop their projects.

A new "materials" centric world is unfolding for billions of people who desire a better lifestyle and are demanding it Technology, education, globalization, and communication, are driving this desire. This is a huge unstoppable mega-trend. The resource sector will be a solid investment theme because of this and the base metal sector will most likely be a leading beneficiary.

Some base metal companies that we own for our clients are:

Freeport Copper and Gold (FCX: NYSE $40.07).

They own one of the greatest mines in the world (Grasberg) and will produce 1.5 billion lbs of copper and close 2.9 million ounces of gold in 2005. FCX currently sells for only 5 times 2005 expected cash flow. Grasberg is also the largest gold mine in the world.

Inco (N: NYSE $40.75).

A major producer of nickel and copper with platinum and cobalt. They produced about 555 million lbs of nickel, 275 million lbs of copper, 350,000 ounces of platinum group metals and 7 million lbs of cobalt last year. The stock is selling for 6 times 2005 expected cash flow and 3.9 times 2006 expected cash flow.

Oriel Resources ( ORL: Toronto $1.10 (C)

Newly listed in Toronto. One of only a small group of developing companies that will be in production relatively soon to take advantage of these metal prices. They will produce nickel and ferrochromium if all goes according to plan. They have $50 million in cash. Canaccord London projects $340 million in EBITDA at full production in 3-4 years. With approx. 400 million fully diluted shares at that time, EBITDA would be 85 cents per share. At 6 times EBITDA you would have a target of $5.10 C. Heavyweight global players like Bateman, ThyssenKrupp and Endeavour Mining Capital are development partners in the deal. This stock is a speculative stock and only suitable for the aggressive portion of a portfolio.

The above stocks are not recommendations but three companies we like currently for the long-term for all the reasons mentioned above.

CAUTIONARY NOTE: Some of the statements in this report are forward-looking statements and as such are based on an assumed set of economic conditions and courses of action. There is no guarantee that the information presented here from reliable sources is accurate. These include estimates of future production levels, expectations regarding mine production costs, expected trends in mineral prices and statements that describe future plans, objectives or goals.  All investments are high risk in nature and the author cannot assume responsibility for the viability of any ideas expressed in this report. There is a significant risk that actual results will vary, perhaps materially, from results projected depending on such factors as changes in general economic conditions and financial markets, changes in prices for silver and other metals, technological and operational hazards in mining and mine development activities, uncertainties inherent in the calculation of mineral reserves, mineral resources and metal recoveries, the timing and availability of financing, governmental and other approvals, political unrest or instability in countries where companies are active, labor relations and other risk factors.

Ken Gerbino

March 2005

Happy reading, live long and prosper.

The Gold Editor

Gold Editor provides, for remuneration, corporate communications and investor relations services to the above mentioned client(s). The information contained in this email is based on existing disclosure documents or other publicly available information. You are encouraged to seek independent verification of any information that is important to your decisions. Neither Gold Editor nor the mentioned client(s) is offering securities or advising or soliciting the purchase or sale of the securities.

-- Posted Tuesday, 29 March 2005 | Digg This Article


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