Re: Commodities Super Cycle- Do you believe in it?
nizar said:
hey richKid,
can u plz post a link to this article (alan kohler), this guy seems 2 b saying everything i wanna hear!
thanks
Riding the super cycle
By Stephen Bartholomeusz, The Age newspaper
December 20, 2005
THE biggest question mark hanging over 2006 and beyond isn't whether the commodity cycle remains "stronger for longer", but rather just how strong and long the cycle is.
It is evident that there is a China-inspired super cycle in commodities occurring, and that in most commodities there is an imbalance between demand and supply of such proportions that it may take years for the producers to close the gap.
In most of the exchange-traded commodities stocks are minimal, and across the board resource companies are grappling with the logistical issues associated with the attempts to rapidly boost production.
With massive consolidation of the resource sector having occurred in the past decade, the supply-side response to the soaring demand has been more disciplined and cautious than in past resources booms, which helps explain the extent of the price spikes that have occurred.
Despite the massive amount of investment occurring in new or expanded projects, no-one expects the commodity boom to end any time soon, despite expectations that China's growth rate will moderate.
The phenomenal growth in the size of China's economy means that economic growth could slow but demand for commodities would still increase in absolute terms.
The issue of how long the super cycle persists is a critical one for the producers and their investors. For the producers, reading the duration of the cycle will eventually produce big winners and losers from the matching of new capacity with the cycle, and the robustness of the projects themselves. If the cycle remains stronger for even longer, projects that might be considered marginal, on the basis of historical average prices, might well have paid for themselves before prices revert to the mean.
For investors, there is the dilemma of trying to understand whether there are more big gains to come from a continuation of the cycle, or whether they are buying in at the top. Over the next few years the position institutions take in relation to the cycle could be a major differentiator of returns.
The norm for resource companies and fund managers alike is to project the current price framework for the next two or three years and then revert to long-term average prices for their valuations.
If today's conditions persist for longer than than they factor into their models, however, the potential for underinvestment as a consequence of the massive divergence from historical norms is considerable.
UBS recently produced an interesting piece of research that compared its own forecasts of commodity prices and valuations of resource companies with the valuations that would be derived if today's spot prices were sustained.
While in some instances ”” oil, gold and nickel ”” its forecasts for 2006 were above the spot price. For most of the commodities the spot price was considerably higher than its forecast. Incidentally, the UBS house view is that the cycle could be sustained for five years, or more.
Valuing companies using today's spot prices is a purely theoretical exercise, as it assumes the super cycle will last not just longer, but forever. But it does provide an insight into the order of difference in values that could be created if prices take longer to retreat towards long-term averages than the resource companies and their shareholders are anticipating in their modelling.
UBS, for instance, is forecasting BHP Billiton will earn $US9.4 billion ($A12.6 billion) in 2006 and generate $US12 billion of cash flow. If current spot prices were applied to BHP production (large amounts of which are sold at contracted prices) it would earn $US10.33 billion and generate $US12.8 billion of cash flow.
Rio is forecast to earn $US6.4 billion and have cash flow of about $US7.1 billion. At spot prices it would make $US7.3 billion and generate $US7.98 billion of cash.
Applying the spot price to their 2007 results produces even more startling results, with BHP's earnings jumping nearly $US3 billion and Rio's rising by nearly $US2 billion.
When those numbers flow through to UBS's valuations of the resource companies' shares, the potential for misjudgments of value becomes obvious.
On UBS's 2005 forecasts, it valued BHP at $18.61. Feed the spot prices into the valuations and BHP would have been worth $43.86. Rio was valued by UBS at $51.21; at spot prices it would be valued at $109.51. Zinifex, now trading $6.21 a share, was valued on the basis of its forecast 2005 results at $3.74. At spot prices it would be worth $11.09 a share. Alumina, trading around $6.90 a share, would be worth $12.10 a share.
On the basis of the forecast numbers, BHP and Rio are selling at about 10 times their 2006 earnings, which isn't itself an aggressive treatment by the market and suggests a considerable degree of caution about the sustainability of the prices and profits. The low pay-out ratios ”” the resource heavyweights pay out less than 30 per cent of their earnings as dividends (they have both returned capital, which is a way of rewarding shareholders without making a long-term commitment to higher dividends) ”” suggest the companies are as conservative about their outlook as the market.
The UBS research, while theoretical ”” if prices were sustained at their spot levels indefinitely inflation levels would inevitably rise, with consequences that would probably undermine the cycle ”” does give a broad feel for the amount of value and/or the opportunity cost at stake in assessments of the duration of the China phenomenon on commodity prices.