Commodity stocks will become "even greater out-performers" after economic downturn - BMO's Coxe

BMO's Dox Coxe asserts that “the next phase of history's greatest commodity boom will have some new characteristics that should make commodity stocks even greater out-performers once the world emerges from the current economic downturn.”

Author: Dorothy Kosich
Posted: Friday , 12 Sep 2008

In his latest Basic Points analysis, BMO Global Portfolio Strategist Don Coxe claims U.S. Treasury Secretary Hank Paulson and Fed Chairman Ben Bernanke took the pressure off heavily-levered banks "by putting pressure on the heavily-levered speculators and hedge funds that were short the banks and the dollar, and long the commodities."

"With help from the SEC and the Commodity Futures Trading Commission, Paulson and Bernanke sprang the trap", which Coxe termed the 'July 13th Massacre.'

Coxe compares Paulson to the late New York baseball coach Casey Stengel, who after being fired as manager of the New York Yankees -- was devastated by the ineptitude of the players on the new team he was managing, the New York Mets.

Stengel couldn't believe that professionals could be so incompetent, thoughts, which Coxe jokingly suggested, may have been on the mind of Paulson when he and Bernanke were trying to save the U.S. financial system, and stop the terror of inflation and the associated commodity run-up and dollar plunge.

Coxe asserted that Paulson knew:

That the ultimate goal was to permit the banks to raise new equity, meaning their share prices had to rise a long way; and

This would force a panic short-covering of dollar positions, setting off a mutually-reinforcing pattern of collapsing commodities, soaring financial stocks, and a rising dollar; and

That a decisive break in gold, grains and oil futures, accompanied by the biggest dollar rally in years, would blow the inflation dragons away for a while; and

Therefore, the Fed would no longer be under daily pressure to raise rates.

"The genius in this strategy was that it relied on excess leverage among hedge funds to take the pressure off overlevered banks, which held huge exposure to F&F paper, guarantees and preferred shares,"Coxe said.

Since the July 13th Massacre, Paulson and Bernanke have been helped by a growing perception that a potential global showdown would be "devastating to perceptions of intrinsic values of commodities generally," Coxe noted. "The Bank of Japan may have signaled this strategy when it published an analysis of commodities in the global economy and asserted, 'Commodities are the thermometer of the global economy.'"

An exception to this type of thinking, Coxe observed, is that gold is "the classic inflation hedge, and can rise even when recessions hit, if inflation is still rising."

Coxe believes that Paulson and Bernanke (with the assistance of SEC Chairman Christopher Cox) cannot manipulate commodity prices indefinitely. "What they have done is to force the excretion of leverage from exposure to commodities and commodity stocks, and to drive many highly-levered hedge funds to the wall."

"This was a short-term shock that worked on a grand scale precisely because there was so much leverage in both longs and shorts, and the unwinding of those positions reinforced the moves on the other sides of the trades," he asserted.

"Now that the Dynamic Duo no longer has much reason to care about commodity prices and commodity stocks, what is the outlook for these Once and Future Kings of the Financial Markets?" Coxe asked.

Right now, naysayers could be correct in their claims that oil and industrial metals may have entered at period of oversupply which could last until OCED consumption reverses its decline and Chinese and Indian consumption moves to even higher levels. "That shouldn't take long within the context of a 25-year bull market," Coxe suggested.

Coxe asserted that commodity company metrics may be evolving. "Some nations' ideas of strategic investing might well have enormous impact on the valuation of commodity producers' shares. Predators of various breeds will emerge."

As evidence, Coxe asks investors to consider that:

The Indian government has been encouraging major Indian commodity companies to make acquisitions outside of the country. This is a change from previous policy, which rigidly restricted exports of capital abroad. Steel, iron ore and aluminum have been among the industries in which Indian companies have established large global presences through acquisitions.

Chinalco surprised mining investors by joining with two companies to acquire Rio Tinto shares, in an apparent attempt to interfere in BHP's bid to acquire Rio. "Like other iron ore-short countries, China has been shocked by the scale of price increases on large-scale forward contracts from BHP, Rio Tinto and Vale."

Putin advised the Norilsk management that it was to appoint his nominee 'who used to run the KGB in Leningrad' as its CEO. "Norilsk is currently being fought over by two oligarchs, one of whom is said to be close to Putin," Coxe noted.

The Chinese are active in numerous Third World commodity-producing nations "with seemingly special interest in those with the most hideous records on human rights," Coxe suggested.

After Russia's invasion of Georgia, there is even more controversy about the proposed Nabucco gas pipeline from the Caspian Sea to Erzerun in Turkey. "Nabucco now seems more needed than ever, but financing for it has become more problematic, given Putin's hostility" to the project, said Coxe.

Xstrata's attempted takeover bid for Lonmin is "opportunistic." Coxe asserted. "With platinum prices down by nearly a third, and with his attempts at a deal with Vale coming to naught, this is a good time for the aggressive Mick Davis to buy a unique asset cheaply. Control of Xstrata is murky, and many observers still assume Marc Rich is involved."

Despite all of the aforementioned events, Coxe observed that sovereign wealth funds have not yet shown an eagerness to use a "short-term weakness in commodities' prices as a buying opportunity."

INVESTMENT RECOMMEDATIONS BY COXE

When financials roll over, "gold and gold mining stocks should move swiftly back into favor. Inflation remains above central bank target levels in the U.S. and in many other countries across the world. Any return to pronounced weakness among the bank stocks will be strongly bullish for gold."

"The biggest near-term upward supply in commodity prices could be natural gas if (1) the sunspots don't reappear, and (2) the historic correlations of gas to oil reassert themselves."

"The Canadian dollar is being hit by the commodity price plunges, deterioration in the trade account, the worsening economic outlook in Central Canada, and the uncertain outlook in the October election. Whether Tories or Liberals win in Ottawa, Canada's fiscal situation will continue to be superb compared to the U.S., particularly if Obama wins. We remain very positive on the loonie as an alternative to the greenback."

"We have no clear idea about how long it will be before we can look back to today's prices for commodity stocks and say, "Wow! I wish I'd loaded up then! We remain certain that day is coming," Coxe declared.

"We are leaving our recommended asset mix uncharged as are the long-term fundamentals of commodity investing," Coxe concluded.