Key Points

• Global boom accelerating
• China crude steel output hits another new record
• Copper prices moving up again
• Gold prices becoming very interesting
• `White’ precious metals looking good
• The stealth onshore oil boom coming into daylight
• Resources stocks beginning to really fire

Exhilarating!  It is so nice to see the gains now coming through in the form of improved market turnover, increased market share by resources stocks, greater market breadth and of course rising stock prices. And client activity is up sharply and the early investors are very happy. So much more to come.

It has been frustrating over the past few years to have experienced extraordinary and mostly irrational negativity over the resources sector, particularly since the most recent highs in April 2011, now three full years ago.  The unceasing and incorrect downgrading of the outlook for China and an equally incorrect strongly bearish commentary on gold have delivered stock prices that were down 80% for the ASX Gold Index (much more for smaller stocks) and 70% for ASX Small Resources.  The net commodity price changes that the harbingers of doom have delivered is just wonderful to see. .  Not much at all really.

	April 2011  US$	April 2014 US$	%	April 2011  A$	April 2014 A$	%
Gold	1556	1301	-16.4	1418	1402	-1.1
Copper	9370	6786	-27.6	8542	7316	-14.4
WTI Oil	114	101	-11.7	104	108	4.5
Iron Ore	182	112	-38.3	165	121	-27.0
US$/A$	1.10	0.93	-15.2	1.00	1.00
China crude steel	700	827	18.2	700	827	18.2

But stocks have fallen so much more.

	April 2011  US$	April 2014 US$	%	April 2011  A$	April 2014 A$	%
XMM	4623	2237	-51.6	5071	2412	-52.4
XSR	5668	2165	-61.8	6217	2165	-65.2
XGD	7295	2116	-71.0	8002	2282	-71.5
BHP	41.78	35.50	-15.0	45.83	38.28	-16.5
XMM	75.50	58.41	-22.6	82.82	62.98	-24.0
FMG	5.61	4.95	-11.7	6.15	5.34	-13.2

So much carnage for so little cause.  Even earnings are so much better.

We have all suffered because of this “Group think” which has pushed capital into unproductive government bonds and bank deposits and resulted in the severe mispricing of assets.

But that is all history and the reverse will now be happening.  The immensity of the cash build up of A$1569bn (RBA February 2014) – greater than the A$1400bn in GDP and ASX All Ordinaries market cap of A$1550bn (just!)- relative to my Flow of Funds model says this Bull Market is going to have to run for years before the cash levels will be down to `normal’.  What level for the All Ords?  Try 10,000+.

(I often wonder why Joe Hockey doesn’t just cut A$100bn off the A$410bn in Federal Budget Expenditures and somehow encourages Australians to take A$100bn out from local bank deposits and invest/spend it as offset. He could give a 5% tax deduction on the first A$100bn shifted out of a bank saving account or term deposit on a first come first served basis in the first year. Wouldn’t that be a good return on your cash and provide some fun at the same time.  The Keynesians should be delighted that the flow of funds is nicely matched and if Joe also cut A$50bn off taxes we would be running surpluses and the economy would boom. Unprecedented times of such a cash build up and unprecedented times of low velocity of circulation in the economy.)

And that is just bank deposits in Australia. But the cash build up is global.  What about the misallocation of funds into overpriced government bonds worldwide that just have to have higher yields to adjust for risk?

And when the world wakes up to that massive post-2007 surge in money supply that is now moving into property again and into most liquid markets like equities and commodities and probably into global PPI and CPI stats, is anathema for bond holders just where will they park their capital?

Just think commodities and equities and bigger!

So my global boom theme is alive and well and seeming to grow with each passing month.

Also China kindly gave us all some cheer by producing another record crude steel output figure of 827mtpa, up 6% on March 2013.  So much for the slowing of China and collapse of steel production and falling iron ore prices. The inventory and output adjustments over the Chinese Spring Festival are yet to be fully understood by commentators but you will recall this very issue was raised here a month ago.  Also, it would be reasonable to conclude that the 2013 Christmas-2014 Spring Festival seasonal slowdown allowed a mill inventory rundown, a port stockpile buildup and a surge in ships to get as much iron ore at the low prices as possible.  Then of course strong steel output and rebuild of mill inventories and a fall in port inventories. There is nothing quite like going to China to see things at firsthand.

Sorry, bears.  I think my idea of new highs in iron ore prices a year or two out will also come to pass.

One major component in this global boom theme is this inventory issue.   It is a concept that I have mulled over for more than the past couple of decades and the more I think about it the more convinced I am that it will be a critical component in understanding the outlook of the next few years at least.  Some might recall the impact `just in time’ inventory management had a over an extended period in the 1980s as pipeline inventory was run down.  Commodity prices were weaker because demand was about 1-2% lower than apparent consumption over a period.  However, when demand increased and as things became a bit tighter this inventory management was termed `just too late’ !

So if we begin with the basic rational premise that markets are people and people make markets then sentiment of the market place is far more important that the PE ratio, the dividend yield or the NPV discount rate.   The volatility over the past few years have shown that these three factors have had such variation that sentiment has indeed been the key factor!

So the unceasing negativity of the outlook for commodities and intermediate goods has probably encouraged most purchasing managers (ie people) to allow inventories to fall.  Without a doubt the internet has had a big influence by providing far greater transparency and allowing for a change in the mix of participants holding and delivering product.

However holding costs for small operators have probably been far higher than the current global wholesale interest rate structure would suggest so it may be that the overall inventory position is even more tightly positioned.

It is my view that the inventory pipeline system and the rise of the BRICs in whatever form you like has become longer and more complex.  So when consumption demand for copper rises because say China is growing at 7.5%pa (and not Wall Street’s preferred 5% and falling) then each inventory manager is going to have to make a call on acquiring just a little more copper to ensure the business has enough to meet customer demand.

Consider what might happen if all the participants decide to increase carrying inventory by say 5%. You probably get something like what happened in the oil market from 1998 to 2008, i.e., from US$10/bbl to US$147/bbl.  Yes a bull market.  For whatever reason.

I consider that there is a real chance that this might happen in copper and this might also explain why copper prices have eluded the bearish targets of Wall Street.

I hope you have been following LME copper inventories (see graph below) and the 420kt (64%) decline since July 2013.

And now look at the copper price!

And, as we say above, it might just happen in iron ore as Chinese steel mills decide that they have to rebuild their inventories again because demand for steel is clearly still firm. (see  Dawes Points Points 26 March 2014).  And in oil again.  And nickel.  Zinc. Lead. Gold and silver.

I can also tell you that here in Australia that other inventory pipeline of stocks called shares in resources companies is also very low.   The intermediaries in this pipeline being the massive A$1500bn in superannuation funds that have shunned the resources sector and put as much as 30% of their funds offshore (on a flow of funds basis these Super fund taxes are contractionary to the local economy to the tune of about A$50bn per year or about 3.5% of GDP), the asset allocators that influence inexperienced trustees, the Financial Advisor industry that acts as another gatekeeper pushing funds into cash and of course the banks themselves whose lending policies have been risk averse and against small business.     (The mining industry could quite rightfully question how many of these bureaucratic positions are just `lifestyle’ jobs?)

So as this all starts to unwind in the face of continually improving local economic fundamentals, changes in Federal Government policies and un-falling commodities prices and non-collapsing China then it will be slow at first then it will be a flow then a flood. Each player in the pipeline will get a little more confident and so it will go.  For years to come.

So these graphics for resources sectors of turnover and market share really do mean something.  First of all they are historically very low and that means the market is underweight.  Very underweight = SHORT!

BHP is increasing market share from a low base but the Small Resources seems to have jumped about 40% from 2.5% to 3.5% so market breadth is increasing. (That must be our LMB, LNG and VXL!)

The major XMM is up from 16% to 19% but Gold is better but not much yet.  It will come.

And the 250 projects needing A$400bn to develop will get access to capital.   

So come back to LME inventories since 30 June 2103.  Are these declines due to demand from current  consumption or for anticipated increased consumption or just more comfortable inventories.  Missing out on those last 4.2 days (240kt) of copper supply just might get embarrassing for some.   And just may be the same also for lead, zinc, iron ore, nickel aluminium, fertilisers, palladium, silver, gold, oil, ….

So copper prices look good again after that little sell off skirmish and the rest of the LME metals are OK.  Even nickel when the fundamentals were getting so bad (major expansion of nickel pig iron output from Indonesia and the Philippines) and with aluminium oversupply has been remedied by closure of high cost capacity (esp here in Australia).  The best thing for low prices is low prices.

Gold is always critical in the outlook and I express my continuing bullishness for  a big number on gold as this next upleg accelerates to reflect the very strong underlying physical demand from China, India and others that will have run down a lot of the loose gold inventory.  Some evidence is suggesting that there is not much inventory left because increased Chinese and the Indian demand have been well in excess of the draw downs from the ETFs.  Now that these are exhausted of easy sellers, where will the next 500t of gold come from?

The technicals look constructive here and higher prices soon would be good confirmation.

So gold is OK but I am also now getting very intrigued by the performances of the `white’ precious metals.

Palladium is looking very strong at present and just might be leading them all higher.

Platinum is following and silver is bringing up the rear.

Energy prices are warming up again too with oil looking to make that long awaited breakout.  Nearly there.

Over in North American the tight oil and gas (better terminology than unconventional or shale oil and gas) boom has sent stocks there into the stratosphere.

Heavyweights Exxon and Conoco-Philips are well on their way.

 

And here in Australia the stealth onshore oil and gas boom I have been talking is now becoming very visible.

It is worth noting first the character of the Nth American and in particular the US with extensive infrastructure of pipelines and services companies makes for great efficiencies and lower costs. But just for single and hopefully contiguous one square mile sections that usually have 10+% royalties and more attached.

The large inland tenements in Australia allow for a totally different approach.  Having 10km of continuous and contiguous tenements gives explorers many more options. Having 50km even better.  Certainly all our costs are several times those in the US but there are likely to be significant trade offs in scale. Let’s just watch for a while.  Over to you, oil and gas industry.

The tight oil and gas here in Australia is applicable to so many basins and I consider it will only increase in importance over the next two decades.

The Cooper Basin is important because some infrastructure is already there and geological knowledge is broad and deep. Activity has been in conventional oil and gas and 3D seismic has provide some outstanding new oil and gas fields at a very high success rate.  The Western Flank has been very exciting and the Cooper Basin is now the largest oil producer in Australia today.

But much more is happening in the Cooper. The tight gas and shale gas targets have encouraged Big Oil groups like Chevron and BG Group to farm-ins and Beach Petroleum, Drillsearch and Senex are surging along with big programmes that plan to find the gas to deliver to the ever hungry new LNG projects at Gladstone on the East Coast.

Whilst concerns have been raised about CSM gas deliverability in Qld and shortages it is interesting to note Santos producing above expectations from its CSM fields and Senex highlighting its high delivery wells.  Nevertheless it will become clear that every LNG plant on the East Coast will be producing flat out and seeking to expand capacity to meet an accelerating global demand for LNG so much more gas will be needed for current capacity and wanted for expansions.  Note that a surprising number of new LNG receival stations are being built in ports all around the world as this market broadens.  LNG long term growth projections may be too low at 6%pa.

So exploration for gas in other parts of onshore Australia is well underway and I continue to like what I see with the Amadeus, Georgina, Beetaloo and MacArthur Basins in their searches for tight oil and gas in Basin Centred Gas/Oil accumulations.

Envision these as being similar to the coal seams in the Bowen Basin or the Sydney Basin.  Tens of kilometres of coal seam are known to be  there so it only depends on the depth and the style and quality of the coal at each site.  No exploration risk just appraisal and development risk.  And so it is with continuous tight hydrocarbon basins. It is no longer exploration but engineering.  The hydrocarbons are there but the question is how do we get them out.

The Amadeus is a special target due to its large size and its three levels of regional seals that restrain all hydrocarbons as well as some very valuable helium.

The recent Mt Kitty discovery by Santos with Central Petroleum could just be something very special because its continuous basin accumulation may be hundreds of km long and goodness knows how wide, up to 600m thick and covered by a massive salt blanket across the Basin.

The 0.5MMCFD flow doesn’t mean much just at present because it will need to be fracced to encourage fracture permeability in its 109m thick section.  Note that the Heavitree has delivered the same gas composition(including almost 6% helium) as was encountered in Magee 100km away. If it is a continuous gas accumulation rock formation and just the 2km Mt Kitty faulted structure section highlighted above is 2TCF then the number across the basin is very large.  Take note of CTPs statement that this discovery` could be the catalyst to interconnect the Northern Territory with the Eastern Seaboard gas market’.  This won’t be small.

Extent of Heavitree Quartzite and strata isopachs (lines of equal thickness indicating thickening to >600m)

And the Heavitree here extends over 400km to the west. Mt Kitty-1 is 100km SW of Magee-1 near the two wells Murphy and Endunde.  Watch this space.

Phoenix O&G royalty shareholders should be very happy (soon to list as High Peak Royalties HPR.ASX) I own all three participants here (STO,CTP and HPR.)

Other players like Santos, Beach, Drillsearch, Senex Armour Energy, Falcon Oil and Gas, Norwest Energy  and Advent have some pretty fancy targets in these tight basins and in another parts of Australia and 20014-15 should bring in some very intriguing results.  So keep watching them too.

All the above is showing that resources stocks are very cheap and many stocks have already started to move.  The broad indices aren’t really showing it yet but I expect they soon will. Very soon.   The June Qtr should be quite strong.

So there you have it.  Gold, oil, iron ore, copper, nickel, zinc, palladium, platinum, uranium, rare earths, technology metals, graphite and LNG.  Just about everything.  Just coal dragging the chain but it won’t be long before a change comes, particularly for coking coal.

No comment here on the Fed, Ukraine, the World Bank, IMF or other distractions just watching the markets for our sector.

So now talk to me at Paradigm and let us help you really benefit over the next few years.

+61 2 9222 9111

Sydney 28 April 2014

Disclosure: I own BHP, DLS LMB VXL LNG HPR AJQ CTP