Why commodity prices are turning Sanjeev Shah's stomach

by Dylan Lobo

Fidelity’s Sanjeev Shah believes it is a fertile time for special situations investing with valuations in the financial and drugs sector looking particularly appealing, but commodity prices leave him queasy.

  

Shah (pictured), who manages the £3.1 billion Citywire Selection Fidelity Special Situations fund, says he has identified a significant number of valuation anomalies in the UK market (see graph below).

  

Shah said: ‘I am encouraged that a number of sectors are not only cheap when compared with their long-term price history but are also disliked by sell-side analysts, under-owned by mainstream investment institutions and are attracting a high number of short sellers.

‘That combination is a good indicator of future outperformance as long as the true value of a company is not properly reflected in its share price. These cheaper sectors provide fertile ground for a stock picker such as myself, and they are currently where I am finding a lot of my ideas.’

Financials and drugs

Areas which are proving to be a particularly fertile hunting ground for Shah include ‘cheap and under-owned financials and pharmaceuticals, which he points out have few buy recommendations from analysts despite their relatively attractive valuations.

Shah believes the valuations on financials are as attractive as at any point in the last 25 years. 'Comparing share prices to book value, the sector has not been so cheap in the past 25 years. As well as banks such as HSBC, which is cheap compared to its long-term earnings capability,’ he said.

He also says he is finding opportunities in the wider financials universe where there is upside potential for rents in UK commercial property, especially in the City and West End, with the added attraction being that property offers attractive yields in a low yield environment.

Shah also believes the drug sector offers exceptional value on a historical basis. ‘The drugs sector is cheaper relative to the broader market than at any point in the past 15 years and valuations are underpinned by strong cash generation,’ he said.

‘I believe the concerns regarding a lack of new products, generic risk and the regulatory threat are well understood and discounted by the market.

Importantly, management at companies such as GlaxoSmithKline is alert to the need to address these challenges with a radical shift in corporate strategy.’

Commodity values stomach turning

In contrast he is bearish on commodities and industrial cyclicals on the basis these sectors are expensive but still in favour with brokers. ‘I’m extremely underweight in these areas as I really struggle to find any areas of interest to me, except in precious metals.’

 

He added: ‘One consensus investment that I am very happy to pass up is that of commodities and also some other cyclical sectors such as chemicals. In both cases, valuations are higher than they have been for years, if not decades, and hard for a contrarian to stomach. I’m also concerned about the balance between supply and demand as emerging markets continue their drive towards greater domestic consumption.’

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Don't Short 10 Year Treasuries, Buy Gold and Silver

by Kevin McElroy

I often write about Treasuries, the dollar and currencies, and at first glance I realize that these subjects may seem to be unrelated enough to avoid altogether. Because they are boring, let’s face it. But we need to be aware of what’s going on in Treasuries, the dollar and currencies, because these mediums are prisms through which we understand commodities.

If gold was priced in chickens, wheat priced in silver or natural gas priced in lean hogs, then we could avoid talking about dollars.

But as it stands, you literally can’t understand what’s going on in commodities without first understanding what the heck is going on with currencies. And right now, we’re on the precipice of an important, long term trend in Treasuries that should play out over the next decade, and possibly longer.

First, a little backstory:

In early 1965, 10 Year Treasury yields briefly dipped below 4.2%. They peaked 16 years later in 1981 at over 15.32%. Rates wouldn’t get back down below 4.5% for 37 years until 2002. My point is: buying 10 Year Treasuries (or any Treasuries, for that matter) in 1965 would have been disastrous.

Today, we’re in similar circumstances. Below, I’ve plotted the 10 Year Treasury Yield (in green) alongside the 30 Year Treasury Yield (in blue):

Treasury yields bottomed in late 2008/early 2009 as investors dumped just about everything in favor of the relative perceived safety of Treasuries. Ironically, or perhaps not so ironically, that period was among the worst times in the last 30 years to invest in long-dated Treasuries.

Since then, some of the best and brightest economists and prognosticators in the market have been pounding the table to short government bond prices.

“The Investment of the Decade!”

That’s how these folks have been describing this opportunity. And I agree with them. Interest rates will rise, bond prices will plummet, and some people will make a boat-load of money shorting bond prices.

They remember the multi-decades long period when you could have doubled your money, year after year, doing nothing but shorting Treasury prices. The main problem with this strategy is that Treasury bond yields, though dependent on immutable market forces, are also subject to the whims and fancies of politicians.

These yields can and do get pushed up, down and all around by the machinations of the Federal Reserve, the United States Treasury, and assorted intermediaries and overseers. In other words, making an investment, short or long, based on US Treasuries puts your money in the way of the many and sundry political forces running this country.

A much easier and less complicated way to invest based on perceived dollar weakness or relative strength is to simply buy (or sell) physical gold or silver.

I understand that buying gold or silver doesn’t exactly follow the same line of thought as shorting Treasuries, but the effect can be largely the same under most circumstances.

For instance, if you had bought gold every year between 1965 and sold it in 1981 (when interest rates peaked) you would have doubled your money nearly every year. You could have done so without opening up a special trading account (as you would need to do if you wanted to short Treasuries) and you could have bought and sold the gold in small increments.

Today, if you want to short Treasuries, there are a few short bond funds to choose from, but even though rates have risen from the early 2009 lows, these funds haven’t performed very well. One of the most popular funds, the ProFunds Rising Rates 10 Fund (RTPIX) lost money during this period.


That’s not to say that it won’t succeed in the future as rates continue to rise, but the other downside to this fund, and others like it, is the $15,000 minimum initial investment.

Now, I want to reiterate- the investment thesis behind buying such a fund is that you believe rates will rise precipitously for the foreseeable future. Again, that’s not the same reason that you’d purchase gold or silver. But the fact that rates are too low right now generally tends to be a positive catalyst for owning gold and silver.

So, not exactly the same thing – but right now, buying gold and silver is easier and cheaper.

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Platinum, Palladium ETFs lure investors

by Commodity Online

Platinum and palladium are two commodities precious metals investors are banking on these days. Prices of these precious metals, popularly known as PGMs, have been on the rise in the last two years. Investors are also piling their money into exchange traded funds (ETFs) in platinum and palladium, says a new research report from Standard Bank - Precious Metals Monthly.

Following is an analysis from Standard Bank on PGMs's performance:

"January saw average platinum and palladium prices for the month both rise by 5% in dollar terms compared to December. The similar percentage increase for each metal, in stark contrast to palladium’s out performance over the previous six months (as shown in the chart below right), masked greater volatility in the palladium price during the past month compared with its sister metal.

The year began with the more volatile palladium realizing a steeper correction than for platinum. As a result, palladium tested the $750 level between the 5th and the 10th as the dollar reached its strongest level against the euro since last September. Thereafter, palladium quickly rebounded; gaining $50 in just two trading days, a performance in dollar terms that was matched by platinum although this represented a markedly smaller percentage increase for the higher priced metal. Over the remainder of January, palladium traded broadly between $790 and $825, with attempts to breach the top of this range meeting strong resistance.

Platinum, meanwhile, peaked at $1,846 (a.m. fix) on the 19th but substantial US dollar weakness then saw the price fall rapidly to below $1,800, a level at which platinum largely remained over the course of the month. However, the start of February has subsequently seen both PGMs rally back towards recent highs, supported in part by improved confidence in the global economic recovery, especially in the United States.

The increasingly supportive macroeconomic data of recent weeks has buoyed the outlook for industrial demand for a range of metals, including PGMs, and not least across the auto sector. Recent figures for auto sales have generally surprised the market on the upside, with Japanese vehicle sales in January reported to have risen by more than 6% month-on-month.

In the United States meanwhile, sales were over 16.3% higher year-on-year in January and, although they were flat compared to the prior month this still led to renewed optimism about the gradual recovery across the industry. (Furthermore, sales of pickups and cross-over vehicles, which tend to have higher PGM loadings, have improved.)

Elsewhere, in the European auto market there were also signs of firmer demand, with new car registrations in December showing their smallest year-on-year decline since March. In China, automotive sales data for January is delayed due to the week long Chinese New Year holiday, making assessments of the state of that market more difficult to ascertain. However, the strength of the latest GDP figures has highlighted the likelihood that this will trigger further monetary tightening to quell inflationary pressures and in all likelihood this could hinder auto sales growth later this year.

Turning to investment, this has continued to provide a generally supportive backdrop to PGM prices over the past month. This was most clearly demonstrated in January by the trend in ETF holdings, which continued the strong inflows that had emerged in the final quarter of 2010 for both metals.

In fact, for the first time ever ETF holdings of palladium increased by more than 100,000 ounces for two successive months. As in previous months, this increase was concentrated in the ETF Securities New York and London funds, although there was also a lift of over 20,000 ounces in the ZKB fund. At the same time, platinum ETF holdings continued to grow at roughly half the rate of palladium, with a rise in January of a little more than 60,000 ounces.

Similar to recent months, but in contrast to ETF holdings, there were relatively small changes in the net investor long on Nymex for palladium, according to CFTC figures. However, it should be noted that in the case of platinum the net investor long continued to rise to a fresh all-time high, as fresh longs were placed in mid-month. As a result, the net long has more than doubled in just over 6 months, from its low on 20th July to the latest available data (for 1st February).

Turning to supply, the most significant development in the past month was the reports from Eskom, which provided some price support in the PGM market. This was due to flooding in South Africa having affected coal supply, leading to Eskom stating that the coal shortage may result in power cuts, with increasing concerns of tightness in the energy market as early as March. This is particularly important for the platinum price as South African output typically accounts for around three quarters of global mine production.

On the supply front itself there were also a slew of production figures in the past month. Lonmin stated in late January that its refined platinum production in the final quarter of 2010 dropped 17% from a year earlier to 81,982 ounces. This decline was not unexpected, due to the planned rebuild of its main furnace and poor weather but was cushioned by the tolling of some 9,000 ounces of platinum. Indeed, the company’s refined palladium production was actually up 10% over the quarter due to more than 35,000 ounces of tolled palladium output. The company had announced earlier in the month that it had reached an agreement with the National Union of Mineworkers (NUM) for workers to receive an 8% wage increase backdated to 1st October 2010, as well as a one-off payment of 850 Rand.

Elsewhere, Norilsk Nickel produced 645,000 ounces of palladium and 161,000 ounces of platinum in the final three months of 2010, down 10% and 7% respectively compared to the prior quarter. The company stated that the declines were anticipated and chiefly occurred at its Russian operations. In fact, taking 2010 as a whole the company’s annual production of platinum was 5% higher and that of palladium up 2%."

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TRIAL OF THE CENTURY: Silvio Berlusconi To Face Sex Charges April 6

by Joe Weisenthal

Berlusconi and Minetti

A judge ruled this morning that Italian PM Silvio Berlusconi must stand trial on sex charges. Specifically, the charge has to do with paying for sex with a minor, and then abusing his power to get her released by the police. His trial begins on April 6.

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Ethanol Doesn't Fuel Commodity Prices

by Pam Golden

Ethanol uses corn, but it doesn't fuel food prices and it isn't the catalyst in the increasing volatility in commodity markets. That was the prompt response from the ethanol industry in the wake of renewed food versus fuel allegations last week.

"Oil and energy prices are much more responsible for increased food prices than anything else," said Bruce E. Dale, Editor in Chief of the Great Lakes Bioenergy Research Center, Bioproducts and Biorefining Michigan State University

"We are not going to make progress in dealing with our energy problems until we make reasonable and realistic comparisons between oil alternatives and the costly status quo of continuing oil dependence," Dale said.

Dale and Tom Buis, chief executive officer for Growth Energy, want to push this discussion deeper into the facts.

"Let's have this debate, but let's have it on facts," Buis said.

"The notion that ethanol is causing today's food crisis ignores reality: the reality of the market, the reality of global trade agreements, the reality that other countries have their own domestic farm policies, and the reality that Wall Street's rampant speculation is driving up food prices," Buis said.

For those who don't want to take his word, Buis pointed people to several reports, including a U.S. Department of Energy's Oak Ridge National Laboratory report that found corn ethanol's contribution to indirect land use change as 'minimal to zero'.

Buis also said ethanol detractors decry the use of corn for ethanol without crediting the industry for the animal feed it gives back in the form of distiller's grains. The percentage of the U.S. corn crop going to ethanol is "just part of the story because you're getting back very high protein animal feed."

On the commodity market side, Buis and market analysts point to non-commercial players as the driving force.

While most believe ethanol plays a part in tightening the supply/demand equation in the corn market, analysts more often point to those who don't have a vested interest in the commodity – who don't hold any product – as driving the market.

"There's no correlation between futures and the cash market," analyst Richard Brock said recently in a presentation unrelated to the food versus fuel debate. "So much cash is in there it's just one speculative crap shoot."

Another aspect of the debate is government support. Though ethanol subsidies are largely discussed, Buis pointed out few are aware of the many tax breaks given to the oil industry and fewer still consider government protection of shipping lanes in the volatile areas of the world from which oil is shipped.

"A lot of their tax breaks are so well hidden in the tax code, it's hard to get a good hand on it," Buis said, noting those tax breaks are indefinite. "Ours are very transparent and they come up for renewal."

The long-term impact of ethanol bashing is that it will hamper development of second-generation alternative fuels, said Todd Becker, of Great Plains Renewable Energy, Nebraska. For a country that claims to wants an independent fuel supply, Becker said, decrying ethanol is not the way to achieve either energy independence or a greener, renewable energy supply.

"If we don't show the industry we support a strong first generation platform than there won't be a second generation," Becker said.

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Why investors are liquidating Gold and Silver ETFs

by Commodity Online

Investors liquidated large quantities of exchange traded funds (ETFs) in gold and silver as prices of these precious metals dropped in January in response to strong Chinese GDP figures and market nervousness in the expectation of more monetary tightening from the Chinese authorities, says a precious metals analysis from Standard Bank.

Where does the gold-silver ratio stands, and why investors are liquidating gold and silver ETFs? Here is an indepth analysis on gold and silver from Standard Bank:

"Silver’s high fix for January was the first of the month, at $30.67, before the gold-related slide took it to a low fix of $26.68 on 28th January. In early February silver bounced towards $29, but much of that improvement was short covering rather than fresh buying interest.

Similarly to gold, the physical market has been strong and tight; there have been times, in India in particular when, in the face of high absolute prices, silver has met more support than gold. Here too, however the “hot money” has held sway and as a result silver unwound part of what had been an over-heated position. We remain friendly for the longer term, but silver is in a long-term surplus and thus remains reliant on investor demand. Seasonal factors suggest that this will wane during February. Silver’s volatile nature makes it unwise to recommend a buy-on-dips policy in the short term; rather, it might be wiser to wait for clear evidence of price stabilization before considering taking exposure in this most volatile of metals markets.

The net long non-commercial and non-reportable Comex positions contracted by 15% between end-December and late January, to a ten-month low, before the price’s downward momentum slackened. This, through, unlike gold, comprised only an eight-month high in the outright short position, while longs actually increased in the latter part of the month, perhaps reflecting confidence that, in the medium term, prices will improve as the fall had been too swift. In early February the position had increased slightly under short-covering as longs bailed out again amid more nervousness.

Silver dropped 17% in euro terms during January before unwinding more than half that fall in the early February rally (safe haven demand for gold and economically inspired-dollar strength). In producer terms, the price average from the start of the year through to early February was 62% up in US$ term year-on-year, up 54% in C$ and 46% in A$.

Silver’s strong run in late 2010 (+72% from late August to the start of January) argued for a correction in price and, when gold faltered, a sharp drop ensued. This meant that silver was notionally paying more attention to the parameters governing gold than those that apply more closely to the industrial metals, since part of gold’s fall was triggered by improved economic confidence. Silver’s daily trading correlation with copper in January was 65%, as it was over the whole of 2010. The correlation with gold in January was 78%, against 58% for 2010. In the medium term, silver is likely to revert towards the industrial metals, but this is more likely to develop when volatility has subsided rather than in the immediate future. It should then also benefit from renewed investor activity towards the end of this year as result of resurgent inflationary fears.

The gold: silver ratio has traded between 45.3 and 49.6 since the start of the year, almost as narrow a range as in December, when the heavy contraction of 2010 was finally arrested. The narrow ranges suggest that the ratio has ceased to attract speculators’ attention of late, and the near-term prognosis suggest that it will continue to hold broadly steady. Silver’s lower unit price, and its semi-industrial base, suggest that silver may be the first to move higher in the medium term. For this reason It is worth watching the index as a lead indicator for trend shifts and developments in both metals; this suggestion is also well founded historically. Silver frequently leads gold when a new trend is developing.

Both gold and silver ETFs have come under liquidation since the start of the year although, on a proportional basis, the silver redemptions have been smaller than those of gold. There was some buying right at the start of the year, but since then the selling has been constant, with just one day when there were any purchases of note. This was during the third week. It came in the wake of a sharp drop in price (from $29 to $27) in response to strong Chinese GDP figures and market nervousness in the expectation of more monetary tightening from the Chinese authorities.

Sales resumed swiftly thereafter, however and holdings in early February stood at 14,221 tonnes, a fall of 577 tonnes in five weeks. Peak holdings were on 5th January this year, at 14,846 tonnes and so the subsequent contraction represents 4% of the maximum. A stabilization in these funds may well be an important indicator of sentiment and could trigger more short covering, but trading conditions in the silver market overall are likely to remain volatile during February."

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