Up, down. Up, down. Tracking the movements of these markets too closely can add neck strain to financial pain.
This week alone, we've seen double-digit moves in both directions from many commodity-related equities, suggesting that investors may have their noses too close to the screen.
Thankfully, each quarter brings a fresh dose of broader perspective from the company whose earnings reports I consider required reading for Fools with commodity exposure. Mining equipment manufacturer Joy Global
All eyes on China
Clearly, I'm not the only investor with all eyes on China for the first indications of stabilization or recovery in commodity demand. China's re-stocking of dwindling stockpiles recently led to a surge in the BDI and a premature rally in shipping stocks. The mere rumor of a second stimulus plan from China this week sent investors diving into stocks like Freeport-McMoRan
"There are indications that supply cuts are achieving their objectives, and that commodities are reaching a point of stability. Lower commodity prices are allowing some marginal steel mills in China to return to production. As a result, iron ore stockpiles at Chinese ports have peaked and started to decline. […] The Company cautions that it is too soon to draw conclusions from limited examples, and in addition would see these as signs of demand stabilization rather than demand recovery."
Although each commodity has its own story to tell, Joy Global describes an overall reduction in global commodity production of about 20% by the end of 2008, a reduction in mine expansions and capital expenditures of up to 50%, and steel output cuts of about 30% worldwide and 17% in China. I have been tracking these production cuts closely and share Joy Global's view that they are likely to overshoot the true reduction in demand.
What's your poison?
For copper enthusiasts, Joy Global offered a stress test for Fools to consider. The company considers about 15% of global production to be unprofitable at sustained prices near $1.50 per pound, and sees higher-cost mines facing closure while lower-cost mines come online in places like Chile. Copper prices have bounced from a low of about $1.25 in December to $1.60 today but have yet to recover to anything resembling a comfort zone for miners. In the meantime, low-cost operators with large cash moats like Southern Copper
If oil sands are your cup of black tea, Joy Global suggests that a return to $70 to $80 oil will be required for expansions of oil sands projects to gain approval.
In the case of thermal coal, demand is expected to correlate with the GDP growth rates of the relevant economies. In other words, Joy Global expects 5% GDP growth in China for 2009 to correspond to 5% growth in thermal coal demand there, and a modest contraction of demand in the U.S. and Europe where GDP contraction is expected. With a foot wedged firmly in China's door, Peabody Energy
It's hard to mine without equipment
Joy Global saw deep disruptions to near-term demand manifest through order cancellations totaling $161 million during the quarter. About 80% of those cancellations came from customers producing North American iron ore Appalachian coal. While the company retains a total backlog of $2.96 billion, concerns that weak demand for new equipment could reach beyond the scope of that cushion and into 2010 has the company looking to rein in capacity while fulfilling existing orders.
I have consistently made a stark distinction between the near-term disruption to commodity demand from the leading wave of this financial storm and the longer-term fundamentals for demand recovery from the emerging markets, particularly Asia. Although demand recovery may not materialize until 2010, this stabilization phase provides the opportunity to gain commodity exposure at compelling valuations, but only for those who can stomach the near-term uncertainty and volatility that Joy Global forecasts.