Dr. Marc Faber, a longtime favorite of mine, likes to say that, "To be a good contrarian, you need to know what you are contrary about."
In other words, to have the courage of conviction to go against the crowd, you have to know the facts cold. Most individual investors cannot be consistently good contrarians -- we tend not to have sufficiently broad and deep expertise. But one area in which I feel confident is commodities. And while many people are looking forward to a coming bull market in equities and thinking that commodities stocks are doomed to keep underperforming, today I'd like to talk about some contrarian ideas that I believe will do well.
The background
One of the most popular commodities indexes -- the Reuters CRB Index -- got cut nearly in half during the last six months of 2008. Historically, such collapses have marked good entry points for commodities, at least on a short-term basis.
Furthermore, the index figures are actually somewhat misleading. Compared to the last major top in commodities back in 1980, nearly 30 years of inflation have depressed real commodities prices even further. Even though the index is higher than it was after prices collapsed in the early 1980s, they're actually at lower levels when you adjust for inflation.
The two-and-a-half giants
Two of the biggest and arguably best-diversified mining companies are BHP Billiton (NYSE:BHP) and Rio Tinto (NYSE:RTP). BHP tried to buy Rio Tinto last year, but Rio fought the deal, and after a lengthy and dramatic period, BHP eventually dropped its bid due to the economic slowdown. The Chinese, though, did not wait long before swooping in and taking a huge stake in Rio.
Aluminum Corp. of China (NYSE:ACH), also known as Chinalco, is buying $7.2 billion in Rio Tinto convertible bonds and taking a $12.3 billion stake in several of Rio Tinto's mines. This gives the Chinese a lot of leverage over the miner, and it helps them secure their commodity supplies in the future. On the other side, Rio gets capital in a tough economic environment. I would guess that this time last year, Rio did not expect that the prices of most of its products would be cut in half.
As you might expect, there's been some political backlash in Australia, as Chinalco's investment has to be approved by both Australian regulators and Rio Tinto shareholders. The fear of China, in my opinion, is very similar to what happened in the 1980s when the United States was terrified of being taken over by Japan.
But if the rest of the world chooses to run huge trade deficits with China -- No. 1 on the trade deficit list being the U.S. -- the Chinese will inevitably come back and buy assets with the excess dollars they have, especially given their concerns over the viability of the dollar as a reserve currency.
Chinalco looks interesting today -- the stock has come down from around $80 in late 2007 to the mid-teens today. The Chinese economy will slow some more, in my opinion -- it remains an export machine, and the rest of the world is not consuming as much -- but it still has much further to develop.
Rio and BHP look very similar on paper, although BHP is bigger and has exposure to oil. But in my eyes, these are the two best-diversified mining companies around. BHP is likely to be profitable in 2009; unlike Rio, it's unlikely to need a capital infusion, given its cash position.
Rio had less cash, so it needed the Chinese to come to the rescue. That's much of the reason for the stock trading at about half the valuation multiples of BHP. Rio looks to be out of the woods here, but I think it will only be an outperformer if commodities surprise to the upside.
What about gold?
The Chinalco/Rio Tinto deal is just one sign that China isn't waiting for the next upturn to start aggressively investing in commodities. Given the combination of China's interest and some of the monetary policy hiccups on the horizon, I'm surprised that gold bullion has stayed below $1,000 per ounce. As I've pointed out before, investors have lots of ways to invest; the most conservative of those remains the SPDR Gold Trust (NYSE:GLD).
But while gold hasn't skyrocketed, it has done fairly well. Other precious metals, such as silver and platinum, have seen huge declines due to their numerous industrial uses, which in this recession have caused demand to dry up.
If an economy emerging from recession does generate inflation, as I expect it will, I believe that silver and platinum will catch up with gold bullion. A way to invest in silver is through the iShares Silver Trust (NYSE:SLV), which trades equivalent to the price of silver per ounce. And a similar vehicle for platinum is the E-Tracs UBS Long Platinum ETN (NYSE:PTM).
The Chinese expect commodities to make them money. I think it's a smart move for individual investors as well.
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