COMMODITY STOCKS

Will commodity stocks ever take a rest? Typically, the late winter/early spring period creates some seasonal weakness, but I remain convinced that the long term uptrend in natural resource stocks remains intact. My view is premised on three factors. First, the economic ascent of emerging giants like China and India is only at its beginning and as these economies grow, demand for key commodities will grow alongside. Second, many highest quality natural resource producers continue to trade at reasonable valuations, especially when considering their superior growth. And third, institutional managers remain underinvested in key natural resource sub-sectors. Take base metal mining: the eleven largest mining companies traded in the US have less market capitalization than General Electric. Or consider the energy sector, which is tracked by fewer Wall Street analysts than the semiconductor industry. I have a feeling that’s going to change February 3, 2006

ENERGY

US oil and natural gas inventories continue to swell. As of this week, crude oil stocks were 9% ahead of last year and 12% above five-year average levels. Similarly, gasoline and distillate inventories above historical levels. As I was saying all of last year, what we were dealing with was not an energy crisis, but an acute shortage of US refining capacity. On the natural gas front, inventories are also rapidly building. Stocks are 28% ahead of the five-year average and 14% ahead of last year. Things can quickly change if the spell of mild winter weather ends, but if withdrawals from storage continue at current levels, a significant further buildup of natural gas inventories will be inevitable. What does this all mean for oil and natural gas stocks? Fundamentally, not much, because most analysts have based their forecasts on commodity price assumptions which reflect current conditions. The notion of a $80 oil price or a $20 natural gas price may have inspired speculators, but never penetrated the thinking of analyst. Still, the realization that oil will probably settle in the $50/60 range and natural gas will trade between $8 and $9 this year, may impact investor sentiment negatively. Given the attractive medium and longer term outlook for both oil and natural gas, I would use any meaningful correction to add to quality holdings. February 3, 2006

JAPAN

Has the Japanese stock market completed its correction? From a technical viewpoint, the Nikkei has improved its position, but fundamentals remain mixed. Yes, Japan’s cyclical recovery still has plenty of momentum left, which suggests that stocks, still not overpriced by historical standards, have further to go as well. However, the realization that interest rates cannot forever stay near zero and that the Yen will have to rise is now gradually getting priced into stocks. Japan also faces a series of daunting challenges in the medium and longer term, which will make themselves felt in equity markets. First, there are the country’s huge indebtedness (about 150% of GDP) and its massive deficit (above the 6% of GDP). The strengthening economy will help improve Japan’s fiscal position, but tax increases may be needed as well. Then there is the country’s devastating demographic profile, which suggests that tax revenues will falter and a shrinking aging population will need to service a very high national debt. In short: the Nikkei still has further to run, but the best part of its advance (45% in 2005) is likely over. February 3, 2006


Peter Cavelti’s background as a financial analyst and author spans 35 years and four continents. His grasp of global issues is extraordinary and his comments and books have been published internationally. He was president of Canada’s Guardian Trust and subsequently owned his own firm, which managed some of the best-performing natural resource mutual funds. Peter firmly believes that only an integrated understanding of geopolitical, demographic and economic events can lead to successful investing, and that is what his web service Perspectives is about. If you feel keeping on top of relevant global events takes too much time, Perspectives is for you. Whether it’s investment advice or political analysis, Peter offers his insights in concise and easy-to-read form. Best of all, Perspectives is free. Visit www.cavelti.com and sign up today!