The Upside to Trying Times

Eric Fry By Eric Fry
Macro Strategist

Commodities

Investing successfully in the natural resource sector is rarely easy. But sometimes it feels agonizingly difficult. Right now is one of those times.

During the early 2000s, I worked with a collection of natural resource investors who called themselves the “Hard Money Group.” But because the resource markets had performed so miserably during the late 1990s, competitors labeled them the “Hard-to-Make-Money Group.”

But the “Hard Money Group” had the last laugh. The resource markets began inching higher in 2000 and then soared for most of the ensuing decade.

Today, conditions in the resource sector aren’t as delightful as they were during the early 2000s. Many resource stocks are performing as well as can be expected and delivering solid gains… but most are not.

Profit growth isn’t the problem, however. News headlines are.

Despite robust profit growth throughout the resource sector, the stocks of many companies are struggling to advance because the news cycle has become so toxic.

Investors can see very easily that companies are posting strong results today, but they fear what those results might become tomorrow if trade tensions between the U.S. and various parties erupt into a full-blown trade war.

We do not yet know how severe or widespread the pain of a trade war might become. But investors are already showing clear signs of anxiety.

Since June 14 – the day President Trump approved the latest round of tariffs on Chinese imports – global stock markets have lost more than $2 trillion of market value.

For perspective, the total bilateral merchandise trade between the U.S. and China amounts to just $636 billion. So even if both governments levied a 15% tariff on every single imported item, the governments would reap less than $100 billion – less than 5% of what global markets have lost in the last two weeks.

The incessant volley of tariffs and trade war headlines creates a great big pile of risk and uncertainty, which causes many investors to sell first and ask questions later.

The anxiety seems to be especially acute in the resource sector, where investors are worrying that a trade war could adversely affect demand for every commodity under the sun – from crude oil to copper.

As a result of this pervasive angst, many resource stocks are “decoupling” from the price trends of the commodities they produce.

Let me explain…

During a typical bullish phase, resource stocks provide leverage to their underlying commodities. So if the price of copper were to rise 50%, a copper producer’s share price might rise 100% or 200%… or even more.

But in today’s anxious environment, the opposite is occurring: Many resource stocks are performing worse than their underlying commodities.

The crude oil market provides a telling example. The price of crude has been moving higher for more than 18 months. Initially, most oil stocks moved higher, in sync with the oil price. But that relationship has broken down somewhat over the last few months.

Even after this week’s sell-off, the price of crude is up 11% during the last six months. And yet the two largest oil sector ETFs on the New York Stock Exchange are showing losses for that time frame. The oil services sector is taking a particularly hard beating…

A similar trend is unfolding in the base metals markets.

The share price of Norilsk Nickel (OTC: NILSY), one of the world’s largest nickel producers, has been trending lower since the start of this year, despite the fact that the price of nickel itself has continued to trend higher…

Even in relatively obscure resource markets, like vanadium, lithium and graphite, being right about the direction of a commodity has not guaranteed you’ll make money by investing in a producer of that commodity.

Syrah Resources (OTC: SYAAF) is a major producer of graphite. Its stock has produced a loss over the last 12 months, even though the price of graphite has jumped nearly 50%…

One final example of the challenging conditions in the resource sector comes from the cobalt market.

Last month, a company named Cobalt 27 (TSX-V: KBLT) teamed up with Wheaton Precious Metals (NYSE: WPM) to arrange a cobalt-streaming deal with Brazilian mining company Vale (NYSE: VALE).

A metal-streaming deal, as some readers may be aware, occurs when a company provides an upfront payment to a mining company in exchange for future production from a specific mining operation.

Typically the streaming arrangement obligates the mining company to sell future production of a particular metal at a price that is well below the current market price. This exact deal is the one that Cobalt 27 and Wheaton just closed with Vale.

Under the terms of the transaction, Cobalt 27 and Wheaton will pay Vale a combined $690 million to purchase 75% of the finished cobalt produced in Vale’s Voisey’s Bay nickel-cobalt mine in Labrador, Canada.

All three parties said they were very pleased with the transaction. But the stock market doesn’t believe any of them.

The stock prices of all three companies have fallen since the day the deal was announced.

Wheaton’s shares have slumped 1%, Vale’s are down 5%, and Cobalt 27’s have dropped more than 25%.

Presumably the transaction is a good deal for at least one of the parties involved. No transaction can be a bad deal for both the buyer and the seller. But that’s the de facto verdict the market is rendering so far.

These trying times in the resource sector won’t last forever… even if it may seem like it’s been forever already.

Look on the bright side: Moments like these are buying opportunities. They are difficult and frustrating. But with a little bit of time and patience, they can lead to immense profits.

Good investing,

Eric