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April 19, 2015

Finding Value with Plunging Commodity Prices

By Frank Holmes
The Shanghai Composite is up 87 percent year-over-year and is currently at a seven-year high.  So what’s the deal with Chinese equities right now? After all, China’s economic growth for the first quarter of the year cooled to a six-year low of 7 percent.
The market surge is mostly attributable to monetary easing and government policy changes such as housing stimulus and modernization of the country’s financial structure. But there’s more at work.

Saving Big on Commodities Slump

Also contributing to the bull run is the plunge in commodity prices since last June, brought on by both the strong U.S. dollar and a slowing global economy.
Such market conditions have obviously been a challenge for those involved in the production of raw materials and natural resources. But they’ve been a windfall for net-import countries, China included. Most of the beneficiaries are Asian and Eastern European nations—excluding Russia, whose economy largely depends on revenue generated from oil exports.
Besides Russia, the biggest losers have been Latin American countries, huge exporters of some of the hardest-hit resources—crude oil, sugar, soybeans and coffee.

As the world’s largest importer of natural resources, China saves an estimated $600 million a day on its oil import bill. That’s a staggering $200 billion a year. Low oil prices, in fact, should help boost GDP growth in the entire Asia-Pacific region between 0.25 and 0.5 percent, according to Rajiv Biswas, economist at consulting firm IHS Inc.
Low oil prices are also helping many businesses and companies such as American Airlines keep more capital in their coffers. For every $1 change in oil, American saves about $105 million per month in jet fuel costs, according to airline research analyst Helane Becker of financial services firm Cowen Group.
Amazingly enough, precious metals are the best-performing commodities sub-sector so far this year, having collectively lost 2.5 percent.

Of the 29 resources featured in the chart above, only red meat is in the black.
Platinum and palladium are fundamentally undervalued right now, and demand for both metals is expected to pick up this year. Low prices should spur platinum jewelry demand in China, while an increase in automobile sales in the U.S., eurozone and China should help palladium. (Palladium is used in the production of catalytic converters.)Whereas many of these commodities are facing oversupply issues, the cattle industry as well as barbeque purveyors are currently struggling with a brisket shortage, which have driven the wholesale price of the popular cut of meat up 60 percent from last year. Several barbeque joints here in San Antonio, in fact, have fallen victim this year to what the media are calling “the brisket bandit,” who’s made off with thousands of dollars’ worth of meat, both raw and smoked.

The Start of Mergers and Acquisitions

The challenging crude oil environment has prompted the first of what will likely be a new wave of oil and gas company mergers and acquisitions (M&As) similar to what we last saw in the late 1990s. If you recall, Exxon merged with Mobil in an $80-billion deal, BP tied the knot with Amoco and Chevron bought Texaco.
Now, for double that price in cash and stock, Royal Dutch Shell plans to gobble up UK-based BG Group in the biggest deal since the Exxon-Mobil merger. The combined companies will become the world’s largest producer of liquefied natural gas (LNG). Shell’s oil and gas reserves will grow 25 percent and give the company huge exposure to proven oilfields in Australia and Brazil. As is normally the case, the company being acquired sees a spike in share price, and BG is no exception; this week alone, its stock has risen more than 30 percent.The current cycle kicked off last November when titan Halliburton agreed to purchase Baker Hughes for $35 billion.
It’s doubtful we’ll see a deal this round as massive as Exxon-Mobil, but we expect more to occur among the junior to mid-tier producers and explorers.
About The Author - Frank Holmes is CEO, Chief Investment Officer of U.S. Global Investors, an investment management firm specializing in commodities and emerging markets based in San Antonio, Texas.  Frank is also the co-author of The Goldwatcher  (EconMatters author archive here.) 
The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters. © EconMatters All Rights Reserved | Facebook | Twitter | Free Email | Kindle

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