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What to Do About Falling Commodity Prices

By Matt Badiali, editor, S&A Resource Report
Monday, February 5, 2007

"The price of copper could fall by half, to $1.50 per pound."
 
Jaws dropped. The audience at the New Orleans Investors Conference in November was ready for another speech about how commodities were going to make them rich, but Paul Van Eeden, a precious metals analyst, told them exactly what they didn't want to hear.
 
Paul believes a global economic slowdown will act as a drag on China's GDP growth... growth that depends heavily on exports. And if China ships fewer cars, toys, and electronics, that means less demand for copper.
 
Hyped-up commodity investors should take Paul's point to heart: Prices could easily go down this year.
 
I've learned the hard way that you can't simply bet on the rising price of a given commodity. That goes for copper, oil, gold, corn, whatever. Instead, our most important job as investors is to buy cheap assets. That way, you reduce your downside risk if a commodity price dips. And if a commodity price rises, well, that's just icing on the cake.
 
As simple as it sounds, that can be a hard discipline to maintain. It's too easy to excuse high operating costs when a company gets top dollar for its production. But these high-cost operations are heavily leveraged to the assets they produce. While all that leverage may be good in a period of rising prices, it can crush a stock when commodity prices fall.
 
So I try to think long-term when I buy mining companies. And my strategy is to find the assets selling for way less than they are worth.
 
That means only buying a copper company for less than $1 per pound of reserves, even when the price of copper soars above $3.
 
Here's an easy method for sorting the wheat from the chaff among commodity companies: Divide the market cap by the reserves (both figures are readily available in the most recent presentation or quarterly report). This should give you the price to reserves (in dollars per pound or ton or barrel).
 
Compare that number to the current market price of the commodity. If the price to reserves doesn't give you at least a 20% discount to the commodity price, find a new company. That way, falling prices won't keep you up at night or stop you out of fantastic investments. That's why I don't worry much about the price of copper falling fifty cents.
 
This simple technique will insulate you from all but the greatest collapses in commodity prices. And if the market heats up, your overlooked company soars along with it. Your cheap producer becomes the next big story... and you reap the reward for getting there early.
 
Good investing,
 
Matt Badiali
Editor, S&A Gold Report




Market Notes
Joining the Dow Industrials, Dow Transportation Average hits a new high.
 
Agricultural equipment producer Deere & Co. at new high.
 
Nearly all consumer goods, financial, real estate, and health-care ETFs at new highs.
Market Watch
Symbol Price
Change
52-Wk
S&P 500 1221.53 +1.3% +10.1%
Oil 37.77 +1.5% -2.8%
Gold 135.20 -0.1% +13.4%
Silver 27.93 +0.4% +47.9%
US-Dollar 80.67 -0.8% +8.1%
Euro 1.32 +0.6% -12.1%
Volatility 19.39 -9.2% -8.2%
Gold Stocks 564.53 +1.3% +10.6%
10-Year Yield 3.00 +1.4% -9.6%

World ETFs
Symbol Price
Change
52-Wk
USA 122.56 +1.3% +10.2%
Canada 30.44 +1.3% +13.8%
Russia 21.63 +2.3% +16.7%
India 37.73 +1.9% +20.0%
Israel 16.47 +0.9% +9.7%
Japan 10.58 +1.0% +7.4%
Singapore 13.88 +1.0% +19.2%
Taiwan 14.72 +1.6% +17.8%
S. Korea 56.56 +1.7% +22.8%
S. Africa 70.85 +3.9% +22.9%
China 45.06 +1.4% +0.1%
Lat.America 52.82 +1.4% +6.7%

Sector ETFs
Symbol Price
Change
52-Wk
Oil Service 136.18 +1.5% +14.8%
Big Pharma 64.13 +0.6% -3.3%
Internet 72.13 +0.7% +22.3%
Semis 16.03 +2.1% +28.9%
Utilities 31.21 +0.3% +1.6%
Defense 18.51 +1.3% +10.1%
Nanotech 9.99 +1.3% +0.0%
Alt. Energy 9.95 +1.4% -4.4%
Water 18.31 +1.1% +12.2%
Insurance 16.07 +1.2% +18.3%
Biotech 20.58 +1.1% +27.1%
Retail 19.65 +0.1% +28.4%
Software 24.59 +0.9% +24.1%
Big Tech 53.73 +1.0% +21.9%
Construction 12.99 +2.1% +13.3%
Media 13.57 +1.1% +25.0%
Consumer Svcs 67.26 +0.8% +23.3%
Financials 54.87 +2.4% +5.2%
Health Care 64.22 +0.7% +1.3%
Industrials 63.25 +1.6% +19.7%
Basic Mat 73.57 +1.6% +21.6%
Real Estate 55.24 +1.4% +23.8%
Transportation 91.17 +1.4% +25.6%
Telecom 22.48 +1.1% +17.1%

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