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China Won't Be Saving Grace for Commodities

Source: The Gold Report 4/24/2009


"If you think that you can be a beneficiary of some commodity strategies, just stick with it in the downturn," says John J. Licata, chief investment strategist at Blue Phoenix Inc., adding "you'll be all the better for it." Bullish on gold, platinum, palladium and natural gas, John is anything but bullish on the recovery, which he sees happening later than expected. In this exclusive interview with The Gold Report, John shares his near- and long-term outlook on the various metals and discusses what he feels are the best investment plays in the sector right now.

The Gold Report: John, you've said that you are not bullish on the recovery. We've recently noticed that things are starting to pull back. What’s causing the pullback, in your opinion? Why isn’t there more euphoria about some of the recently released earnings?

John Licata: We’ve been hearing from many companies, prior to earnings releases, that the second half of this year was going to look a lot better. Once these companies actually started to release earnings, however, we started to hear that recovery could be pushed back in 2010.

TGR: You were recently on MSNBC with Maria Bartiromo and in that interview you mentioned that you see further downside in some other commodities like gold and copper. Can you explain that a bit more?

JL: Yes. I was talking about the potential for prices to pull back in copper as well as gold. Both of those have actually pulled back since that segment. I’m more enthusiastic about being long gold rather than being long copper at the moment. This week Freeport-McMoRan Copper & Gold Inc. (NYSE:FCX) releases earnings and I think they’d love to hear management say that they’re going to be increasing output; but, from recent conversations management has had in the media, it doesn’t look like that’s going to happen any time soon.

I think Wall Street's thinking that China is going to be the saving grace for commodities is inaccurate. I also think Freeport-McMoRan’s management has blatantly said that they don’t think that copper prices have bottomed out, but they still think that North America has more downward pressure, and they said they don’t think that China is going to be the saving grace.

Copper prices are up about 40% year to date. As I said, I think they’re due for a pullback. As far as gold, I’ve been advising my clients to become buyers if gold moves back down to the $850 range. We came pretty close to seeing that on Friday and today we’re up north of 20 points in the gold market. I think gold is one of the best asset plays in the world. I think there’s been a fear factor with gold, causing it to move lower because of fears that the IMF was going to be dumping gold prices to raise money. I don’t think that’s such a credible argument. I think that gold is too important right now and most of the pressure we’ve been seeing is because of that. But I think that the IMF would not be dumb enough to dump gold and hurt their best investment right now in such a time of market uncertainty. So I do think that there’s a buying opportunity around the $850 level and I still have a $1,200 price target on gold for year-end 2009.

TGR: What’s going to drive gold from $850 to $1,200?

JL: Well, I think there are a couple of factors. I think that there’s been a lot of confusion amongst ECB (European Central Bank) board members whether or not they should be cutting their interest rates below 1.25 and I think that confusion is going to cause gold to be more of a safe haven play. In 2004 there was an agreement signed by the ECB that they would limit gold sales; that expires this year, I believe this fall. So I think that any renewal of that agreement is going to be a bullish sign for gold. I don’t think we’re out of the woods yet in the stock market globally and I think that gold, once again, is going to be seen as a safety play. If the IMF (International Monetary Fund) reassures people that they’re not going to be dumping gold, that's another bullish play and I think that we can see hyperinflation in late 2009 or 2010. I think that’s going to be another great point for gold prices.

TGR: You’re saying at $850, buy gold. Are you suggesting physical gold, gold ETFs, equities?

JL: I’m not suggesting buying the equities. Frankly, historically, the equities don’t move in tandem with the price of gold futures. If I had to suggest anything, I would either buy the GLD, which has been a great performer as of late, or actual physical gold if you could, but I would not buy the gold stocks if I were thinking that the move was going to be so strong. Again, historically, the stocks tend to underperform the physical commodity.

TGR: But the stocks have been driven down so far at this point in time, especially near-term producers, to record lows. Why wouldn’t we expect to see some bigger jump in the equities compared to gold, which is already at $850 or $900?

JL: First of all, I think that gold prices are going to move substantially higher, so on a percentage move, I’d rather be in the futures than in the equities. If I’m looking at some of the producers, I’m not discounting the fact not to buy gold stocks. I just think that the best way to play it is to belong to GLD or the actual futures themselves. A company like Newmont Mining Corp. (NYSE:NEM) failed to hold the 100-day moving average on Friday. It’s trading now well below $40. We’re seeing somewhat of a move right now. I think if we’re going to see any investment going into the equity side of the gold spectrum, I would actually look at some names within the group, maybe a company like Fronteer Development Group (TSX:FRG) (NYSE.A:FRG), which actually has a joint venture with Newmont Mining that has interesting assets, no debt, and a lot of cash. So I think that there are opportunities within the equities spectrum. Again, I just think that the physical is actually more of a better return scenario.

TGR: The same economic factors you are seeing that are driving gold prices, will they drive other precious metals and, if so, which ones and to what extent?

JL: Yes. I’m actually bullish on palladium prices. I think palladium and platinum prices can move higher. I think palladium can almost be seen as a jewelry substitute, especially in China right now with many manufacturers looking to take in more palladium just because they’ve seen the trend among the youth in China when it comes to palladium, due to prices. And I do think, when you look from a percentage move year to date, you’ve seen palladium prices are up 14% year to date, but they’re still trailing platinum prices, which are up about 26% year to date. I think those are two metals that tend to get overlooked, but I think PBMs are a good place to be.

When you look at platinum, most people don’t realize that you need platinum for catalytic converters in the auto world. So, whether we’re seeing a downsizing in cars from trucks to hybrids, you still need catalytic converters. Even though GM might file for bankruptcy, I think there are opportunities for other foreign makers to pick up the slack, so to speak. We’ve still seen auto demand in China ramp up. It has slowed in recent months, but it’s still positive for the year. So I think that platinum and palladium are two metals with much upside and I think that if gold goes higher like I think it will, I think those are two metals that could quietly show some really strong returns.

TGR: How does the investor play the platinum and palladium?

JL: Actually, there’s an equity that I like a lot, Stillwater Mining Company (NYSE:SWC). I had a recent conversation with management. They are still comfortable producing over 500,000 ounces by year end. They still see strength in the Chinese auto demand, but not as fast as it was. But it’s still strong. They’re managing to stay cash neutral. They’re not really seeing cash erode, which I think is a really good thing right now.

Talking to management, they said that there’s potential for more interchangeability with platinum and palladium due to new technology, which I think is interesting as well. They mentioned that there’s nothing really new on the front in terms of rushing inventories. They quit being a glut on the market place, but they also think that maybe a lot of the metals has already been shown to the market due to low energy prices, causing maybe some of these companies to look to raise cash by selling some more of their PBMs, so maybe some of the burden that’s been on those two metals might be past due. So Stillwater Mining is a company that I happen to like a lot.

TGR: Are they platinum and palladium or just platinum?

JL: They’re platinum and palladium and, actually, 75% of their output is palladium and 25% is platinum. It’s a little bit more than a 3:1 ratio. The interesting thing I like about them is GM and Ford are two of their big customers. But if GM files for bankruptcy, the company still thinks that they’ll be fine and, in fact, they don’t think they’ll have a problem selling the metal whether GM or Ford are still around. If you were looking for palladium prices to move higher as I am, then Stillwater might be a good way to hedge that position.

TGR: If GM and/or Ford go bankrupt, wouldn’t that put a downward pressure on Stillwater’s equity price, at least for the short term?

JL: It could be from a short-term trading perspective. Management seems to think that they have no problem selling the PBMs on the open market. Many people have already taken into account the company’s exposure to both General Motors and Ford, but the headline risk, I think, would be a buying opportunity.

TGR: You’re very bullish on natural gas. We see you’re bullish on gold and platinum and palladium. How do you compare these various plays, natural gas against gold?

JL: I think the potential for the price of natural gas to double, I think, is tangible. So, in terms of best commodities pitting themselves against each other, I’d like natural gas over gold and that’s saying something, considering I’m very bullish on the price of gold. Both crude oil and copper, I think, are near-term shorts, but I do see more of an upside for crude oil by year end than I do with copper. If you’re saying to be bullish on gold, then obviously platinum and palladium, you can’t discount the fact that silver prices are probably going to go in tandem with gold prices.

TGR: Do you see that the ratio between silver and gold will start to become more narrow? Will silver outperform gold?

JL: I don’t and the reason I don’t is because silver also has industrial demand and that’s one of the reasons why it’s been held in check thus far. Silver is still used in cameras and cell phones and water purification, so I think silver more than the other metals is used more for industrial purposes. So, unless the economy really starts to ramp up, I think you will see a rise in silver, but I think it will be held in check until we start seeing signs of a better economic pulse.

TGR: Very good. John, are there any other insights you’d like to give to our readers?

JL: I think that you have to look at some of these commodities from more of a bird’s eye view. A lot of their volatility has been exaggerated due to the fact that now we’re in more of a global marketplace more than ever. If you think that you can be a beneficiary of some commodity strategies, just stick with it in the downturn, because if you do, I think in the long term you’ll be all the better for it.

John J. Licata is Chief Investment Strategist at Blue Phoenix, Inc., an energy/metals independent research and consulting firm based in New York City. He has appeared regularly in the media (CNBC, Bloomberg TV/Radio, Business News Network, Barron's, etc.) over the years for his insights/forecasts in the commodity spectrum. Blue Phoenix Inc. correctly predicted $1,000 gold and $100 oil in the past 12 months.

After studying economics and graduating from Saint Peter’s College (where he received the Wall Street Journal Award for economic excellence), Licata set his sights on Wall Street. During his more than 13-year career, John has held both trading and research positions on the NYMEX, Dow Jones, Smith Barney and Brokerage America. Early in 2006, he founded Blue Phoenix, based in New York City.

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