Metals Are Burning Up the Market

Suppliers are dealing with strikes and outages. But as demand soars, investors are seeing gold, silver, and other commodities hit their highest prices in years

Investors in the metals market have been treated to a nostalgic -- and profitable -- trip down memory lane this month. Prices for gold, silver, and platinum are at the highest levels since the early 1980s. And then there's once-lowly copper. The red metal has set new all-time highs, finishing Mar. 29 at almost $2.46 a pound, yet another record. Aluminum and zinc are trying to get into the game, too, having recently exceeded their highs of the 1990s. And the metals bonanza of 2006 follows three previous years of rising prices.

So isn't it time to sell these hot commodities and the stocks of companies that produce them? Not so fast, say analysts and fund managers. Commodity cycles run in decades -- and there are plenty of fundamental reasons why metal prices should, at the very least, remain elevated.

"We see good global demand while supplies are facing labor and mining problems," says Derek van Eck, chief investment officer of Van Eck Associates in New York. "I just can't find a big, bad story out there anywhere on the horizon that's going to change the picture."


  So far, 2006 has played much like the previous three years. Gold -- which was selling for only about $250 an ounce in 1995 -- raced to $572 an ounce in early February, sold off and has since rallied back to $578, up 12% for the year. (see BW Online, 1/3/06, "Through a Gold Bug's Eyes").

Copper has gained almost 20%, as renewed labor problems at mines in Mexico and continued strong demand around the world surprised many investors who were expecting a selloff. Silver is up 26% as investors bet that a new exchange-traded fund from Barclays will soak up supplies in an already tight market. Aluminum is up 22% and zinc almost 40% as demand for heavy equipment, airplanes, and infrastructure such as highways and railroads remains strong across the globe.

Gold sometimes trades in its own world as the safest of all safe havens in times of turmoil. The current rally is being fed rather by increased buying from a host of areas, according to the World Gold Council. Jewelry demand rose 14% measured in dollars, industrial demand increased 11%, and investors upped their purchases by 37%, including a 67% increase from exchange-traded funds in the U.S. and elsewhere, the council reported.


  On the supply side, mines produced only 1% more gold than they did in 2004. Frank Holmes, chief investment officer at U.S. Global Investors in San Antonio, has been bullish on gold throughout the current cycle; he points to the run-up in oil as an overlooked factor. Billions of petrodollars have already flowed into gold, he says. Based on the historic relationship between the two commodities, he says, gold should hit at least $700 within a couple of years.

Still, that doesn't mean that shares of every gold-mining company are a buy, say the fund managers. The biggest producers, companies like Newmont Mining (NEM) or Barrick Gold (ABX), aren't able to increase production much and are operating older, less-efficient mines than some smaller players. Van Eck favors mid-tier players including Meridian Gold (MDG) and Agnico-Eagle Mines (AEM). Holmes likes Goldcorp (G) which is showing growth and has diversified into copper.

Silver rose last year as demand for the metal in jewelry and electronics grew faster than expected. But lately, silver has been running higher because of ETF excitement. (see BW Online, 3/27/06, "Funds to Cover Every Angle"). Until two years ago, no U.S. fund was available that invested directly in precious metals. Then, in 2004, State Street got regulatory approval for an exchange-traded fund that would buy gold. That fund has already ballooned to over $6 billion.


  While there may be less interest in a silver ETF, the silver market trades far less in a day than gold, so the impact of the ETF could be greater. Barclays hasn't said when its silver fund will hit market, but it's expected shortly as the Securities & Exchange Commission approved its listing on Mar. 20. Meanwhile, investors who don't want to wait can buy shares of silver producers. Silver Wheaton (SLW) has been able to increase cash flow at double the rate of the metal's advance, says U.S. Global's Holmes.

Copper, on the other hand, has been bucking its own trends. The price of copper has historically been seen as a solid indicator of economic growth. With the Fed and other central banks raising interest rates to slow their economies, the price of copper ought to be ready for a fall. However, copper-mining companies haven't added much supply in recent years, and strikes and accidents have taken some producers offline.

There were 23 outages at copper mines and smelters last year and four more so far this year, says Citigroup (C) analyst John Hill. A landslide last week at Freeport-McMoRan Copper & Gold's (FRX) Gasberg mine in Indonesia unsettled the market and sent prices higher even as the company said production would continue. Hill rates Inco (N), the Canadian mining company, as a "buy" because of its growth prospects and Phelps Dodge (PD) a "hold" because of below-market hedging agreements. (see BW Online, 4/3/06, "Phelps Dodge: Time To 'Make A Buck In The Muck'").


  Aluminum and zinc may be the most promising metals, as they've been late to the party, some analysts say. "They've sat out the metals cycle but now they're really starting to participate," says Citgroup's Hill. Aluminum is in high demand to build aircraft ordered by Asian and Middle Eastern carriers while zinc is needed to produce galvanized steel. (Railroad and other infrastructure projects in emerging markets are fueling steel demand.)

Meanwhile, high energy prices have forced some U.S. and European aluminum smelters to shut down while accidents and strikes have curbed output in other countries. Alcoa (AA) reports earnings on Apr. 10, with a likely "upside surprise," says van Eck. Analysts are expecting earnings of 51 cents a share. To be sure, it's not just metal prices that have exploded in the commodity market. Everything from sugar to coal has rallied, not to mention oil, which sits at more than $66 a barrel, not far below its 2005 high of almost $70. (see BW Online, 2/6/06, "Oil Prices: The New Reality").

Dan Rice, manager of the BlackRock Global Natural Resources Fund (SSGRX), says copper producers like Phelps Dodge may be attractively priced but energy stocks, particularly oil drillers and coal companies, are even more attractive. Investors looking for a commodity play would be better served to focus on energy, he says. But for those who want an investment with a little more shine, silver and gold certainly glitter more than a lump of coal.

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