One area that looks in danger of running out of steam is the commodity sector. There’s not a week goes by without some leading pundit espousing the merits of the ‘“super-cycle’” and how the voracious appetites of emerging nations are driving demand for raw materials off the scale. Certainly, this industrialisation process is a major factor, but it is not the whole story.
Ten years ago commodities, oil and metals were all seen as poorly performing asset classes and were shunned by fund managers. How attitudes have changed. Investors are now pumping literally billions of dollars into everything from gold bullion to rice futures. To me, this second wave of demand is a worrying sign. It means a substantial chunk of the price-action has been caused not by industrial users, but by speculative traders. This has ratcheted prices up to unsustainable levels, way above their intrinsic worth, especially as the global economy is decelerating.
When the penny drops and traders realise this is not a one-way bet, I suspect we’ll see one almighty correction as leveraged positions are rapidly unwound. One catalyst could even be this summer’s Beijing Olympics, if the Chinese government decides to rein in its overheating economy.
Anglo American (AAL), rated a BUY by Merrill Lynch
Of course, until this sell-off occurs, mining stocks such as Anglo American will continue to reap the benefits. Anglo is one the world’s largest miners, owning vast deposits of base/ferrous metals such as platinum, copper and iron-ore, together with coal reserves and diamond interests via its 45% stake in De Beers. But now looks a prudent time to take profits for the following reasons.
On top of its exposure to the commodity bubble, much of Anglo’s operations are in politically unstable territories. Around 40% of its mining assets are in South Africa, which has had a debilitating power crisis this year. The country’s main electricity generator has forced firms to cut consumption by 10%, hurting Anglo’s production. This looks like being a long-term issue; the power shortages may not be fully resolved until new infrastructure is bought on-stream in 2012.
Secondly, in 2004 South Africa’s ruling party introduced radical legislation under the Black Economic Empowerment (BEE) Act. BEE attempts to redress the financial inequality of traditionally white-run businesses by transferring part of the economy to black control. One measure has been to compel all local firms to sell a 25% stake in their businesses to new black partners, heavily diluting existing shareholders. So far foreign companies have been exempt, but there is always a possibility that if political mandates change, then Anglo may in future be “encouraged” to comply.
Lastly, Anglo’s shares do not look cheap, trading on “top of the cycle” p/e multiples of 11 and ten for this year and next. To me, this red-hot sector is overdue an ice-cold bath.
Recommendation: TAKE PROFITS at 3,445p
• Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments