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Why metals stocks haven't peaked
Call the theory Peak Metal. The price of gold and other metals, and related stocks, will keep rising as finding new sources gets harder and more expensive.
By Jim Jubak
Is it too late to buy into the boom in metals stocks -- everything from gold to silver to copper to iron to zinc? After all, flashy gold stock Goldcorp (GG, news, msgs) is up 130% or so in the last 52 weeks, and traditional, plodding copper stock Phelps Dodge (PD, news, msgs) isn't far behind, with a 90% return.
Or does the current boom in metals have longer to run, making this a good time to buy despite gains like these?
Investors looking to answer questions like those should take a clue from the boom in oil prices and particularly from a theory called Peak Oil. The analogy isn't perfect -- the commodity markets for metals are much smaller and much more speculative than the market for crude oil. But applying a theory that I'm calling "Peak Metal" argues that while short-run risks have risen recently, the boom in the prices of metals and metal stocks is a long, long way from over. Over the long term, the only thing likely to derail it, in fact, is a big slowdown in the global economy -- and therefore in global demand. And that doesn't look likely in either 2006 or 2007.
The supply squeeze at work
Peak Oil is a controversial theory that argues that, sometime soon, global oil production is due to hit a peak. After that point, no matter how much money oil companies spend on exploring for new oil and developing new reserves, global oil production won't go up. After a period of stagnant production, global production will indeed start to decline.
Most of the controversy about Peak Oil involves shouting matches about when -- if ever -- this peak will occur. Estimates range from now to 2008 to 2020 to never.
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To me, predicting the date for peak production is an interesting parlor game. Given the immense ignorance we have about the true levels of production and reserves in major oil producers such as Saudi Arabia and Russia, I simply don't think it's possible to come up with a specific year.
But I find the mechanisms that Peak Oil theory has developed to explain the direction of oil prices and the operation of the oil market immediately applicable to the metals sector.
Here's how those mechanisms work for oil: As oil production moves toward the peak, oil also becomes harder to find. Discoveries are smaller and in less-accessible regions or geologic formations. And it costs more to produce the crude from these discoveries.
Producing oil from existing fields also gets more expensive: It's never possible to recover 100% of all the oil in a field, and recovering the last barrel of oil also requires more technology, more equipment, and more dollars than recovering the first barrel. Peak Oil theory also notes that extracting oil from a field damages the field by allowing water to infiltrate the oil pools, by leading to the collapse of rock or sand formations, and the like. That happens even if the oil producer has put adequate capital into the infrastructure of the field, which most oil producers haven't done over the last decade or two.
The price of oil rises as the peak approaches for both reasons.
It's at this stage that opponents of Peak Oil theory often object that Peak Oil doesn't take into account the effect of those higher prices on oil production. As oil prices go up, it becomes profitable to exploit oil deposits, such as Canada's huge oil sands reserves. And it becomes profitable to find substitutes for oil -- such as ethanol or bio-diesel. This postpones the day of Peak Oil, perhaps indefinitely.
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