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Making matters even worse for the commodities is the fact that the artificially higher prices encouraged the development of new supplies, which have ultimately proven to be ‘uneconomic.’ Canadian oil sands projects were front and centre in this development as many of these projects had ‘all-in’ costs (operating costs plus capital and financing) of over US$80 per barrel. But with prices over US$100 and expectations for higher levels going forward, many of these projects got a ‘go ahead.’ With oil prices now under US$40 per barrel, they would clearly not be started today, but many of them are over 50% along the way to completion. If a company has already spent $3 billion on a $4 billion project then they will often decide to take it to the ‘finish line’ as long as the operating costs are below the market price, since the ‘marginal profit’ can be applied to the long-term debt and capital costs of the project. Since many of these projects have operating costs below US$40 per barrel, then they will not halt the project. The bottom line is that supplies have not been cut back as much or as quickly as many market players would have expected, which is why prices continue to head lower!
In terms of the resource stocks, we still don’t see good value even at the current depressed prices. Unlike the stock market lows in 2009, when we could at least argue that we were buying stocks near record low valuations, the resource stocks are still not good value using current commodity prices. If prices stay near current levels, more companies will still have to reduce dividends, sell assets, cut costs and even raise equity to reduce debt levels and figure out how to survive in this downturn. We have recently seen an onslaught of such actions be the major resource companies. First, Kinder Morgan slashed its payout by 75% after watching its stock fall by over 65% in the past six months. That was followed by mega-miner Freeport-McMoRan’s suspension to its dividend to save $240 million in annual cash flow while slashing capital spending. Anglo American PLC, another giant metals producer, also halted its dividend. Teck Resources chopped its payout twice this year as prices for its key products, including coal, copper and zinc, kept on sinking to ever lower depths and it still directs any current cash flow to its Fort Hills oil sands project. Barrick Gold slashed its dividend in August to conserve cash in a dismal market for precious metals. That same month, Crescent Point Energy cut back on its shareholder payments, blaming the move on the prolonged malaise in oil prices. Glencore PLC, the Swiss-based commodity-trader-cum-miner, scrapped its payout in September. Vale SA, the giant Brazilian iron ore producer, cut its dividend months ago, while U.S.-based Cliffs Natural Resources, another big iron ore producer, eliminated payouts.
Applying the logic we have seen in analyzing the bubble in commodity markets to the current state of the stock markets yields some interesting parallels, in our view. While stocks are not necessarily at record valuations, they are certainly expensive on a historical basis. One broad measure of stocks is the so-called ‘Buffet Indicator’, or the ratio of total corporate equities to gross domestic product (GDP). Like the ‘Tobin’ or ‘Q’ Ratio, it measures the total value of stocks against the value of total output for the economy. While a measure like this implicitly ignore factors like profit margins and the impact of trade, the chart below clearly shows how extended this measure got at the market peaks in 2000 and 2007, and how it is well above that 2007 level today. On a long-term basis, this measure shows stocks as being more than 50% above their average level!
