Saturday, November 1, 2008 0 comments ++[ CLICK TO COMMENT ]++

Can Goods-Producing Commodity Industries Be In A Bubble Like The Dot-coms?

I have no idea whether commodities are/were in a bubble or not. I've been bearish but it's not clear if this is a long-term correction or a short-term one. We can only tell the nature of most bubbles in hindsight so this post isn't a prediction of the future. Instead, let me address one of the arguments presented by commodity bulls.

Many commodity bulls claim that commodities cannot be in a bubble like the dot-com bubble in the late 90's. After all, dot-coms barely had any sales and produced very little tangible assets. As for commodity industries, they produce hard goods that are actually needed by the world and can be sold. Or so goes the thinking. Yet I will argue that this is a completely misleading view--at least when it comes to investing.

Commodity businesses may be capable of producing hard goods but people forget that these goods are equivalent to the zero sales of the dot-coms if the commodity prices are low. What is happening right now is that many commodity businesses are starting to face financial problems, not because they own toxic mortgages but, because they own commodities that are starting to become uneconomic. The prices have dropped so much that sitting on an ore of zinc may be equivalent to owning a virtual website with zero sales in 2000.

The Globe & Mail, being close to the action in Canada, where there are a lot resource companies, reports on the financial difficulties of High River Gold (TSX: HRG) and Breakwater Resources (TSX: BWR). Now, I should note that these are small-caps so this isn't quite the equivalent of Royal Bank of Scotland going down or Citigroup losing more than half its value. But remember that it is the little ones that get inflated to insane valuations during most bubbles. There was far greater wealth destroyed when Cisco collapsed in 2000 but the real sign of the times was a small-cap like pets.com.

People may not be familiar with these companies but they were quite popular with Canadian mining investors. I know, because I was thinking of investing in High River Gold a few years ago (when I was bullish on gold.) Check out the 10 year chart of these two to see the massive rise and the subsequent collapse (source: bigcharts.com):



These companies may have suffered due to company-spacific issues but the point I want to make is that resource companies with decent assets--these are not pure exploration companies--can end up worth almost nothing. In other words, commodity businesses are just as vulnerable to bubbles as those dot-com stocks. The fact that these companies have tangible assets doesn't really mean much given that commodity prices tend to be very volatile. Remember, those who bought these stocks a couple of years ago, or even last year, have posted losses as big as those investing in companies owning toxic mortgages!

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