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Why you should think Asia, not America, when you invest in commodities

Growing demand in Asia should keep commodities strong despite the U.S. slowdown, says one analyst. Plus a look at dividend-paying stocks.

Canada is rich in natural resources. That’s a pretty obvious statement, but it’s not a complete one. Canada’s natural resource firms don’t just draw their wealth from our own soil but from around the globe.

In short, the experience and expertise bred of generations of exploring, digging and drilling is one of the main reasons Canada stands at the forefront of the global commodities trade.

And that has stood Canadian commodities firms and their investors in good stead during a period of global growth. We’ve enjoyed a sustained bull market in commodities prices. But surely, with the economic slowdown in the U.S., that must be coming to an end. Didn’t that bring the markets thundering down on Friday?

Hold on, says one Canadian analyst. It’s not all about the U.S. anymore. Asia counts, too. And Asia keeps calling up and asking for more.

Mr. Grant Campbell, writing in Investor’s Digest of Canada, tells us what Asian demand will do for Canadian commodities, and which stocks are due to benefit the most.

But today’s market conditions still call for caution on the part of investors, so we’ll also consider some dividend-paying stocks that are available at knock-down prices.

The Chinese spinoff

One note before we proceed. Several of the stocks that we discuss today have appeared in these pages over the past few weeks. That’s not because we’ve fallen in love with them (we’re perfectly neutral), but because they keep popping up on the radar screens of analysts we cover regularly. This in itself is no guarantee of success, but it is interesting to see a mini-consensus grow around some stocks.

And now to business. The business of commodities, to be precise. Mr. Grant Campbell has some very specific points to make about Asian growth.

China is the key, of course. “The growth rate in China has been in double digits for years now and appears to have the potential to continue for a while yet.” The Chinese central bank has been trying to slow down the red-hot economy with interest rate changes and other adjustments, but with no apparent success so far.

But this rapid growth goes far beyond the borders of one country, big and dynamic as it may be. “All of Asia has been receiving a positive spinoff effect from the robust growth in China.” And all of Asia is witnessing a transition that took several generations in western society.

Millions of middle-class families

“The creation of millions of middle-class families is increasing the demand for consumer goods and housing at a pace never seen before in history,” says Mr. Campbell. “The economy of the entire region is benefiting from this huge expansion in demand. The economic expansion is also creating additional middle-class families in countries like Vietnam and Singapore.”

India, of course, is the next biggest generator of growth in Asia behind China. And it is adding middle-class families at an astonishing rate — several million a year. It is also advancing swiftly in the field of technology.

“The momentum towards further change is increasing and the number of potential new customers is staggering,” says the analyst. “These economic changes will ultimately have an impact on one-third of the world’s population which, in turn, will have a long-term impact on the rest of the world.”

The demand for materials to feed this growth is not going to dry up overnight, in Mr. Campbell’s view. Far from it: it will “continue for years, possibly decades into the future. This increased demand will affect a number of areas globally, including food, energy, precious metals and base metals.”

The flaw in the analysis

Today, Mr. Campbell is concentrating on base metals. Over the past five years, the prices of most of them have risen and then stabilized at much higher levels than have been seen in the past. Many observers believe that they must fall now with the anticipated slowdown in the U.S.

“The flaw in this analysis is that prices did not increase solely because of U.S. demand but to a dramatic increase in Asian demand,” says the analyst, “so it is unlikely that these prices will fall due to a reduction in U.S. economic growth.”

Energy prices might slip down, he adds, but not for long and not too far, since demand is due to rise in regions beyond the U.S.

Base metals aren’t likely to fall at all, because in their case, supply has not kept up with demand.

A 10-year time frame

For the better part of two decades, in the 1980s and 1990s prices were low and new capital for exploration and development was not easy to find. Few new mines were opened and many existing ones were shut down because it just wasn’t worth keeping them going at prevailing prices.

Now that everyone wants to get more stuff out of the ground, it’s not as easy as it was twenty years ago. Although current prices justify the expenditure, says Mr. Campbell, “but environmental concerns and regulatory hurdles have extended the time frame for new discoveries to come into operation as new mines.”

10 years is the rather long stretch now between discovery and production. “The long time frames and the huge capital investments required will keep commodity prices high as demand is likely to remain above supply over the long term.”

This is good news for Canadian mining firms. And since the industry has been “consolidating” considerably in recent years (so long Inco, Falconbridge, Aur Resources and others), this development is good for smaller emerging producers as well as the big, established groups.

Mr. Campbell has four stocks to recommend that run the gamut from big to small. The first three were all recently recommended as long term buys by another leading Canadian advisory, as we reported last week in this space.

Mr. Big and three others

Teck Cominco (TSX-TCK.B) is now Mr. Big among base metal miners in Canada. Several recent setbacks have been well documented, but its future is scarcely tarnished. Teck is one of the largest zinc miners in the world, for starters, but it produces much more besides. It has properties in Alaska, B.C., Newfoundland, South America and Australia, it also turns out copper, metallurgical coal and gold — and it has a stake in the Alberta oil sands, as well.

“The company is very well positioned to participate in the continuing growth in Asia,” comments Mr. Campbell. “The company is likely viewed as an interesting merger or buyout opportunity by other global miners as well.”

Another producer that should do well by Asian demand is HudBay Minerals (TSX-HBM), which produces zinc and copper at three different operations in Manitoba and Saskatchewan and refines and processes them at facilities in Manitoba, Michigan and New York.

A rising star in the Canadian mining scene appears to be Lundin Mining (TSX-LUN), a very global company. Lundin produces copper, zinc, lead and gold from mines in Sweden, Portugal, Ireland, Spain and the Democratic Republic of Congo. It has made two strategic acquisitions over the past two years that should lead to further growth in the years ahead.

Smaller than the preceding three, but no slouch internationally, is Breakwater Resouces (TSX-BWR), which has four mines in B.C., Quebec, Honduras and Chile. It turns out zinc, copper, lead, silver and gold. It is due to produce over 120,000 tonnes of zinc and two million ounces of silver annually.

Not the range in entry prices among these stocks. Teck is highest, of course, opening this week at $41.25. The price for HudBay is less than half that, at $17.75. Another ten bucks down the scale is Lundin at $7.77. Breakwater is the minnow of the bunch at $1.19.

So if you agree with this analyst that Asia’s insatiable demand will keep Canadian mineral producers happy, you can get in on the action at almost any price you’d like.

And speaking of prices, let’s take a brief look at how to get some dividends cheap.

Not overvalued now

Mr. Larry MacDonald is a regular columnist with Investor’s Digest of Canada and an admirer of dividend-paying stocks, with one caveat.

In the past, says this analyst, “I never got around to talking much about dividend stocks for fear they had become too popular and overvalued. What gave me that impression was several recently published books advocating the approach and the growing list of blogs focused on dividend stocks.”

The dividend tax credit helped push the popularity of these stocks even higher, as investors began to accumulate them in unregistered portfolios as retirement vehicles, in competition with RRSPs.

“That was then,” says Mr. MacDonald. “Now, I don’t think we can say dividend stocks are overvalued — at least in certain sectors.” Today, many dividend-payers are trading yields unseen in a long time.

The analyst has taken stocks trading significantly above their five- to seven-year average yield — and with a history of regular dividend growth. He has also specified stocks whose dividend payout ratios are not too high to sustain.

His undervalued list includes two Canadian banks. Bank of Nova Scotia (TSX-BNS) and Royal Bank of Canada (TSX-RY) are both yielding over four per cent. We have seen a good deal of sentiment for the big banks since they have been affected by the credit crisis. Get ‘em while they’re cheaper is the general call to action.

One of the better values

Not surprisingly, two more financial companies are on Mr. MacDonald’s list. Great-West Lifeco (TSX-GWO) has raised its dividend at an annual rate of 17.5 per cent and is yielding four per cent.

IGM Financial (TSX-IGM) has a dividend growth rate just above 15 per cent and a yield of 4.7 per cent. This is Mr. MacDonald’s favourite. “My guess is that IGM Financial represents one of the better values in relation to its company fundamentals.” Its yield is the highest in this group and its business model is strong, he adds.

Finally, two non-financial stocks make the grade. One is Husky Energy (TSX-HSE), whose dividend is yielding over three per cent, and growing annually at 50 per cent.

Telus Corp. (TSX-T), yielding over four per cent, “has one of the better mixes of yield, growth and payout ratio,” says Mr. MacDonald. Some investors, he adds, might be leery of missed earnings projections, a moderation in the wireless revenue growth or regulatory changes that are bringing more competitors into the industry. But there is still a lot of growth in the field, he concludes.

When the markets are tumbling (again!), it’s not easy to believe in the future, grit your teeth and buy up stocks that look like they will succeed in the long run. But if these two Investor’s Digest analysts are right, the people who are buying good stocks at reduced prices will do a lot better than those who are selling them.