Commodity Superpower!

For readers who have been following Larry’s forecasts in recent months, China’s bid yesterday for another North American oil company should come as no surprise.

This is precisely what he’s been telling you would happen all along, and now it’s exactly what we’re seeing — in aces and spades.

This is big.

The buyer, China National Petroleum, is China’s largest government-owned corporation and the largest of its Big Three energy companies.

The amount offered for Canada-based PetroKazakhstan, $4.18 billion, is about DOUBLE what another Chinese company paid for IBM’s PC business, China’s largest foreign acquisition in history.

Meanwhile, Kazakhstan — where China will now control a substantial chunk of the oil reserves — is the ninth largest country in the world, nearly four times the size of Texas.

The lessons to be learned from this event are equally big …

Lesson #1. China’s bid for a large North American oil company reinforces what Larry has been stressing about undervalued oil reserves.

With yesterday’s announcement, China is sending a clear message to the world that it’s ready and willing to bid up those reserves stubbornly and aggressively.

Expect more, much more, to come!

Lesson #3. And it highlights a megatrend that too many investment strategists have so far been ignoring. Specifically …

Look Who’s Dominating
World Commodity Markets!

Back in the late 1960s, when travel to China was off limits, I sought the next best thing.

I spent several summers in New York’s Chinatown. I was probably the only teenager that ever attended Chinese first grade on Mott Street. And I was probably the only Berlitz teacher to enroll as a student in their programs for Cantonese and Mandarin. I followed up with Chinese culture, economics and politics at NYU and Columbia.

In those days, friends from Hong Kong and Singapore frequently boasted that, someday, China would become a dominant, world-class, capitalist deal-maker in the free market for natural resources. I saw the potential. But I never dreamed I’d live to see it happen in my lifetime.

Yet, that’s exactly what I see taking place right now.

Indeed, while the attention of the United States is riveted on Baghdad, Basra, Kabul and Kandahar, China has been locking up deals and buying up natural resources in Angola, Nigeria and Sudan … Argentina, Brazil, Ecuador and Venezuela … Australia and New Zealand … Central Asia and Southeast Asia … not to mention North America.

In Africa, a consortium that’s 40% owned by the same company that made yesterday’s bid — China’s CNPC — pumps over 300,000 barrels per day in Sudan. China is also going after oil in virtually every other oil-rich nation on the continent.

In Central Asia, in addition to its mega-deals in Kazakhstan, China will build a hydropower station, two metals plants, a railway and highways in nearby Kyrgyzstan — all in exchange for access to the country’s natural resources.

In Australia, China has just begun a second round of talks on a free trade agreement that could eventually be worth about $20 billion to the Australian economy. And in neighboring New Zealand, China has just announced it is likely to secure crucial supplies of natural resources under a proposed free trade agreement.

Especially intense are China’s new and burgeoning economic links with Iran.

Beijing and Tehran recently signed a mega-pipeline project worth $100 billion in 2003-04 and likely to be worth over $200 billion in 2005-06. Also last year, China’s state-owned oil trading company signed a 25-year deal to import 110 million tons of liquefied natural gas from Iran. This deal, in turn, was followed up by a much larger deal with China’s Sinopec.

China is everywhere. It has mineral and oil sands extraction contracts with Canada, seaport agreements with Panama and mining contracts with South Africa. It’s in the Amazon, the Outback and the Asian steppes. Its big companies have opened offices in London, New York, São Paulo, Sydney and virtually every financial center on the planet.

And this is just the beginning. China will continue to drive up not only the price of energy, but also the value of coal and iron ore, beef and soybeans, gold and silver.

Plus, look how this megatrend permeates nearly every major news development of the day …

Commodity Megatrend
Shocks America and
Leaves Wall Street Clueless

When nightly news anchors report that world commodity prices are soaring, most Americans flip to another channel.

But when gas prices at the pump hit a new, all-time high, they stand up at attention; and that’s exactly what happened yesterday.

According to AAA, the price for unleaded regular climbed to $2.614 per gallon last week, the highest in history in nominal terms.

I stress “nominal terms” because, after adjusting for inflation and wage growth, it’s still not nearly as big of a deal as it was in the 1970s.

And, it’s still not high enough to dissuade most Americans from taking their gas-guzzling SUVs on the road this Labor Day weekend, projected to be one of the biggest driving weekends in history.

A survey from the Polk Center for Automotive Studies finds that 59% of Americans SAY they’d drive less because of higher gas prices. But what they really DO is another matter entirely.

The problem: There is only so much driving Americans can cut back on. They still have to drive to places like work, school, and stores, regardless of the price of gas. And for the price of switching to fuel-economy cars to save money in the future, they can buy hundreds, even thousands, more gallons of gas in the present.

So instead of cutting back on fuel consumption, most Americans are going to cut back on other, non-fuel expenses — like eating out or buying new clothes.

And you can bet that this forced frugality is going to work its way into …

Slumping Corporate Profits

Don’t believe me? Ask the people that run America’s largest corporations.

A new survey by PricewaterhouseCoopers shows that more than one-third of senior executives surveyed believe their companies are vulnerable to rising oil prices.

So they’re scaling back expectations for revenue growth, new jobs, and new investments.

Among them, 52% said higher oil prices would have a strong (23%) or moderate (29%) negative impact on profit margins and 36% see higher oil prices as a barrier to growth.

So whom do you believe? The Wall Street crowd that’s trying to bat away $60 oil like a pesky mosquito? Or the executives running America’s largest corporations?

Rising Commodities
Sink J.M. Smucker

The peanut-butter-and-jelly business is pretty darn consistent.

But something went very wrong at J.M. Smucker when its Q2 profits fell 12 cents short of Wall Street’s expectations of 63 cents.

What’s the problem? Consider their own words: “Gross margin,” they just announced, “was 32.3% … compared to 34.9% last year, PRIMARILY DUE TO HIGHER COMMODITY COSTS.” (Emphasis is mine)

While oil has been hogging all the commodity headlines, the reality is that commodities prices are almost universally higher. It doesn’t matter whether you’re talking about crude oil or peanut oil, gold bullion or blueberries, the mantra is the same:

The … price … of … commodities … is … UP. Period.

I don’t mean to harp on Smucker. It sells for a reasonable 14 times earnings, has a low debt-to-equity ratio of 28%, pays a 2.6% dividend, and is the type of conservative growth stock that I’d normally like … but when its shares are a lot cheaper. Not now!

Heinz Also Squawks
about Commodities

Heinz hits its Q2 profit numbers and claims that business is great … but it’s STILL complaining about rising commodity prices and the recent strength of the dollar eating into its profits.

CEO William Johnson puts it this way. “We are still tracking to our full-year outlook despite increased commodity cost pressures and a stronger U.S. dollar.”

As I see it, here’s Heinz’s problem in a nutshell:

In the last 12 months, the company was able to grow its Q2 sales from $2.0 billion to $2.11 billion — a 5.3% increase. The cost of goods, however, grew from $1.26 billion to $1.35 billion — a 7.1% increase.

So Heinz’s cost of production is rising at a faster rate than its sales — not good!

Heinz is a well-managed company, but there’s not a darn thing it can do to preserve profit margins when its raw materials costs are skyrocketing.

Three-Generation
Households on The Rise

Rising costs affect more than just corporate profits and stock prices. They drill down into the very core of society.

Consider, for example, this under-discussed consequence of the red-hot real estate market and rising energy costs:

A growing number of three-generation families are moving in together.

According to the Census Bureau, from 1990 to 2000, the number of multi-generation households increased from 3 million to 4.2 million, up 38%.

And according to Andrew Cherlin, a sociology professor at Johns Hopkins University, “This is not happening because of family sentiment. It’s happening because the middle generation needs help.”

I stress this because government officials and Wall Street pundits keep painting a picture of economic prosperity. It may look that way to them behind the tinted glass of their limousines, but a large number of Americans aren’t so lucky.

Our economy isn’t in horrible shape right now. But it’s also far from the “big growth machine” that Wall Street thinks it is.

Our recommendation is simple: Buy the investments that are benefiting from rising commodity values. Sell the investments that are being driven lower by the same megatrend.

If you are relatively risk adverse, use natural resource and gold mutual funds such as those Martin recommends in his Safe Money Report and Larry recommends in his Real Wealth Report. For example, consider US Global World Precious Minerals Fund (UNWPX) and Scudder Gold & Precious Metals Fund (SGLDX).

If you are willing to be a bit more aggressive, also consider the stocks they recommend. Most have already moved sharply higher. But you can still buy them on any correction, such as the one we saw last week.

For example, although crude oil prices have already begun to rebound from last week’s sharp correction, the oil service stocks are just beginning to do so.

And if you want to really go for maximum leverage, take a look at call options on energy stocks. That’s Larry’s specialty. (He tells you more about it in his latest report.)

Best wishes,

Martin Weiss
Larry Edelson, and
Tony Sagami

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