The Commodity Investor Q&A
With Matt Badiali
December 17, 2008
Q: Teck Cominco (TCK) sells for one times earnings right now. I know the mining business is highly cyclical and capital intensive. So maybe I'm way off base here... but at a glance, this seems insanely cheap to me. – D.F.
A: D.F., my answer to this question might save you a fortune this year...
Frist, let's back up... A price-to-earnings (P/E) ratio comes from two pieces of information: share price and earnings.
The share price of Teck Cominco – along with just about every commodity stock out there – has taken a massive beating. Teck is down 91% in just seven months. And when you compare that share price to the last 12 months of earnings, the stock starts to look pretty darn cheap.
The same is true of several blue-chip commodity companies... The world's best offshore drilling company, Transocean, sells for 2.8 times earnings. And Rio Tinto, the world's largest aluminum producer, goes for 2.9 times earnings.
But using these P/Es to screen commodity stocks is like driving using the rearview mirror. You need to remember that earnings come out quarterly, while share prices change every day. So right now, you're comparing current share prices to two-month-old earnings numbers.
Since October, the price of oil has fallen 57%. The price of copper is down 52%. The price of nickel, lead, and zinc are all off over 60% from their highs this year.
In other words, commodity company earnings are about to hit a brick wall. Teck earns 49% of its profits from copper mining and 30% from zinc mining. That means almost 80% of its earnings are in jeopardy.
Right now, value guys are getting excited about what looks like unbelievably cheap commodity companies. But those P/E ratios are a trap. Because earnings are going to come in a lot lower, you'll end up paying a whole lot more than one times earnings for Teck and its peers.
Q: Please give your opinion as to the advisability of buying the SLV iShares as an alternate to buying bullion coins. – W.G.M.
A: The iShares Silver Trust (SLV) tracks the "spot price" of silver. Each share of SLV is backed by 0.98 ounces of silver and as of this writing sells for $10.50. Silver goes for $10.30. So you're paying a 2% premium.
Bullion silver coins, on the other hand, are going for as much as 100% over the spot price of silver... and that's if you can find any at all. If you buy in bulk – say, a 1,000-ounce bar – you'll only pay about 3% over spot. But the darn thing weighs more than 60 pounds.
Whether the extra premium for coins or the hassle for a silver brick is worth it depends on why you're buying silver...
If you're buying long-term for savings and insurance against catastrophe, then you should probably build your position in the physical metal. But if you're buying to make a profit on an uptick in silver, then SLV is a better trade.
Investors are starting to fear inflation, so I'm bullish on just about all the metals funds. This trend is only a couple months old, so we have a perfect opportunity to jump in early and make some good money. You can get a rundown of a few other useful funds here.
Good investing,
Matt
P.S. To submit questions for the Commodity Q&A, send me an e-mail and look for answers every Wednesday. Remember, I can't give personalized investment advice.
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