The Commodity Investor Q&A
With Matt Badiali
January 21, 2009
Q: In your recent S&A Oil Report, you mentioned taking a position in refiners before the summer driving season. Why aren't you buying now, what are you waiting for? – G.B.
A: At the end of December, just before my issue came out, refiners' margins were terrible.
A refiner makes money on the difference between the value of the products made out of a barrel of oil (gasoline, diesel, jet fuel, etc.) and the cost of the oil itself. That's called the "crack spread."
A barrel of oil holds 42 gallons. So when oil cost $40 a barrel at the end of December, refiners paid $0.95 a gallon to buy the raw material. You might have paid about $1.50 a gallon, but after taxes and other costs, refiners only collected $0.84 per gallon selling gasoline...
In other words, the crack spread on gasoline was negative and refiners were losing money on every barrel of oil they converted to gas.
Things are much different today.
I measure the industry crack spread using prices on gas, diesel, and heating oil. It's a rough gauge, but it does what I need it to do – it lets me know when refiners as a whole are profitable.
According to my numbers, the average margin for refiners over the last five years is $12 per barrel. At the end of December, it hit $3.73 per barrel, nearly a five-year low.
Since then, it has risen steadily. Today it's up around $18.50. That hasn't been lost on the market... The three largest refiners are up nearly 80% on average from their bottoms in October.
But I don't think we've missed the move. Back in 2004, we saw a similar setup – low (but rising) share price and a rising crack spread. Judging from that, we could see another 80% from here.
Q: Copper miners took a beating in late 2008 and look pretty cheap today. I'm thinking about buying... Do you think the copper price getting pretty close to the bottom? – B.I.
A: No, not if you look at the last 10 years...
Supply Is on the Rise...
Copper Could Get a Lot Cheaper |
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After nearly two years above $2.50 per pound, the price of copper fell 66% in three months. That's an incredible decline. The price hit a low around $1.20 per pound, which it hadn't seen since early 2004.
You might think that's a bottom, but the amount of copper stored in warehouses, as reported by the London Metal Exchange, is the highest it's been in five years.
If a global recession continues to hurt demand, you could see the copper supply continue to rise. As you can see from the chart, rising supply corresponds with falling prices. Supplies could get a lot higher from here... and copper prices could go much lower.
If the economies of China, India, and the U.S. continue to decline, you can expect to see a return to sub-dollar copper prices.
So I'm not in a hurry to jump into copper stocks right now.
Good investing,
Matt
P.S. Every Wednesday, I answer reader questions about natural resources and the commodity markets. To submit a question, just send me an e-mail and look for an answer next week.
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