If commodities are going to be hot again in 2006 (as most of the members of the Barron's Roundtable, as well as our own MoneyWeek Roundtable, think they are), what's the best way to make sure you get your share of the gains?
One way, says Fred Hickey, the editor of the High-Tech Strategist, is to get exposure to one of the best resource economies there is: Canada. He suggests buying short-term government bonds there, as doing so will give you both interest (3.75%) as well as any gains to be made out of the strengthening currency. Hickey is also a fan of gold and suggests the StreetTracks Gold Shares ETF (GLD, $55.88) as a way in.
For a slightly different natural resource opportunity, Oscar Schafer, the proprietor of OSS Capital Management, turns to the Sudbury Basin the site of a meteorite strike 1.9 billion years ago. One of the resulting two major areas of mineralisation (the contact zone) has been extensively explored and exploited by the world's multinational miners, but the other (the foot-wall zone), Schafer tells Barron's, has been "largely ignored".
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FNX Mining (FNX.TO, C$15.09) acquired the right to explore this zone in 2002 and has since reported "at least 2.5 million tons" of high-grade copper and nickel veins present. But this could double with further drilling, or even quintuple if the zones of mineralisation turn out to be connected. Assuming 2.5 to 4.5 million tons of ore body, conservative commodity prices, and including C$2 a share in cash and securities on the balance sheet, the value for FNX's assets works out to between C$15 and C$20 a share.
New York Eagle Capital Management's Meryl Witmer suggests looking to the steel sector. One of her picks is Chaparral Steel (CHAP, $40.45), one of the three largest producers of structural steel in North America at a time when capacity is tight. The company has solid pricing power in the wake of Hurricane Katrina and, with "steel intensity per square foot built increasing", it should help earn about $5.50 a share in free cash flow this year. At this rate, it will be debt free and generating about $6.25 a share in free cash flow in two years, implying a target share price of between $50 and $60 a share.
Walter Industries (WLT, $56.92) is also interesting in that it produces the coal that makes the steel, says Witmer. The firm has around "20 years of proven reserves of high-quality metallurgical coal" in reserve and also produces natural gas and "infrastructure and flow-control products for water and gas-distribution networks and waste water facilities". The shares are valued at $35 for this division alone, based on fairly conservative coal and natural gas price assumptions, and putting them on a fairly conservative 14 times multiple. Adding this to the $38-$46 a share valuation for the water division (a growth market, as "a large portion of America's water pipes and valves will need to be replaced in the next 25 years"), plus $2-$3 a share for its other activities, and the price target for the company is $75-$84 a share.
The Barron's Roundtable was also pretty keen on pharmaceutical (and related) firms. Schafer likes Flamel Technologies (FLML, $23.06) and Germany's Schwarz (SRZ.F, e52.89). Flamel modifies blockbuster drugs for major pharma firms to help them manage their patent expiries. Assuming it meets various research and development milestones, within two or three years it could "earn €3 to €5 a share and could be two to three times its current price".
Schwarz, meanwhile, is developing an anti-convulsive drug and has a once-a-day patch for Parkinson's disease that has just been approved by the EU. At the moment, it is "reasonably valued" with an enterprise value/sales ratio of 2.8 (the low end of the industry's range). However, if one of its products takes off, it will look cheap, and if all five of the products in its pipeline work, then it "will earn more than €10 and sell at more than €200 a share in the next few years".
Marc Faber of the Gloom, Boom and Doom report also sees value in pharmaceutical stocks. For those who are bullish on the US generally, he highlights the attractions of Merck (MRK, $36.96), Schering-Plough (SGP, $19.88) and Pfizer (PFE, $24.52) "all relatively high-yielding companies" and trading at an approximately 30% discount to their global peers.
However, Faber's main theme during the Roundtable was less drugs than the risk of a "significant" increase in international tensions as a result of factors such as rising commodity prices, war, a slowdown or recession in China and a potential bird-flu pandemic. That means volatility ahead, so he suggests getting exposure via the CBOE Volatility Index (VIX, 12.39).
In the meantime, to address the unprecedented shift of wealth from the US to Asia, he recommends five Asian real estate plays IOI Properties Berhad (IOIP.KL, MYR8.00), Suntec REIT (SUN.SP, S$1.10), Macquarie MEAG Prime REIT (MMP.SP, S$0.95), Rojana Industrial Park (ROJANA.BK, 10.70 baht) and Ticon Industrial Connection (TICON.BK, 14.10 baht) all of which have yields in excess of 5.5%.
He also likes Malaysia and Taiwan in the form of the iShares MSCI Malaysia Index Fd (EWM, $7.12) and the iShares MSCI Taiwan Index Fd (EWT, $12.84). To benefit from the dramatic increase in air traffic between east and western Europe, he recommends Deutsche Lufthansa (LHAG.F, e12.37).
