What's the difference between a boom and a bubble? The answer is a simple one. A market is showing signs of being in a bubble when prices reach levels that are entirely unjustified by the fundamentals. But it is booming when prices are rising fast but those price rises are justified by the fundamentals.
Consider the period in the late 1990s when internet stocks seemed to be doubling every day. That was definitely a bubble. Speculators were buying for no good reason other than that they thought prices would keep going up.
Sure, they justified it in all sorts of clever ways it was repeatedly said, for example, that the new economy with its permanently low interest rates and massively improved productivity had created a totally different world where paying 100 times earnings for a share was a perfectly reasonable thing to do. But no one really believed, or indeed much understood, any of that and it wasn't a perfectly reasonable thing to do.
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Instead the explanations were just nonsense background noise to an almost unprecedented breakout of greed - and we all knew it. Note that 70% of fund managers surveyed by Barron's a year before prices started falling said they thought the market was in a speculative bubble. But most of them then kept on buying anyway.
Next consider the huge rise in the prices of metals over the last three years or so (they have climbed on averge around 100%). There are plenty of voices out there claiming that this too is a bubble, and pointing to the recent falls in prices which have seen copper fall 5% from its highs and zinc come off over 10% - as a sign that it bubble is collapsing. But those voices are wrong.
Instead this looks to me more like a boom driven by very simple fundamentals. You don't have to understand anything about productivity and the way it is measured, or about inflation and interest rates to understand why metals prices are rising. Instead all you need to know is that demand for most metals is greater than supply. And the dynamic of that imbalance isn't going to change any time soon.
China and India are growing at enormous speeds and consuming equally enormous amounts of every commodity known to man. China is now the largest consumer of copper (which it uses more of than Japan and the US put together), zinc, tin, rubber, wool and cotton in the world. But given that it like India is still at a relatively early stage of its industrialisation process, it's going to be consuming a great deal more over the next few decades.
Today there are only two really big major cities in China for example Beijing and Shanghai - but that won't last. There are eight or nine in the US and there is no reason why the Chinese shouldn't have just as many, particularly given the way its 1.3 billion strong population appears to be taking to urban life. This means a huge amounts of building work (if they can wrench any cranes out of the hands of the frenzied developers in Dubai of course) and hence a need for large amounts of copper, aluminium, steel and lead.
And once the cities are built the Chinese are going to need cars to drive around them in (right now there are just over 6 cars per thousand people in China whereas in the US and Japan there are over 400 per thousand) as well as a couple of televisions computers and telephones each to suit their new urban life styles.
Again, all this needs metal lead for car batteries, platinum and rhodium for catalytic converters, little bits of silver (one of the best electricity conductors in the world) for each keyboard and steel for pretty much everything else.
But, as I've pointed out before, for most metals the supply simply isn't coming through to meet demand. Inventories are still at very low historical levels. Few new mines were opened during the long bear market to 2000 and the big mining groups are still dragging their feet when it comes to finding and developing new discoveries - for example, Phelps Dodge said last year that it intended merely to enlarge its current copper mines rather then to open new ones.
But even if they were investing hugely in new projects, it would take them years to move new mines into production. Add it all up, and as Charles Hansard, chairman of Aim listed African Platinum (which has a very interesting-looking site in South Africa) told me a few weeks ago: "This isn't just a bull market, it's the mother of all bull markets."
So what of the recent falls in prices? To me they represent nothing more than a blip in a long-term secular uptrend. Bull markets don't move in straight lines it would be very odd if they did and are always vulnerable to profit taking and short term volatility. Given the huge run up in prices in December and January, a short bout of timidity should hardly come as a surprise or as a long term concern.
Finally on the issue of whether the metals market is in a bubble or not I'd ask you to look at the p/e ratings of the various diversified miners listed in the UK. Most are barely in the double figures and that's with earnings estimates based on assumed prices well below today's levels. This wasn't and isn't a bubble. Instead, so far, it's barely the beginning of a real boom. Most bull markets in commodities last 15-20 years. This one has been going for a mere five. BHP Billiton, Xtrata and Rio Tinto are all good stocks to own for the long term.
First published in The Sunday Times (19/02/2006)
