Why biotech is fast becoming the story of 2012

Gentlemen! We are all afraid of prostate cancer, are we not? And all the more so because the doctor could recommend the ultimate remedy castration! But even that may not be enough. Some cancers are resistant to castration.

But now there is hope, thanks to MDV3100 a drug that has been shown to extend the life of prostate sufferers. It's the lead product of Medivation (Nasdaq: MDVN) which has seen its share price quadruple over the last year.

This is the type of medical breakthrough that's driving a new bull market in biotech. The key Nasdaq Biotechnology Index, which already outperformed the broader market over the previous three years, has gone into overdrive adding 15% since the start of January.

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As you may know, I have talked about biotech before. I mentioned the high risks and the scintillating rewards.

I firmly believe that this will be the most exciting story of 2012. I mean you only have to look at the scale of the investment being pumped into the industry right now.

The big players are locked and loaded for biotech

Most of us know very little about biotechnology. Maybe we understand that it means the manipulation of living things to serve our own purposes. Maybe we know that much of what goes on under the heading of biotechnology relates to medicine. But few of us could go much further than that.

This is what smart investors like. They love the idea of getting in to a hot new story while others are still struggling to get their heads around it. The typical bull market sees professional investors get in early, and the private punters arriving at the party long after the best of the fun.

Right now, there are plenty of signs that professional investors are backing biotech. In 2011 venture capitalists invested $28.4 billion in the biotech sector, a 22% increase over the previous year. Now big new funds such as Flagship Ventures $270m life sciences vehicle are gathering ammunition to fire at biotechnology.

Key for any stock market theme is that it must have firm foundations. The natural resources theme was not a fantasy. It was based on rapidly growing demand meeting limited supply. The same could be said of biotechnology.

Biotech is needed now more than ever

The population is living longer, and the conditions which were once written off as mere old age' now demand treatment. The result is a massive increase in demand for new therapies. Meanwhile the major pharmaceutical companies have seen diminishing returns from their research budgets. With regulatory authorities, headed by the all-powerful US FDA, taking an ever more cautious approach to approvals, the supply of new therapies has simply not met the demand despite some notable successes in areas such as AIDs and smallpox.

This supply and demand imbalance is driving another key area for biotechnology research. Last week, I met Sir Ben Gill, former president of the National Farmers Union, and now chairman ofEden Research(PLUS: EDE). Eden uses naturally occurring compounds called terpenes to boost the defence mechanisms of food plants, and Sir Ben kicked off our meeting with a ten minute lecture on the world's impending food shortage.

These trends are fundamental and will not change. But the sudden upsurge in biotechnology shares reflects more than just this. There are signs that the pace of change is accelerating. The number of new drug compounds approved last year was the highest for some time.

Western governments don't want to be muscled out

Healthcare is a huge burden, but a 1% reduction in mortality from cancer alone would, according to University of Chicago economists Kevin Murphy and Robert Topel, have a present value to the USA of nearly $500bn. A complete cure would be worth about $50trn.

Western governments want to support biotechnology, especially as China, India and Russia are muscling in on the global market. So now a record number of trials are in progress, both in the clinic for human therapies and in fields and greenhouses for bio-engineered plants.

As big pharma edges closer to the patent cliff' it is stepping up the hunt for promising external research projects and it is prepared to pay sums that transform small biotech research companies overnight. An example is this year's $2.5 billion acquisition of Inhibitex (NASDAQ: INHX) by Bristol-Myers Squibb. The former's share price has gone from $4 to $26 since the autumn.

Where will the next bonanza come from? There is no shortage of candidates. In the US alone, there are more than 900 biotechnology products in development, with more than one-third aimed at cancer and related conditions and more than 20% targeting infectious diseases. It's almost guaranteed that amongst these biotechnology pioneers there'll be some major stock market winners.

You won't want to miss this

I am so confident in the biotechnology sector that I have dedicated a new newsletter to the industry. This letter will radically change the way you invest this year.

This article is taken from Tom Bulford's free twice-weekly small-cap investment email The Penny Sleuth. Sign up to The Penny Sleuth here.

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