Heavy Metal Hedge

Luke Burgess

Updated October 6, 2005

Dear Wealth Daily reader:

Over the past few days all of the major markets have experienced the proverbial tanking.

The TSX has lost 5% in the past 4 days.

Since Tuesday, investors have pulled out of markets faster than the Karate Kid ran from the Cobra Kai at that Halloween party.

Inflationary, energy, and geopolitical concerns, among a myriad of other worries, have sent investors running for the hills.

But is bad going to become worse?

The R-Word
The American economy is on a borrow and squander binge.

In times like these corporate and government resurrected their financial regulators, sometimes referred to as "spending Nazis", and call upon them to cut jobs and mop up free flowing cash.

And this, my dear reader, will possibly lead the U.S. into recession.

Economists and Wall Street prophets are clandestinely reneging after months of cloud nine reports about a cheerful economic outlook in the United States.

Soaring gas prices, fears of outlandish home-heating costs this winter, tumbling consumer confidence, rising interest rates and falling new-home sales have silenced the optimists.

Energy-price spikes, rising interest rates and housing slowdowns have played important roles in past recessions. And now analysts are digging the R-word out of the dumpster.

But please don’t get me wrong. I don’t believe this is the end of the world.

There is still a shred of hope.

Billions of dollars will be spent in rebuilding after the hurricanes. And long-range interest rates so far have refused to follow the Federal Reserve’s endeavors to intercept inflation by raising short-term rates 11 straight times.

The fact is that the US remains the global investment zone of choice. And we certainly won’t give up without a fight.

But in the meantime investors are turning their attention to metals.

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The Metal Hedge
Precious metals have always been used as a hedge in time of economic distress. And we’ll certainly see higher metal prices throughout the rest of this year.

But supply and demand problems will also influence prices as well.

Merrill Lynch believes that aluminum prices have not yet peaked. The investment management firm believes that aluminum prices will average 90¢/lb in 2006, compared with about 83¢ so far this year.

Aluminum prices have been on the upward trend. Since 2003 they have increased close to 30%.

According to inventories monitored by metals exchanges in New York and London, supplies will fall by two thirds by the end of next year, reducing them to the equivalent of 3.5 days of demand, from 10.2 days in September. Similar supply reductions have helped copper and nickel prices double since 2002. Aluminum prices have gained 40% since the end of 2002 while copper has risen 131% and nickel has more than doubled.

Demand for aluminum has also jumped lately in part because of the rapid economic growth in China, boosting a demand for buildings, cars, trucks and appliances.

According to the International Aluminum Institute, global aluminum production has increased by 9% this year, mostly because of a 20% surge in Chinese production.

Demand for gold in India, the world’s top consumer, is expected to pick up in the coming days with the start of the festival season.

India’s gold imports were hit in past weeks because of recent high prices, which reached near-18-year highs last month. But now festival demand should kick in. Demand for gold always rises in India during the festival season, which peaks in November with Diwali.

Dealers and industry officials in India say they expected strong gold demand during the festival season if international prices settle around $460. If prices settle at a lower level, then they expect an exceptionally strong demand.

Also the income of farmers have been recently been boosted because of the good monsoon season bring much needed rain to the region.

This boost in income will spur a higher demand for jewelry.

Steel prices are climbing again as the costs of energy, raw materials and transportation surge in an unstable business climate.

The price of hot-rolled band steel has risen to about $610 a ton, up $120 from only two months ago. And according to experts, another $40-per-ton increase is expected in November.

Purchasing Magazine recently quoted sheet steel, the most common product used in cars and appliances, rose to $500 a ton in September from $435 in August.

The overall decline in steel imports from levels a year ago, coupled with the aftermath of Hurricane Katrina and strong demand from China, could contribute to greater supply shortages and increased price.

Record molybdenum prices show no sign of falling any time soon. Prices for molybdenum oxide have jumped from $7/pound at the start of 2004 to $34/pound now.

China, a key consumer of molybdenum, represents 20% of global supply.

Supply from China is tightening as the country is changing its development strategy and adopted environmental and work standards used in Australia, Europe and the US.

This new strategy definitely means less production. And less production means less supply. At the end of the day the offer of molybdenum to the West from China will fall.

– Luke Burgess

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