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My Kind of Decoupling

The word 'decouple' is once again making the rounds. I like it – but my decoupling isn't the same as most.

Last time 'decouple' was popular was in 2009. It was applied to emerging markets, which investors hoped could keep running despite the global financial crisis.

This time around people are hoping the US can 'decouple' from the rest of the world, continuing its economic recovery despite a recession in Japan, a stagnant Eurozone, and a slowing China.

Sure. Whatever.

I say that because the market I care about – mining – was completely excluded from the big ol' bull run of the last few years that lifted the S&P 500 by more than 200%, the Dow by almost 170%, the Toronto big board by 100%.

Whether those runs can continue is a topic of endless debate.

Believers point to improving jobs, construction, and economic growth numbers in the United States to argue America truly is recovering. If so the rally was justified and can continue – provided the US can decouple from the stuttering economies of Europe and Japan.

Non-believers point to the $70 trillion injected into America in five years, a Hail

Mary experiment that created investment hope where there was none. With quantitative easing now over, the bears think the reality of a slow-growing, debt-burdened United States will drag markets back down – keeping them coupled with Europe and Japan.

I don't know how much of the US recovery is real. Both camps make some good points.

Quantitative easing was significant, injecting confidence into the markets. That confidence created some real growth.

Much of the QE money, however, is still sitting still, because rock bottom interest rates have given banks little incentive to lend it out. When rates start to rise the velocity of money will pick up speed quickly – and then we will learn about the long-term impacts of the Great Liquidity Experiment.

In the six months or year until then, the real growth that QE enabled will try to gain momentum, whatever transpires in Europe and Japan. It might work; it might not.

Regardless, I have reason to believe the sector I care about will remain decoupled from all of this and start its long-awaited rally.

Miners got kicked out of the recovery party early on. Metals explorers, developers, and producers rallied for 2009 and 2010, then started a long slide.

While the rest of the markets climbed, major miners declined. The biggies – Glencore Xstrata, BHP Billiton, Rio Tinto, Anglo American, Freeport McMoRan, Barrick, Goldcorp, and so on – are all down 30 to 50% or more since 2011.

Every metal is worth less today than it was in 2011, from copper (down 30%) to molybdenum (down 40%), gold (down 25% or more, depending when you start counting) to silver (down 60%), iron ore (down 50%) to metallurgical coal (down a whopping 70%).

But the cure for low prices is low prices. Gold is cheap, so Russia, China, and others are stockpiling. Silver is so cheap that most miners are losing money on each ounce, a situation that cannot last. Many copper operations have reduced output in hopes of price improvement, which has the copper market in deficit for its fifth year. Zinc prices are already responding to tight supplies, a result of underinvestment in the oft-overlooked metal.

I realize this kind of cure only works if there is demand for metals. Demand there is, regardless of what happens in the US, Europe, or Japan.

Because China.

As John Ing of Maison Placements wrote recently:

"America's debt load is its Achilles heel. China is poised to take advantage of this. The foundations for a Sino-centric financial system have been laid with gold a major part of it. We believe resource-dependent China has taken a page from Sun Tzu's book, using its diplomatic and economic muscle to regain superpower status… China consumes most of the world's resources and sits on the largest cash reserves."

Between its drive to dethrone the US dollar (with gold or the renminbi) and its ceaseless push to improve the standard of living for its 1.3 billion people, China continues to provide huge support for almost every metal.

Chinese growth is slowing, but only a bit. Thinking about China it's important not to lose sight of the forest for the trees. A slight miss on GDP growth one quarter gets all kinds of attention. Meanwhile, the Chinese government's current Five Year Plan is focused on moving another 250 million people from the countryside to cities.

That move itself will require immense piles of copper, zinc, iron ore, and other metals. But demand will not end once all the new houses are built.

The rationale behind the move – to greatly grow China's consumer market – will add heaps of long-term metal demand, as hundreds of millions of newly urban Chinese buy cell phones and cars and dishwashers and air conditioners.

That's the forest. And it doesn't care about Japan or Europe. In fact, that is precisely the point – after getting hit hard by a financial crisis on the other side of the world, China realized it had to move shift its economic engine away from exports and towards domestic consumption.

Hence the urbanization plan. If you're wondering why it hasn't gotten much press, that's because it hasn't started yet. Instead, the Communist Party is laying the groundwork. That's the real impetus behind its crackdown on corruption: the government knows it has to plug the graft holes before pouring urbanization money into the system.

But the money will come, fueling another building boom in China.

India also matters. The world's second-most populous country continues to electrify its countryside and build infrastructure, while its middle class expands. Many other countries are doing well and needing more metals every year, including Mexico, Malaysia, most of the 'stans, Ghana, Cambodia, and the Philippines.

Then there's the fact that Europe is perhaps not doing so badly after all. A week ago Germany released trade and current account numbers way better than expected. Then Germany, France, and the EU released third quarter GDP numbers that, again, were way better than expected.

Maybe Europe will strengthen alongside the United States. Maybe Japan will slide into a recession for several quarters, or even several years. Any of these outcomes will impact metals demand.

But demand will still rise, a lot and against a background of limited supply.

The details are different for each metal, but the thesis is the same. After four years of sliding metal prices, plummeting share prices, rising costs, and limited access to capital, the metals sector is at a bottom.

It has to climb back up, because regardless of the Dow's gain or loss, or Japan's latest GDP number, or housing starts in America, global demand for metals continues to rise, supported by huge populations in China and India and other developing nations demanding access to electricity and transportation.

It doesn't matter to me whether the countries and economies we love to focus on stay coupled or go their separate ways. What matters is metals demand and whether there is enough supply to make ends meet.

Supplies will soon be insufficient for many metals – already are for some. And that will send metal prices and the mining sector back up, no matter what the Dow does.


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