Investing

I've been looking at long term commodity prices to develop an average price to use in valuation. Here are some long term averages for LME Nickel (click for larger image).



Here are averages for Australian Thermal Coal, Copper and Crude Oil (simple average of three spot prices; Dated Brent, West Texas Intermediate, and the Dubai Fateh).



There are lots of implications. These prices were higher than I expected for oil, lower than I expected for Nickel and about right for copper and coal.

It's worth mentioning the corresponding spot prices as of January 23rd (USD):

• Nickel - 5.18
  
• Copper - 1.47
  
• Oil (sample average as above Brent, WTI & Dubai Fateh) - 46.17
  
• Australian Thermal Coal - $81.46

An equally important metric is the marginal cost of production (USD unless noted).

• Oil US offshore - $69.75, Average Western Hemisphere - $47.63
  
• Copper Marginal Cost - $1.8
  
• Australian Thermal Coal (based on Credit Suisse research) - $70-$80 AUD, $80 USD to meet project hurdle rates
  
• Nickel Marginal Cost - $6.8

Putting it all together:

• Nickel and Copper look to be the most undervalued against their average range and spot prices
  
• Crude oil is much lower than the marginal cost of production but is within it's long term average range.
  
• Australian coal is well above the long term average and fractionally above the marginal cost of production.

Looking at long term averages assumes that supply and demand are relatively constant over long periods of time. It is worth considering that China and India may have permanently increased the demand for these commodities at a given price. It is also worth considering that decades of underinvestment, depleting resources, political instability and environmental laws have shifted the supply curve such that there is now a lower supply at a given price.



I do believe that this is what's happened BUT most importantly I'm not investing on that basis. The key here is to invest in commodity companies that are valued based on commodities priced at or below the marginal cost of production and long term average prices.

When to sell

Given that buying is relatively easy, how do we decide when to sell. I'm going to choose price points for Nickel, Crude, Coal and Copper.

NICKEL
Nickel - $7.75 USD. Nickel can be replaced in Stainless Steel manufacturing by Nickel Pig Iron at about $8 USD for Nickel. The $7.75 is the 2000-2008 average. This is the number based on long term economics that draws the line between investment and speculation. I would expect to sell most of my Nickel stocks once they become priced based on $7.75 Nickel.

OIL
Oil - $85 USD. I need to keep an eye on the marginal cost of production and depletion rates. This article puts current marginal cost at closer to $85-90USD based on Goldman Sachs. I'm going to place my initial long term oil price at $85USD and I'll continue to monitor the situation. I would expect to sell some oil exposure once my oil stocks become based on that long term price.

COAL
Coal - $80 USD. Based on Credit Suisse's research, Thermal coal at $80USD and Coking coal $90USD (which is Russia's marginal cost versus Australia's at $100AUD) are good price points. Based on energy equivalence thermal coal would sell for around $130USD with oil at $85 USD. Thermal coal is very tightly tied to long term oil prices and energy demand. I will watch changes in oil prices and energy demand closely but I would expect to be reducing my coal exposure once long term thermal prices of $80USD are factored into coal equity prices.

COPPER
Copper - $1.80. I don't own any copper equities but it would seem that any companies reflecting $1.47 or worse copper would be a great buy right now. Once equities reflect $1.80 copper, it will be time to reduce positions.