Rising Commodity Prices

Rising Commodity Prices: What's an Ourobouros?
by Eric J. Fry
The Rude Awakening
Wall Street, New York
Friday, September 16, 2005

Eric Fry explains how Rising Commodity Prices could cause lowered profit growth for natural resource companies.

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The Rude Awakening PRESENTS: Soaring commodity prices are
taking a big bite out of the profit margins of the very
same companies that produce the stuff.

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WHAT'S AN OUROBOROS?
By Eric J. Fry

Sometime around 1600 B.C., the Egyptians created the image
of a serpent devouring its own tail. A few millennia later,
the Greeks gave the serpent a name, "Ouroboros." Today, a
descendant of this curious mythological serpent seems to
have taken up residence in the natural resource sector...
Soaring commodity prices are taking a big bite out of the
profit margins of the very same companies that produce the
stuff.

For more than four years, most natural resource companies
have been enjoying brisk demand for their products...and
rising prices. Unfortunately, rising commodity prices are
causing production costs to increase sharply for the
commodity companies themselves, thereby eating into their
profits.

We should not be surprised, therefore, if profit growth at
many resource companies begins to slow down, or grinds to a
halt completely.

As a case in point, the nation's third-largest steelmaker
recently shocked its shareholders by announcing a loss for
the quarter, instead of the anticipated profit. The
culprit: rising costs for natural gas and scrap metal. The
stock dropped sharply on the news.

BHP, the world's third-largest iron ore exporter, is also
griping about rising costs. The company is spending about
34% more money than last year to produce iron ore, and
about 28% more to extract oil.

International Nickel's production costs jumped 20% this
year. And since energy accounts for 40% of this Indonesian
miner's expenses, costs are certain to rise. The Indonesian
government hiked the state-controlled price of diesel fuel
by 16% last month. Then last week, the government boosted
the cost of gasoline and kerosene, while also announcing
its intention to hike petroleum prices again in October.
Even after the recent hikes, Indonesian citizens pay only
87 cents for a gallon of gas. So prices in the country
still have much higher to climb before reaching
international norms.

Rio Tinto Group, the world's No. 3 miner, last month
reported a 7.7% rise in expenses in the 12 months ended
June 30.

Rising Commodity Prices: Coal and Agriculture

Meanwhile, the price of materials and parts used in open-
pit coal mining, such as steel and tires, jumped more than
5% last quarter alone. That's the biggest one-quarter
increase in almost five years.

Over in the agricultural sector, the news is even worse:
production costs are soaring while product prices are
tumbling. The price of corn, at $2.07 a bushel, languishes
just a few pennies-a-bushel above 17-year lows. But
meanwhile, the price of diesel fuel has rocketed 65% over
the last year. Farmers are caught in a "cost-price
squeeze," says Rick Tolman of the Corn Growers Association.

Wages are also rising throughout the mining sector. "Mining
companies are running short of the workers they need to
expand production and to capitalize on today's sky-high
commodity prices," Bloomberg News reports.

Down in Australia, many geologists are demanding – and
receiving – A$200,000 a year, or about four times the
historic average wage for a geologist.

The same serpent that's eating away at the resource
sector's profits, may also be gnawing away at the
investment prospects of many emerging markets. Since
resource stocks wield a sizeable influence over many
emerging markets, the fortunes of these two investment
sectors are closely aligned.

The iShares MSCI Emerging Market Index ETF (NYSE:EEM) and
the iShares Goldman Sachs Natural Resources Index ETF
(NYSE:IGE) tend to track each other very closely, as the
nearby chart illustrates. (For "quant jocks," the R2 of
these two stocks has been .90 over the last two years,
based on weekly data).
 
"The Ouroboros," one touchy-feely Website explains,
"symbolizes the cyclic Nature of the Universe: creation out
of destruction, Life out of Death. The Ouroboros eats its
own tail to sustain its life, in an eternal cycle of
renewal."

The "eternal cycle of renewal" may seem like a majestic and
sublime concept, but that does not mean than any one of us
should volunteer to be the tail.

[Ed. Note: Eric Fry has quite a passion for making astute,
and sometimes entertainingly obscure, observations. In a
special 'evening edition' of yesterday's Rude Awakening he
noticed something else just lying around waiting to make
people money. Make sure you check it out here if you missed
it:

www.agora-inc.com/reports/AFR/WAFRF9A8/

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And the Markets...