Commodity Boom: "I tell you pal, we are going into a new age"... G Gekko circa 1987

There is no doubt in our minds that the world is in the midst of a resources boom that will

last for decades to come.

This boom has taken the world economy and in particular the resources sector by

surprise, with commodity producers battling to keep up with soaring demand for raw

materials.

We believe there are some simple but fundamentally sound reasons for the sustainability

of the current resources bull market. Quite simply, they relate to the laws of supply and

demand.

When we cast our eyes across the broad resources market, we see a scarily familiar pattern

emerging for nearly all commodities. This involves market conditions of strongly rising

demand, combined simultaneously with relatively few new commodity supply sources

on the horizon.

We emphasise that this applies across the board, but an examination of several key

commodities provide excellent case studies. In our view, the best examples are gold

and oil.

To begin with, let us turn our attention to gold.

We believe it is fair to say that resource company management has become a lot more

conservative over the last few decades. There are far less risk-takers now, a mindset

likely molded by many years of poorly performing commodity prices.

Certainly in the gold sector, the key theme became the acquisition of ounces and

production, rather than exploration. It was cheaper to buy ounces in the ground than

to go out and find them, particularly when gold was trading at just US$270 per ounce in

Consequently, the gold industry throughout the 1980s & 1990s became reliant on

mergers & acquisitions for growth. This was a low-risk strategy in the short-term and

popular with shareholders and management alike.

However, this strategy had unfortunate longer-term consequences and the chickens

are now well and truly coming home to roost.

Firstly, the slashing of exploration budgets in favour of acquisitions led to a dramatic

drop-off in the rate of new discoveries. Hence, the production line of new mines has been

disrupted.

And when China came along and led the surge in commodity demand that we see today,

the problems were exacerbated.

The result is that gold production from the traditional 'big three' producers - the USA,

South Africa and Australia - is in decline. Essentially, the gold industry is a mature industry

in crisis.

Quite simply, there are few major world-class mines on the drawing board for the next

decade.

So the resource sector is paying the penalty for decades of underinvestment in exploration

spending: what we like to refer to as resource sector 'R & D.'

An examination of the oil sector decade paints a similar picture. Essentially, it was easier

and cheaper to acquire barrels than to explore for them.

Again, this seemed like a sensible strategy at the time, particularly when crude prices

plunged to US$10 a barrel in 1997 in the wake of the Asian economic crisis.

But the consequences for the oil industry are significantly worse than those presented by

the gold sector as oil is the lifeblood of the world economy.

Once again, the chickens are now coming home to roost. The world's major fields are

maturing rapidly and there is an increasing reliance on smaller fields to plug the gap.

A decade of under-investment in the exploration for new fields has meant that oil prices

have surged more than six-fold during that time.

And because it takes years to find, develop and successfully produce from a world-class

oilfield, there are no easy fixes. Sensible investors are aware of this, which is why oil prices

are heading towards US$100 a barrel within the next few years.

When one also throws in other factors such as the question marks over Middle East

reserves, the fact that OPEC's share of world oil production is set to increase and that

production from big fields is declining by 16 on

last year.

Looking at the broad sector once again, the simple laws of supply and demand that usually

apply in resource markets do not seem relevant at the moment.

The laws typically dictate that when prices rise due to strong demand, new sources of supply

are attracted to the market, and hence prices will ease.

Scarily, the scenario that is playing out before us will ultimately see record commodity

prices pretty much across the board, but with stagnant or declining production in many

instances.

There is a scarcity of new projects in the wings, but even some of those projects ready for

development are being shelved due to high development costs.

So even in an environment of record prices it is difficult to bring new projects onto the market.

What hope is there if prices soften?

And is the Chinese juggernaut likely to stop any time soon? The answer is no.

The world is experiencing a once-in-a-century boom via China. The country is undergoing

unparalleled industrialisation, with an enormous rural migration to cities. In turn, this is

providing the low-cost labour that is driving China's industrial development.

China has experienced ten-fold growth since the 1970s and over the past decade has

averaged 9 over the past four years, the fastest

pace since it gained independence and second only to China. It is forecast to average

growth of 8 to 13 to 22,

energy stocks are up 118, and key

commodities copper and oil are up five-fold and three-fold respectively.

So far this year there have been some key commodities that have outperformed and are

very much in favour with investors and speculators alike. These include uranium, nickel,

copper, platinum, iron ore and silver.

By comparison, commodities like gold, oil, coal and zinc have relatively underperformed.

With our unrelenting focus on finding value, particularly amongst those commodities that

are somewhat out of favour with mainstream investors, we believe there are some bargains

to be found.

As a result, we believe commodities such as gold, oil, coal and zinc will play catch up and we

favour investment in companies exposed to these commodities. We firmly believe in not

following the herd!

IMPORTANT: This message, together with the Fat Prophets website

(www.fatprophets.com.au) and all

its contents have been prepared for general information only, and as such, the specific

needs, investment objectives or financial situation of any particular user have not been

taken into consideration. Individuals should therefore talk with their financial planner or

advisor before acting on any information present on this message or the Fat Prophets

website. Performance is hypothetical and based on recommendations made in the Fat

Prophets report. The table is updated monthly. Transaction costs have not been taken

into account. Past performance is not a reliable guide to future performance, and

investors should be aware that returns can be negative. For a full explanation of the

performance calculation methodology,

please

contact fat prophets.