It’s easy for investors to get caught up in the hype of the market – which sectors are doing well, which stocks are doing well, and why you might want to invest in something that is skyrocketing. This hype comes from many different directions, but the media and friendly word-of-mouth recommendations from friends and family are often the key influencers.

Savvy investors, though, realize that the buzz is just buzz. They know that real investing success comes from listening to sensible, well-researched experts who don’t just talk up particular stocks but rather they talk about why whole sectors might move in a particular direction. Adrian Day, founder of Adrian Day Asset Management, is a calm, expert voice in the storm. Adrian Day Asset Management manages money for individuals and institutions and their focus is on global investing, value investing, and resource investing.

Recently, we met with Mr. Day at the San Francisco Hard Assets Conference, where he was a speaker. We met with him after his talk to dig deeper into his topic. “My topic was about the impending shortage of resources in the years ahead,” Mr. Day said. “That [forecast] is based primarily on two major hugefactors: First, the growth of industrialization of China, which means a huge pick-up in the demand for resources. And second, the growing geological, technical, and political constraints of increasing resources.”

In short, demand is rising from nations that are undergoing industrialization while supply is tightening. When this happens, prices rise. So we asked Mr. Day what sectors would be impacted: “I think it’s going to affect commodities across the board – precious metals, base metals, energy and agriculture. The specifics  of supply and demand are different for different commodities. It’s more a matter over the long-term of when the different commodities are going to increase in price.”

Then we turned our attention to some of the specific commodities that Mr. Day feels will see increases. We talked in detail about copper, platinum, zinc, and uranium; although there will be many other affected commodities: “In the near term, copper is going to be affected most. When a country first industrializes, they use much more copper at the beginning of the industrialization process than they do later on. As China develops, they need copper for infrastructure, for construction, for wiring, and so on. So copper will be number one. Platinum is also interesting. It’s used in automobiles and there is a huge pick-up in demand for automobiles in China. Right now, zinc is okay; but in 3 years we could have a shortage problem. Right now, there’s excess capacity of uranium; but the big increase in demand for uranium in China’s nuclear  powerplant program, doesn’t really start until 2015 or 2016.”

Next, Mr. Day talked about just how critical this impending commodity shortfall will be, and gave investors useful numbers to understand just how significant this could be for the sector and for investment portfolios: “People have not fully grasped the enormity of this increase in China’s consumption. As a country industrializes, there is a similar pattern of the way that demand increases. There’s a slow acceleration for many, many years, and then as economies reach a certain level, they reach a take-off point and demand accelerates over a ten-year period before it plateaus and the economy matures. We’ve seen this in Japan and Korea, and we saw it with the US and German a century ago. It’s a little quicker than it was a century ago, but it’s a similar pattern.”

To explain this to MetalsNews readers, Mr. Day provided an example of the pattern in other economies: “In the 1960’s, we saw Japan using a barrel of oil per person per year, and it moved up slowly in the mid 1960’s to about two barrels per person per year. And then, over  a ten year period, it dramatically increased to 15 barrels per person per year. Korea had a similar pattern: They went from less than one barrel per to three barrels to 15 barrels. The point is: Every industrialized country around the world – whether densely populated or less populated – uses about 15 barrels [or more] of oil per person per year to run the modern economy.”

So, what does that mean for China? Investors should take note, and realize that this isn’t just a conversation about oil, but rather a conversation about all commodities. Mr. Day explained: “China consumes about 3.75 barrels per person per year right now. They are at that take-off point and will move toward 15 barrels per person per year. Even if the demand is only a quarter of [the 15 barrels consumed by other industrialized nations], the demand increase from China is going to overwhelm the available sources of supply. That equation can be repeated with copper, zinc, nickel, over and over again. The patterns are the same for industrialized economies and we don’t see where the resources are going to come from.”

Next, we turned our attention to Mr. Day’s specific investments – what has his attention and his money. Readers may recall that the last time we spoke to Mr. Day he told us he was keeping a lot of cash (rather than investments) in the portfolios he managed. So we asked him about whether his current position still had as much cash. “We did have a lot of cash,” he said, “But today, we have less cash and we’ve been slowly putting it to work. We have very little cash right now. We’re pretty fully invested and now we’re starting to trim a little because some of the prices have moved up too far, too soon.”

In spite of the recent recession, commodity prices have returned to optimistic levels. Mr. Day attributes that to China’s demand for commodities. But we wondered if it was a bubble. Mr. Day responded: “When you look at 2008, that was the worst decline for 50 or 60 years, and within a year, prices for most commodities were back to where they were before. But are we in a bubble or a mania? To answer that, I would look at the price points of commodities and also anecdotally. From a price point, gold is at an all-time high, but on an inflation-adjusted price, it is well below its highs from the 1970s. The same goes for a lot of commodities. So price-wise, it’s not a bubble. And the increase in the price of commodities has been fairly steady. And on an anecdotal basis: Ten years ago, if you went to a dinner party with your neighbours, everyone was talking about technology stocks. Five years ago, everyone was talking about real estate. But today, if you go to a dinner party today, is everyone talking about commodities? No! When I get into a taxi and the driver starts telling me about his latest gold stock, that’s when I’ll get worried.”

So, what is Mr. Day paying attention to right now? “One of my favourite companies is Virginia Mines, Inc. (TSX: VGQ),” said Mr. Day, “a small Quebec-based exploration company with a market-cap of about $240 million. One of the reasons I like it is because, apart from strong people and a diverse portfolio of assets, they have a business plan that means they don’t have to always go back to raise money. It increases its money each year by earning fees managing its joint venture projects, , as well as on a major royalty it owns. It could come down if the market corrects, but it is a very good value..” Another company Mr. Day likes is Freeport-McMoRan Copper and Gold (NYSE: FCX). “It’s not exceptionally cheap right now, but it’s still a good value: Great company; great assets; great management; strong balance sheet; huge cash flow that pays down debt; and it pays a dividend.”

Investors can easily be swayed by a lot of noise in the market – by friends and family who have un-researched opinions on investments. But savvy investors would be wise to listen to Mr. Day’s insight into the marketplace and consider how China’s massive demand for commodities will impact potential investments.

REFERENCES

ADRIAN DAY ASSET MANAGEMENT

http://www.adriandayassetmanagement.com

801 Compass Way, Suite 207

P.O. Box 6643

Annapolis, MD 21401

Phone: 410.224.2037

AssetManagement@AdrianDay.com

Author of the just-published Investing Resources: How to Profit from the Outsized Potential and Avoid the Risks (published by Wiley).