Dear CIGAs:

Hardly a day goes by it seems without some Wall Street analyst predicting the commodities boom is coming to an end. At least one of these wiz kids has even compared the boom to the dot.com bubble which must be the dumbest thing I’ve ever heard.

While there’s obviously a speculative side to the commodities business (just like any other publicly traded market segment), what you are really dealing with in this case are industrial commodities whose price is largely established by good old fashioned supply and demand. LME metal inventories drop because of rising industrial demand and the price of the commodity goes up, reflecting real or perceived supply shortages. It’s not really too complicated in my view.

First on their list was gold and now these Wall Street wizards are targeting base metals, claiming that an economic downturn/recession in the United States will drive these critical industrial commodities appreciably lower. It’s happened like this in the past and this time won’t be any different! Historic prices, they say, are the only measure for determining future prices as we all know. Well, don’t bet the farm on it - or even the outhouse for that matter.

Let’s face it, most of the world’s largest investment firms were negative on gold for most of its mercuric rise from the mid-$250s. Who can forget Goldman Sachs’ November 2007 recommendation to sell dollar-denominated gold because of its assessment that the U.S dollar would soon stabilize. “We would now use a short exposure in gold, expressed in U.S. dollars, to capitalize on a gradual relaxation of credit concerns in the financial sector over the coming months,” Goldman analysts said, adding that selling gold would also provide “an avenue to benefit from the prospect of stabilization in the U.S. dollar.” In the annals of bad calls, this must qualify for an Olympic gold – the only “tarnished” one ever to be awarded I might add.

A few weeks ago I was in Toronto on business and took in a few technical sessions at the annual PDAC (Prospectors and Developers Association Convention) which draws more than 20,000 delegates from well over 100 countries. These are the people that really have their fingers on the pulse of the minerals industry. Of particular interest to me personally were the various presentations on commodities which were given by some of the world’s most knowledgeable and credible authorities. What I gleaned from these presentations reinforced my belief that we are in a super cycle for commodities that is without precedent in history and will likely not end any time soon –if ever. Mind you that’s not to say that there won’t be some weak periods along the way.

Immediately below, I’ll discuss some of the key points brought up by the various speakers. But first let me say that you don’t have to look too far for tangible indications about the future of commodities markets - especially for base metals. London-based Rio Tinto PLC and Australia’s BHP are seeking a 71% increase in iron ore prices from the Chinese who are also resisting demands from both companies to sell a portion of their contracted volume on spot markets where prices are substantially higher. Rio Tinto sold iron ore on the spot market for as much as $190 a metric ton in December - more than twice the equivalent of $85 a ton that it’s sold under contract. That’s serious pricing power and a good indication of things to come in my opinion.

As most people know, iron ore is used to manufacture steel which is critical to every industrial society. But a lot of other mineral commodities are used in the steel manufacturing process including metallurgical coal which, incidentally, has tripled to approximately $120 per metric ton (Western Canadian contract price) since 2001. Without doubt steel is among the best indicators of what demand could be for other key industrial metals including nickel, cobalt, molybdenum and many others.

Don’t be hoodwinked into believing that the U.S. is the main driver for commodity prices these days. Raw material demand is booming in China as consumers there use more grains, metals and energy products. Also worth noting is that China’s steel output is four times that of the U.S. which was virtually obliterated by the U.S. administration’s high dollar policy. In addition, China’s next door neighbor, India - with a population of 1.1 billion - is expanding rapidly and is sorely in need of infrastructure improvements which will create new demand for metals that are already in short supply. Low stockpiles of critical commodities should keep prices volatile and projections for new sources of supply could prove to be overly optimistic.

With real economic growth largely confined to Asia, currencies such as the Chinese Yuan and the Indian Rupee are destined to become stronger. That will make commodities in these respective currencies cheaper including gold which has strong cultural underpinnings in Asia.

Nevertheless, despite this positive outlook for metals, some analysts are predicting a significant downturn in base metal prices as the U.S. economy cools. This has prompted Ernst & Young (a leading professional services organization) to note that metals analysts generally don’t stray too far from the “comfort zone of historic averages” which has proven thus far to be a big mistake in this historical bull market for commodities – and will likely continue.

In summing up I would like to report a few broad observations that I cobbled from various speakers at the Toronto conference, breaking them up into specific commodities:

Gold

Watch for continued safe haven buying as the sub-prime mortgage crisis unfolds. The dollar decline has contributed to higher gold prices but gold has also been supported by the recent decline in bond yields, by demand growth, and by limited Central bank selling. Gold has also been closely tracking some of the so called second tier currencies including the Euro and Japanese Yen. On the other hand, reduced jewelry demand is a negative for gold but it’s worth noting how Indian demand jumped sharply after gold fell of its recent highs. (At $900 plus per ounce it seems even the price sensitive Indians are finding it cheap).

HSBC Securities analyst, Jim steel, arguably one of the most astute readers of the gold market, said that he’s seeing a rotation into resource stocks along with increased investor interest in the broader commodities market. Gold remains supported by commodity price strength and monetary inflation which can only become worse with accommodative monetary policies in the U.S. and in other Western countries. In any event, he sees strong gold prices for the remainder of the year at least.

Silver