The financial world is in turmoil. The monetising of government debts - euphemistically called 'quantitative easing' - means that the world runs huge deficits. The result: proliferation of paper promises that exceeds the ability to create wealth to finance those promises.
The inevitable solution will be to use inflation to debase the value of those promises. Inflation is the gentlest way for society to fill the gap between promises and reality.
With inflation rising, paper assets such as shares and bonds are not the place to be. Commodities are the answer for two reasons:
1. with the US$ dollar falling - the Australian dollar could go to US$1.10 in a heart-beat -, commodity prises (which are still set in US dollars) will be rising;
2. the demand for commodities is driven by people moving into cities. In 2008, for the first time, half the people in the world were living in cities. In the next five years, there will be another 150 million people - about half the size of the population of the USA - moving into cities, mostly in emerging countries.
Investing directly in commodities is almost impossible for the average punter. The next best thing is investing in commodity-based shares in major mining companies. Mining giants BHP Billiton and Rio Tinto are looking more defensive than sectors like property and healthcare and consumer staples. Thanks to the emerging markets India and China which will underpin strong commodities demand for decades, the miners' longer-term earnings growth potential will be better than all other sectors despite the near-term uncertainty created by the RSPT (Rudd will be gone by the next election and his tax grap will never pass through Parliament).
Of the two mining giants, I favour BHP Billiton because of its geographical spread and diversification across a whole range of minerals as well as oil and gas.
My 12-month price target on BHP Billiton is $48. Its last closing price was $38.58, its 52-week high $44.93 in April 2010 (with a 52-week low of $31.33), and its highest ever $50.00 in May 2008. Its NPV is $45.
