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Week Commencing July 07, 2014

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This week we look at the following topics:•Outlook on Commodities•Oil & Natural Gas•Copper, Silver & Gold•Iron Ore & Coal

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Once all these forecasts are published you will have a great opportunity to ask your questions in the webinar. If you have missed anything I will summarise it through the webinars so there is no need for panic. I hope that this will position you well for the new financial year. The last time we published a forecast guide was in January where we said that copper prices should stabilise, energy prices are likely to remain strong and the best companies to consider for share portfolio would be blue chip names who have been beaten down in 2013. We picked the following stocks as our choice of exposures. I have copied the exact section in the report from January for your reference.

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There is no point in writing a new set of forecasts for the market without reviewing how our last set of forecasts performed. If you are a new client or haven’t been reading Invast Insights since the beginning of the year, the full link to the 2014 forecast guide can be found here. I prefer if you visit the link later, it’s not worth distracting yourself at the moment because what I am about to publish below is perhaps more important.

What I will say is that since the beginning of the year, the performance of the stocks we picked has been as follows – Leighton Holdings +31%, Newcrest mining +41%, Oz Minerals +37%, Qantas +14%, QBE Insurance -4% and Worley Parsons +12%. The average return across these six stocks has been 22% in just six months. Keep in mind that we haven’t included dividends here. Adding dividends would see the return closer to around 25%. Over the same period the ASX200 has been up by only +2.8%.

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Not all of the stocks which we picked made money, but most of them did. I hope this provides some context into the comments that you will read over the next few weeks, we do have a contrarian style but we measure and qualify all our comments.

This week I’m talking about commodities but before I start I just want to remind those who attended the webinar I held for Invast on 24 June at 7PM what my overall thoughts were on the Australian dollar. I made the call that I think the currency will be heading back towards the mid 80 cent range over the next one to three years. At the time that I made the comments, some of those on the webinar questioned by reasoning, my charts and my conviction. I made the admission that in the short term the currency could rally to as high as the mid-90s range but then would be met with stiff resistance.

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I hope you enjoy this month’s outlook reports and I look forward to hearing from you at the webinar on 29 July at 7PM.

Regards, Peter EshoEditor – Invast Insights

Outlook for energy – oil and natural gas

If you have been reading the past few reports you would know very well that we remain bullish on energy prices for the remainder of this year and next year. If you have missed our recent reports I suggest you go and read them right now. There is too much content to repeat and if you don’t know the context of what we have been saying you will find it very difficult to understand my outlook for the new financial year. So to ensure you are not lost – please read:Invast Insights Issue 40Invast Insights Issue 39Invast Insights Issue 38 (probably the most important one of the three)

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The two charts below are very important in reaffirming our bullish view on energy over the next year.

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One of the things which we have been stressing about is the impact that the recent violence in Iraq has on oil supply and sentiment in the market. In the three reports which I asked you to read above, we spell out the fact that Iraq is not the most important source of energy supply but that the geopolitical environment there spells problems for the whole region and the potential flow on effect on the world’s largest supplier of oil – Saudi Arabia.

One of the things that caught my eye this week was a report via Al Arabiya last week. BBC reports that “al-Arabiya TV reported that Saudi Arabia had deployed 30,000 soldiers along the 900km (560-mile) frontier after Iraqi forces withdrew. The Saudi personnel were fanning out along the border to prevent attacks by jihadist-led Sunni rebels, it said. On Wednesday, King Abdullah discussed Iraq and the threat posed by the Islamic State in Iraq and the Levant (Isis) with US President Barack Obama in a telephone conversation.”

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The one thing that keeps us up at night is the prospect of the jihadist movement flowing down into Saudi Arabia and no doubt sending a shock throughout global markets. This event will have the real prospect of sending oil higher, perhaps by as much as 20-30%. Eventually the fears will be calmed, the United States knows that a blow out in oil price is the single largest risk to its economic recovery. But energy traders are no fools, they will respond quickly if the regime in the world’s largest oil producing country falls. The Saudi regime is not a freely democratically elected system. The impact will be much different to Ukraine, Russia and the wrangling in Europe.

We’re not expects on geopolitics and we don’t know how this will pan out but we have been writing for weeks now that the situation in Iraq is serious because of the potentially signalling effects on other more critical parts of the energy market. If you read the BP Statistics you will see just how important the Persian Gul region is to the amount of total seaborn oil traded on a daily basis.

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Last week we wrote “Brent has failed to rally above US$115 on what we consider to be fairly significant news in Iraq. It will most likely find support at around US$110 or thereabouts before resuming a higher move sometime later in this calendar year.”As I write, the Brent crude price is doing exactly just that and finding support at US$110 which I think will hold. Don’t be caught off guard, there is a real potential for oil to move higher this year.

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Outlook for metals – copper, silver and gold

Our view on gold and silver is very different to our view on copper and other industrial commodities. We view the first two as commodity currencies which are driven by different factors. In December last year I called a floor in the gold price as the market was becoming overly bearish, I said it’s time to start buying and tipped Newcrest Mining (NCM) as a good consideration.

Since then Newcrest shares are up 41% and the gold price is looking fairly comfortable above US$1300 where I think it will stabilise for the next few years. You can watch my call on Bloomberg TV from December by clicking the image to the left, my reasons haven’t changed.

Also on gold, we wrote fairly extensively in Invast Insights Issue 39 about the impact higher energy prices have on the overall cost of production in gold. We think high energy prices will support the gold price at current levels because the marginal cost of producing an ounce of gold continues to rise in line with higher employment and energy labour costs.

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We wrote “With that in mind we continue to see upward pressure on energy prices to be a major boost for the gold price. The gold to oil ratio is a very popular trade among veteran traders to see the relationship reverting back to the mean average somewhere near 15x. The ratio calculates how many barrels of oil an ounce of gold can purchase. We can take the relationship back more than 60 years through the following chart to see the peaks and troughs brought about by wars and other geopolitical events which caused a shock to the relationship. “

Our view on copper and industrial metals is a little less certain. It is very good to see that copper has once again held the US$3/lb level very convincingly after testing it over recent months. We think US$3/lb is very much a line in the sand, the industry cannot cope with any price below this level regardless of what analysts think demand is doing. At the end of the day countries like China and India need to continue developing and copper is crucial part of that development. India is still behind China in its anticipated copper consumption cycle so there is major demand. Countries like the United States are also key consumers of copper as their economies improve, even if this is falling as a proportion of previous consumption patterns.

We think it’s probably too early to get excited about copper but if we do see US$3.30/lb becoming the next support level over the following months, there will be a case for copper to enter into a bull market and start charging towards US$3.60-65/lb before a possible charge to US$4/lb. We’re just not sure on our timeframe here, we’re fairly confident that we will eventually see these levels but with so much disappointment and distortion to the copper price recently we think it will be premature to go out on a limb with respect to timing.

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Below is a 30 minute chart as of the time of writing, we want to highlight the short term price action and positive momentum. The upper limit of this chart is just below US$3.29/lb so we need to see that region being taken out before we get excited. So in a nutshell, US$3/lb is a major confirmed support level but we need momentum above US$3.30/lb to call the next phase up towards US$4/lb.

Image: Copper price 30 minute chart via Invast MT4 platform

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Outlook for bulk commodities – iron ore and coal

Because the copper price has still not confirmed a major move higher, we aren’t sure that iron ore will either. Copper is the best lead indicator for all other industrial commodities and just as copper has bottomed at around US$3/lb, we think iron ore has found solid support at US$90 per tonne. Having said this, iron ore stocks have been completely sold off in recent months and will be reporting production numbers into July which could surprise the market. The actually earnings numbers will be negatively impacted when full reporting takes place in August, but most of this is reflected in the market at current levels. For those with a higher tolerance of risk, the following iron ore names have the greatest operating leverage should prices bounce back above US$100 per tonne.

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It’s difficult to call a bottom in these stocks given the way that the iron ore price has fallen but we think they should at least find some limited support as the market rises. Investors will be looking at diversifying outside of banks and financials which have been a very heavily crowded space. What the iron ore stocks need to see in order to sustain any improvement in their shares is an iron ore price above US$100 per tonne, considering that the industry is producing at an all in basis somewhere near the US$80 per tonne once adjustments are made. We don’t place too much credence on the cash costs which are often quoted.

Our view on coal is probably the least exciting. The commodity cannot be easily traded at a spot level and exposure on the stock market is difficult – there aren’t too many independent pure play coal producers left on the market with low sovereign risk and producing a decent enough level to justify the attention. There are some names but we can count these on one hand. Best to ignore the space all together and focus on the more liquid opportunities.

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Trading ideas

Watching copper for a break through US$3.30/lb is probably the one key thing on our list. Copper can be traded on a spot basis, the market is fairly liquid and we might see more volatility over the next year. Gold is popular but we think will be fairly flat in terms of pricing. Brent is now doubt finding support at US$110 per barrel as stated above and then will consolidate before popping up higher on event risk – maybe Saudi Arabia? Not sure yet but we are watching. The gold to oil ratio is something we wrote about a couple of weeks ago and is probably one of the more interesting trading ideas in the commodities space to consider. Both commodities have a certain sense of correlation in the markets and are strongly correlated at the operating level – whether you are a gold or oil miner. With global central banks flooding the system with cash, we see upward prices for both. But one will rise more than the other.

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The gold to oil ratio is a very popular trade among veteran traders to see the relationship reverting back to the mean average somewhere near 15x. The ratio calculates how many barrels of oil an ounce of gold can purchase. We can take the relationship back more than 60 years through the following chart to see the peaks and troughs brought about by wars and other geopolitical events which caused a shock to the relationship.

Image: Gold to oil ratio since WW2 via www.macrotrends.net

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At 15x the current Brent crude price, gold implies a price at US$1,710 per ounce. Using West Texas crude as the base measure, gold implies a price of US$1,590 per ounce. The 15x multiple isn’t an exact or precise measure but it is merely a level which the chart above suggests is the post-war average. The impact of higher oil prices has a huge flow on effect on global inflation and this is what gold bugs thrive on. The correlation between both is uncanny. Because of this, we think gold can continue to rise with the recent break through US$1300 a potential catalyst to see it move higher. The gold to oil ratio can be traded through Invast’s MT4 platform, it means you don’t necessarily need to get the gold price movement correct or the price of oil correct, rather the ability of gold to increase relative to oil (which has moved higher in recent months) in order for the ratio to come back towards the average range of around 15x. Timing here is important, as with many other fundamental trading strategies.

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We’ll talk through the gold to oil ratio in the webinar on 29 July at 7PM. If you don’t have an Invast account or at least a demo trading account we suggest you arrange this before the webinar so that you can be in tune with how we measure, place and execute the trade – also through customising the charts and calculation process. Click on the banner below to access the full suite of July webinars.

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Peter’s webinar will cover both the fundamental and technical outlook going forward plus the key drivers to look out for and is expected to fill fast. Q&A will be open straight after the webinar. Register now by clicking the image below.

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Go to www.invast.com.au/insights to get a complimentary 4 week trial and receive the latest insights as they are published to our live clients.

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DisclaimerPlease note that you are receiving this report complimentary from Invast Financial Services Pty Ltd (AFSL 438 283). Invast staff members may from time to time purchase securities which are included in this or future reports. The authors of this report may or may not be holding a position in the securities mentioned. Please note that the information contained in this report and Invast's website is of a general nature only, and does not take into account your personal circumstances, financial situation or needs. You are strongly recommended to seek professional advice before opening an account with us.

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