BMO Capital Markets Global Mining Conference
Keynote Speech - February 25, 2008

Don Coxe
Hollywood, Florida

“For Miners, The Best is Yet to Come”

Yes, six years ago this week, I spoke to a smaller gathering, as Mike said
and I said what was coming was the greatest commodity bull market of all
times. Well I found out afterwards that a lot of my BMO colleagues thought
I was stark, raving mad, but they said “You know, a lot of the people
enjoyed that, it made them feel good.” So they invited me back the next
year.

And a year and a half later, I published a Basic Points issue: An
Investment Sonata in a Miner Key. And we’ve reproduced it in this issue of
Basic Points because what we did in that is predicted the next five years
and what was going to come thereafter. I’m an historian by nature. I look
for major trends that take years to fulfill themselves. My book was about
a Triple Waterfall crash of technology, which followed the Triple Waterfall
crash of commodities. And the Triple Waterfall crash of Japan.

Each of those trends takes ten years to go up and two decades to go down.
So for technology, it’s a long time yet before it reaches bottom. But what
it means is for this industry, we’re still in the early stages of what will
be the greatest boom you’ve ever seen. But I use as my theme, in that
piece, the structure of the classical sonata form, which is three parts –
it can be done in four – but three parts. And the first one is done
moderato and you get the themes. And it goes on for a long time, it’s sort
of cheerful.

Then you have a second movement, which is short. Sometimes it shifts into
a minor key. Much more reflective and it’s usually a slower tempo. And
then it sets you up for the final movement, which – and I use the Beethoven
violin sonata for that – which comes out of the box, just roaring out, at
high speed, with joy permeating. And I said that’s what’s going to happen
to the mining industry.

So we are in or we have entered in to the slower movement. Does that mean
it’s bad news? No! This is a time at which you move from one kind of
strategy to another. I used as my mantra for investing in the stocks “You
invest in companies with unhedged reserves in the ground in politically
secure areas of the world.” Don’t worry about short term swings in
earnings, look at the question of the value of what’s in the ground because
we aren’t going to have enough of it to meet what is this century’s biggest
trend.

Chris Patten - who was the final administrator of Hong Kong, before it was
subsumed into China - when he was installed as Chancellor of Oxford, said
“For the first eighteen centuries after the birth of Christ, the two
biggest economies in the world were China and India. But they didn’t
experience the Industrial Revolution the West did. So they moved way down
in the global ranking.” He said, “In this century, we revert to normal.”

By the middle of this century, the two biggest economies will be China and
India. And what he didn’t say was that when you move from a non-industrial
economy to becoming a major industrial economy you chew up basic resources.
You chew up energy and you chew up metals and you chew up…food.

So, the big trend – and we’re still in the early stages - is we are
adjusting the share of the global pie. For the twenty-one year Triple
Waterfall crash of commodities, as the global economy expanded, the share
of the pie that went to primary producers – oil producers, metal producers
and food producers – shrank, in relation to the world. We are going
through a long, long cycle in which that gets reversed.

The growth in income of primary producers will continue to outpace the
growth in the economy. We are addressing the balance and it’s being done
for us by the demands of these new economies coming forward with their
billions of people. This at a time when a collapse in the birthrate in the
OECD countries, has meant that their consumption patterns aren’t terribly
important for primary products.

That is the adjustment that we have to go through as investors. That’s the
adjustment that we have to go through as people building companies. Which
is to say, where is the demand? Where is the pricing power? How can we
create the resources needed as these people move from poverty to middle
class to wealth. They need what we’ve got to find and produce for them.

That means the weighting of commodity stocks will continue to rise in
global indices.

And the scale of this is so gigantic, that the tendency is to say “Well
look, we’ve got a crowd this big now, it’s the top of the market.” No!
It’s simply a form of top at one stage of the cycle. Because up until now,
it’s been a pure scarcity factor. What happens in that, is that the
price/earnings ratio of the commodity producing companies, shrinks, in
relation to the rest of the market, because people say I’m not going to pay
up for these earnings, because they aren’t going to last. Commodities are
short-cycle.

What needs to happen is that people say “Oh no, this is a multi-decade
cycle. And this is the group that will continue to grow earnings the most,
have the most pricing power and where there’s the biggest payoff for having
quality management.” And when that happens, the price/earnings ratio will
rise and rise and rise.

But against that are other trends. You see, the last time there was a
“mining boom”, was during the stagflationary 70’s. And we had periods
where base metals rose in price beyond their economic value because people
wanted to buy hedges against inflation. Now the pure hedge, gold, and
other precious metals did brilliantly, going from thirty-five dollars an
ounce to eight hundred and fifty, before entering a twenty-one year
collapse to two hundred and fifty dollars an ounce.

But why people would think that they could hoard copper and that was going
to go up ahead of inflation was beyond me.

What is going to unfold is people are going to realize that the risk in
commodities is actually lower than the endogenous risk within the rest of
the stock market. Why is it that the TSX has outperformed the SPX for six
years? Is it because all Canadian companies are brilliantly run compared to
American companies? No! It’s because the weight of commodity companies in
the S&P is only eleven percent and of that the overwhelming weight is Big
Oil companies and the phrase “Big Oil” is going to have to disappear from
our vocabulary. Because Big Oil has run out of unhedged reserves in the
ground in politically secure areas of the world.

So the oil companies reserve life indices are shrinking, they’re buying
back their stock, they’re paying more dividends, they are no longer hedges
against inflation. The real hedges against inflation in the oil industry
are those like the Alberta oil sands companies - assuming Alberta doesn’t
screw things up hopelessly - that will be allowed to develop their reserves
which will rise faster in value than inflation.

Now, we switched our emphasis last year away from the base metal companies,
seeing this pause coming. And we moved gold to the top of the list,
because gold does several things and you never know at a given time what
it’s telling you. Gold, of course, trades inversely to the US Dollar,
which was clearly in a bear market. Gold also is a pretty good predictor
of inflation. Now at eight hundred and fifty dollars an ounce, it
certainly wasn’t predicting, inflation, that was a mania. That was a
mania like the tech mania which was the greatest collective idiocy in the
history of financial markets.

But the other thing that gold does, if it moves up fast at a time that
inflation isn’t yet serious, what it’s telling you is there’s a financial
crisis coming. Gold senses this better than any other commodity. So when
we saw what was unfolding in subprime mortgages and collateralized loan
obligations and all these creations done in what I call Jurassic Park
Avenue, where they were creating these complex structures, it was abuse of
technology really, an attempt to bring tech back in another form.

So what we have then is a recession in the US, which may spread across the
OECD, brought on by the greed and bungling of Wall Street bankers by
creating these new Jurassic Park Avenue creations. The Jurassic Park
people created dinosaurs in their labs and thought they could control them.
And then the dinosaurs took over the island. So great investment banks,
great ones, brilliantly managed…their stock prices are plummeting because
they couldn’t control what they had.

Gold kept going up through all this because gold is the only financial
asset that is nobody else’s liability. It is a pure protection against
problems in the financial system. So what we told people then was to way
overweight gold stocks and gold in your portfolio. We’re sticking with that
recommendation.

And the problem of course for the gold mining industry also, is to replace
their production in politically secure areas of the world. So listening to
the presentations this morning, from the companies, what you could see was
the companies were doing it right, are getting the production, controlling
their costs, building their reserves. That is the lifeblood of the industry
and as we come out on the other side, then we’re going to move into a
different kind of world. Because now inflation is coming back.


And the sign that it’s going to keep going was the day after it was
announced that the US CPI was the highest it had been in fifteen years,
with the US stock markets closed, Ben Bernanke got a telephone meeting
together of the Fed and cut the Fed funds rate by seventy-five basis
points. And he followed it up a week later with another fifty. In other
words, the supposed guardian against inflation for the central banking
world had thrown in the towel. This at a time when the inventory to sales
ratio in the US was the lowest on record.

You see, during the twenty-one year Triple Waterfall crash, where inflation
kept falling along with interest rates, what we had was an oversupply of
energy, an oversupply of metals, an oversupply of food and an oversupply of
labor. We used up the first three scarcities, the first three oversupplies
that have become scarcities, and we can look forward to at least
twenty-five years in the OECD where we’re going to have trouble replacing
the retirees and those who die with new entrants to the labor force, which
means labor costs are going to continue to rise. A recession will slow it
down, but not by much.

So the commodity companies…the commodity companies are the ones who can
offset these costs by their ability to do a better and better job with
lower and lower grade ores and to meet the demands, the relentless demands
from China and India and the other Third World countries that are
progressing and they can do this and grow their earnings at a time when
other companies - conventional companies who prospered during the long
deflationary period - these companies are going to really be struggling.

Over sixty percent of the entire gain in the S&P from 1982 to three years
ago, came from the drop in interest rates. All these companies were paying
out huge bonuses and stock option payments…all it was, was simply that
money got cheaper and cheaper. And their costs were well controlled. Now
we’ve used up that bonus. So therefore people are going to look to the
kinds of things that people in this room produce or will be producing and
saying “They inherently have a built-in structure which will enable them to
outperform inflation as it comes back.”

So we will gradually then start to apply a premium price/earnings ratio to
the great mining companies, whether they are producing copper or nickel or
lead or zinc or uranium or coal, we’ll make decisions on the supply/demand
of each of these, but, instead of having a discount to the P/E, for these,
we’ll have a premium. Because people will say “We’ve got to protect
ourselves, we’ve got to protect our wealth at a time that inflation is
coming back.”

So, the fact that we’ve got a big crowd is not a sign of a mania or a top.
What it is, is a reflection of reality. Fortunately for most of the people
in this room, you got this story before the markets did. And you’ve
prospered up ‘til now. You will continue to prosper, because even this
slowdown will not mean a collapse in the price of base metals or their
stocks.

For one thing as we heard this morning in the presentations, that if the
stock of a mining company falls, meanwhile if the price of the commodity
isn’t going down that much, that company will simply be acquired. Because
those who do have the cash flows and do have a vision of how the world will
unfold will say “Look, we’re having trouble finding new ore bodies in
politically secure areas, we’ll just buy up the companies that have them.”


The presentation by Freeport McMoran where he commented that they paid off
the last six hundred and fifty million of Phelps Dodge’s hedges…after I
spoke five years ago, I attended the Prospectors and Developers Association
Convention. When I left that meeting to go back to Chicago, I was stopped
in the hall by a gentleman who turned out to be a senior officer of Phelps
Dodge. And he said “You didn’t have any notes. You didn’t have any
handouts.” I just took down notes and he was aggrieved about that. And he
said “You said copper prices were going to go up over a dollar!” And I
said “Yes.” And he said “…that it was a trend that was going to last for
years. Why?”

So I told him, briefly, and he said “Mr. Coxe, I would love to believe you,
but I just want Phelps to be there two years from now when I’m due to
collect my pension.” I watched the insider trading and I watched the
build-up of hedges being put on by the company. That was when I came out
with my maxim about where the world was then, which is “The greatest
investment opportunities come from an asset class where those who know it
best, love it least because they’ve been disappointed most.”

It was true of the oil industry. In 2003, Lee Raymond CEO of ExxonMobil
said “There’s talk of fifty dollar oil, don’t you believe it. In the
unlikely event that oil went past forty dollars, we and the other big oil
companies would bring on so much new production from Russia and Venezuela
the price would go back to twenty-five dollars, that’s all it’s worth.” He
didn’t see the way the world was unfolding.

The valedictory press conference for Lee Raymond…ExxonMobil regrets it will
commit no new capital to Russia and Venezuela, ExxonMobil’s reserve life
index has fallen from seventeen years to twelve years. It will continue to
fall. Exxon is a paper tiger. Great company, brilliantly managed, but,
what it could not do was replace its production with reserves where it
could count on it.

So this industry which doesn’t have the challenge of the Venezuelas of this
world to fight with, this industry has a unique opportunity to prosper as
we go forward to the next stage. By getting its reserves in place, getting
its production facilities in, probably building hedges against rising
energy costs, those kinds of things or as we heard this morning about
setting up wind farms to offset the cost of electricity. These are the
kinds of strategic decisions that are going to be made.

Investors have a tendency that when they see they’ve made a lot of money in
one section of the stock market while the Street continues to say “Well,
these are cyclical stocks, not entitled to high P/E ratios” when we have a
sell off in the stock market, they also sell off the stocks they’re up in,
because the margin clerks are in charge. And they’re being cleaned out of
their supposedly good quality stocks, so they sell off.

So therefore as this bear market has got underway, what we’ve seen has been
a sell off in commodity stocks. The one exception to that has been the
agricultural stocks which just keep going to new highs week after week
after week. But, what you see is people still say, that what you’re in is
an inherently riskier industry and you’re more tied to economic activity
than other industries therefore your stock isn’t worth as much.

Look! The changes that are going on over in Asia are so vast…just one
statistic I saw on the plane coming up, supermarket sales growth from 1997
to 2005, 8% in the US, 5% in Europe…488% in China. 488%, because you see,
those people are switching from a bowl of rice and a loaf of bread to a
middle-class diet with meat and/or dairy products. And therefore we have
the lowest carryover of grains relative to consumption for which we have
records. Now when food inflation comes and it’s now coming big what that
will do is drive overall inflation up, so therefore those complacent
economists out there who say “Oh well, there won’t be much inflation
because we’re going to have a recession in the US, that’ll drive down
inflation…no…no&hellip... Supply and demand is going to prevent a retraction in
food prices back to lower levels.

So, what you see is in China, they’ve now got the worst inflation in
fifteen years, it’s up seven and a half percent but if you take out food
it’s up one percent. Already because they have to pay their workers more,
their costs are rising. You may have noticed that for the first time in
more than fifteen years, the cost of clothing in the US over two years rose
faster than inflation rates, because China is raising its prices. For the
last eight months, exports from China in to the US have been priced at
higher increases than overall US CPI. In other words, inflation is being
imbedded in to the system.

Once people understand that and that’s a gigantic change of thoughts
because ninety-five percent of the economists are committed to the world as
it was, what they’re going to say is “Well, how can I own assets that
inherently protect me against these prices? Who is it who has the pricing
power under this? So prepare yourself for a reversal of the recent trend,
which is that commodities outperform the stocks.

If you take a chart of the price of copper, we used this in our Friday
conference call, which is a gigantic flag pattern. Any technical analyst
in the room knows how flag patterns work. It’s like those flags at the
back of sailboats, those little triangular flags? Well, the price chart
for copper shows a long-term flag. And if you use the log chart, as of
last Thursday it broke out on the up side. It broke out on the up side at
a time when all the talk in the US is inflation. What is going on?

These are the kinds of things that people are going to have to adjust to,
you are still in the minority. Don’t look around this room and say “Well
with all these people here, this idea is out there it’s moved from Page
Sixteen to Page One.” One of the reasons for the minority is because of the
make up of the S&P. There are two
mining stocks in the S&P. Freeport and Newmont. So when I would talk to
US clients about mining stocks, they weren’t interested in developing any
buy side analysis of it because “Oh, you have to invest in all these
companies located in Canada or Australia or where else. So, we’re going to
stick with the stocks we know.”

The US stock market is ill-positioned for the way the world is going to
unfold, so therefore it will continue to underperform global markets. As
Canadians in the room, what you’ve got to adjust to is the fact that you’ve
still got the best investment attractions available to you. Now I regret
that two of those were taken out. I bitterly opposed them at the time. I
said Canadians were selling them too cheap, Inco and Falconbridge. It was
interesting that their buyers said they were able to cover their costs with
three years earnings after buying them.

National treasures that have been around for a century and they got sold
for three times forward earnings. Now, not the earnings that Wall Street
analysts predicted for them, because they kept using a collapse in metal
prices as part of their assumption. They valued reserves in the ground
with copper at ninety cents. Sure, there’s going to be some pull backs in
metal prices. But I don’t believe that the stocks will sell off badly in
this, and frankly you should be adding to your positions as investors if
they do. You will either be taken out by a big mining company or in the
next cycle, you’re going to get paid huge for holding on to those stocks.

There might be a temptation to say, “Well look, he was lucky enough to get
on a big winning streak at about the right time. So he’s unwilling to give
it up.” Yeah, I’ve been around this business, as Mike said, for fifty
years. And the only reason I feel confident about this is because as an
historian I can see these major trends that take so long to be filled out
and the way in which you win is staying with them and adding to your
positions when the faint of heart or the badly invested get out of them,
saying “Oh boy, did I make a big profit on that! And I got cleaned out of
my really good stocks by my margin account. The really good ones out
there.” [skeptically] Uh huh. Yeah.

So predict that over the next ten years, ten to fifteen years before we’ll
peak in this cycle, that what we’re going to see is returns on the mining
stocks beyond what you would have thought possible. Just as I said six
years ago that the next five years were going to be beyond what you thought
possible. But this time it’s going to come in a big boost in the P/E
ratios. In other words, the stocks will outperform the metals. Because
people will say “This is something that I can hang on to. This is
something that protects its value in a world that’s becoming more and more
difficult.” I can tell you, once food inflation breaks out, you have all
sorts of chaos. The biggest challenge to the Chinese administration is not
the question of freedom of speech, it’s the question of inflation.

At the Tiananmen demonstrations, they were demonstrating about a variety of
complaints, but the biggest complaint was about inflation back then. And
now inflation is coming back there. Over the weekend there were riots in
about six countries in the world over soaring costs of food. Lots of
governments are going to be destabilized. As people realize that there’s
an underlying thread to these stories, what they’re going to say is “Well
how can I be properly positioned?”

For you brokers in the room who are trying to advise clients on how they
position themselves, I urge you to suggest that a long-term investment
approach is very much in order. On the short term, I have no doubt that
the gold stocks will outperform the base metal stocks, except for those
that get taken out. But, the base metal stocks are the ones that are tied
to the growth of industrial production, particularly in China and India.

Look, Chinese industrial production grows at twice the rate of Chinese GDP.
And the heavy metals aren’t big components of their exports. They are
building the infrastructure and the buildings within China. China isn’t
sending five million cars to the United States. So it’s not a matter of
converting into heavy metal. The sixty-five percent increase in iron ore
prices is already encouraged the steel companies of the world to start
raising their prices and that’s when it starts to show up in inflation
statistics.

See, the fact that copper was at $3.20 was irrelevant to inflation
statistics. The fact that nickel got as high as 22 and has pulled back,
that was irrelevant. But once you see that even at a time of softening
OECD economies that steel prices are going up, it tells you that the game
has changed.

Putting this together, I’m telling you to adjust to the fact that we’re
going to go through a period of bad news for the advanced industrial
economies. But that’s part of the process of adjusting to what Chris
Patten was talking about. Back in the 1990’s, a group of canny Scottish
investors in Edinboro looked at the exports coming in to Britain from the
US and saw that there was a big changeover from just cotton and
agricultural products to industrial products. And they said this is going
to be the next big story. So they started buying US stocks and they stayed
with them…through the Depression even. And then the war broke out. And
that pool of money was so significant that Churchill nationalized it to get
the money and paid them in British Pounds, to make the first payment under
Lend-Lease. But they were long-term investors and they could see where
global leadership was changing.

Historians a thousand years from now will be writing about this period of
time. And they will be marveling at the number of people who even with the
evidence that they had, and because of the Internet and everything you get
all the statistics right at once, that people rejected the evidence that
was on their screens and in their books and in their newspapers and they
said “No, we’re going to go back to normal again, where we rich people will
have it our own way.”

Those who adjust to changes at the hinge of history are the great
investors.

Those who adjust to changes at the hinge of history are the builders of
great corporations.

Fortunately both groups are represented here today.

Thank you for coming.



Question and Answer Period

Q: “I believe you said that you felt that the gold stocks were going to
outperform the base metal stocks over the longer term and…”

DC: I didn’t say that. I said over the near term gold stocks would
outperform base metal stocks.

Q: “Okay…”

DC: “Because gold is going to keep going up as the financial crisis gets
worse. The financial crisis is not good for base metals.”

Q: “The financial crisis that we’re going in to right now…”

DC: “I beg your pardon?”

Q: “The financial crisis that we’re headed in to this year, in 2008.”

DC: “Financial assets have a long way to go, down.”

Q: “When will the gold stocks start to outperform gold?”

DC: “Once people realize that in an equity portfolio, the only way they can
buy a hedge against Wall Street bank stocks going down is either to sell
them short or to buy gold stocks. That hasn’t yet permeated all the
thinking of major investors. It’s just started. Thank you. Next
question.”

Q: “What impact, if any, have financial instruments have on commodity
prices?”

DC: What impact, if any, have financial instruments have on commodity
prices? Well, what you can get when you have a financial crisis hitting,
is people will bail out of what they call risk assets. So to some extent
the people had pure commodities or had commodity futures, they would sell
them off to cover the costs of what they were getting squeezed by their
lenders.

We haven’t seen much of that because the commodity prices have held up
beautifully through this. But before we reach the bottom, see…this is a
pure financial bear market. It came at a time the US economy was strong
and the bank index entered a bear market. And I could see it was going to
become a big bear market for stocks because the Dow Jones Industrial and
the S&P actually went to a new high in October. That was the point at which
I said “We’ve entered a bear market.” Because they were just ignoring the
reality that every single bear market begins by underperformance by the
financial stocks.

And every bear market that begins that way doesn’t end until the financial
stocks stop underperforming the market. So, to the extent that people say
“I’ve just got to raise money” and their lenders say “We’ve got to call in
these things”, they hurt commodity stocks and commodities.

Yeah, there’s going to be a lot of fear in the market. There’s not enough
fear yet to give us a bottom. Thank you.”

Q: “I beg your pardon, sir. I am a contrarian. Don’t you think there is
one bad sign short term? There are so many people here that by French
standards in the short-term that we…I have a question marge.”

DC: “Could you repeat that, Mike?”

Q: “The question is wouldn’t a contrarian think that the size of the
attendance this year could mean that there could be a short-term sell off?”

DC: “Yeah. The question is: big crowd here so therefore, does that mean
there will be a short-term sell off? Remember that [laughs]…although there
have been other mining conferences, in the overall scheme of things of US
conferences, or global conferences, this isn’t a huge deal. And so, I’m
telling you, you’re still in the minority. I know this because I cover so
many US, major, long-only accounts. And I know how little of their money
is committed to the commodity stocks.

Yeah, some of the hedge fund I cover are huge in this. But they’re getting
capital as it turns out. As you may have noticed last week, it turned out
that the well-performing US hedge funds have no problem getting capital
even while other borrowers from the banks are getting squeezed. So yeah,
we could have a short-term sell off. Once fear comes in, there’s a rush in
to cash. But to show you how serious the inflation risk is, the US
ten-year note is now selling at a sixty-basis point negative real yield.
That hasn’t happened since the runaway inflation of the 1970’s and we’ve
just started to go in to this slowdown in the US, which means US short term
rates are going to be cut further.

We are imbedding into the system, more inflationary pressures. And, look,
I came into this business in ’72 and I watched how the central banks then
got scared of what was going on and pumped liquidity into the system, but
it was a decade with three recessions. It failed, dismally.

So the fact that we are already at this stage, ordinarily when the Fed
drives down real yields, that brings you to the bottom. The big recession
of 1982, the yield on the ten year note, the real yield was twelve percent
when the US went into recession. At the beginning of the recession. This
time the real yield is at negative sixty basis points.

So this is a high risk environment. And anybody who thinks that inflation
is going to come down just because there’s going to be an increase of one
percent in US unemployment has not read history. What they’ve read is the
history of the last twenty-five years. Next question.

Q: “Don, over on your left. On your left. Sadly I agree with some of the
things you said in your presentation. I say sadly insofar as I was hoping
for some P/E expansion in let’s say for example two of the best companies
in the resource sector, BHP and Rio Tinto. Now, I’ve been waiting six or
seven years already for the P/E’s to expand to twenty times earnings and in
fact they’re still badly trailing at ten times earnings. Do you foresee
any triggers, looking out in the future, whereby these companies probably
should trade at somewhat higher multiples than where they are at the
moment?”

DC: “Okay, I predict that the BHPs of this world will trade at above-market
multiples within three years. And the top of the market will be when they
have something like the premium the rest of the market, the tech stocks had
in 1999. At that point, in the unlikely event that I’m invited back to
speak then, I will tell you, you’ve had fun, take money off the table.
That’s a loooooooong way ahead. Thank you for that question.”

Q: “Regarding the food prices. I mean the food prices have risen
significantly. When do you expect the increased food prices to trigger an
increase in supplies of food? Do you think the supply of food will not be
sufficient to dampen further price increases?”

DC: “Well the food price inflation has just begun. I think we face a
global food crisis within the next three years. All we need is a crop
failure in the US Midwest and we’ll have the worst food crisis known to
history. We’ve got seven weeks supply of wheat on hand in the US. And
that means for the first time the American Bakers Association has asked the
US to stop exporting wheat, which would violate all the free trade
agreements.