Resource prices, particularly those of base metals, have been savaged over the past year as global demand slowed and credit concerns caused retrenchments. Many are trading at just half last year's average; zinc is just one-third, nickel barely a quarter of their 2007 average, let alone peak, prices. The rapidity of the declines, not just their extent, has been devastating. Only gold has held its own.

The supply response from producers, however, has been swift, with production cutbacks and projects postponed. Major mining companies have cut this year's projected capital spending by more than 50%. This is not surprising given that so much of output is uneconomic; two-thirds of Freeport's U.S. copper production, for example, has a cash cost of over $1.40, above today's price.

Lack of Major New Mines will Hamper Supply

Further out, however, supply is constrained across a broad range of commodities, and once demand comes back, the supply response will, of necessity, be slower, leading to rapidly rising prices. And as we've discussed before, despite the huge sums spent on exploration in the past decade, the number of new large projects discovered in a whole range of resources has been rather slim.

Again, look at copper. Down 60% from last year's average price, much copper is unprofitable at today's price. But worse: much of production is from mature mines that are declining. Of the top six global mines, half are more than 70 years old, two a century old. On the horizon, Freeport's Tenke Fungurume in the Congo is the largest undeveloped project, but the government is still (again) trying to renegotiate the terms. We don't believe Freeport will commit the vast sums of capital required to develop this mine in anything like the current environment.

Uranium is another market whose short-term outlook may be subdued, but whose longer term fundamentals remain firmly intact. Uranium may have bottomed; indeed the unreliable spot price has rallied 25% to $55/lb in recent months (down from a 2007 peak of $136). This rally was caused by producer restocking and a cessation of investor liquidation. The price may drift lower in the near term, particularly if we see renewed fund selling. But further out, based on strong demand from countries with nuclear plans on the drawing board and the ever present threat of supply disruption, we are bullish.

Gold Holding Up, Though Stocks Depressed

Gold was one of the very few assets to hold up last year, fulfilling its role as a preserver of capital. In U.S. dollar terms, of course, it has been essentially flat, given the recent strength in the dollar on safe haven grounds. That will change, as we discussed in a previous letter; when investors start selling dollars, gold will move sharply up in terms of that currency... as indeed it has been doing against most other currencies this year.

We are already seeing the first stage of this development. In September and October, hedge funds, forced to liquidate to meet margin calls and redemptions, sold first their most liquid assets, and that meant, primarily gold. The funds and institutions were selling even as retail buying was surging to panic levels. Now that the urgent forced liquidation phase is over, we see gold beginning to move up again; it's up 15% since early November, despite the recent pullback.

The dollar may have another rally, and gold a corresponding correction, but it now appears that we have seen the lows, and gold will be significantly higher a year from now as the dollar resumes its decline.

Few Strong Companies, Large or Small

The stocks remain extremely undervalued relative to bullion, but for some good reasons. In short, the major gold companies have been destroyers of capital over many years, while more recently, as the gold price moved up, so too did input costs, meaning margins hardly moved. This is why we have few seniors on our list, emphasizing those with strong balance sheets, low costs, and the few companies that have indeed been creators of wealth.

It is also why we have increasingly emphasized smaller companies who are, for the most part, finding the new mines, and are attractive targets for the resource-starved seniors. Being small, however, the stocks are thinly traded, and susceptible to wild price swings; the last several months have been painful.

Now tax-loss season is behind us, this sector has experienced a rather strong bounce; Allied Nevada from $2 to $3.71 over the past month; Virginia from $2.31 to $3.40; Almaden from 50 cent to 64. All these stocks have retreated from their New Year peaks, but the appreciation off the lows is still impressive in percentage terms. So while this sector is still considerably down from its highs, it is moving solidly off the depressed lows of the past month.

This is the Time to Accumulate, While Cheap

So while we are not expecting an imminent turn-around in global demand, whether in uranium, copper, oil, or other resources, this period of weakness is a good time to accumulate top-quality, low- cost producers on weakness as well as the commodities themselves, where feasible. And we are buying solid gold producers and the explorers with management and cash and the projects to succeed; indeed, we have added several stocks over the past several weeks.

Adrian Day's Global Analyst is published by Investment Consultants International, Ltd. Day is also President of Global Strategic Management (GSM), a registered investment advisor.