COMMODITIES SUPER CYCLE OR BURSTING BUBBLE?

By George Wannabe, MacroWonders

Much has been written on commodities being in a super cycle. I will quote Jim Rogers with catch phrases such as “Either the economy gets better and prices go up or the Fed prints money and prices go up”.

My guess is the reality is not that simple especially when considering commodities as an asset class or a “buy and hold” investment.

For one, as it is well explained by SocGen’s Dylan Grice via FTAlphaville, commodity prices in real terms have gone nowhere thus making it a bad “buy and hold” investment.

Some like GMO’s Jeremy Grantham believe this is about to change as we have reached the point where we are running out of resources but only time will tell if “It is different this time”.

For now though, real prices have gone nowhere and this is especially true for investors as prices have been in contango for much of the past years.

Furthermore, as Grice explains:

“A bushel of wheat, a lump of iron-ore or an ingot of silver today is identical to a bushel of wheat, lump of iron-ore or ingot of silver produced one thousand years ago. The only difference is that they’re generally cheaper to produce because over time, human innovation has lowered the cost of production. When you buy commodities, you’re selling human ingenuity. Why bet against human ingenuity by buying physical commodities when you can bet on it by investing in the enterprises whose task is to remove the bottlenecks and lower commodity prices? So devote cash to the fixers, not the source”

And there I have to agree with him. Super cycle or not, the only way to successfully “invest” as opposed to actively manage commodities is through the producers. The chart below of Exxon and the United States Oil Fund ETF is a great example.

Looking ahead, my guess is the secular demand story is not over.

The industrialization of China, India and Brazil is far from over and is at a commodity intensive stage. While the mass urbanisation stage is well entrenched McKinsey estimates there will be 3x the US current population living in cities in China by 2025 and nearly 600m in India by 2030. This will require the build of mass transit systems.

But more importantly, Chinese and Indian consumers income are reaching levels where consumer demand should rise sharply. This will underpin car demand and lead to further infrastructure needs.

The same is happening in Africa while infrastructure there is still lagging.

However, despite the fact that there is plenty of time left in the cycle I would be very cautious in the short term.

The reason for that is China. Even if Jim Chanos is only half right on the property bubble, the very sticky inflation will make it even harder for the government to engineer a soft landing.

A property crash or financial crisis in China where raw materials such as copper are also heavily used as loan collateral in sometimes dubious manners (more on that here) could cause prices to plummet in even greater proportions than in 2008.

I am not calling the crash but the potential volatility is another reason to stick with cash rich quality producers which could even profit from a downturn by acquiring quality assets on the cheap.

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