“COMMODITY PRICES SEEM MUCH TOO HIGH”
I rarely use technical analysis in my work, but there are times when a picture really is worth a thousand words. Sometimes a chart can help an investor to visualize market relationships better than raw data can. In this way, technical analysis can be particularly helpful in gauging risks and potential mean reverting situations. One such potential mean reverting situation is the long-term outlook for commodity prices. This is, in my opinion, particularly important given Wall Street’s recent attempts to push the “commodities are an investment class” theme.
As I’ve previously mentioned, betting on the actual commodities is never an investment. In fact, over the long-term, commodities have very poor real returns. Rather, an investor who is looking to benefit from a commodity bull market or the negative correlation of some commodities, is better off investing in the ingenuity of the corporations that benefit from these markets. In this manner, you are actually buying human ingenuity rather than buying physical commodities which are the equivalent of selling human ingenuity.
In a recent strategy note, analysts at Societe Generale discussed the long-term surge in some commodity prices and why it could be foreshadowing of a mean reverting event:
“Commodity prices seem much too high as economic growth is slowing. Over the past three years, all commodities have touched historical highs. The most recent high seen for Gold, in August, was sparked by forex fears. Oil prices used to be very sensitive to US growth, but things are different this time, as emerging market demand partly outpaces that of the US, maintaining global oil demand at high levels. But, now the surge in Gold suggests that markets are looking for safe haven investments, as was the case in the 1930s and the 1970s. Hence, financial markets begin to doubt that the current forecast for global growth of 4% pa is sustainable, thus, commodity prices seem much too high at this stage of the economic cycle.”
Now, I don’t like lumping gold into this analysis because I think gold has some intangible components that make it more unique than other commodities, but I am generally skeptical of the idea that broad commodities are going to sustain high real prices in the same manner that other asset classes have historically. As Jeremy Grantham believes, this time would truly have to be different in order for this to persist. Of course, this is not my way of saying that one should go out and short all commodities. Quite the contrary. It just means that you have to recognize that you’re speculating when you buy raw commodities and if you’re trading that might suit your needs perfectly fine. If instead, you are an investor with a long-term diversified focus you would be wise to focus on the underlying ingenuity that benefits from commodity markets by investing in the actual corporations themselves. Don’t fall for Wall Street’s latest sale’s pitch which is trying to push investors into physical commodities of all sorts. History is not on your side.
Low rates cause the price of money to go down the toliet.
a nice look at commodities from a “non-commodity” economist —
thanks, Cullen — maybe you’d like a copy of my book? It gives a real historical view of “oil as an asset class” from a veteran trader of the market for 25 years.
Cheers!
http://www.amazon.com/Oils-Endless-Bid-Unreliable-Economy/dp/0470915625/ref=sr_1_1?ie=UTF8&qid=1295887680&sr=8-1
Dan,
Great to see you here. I’ve been meaning to read it actually. I’ll shoot you an email.
Best,
CR
Cullen-
I’m out of sorts today….can’t seem to do anything right today. I have that feeling I get sometimes of the pressures of managing money and the data flow as well as client visits that I think just overwhelmed me.
Going to shut it down and find the slow lane home. maybe take a long walk tonight….not my best day.
peace
These types of graphs miss a couple of dimensions.
First of all, the economically active population has increased dramatically over graph’s time span. Also, the “quality of life” (read per capita resource consumption) has gone up over time. Additionally, as the earth is a (finite) sphere in space with a finite volume and we’ve been using whatever is in that sphere the remaining quantity AND quality of the remaining resources at the most recent point on the chart is quite different from the first point on the chart.
That is not to say that if economic activity is muted – probably a likely scenario given the fact that we have 111 brent with 10% unemployment (think where crude will be if/when unemployment is at 6%) – commodity prices can show dramatic volatility while we’re grinding along a growth ceiling.
You had better refine your optics.
Commodity prices are high-er because demand is returning.
The Chinese/Indian middle class is the new normal.
Let me make this point more clearly – I am not saying that commodities can’t continue to generate decent returns. I am fully aware of the long-term bullish trends in emerging markets, etc. My point is that buying commodities via ETF’s and other physical channels are unlikely to generate the same returns that you’ll obtain in other commodity related asset classes. For instance, I’d rather buy XYZ oil & gas rather than actually storing some oil and gas in my living room or buying some ETF which is likely to suffer from negative roll yield.
Agreed.
Absolutely, commodities and commodity etfs (the ones that are based on futures contracts or physically holding a commodity) are not good for long term investing. They are for traders only! This should be listed next to each ticker. FOR TRADERS ONLY.
Now a trade might last up to several years…, but still. If you are bullish long term on a commodity, you’ll do better owning some gold mining companies, ConocoPhillips, CF Industries, MLPs etc.
“More unique than” is very bad English
An additional bonus is that XYZ producers have dividend yields well in excess of the ten year treasury. Many of them also have a history of consistent dividend hikes.
Interesting but if we make the assumption that gold is proxy real money (and we wont really know until the depth of a total financial shut down, which in my view is on the cards as fractional reserve banking gets assigned to the rubbish heap) then we need to look at commodity prices in gold terms.
This gives us an interesting framework to view prices. Most of us know that stocks are still not cheap versus gold (I like to use very long term charts of 100 years or more). But oil is almost exactly at fair value versus gold. i.e its price rise is commensurate with the rise in gold and add credence to the gold is money argument. Obviously in a recession when demand for oil falls then we should see oil become cheaper versus gold but there is nothing untoward in oil prices.
We also have house price data going back to around the late 40′s and houses are now falling to their lower end versus gold, which makes some sense and clearly could and should fall further if the financial crisis is not finished thus mortgage lending is constricted.
Industrial metals are still deflating versus gold as the super cycle peaked globally with global GDP back in 2007 and still has a long way to go, which is in line with your conclusion. The key driver, China, will never again produce the huge strong YoY increases in demand. It is mathematically impossible. Fact.
The ones that trouble me greatly are agricultural prices which are still near their all time lows versus gold. From a supply and demand perspective we really don’t have nearly enough stocks of food to counter any supply shocks and prices keep rising. It is interesting to note that ag prices in 2008 fell sharply with global growth. This time around ag prices fell initially (as CTA’s got stopped out) and then began to climb again with many making new highs. This is without QE that people trumpeted as the cause of price rises (of course, total rubbish as no velocity of money makes QE useless).
This, from a global macro perspective, is more than concerning. It suggests that supply is so constrained in ags that higher prices are inevitable (clearly there will be ups and downs with harvests etc). With many countries outside of the West spending 35% to 45% of their income on food then this is a troubling development. It also spills into their inflation numbers, causing further rate hikes in a slowing global economy where consumption is crimped.
2012 is setting itself up to be one hell of a year…maybe the Mayan were right after all!?!
Macro-
uhhh..are we identical twins. I agree with everything you just wrote. You just gave me the hebejebes but in a good way. You write much better than I..like you actually understand the english language. Which I can speak but..
In fact your views are so eerily similar to mine I can tell you there are three people who you will not agree with here. Don’t worry they’ll come to you.
And…I am now worried about something much more important. I just called my wife and told her if I hop into be bed tonight and call myself Macro please call 911. It may sound like me but it’s not me.
VII:
Dude… you kill!
I gotta come here just to get my laughs for the day.
I like your assessment(and Macro’s).
What do you buy, when you buy food (investment wise)? I’m no high flying trader, just a family guy (maybe that should be my avatar?) trying to preserve a retirement nest egg, and able to trade in stocks, mutual funds, ETFs, and bonds inside a Vanguard IRA.
I’ve been considering SCPZF (Sprotts resources) for their Canadian assets. Bought MON in Jan, sold in May on a dip.
Glad to see you contribute so much, it’s a lot of fun!
Roger
With regards to your question, I think that unless you are fully conversant in an investment theme you should not really invest in it.My advice is never to look for “hot” themes but do your own homework and become your own expert in the things that interest you. It gives you a much better chance of success.
Additionally, in a world of very low capital gains it is often better not to invest than to invest (people are all too consumed by trading as opposed to investing too), and in a world which is potentially one of the most risky in history then my suggestion would be to worry more about which bank your cash is in and how to protect your income stream (your single most important asset..don’t forget an income of $100,000 is equivalent to having $4.5m in the bank and putting it in US 10 year bonds at 2.2%) than trying to make money in financial markets. The downside dwarfs the upside right now from a total risk perspective.
There are however many ways to play Ags and the easiest for you to look into are the fertilizer companies. Personally, I invest in the commodity futures and some related equities such as the fertilizer companies. Ags are so phenomenally, gut wrenchingly volatile that your position size has to be smaller and your stop loss wider…
VII
Thanks for the advice. Agreed that homework is always needed, hence my avid readership here. Caution is always needed, since I am not only competing in the market against my peers (common investors) but against highly skilled and amply resourced professionals (like yourself).
Income streams matter greatly, but as I began to see that opportunity narrow in the past few years, I redirected efforts at the investing end. Possibly not the better choice, as time spent learning about investing could be spent in my trade (loan origination). But one has to consider the hedonic value of learning a new thing.
I can truthfully say that I have “beat the market” over many time frames since I began trading/investing a bit more actively,(if one defines beating the market as beating the S&P), but perhaps not by as much as the efforts and risks to do so would have warranted. At least I have been able to stay ahead of nominal inflation.
Investments of my size do not merit professional management. The cost of advice good enough to matter would overtake the gains.
We common investors would all be much better off if we were still in defined benefit plans, but Wall St convinced us,(and our employers) that we would be better off in 401Ks and mutual funds, forcing us to actively and intelligently manage our investments, or risk losing them to ineffective trading, excessive fees or inflation (or all three!!).
Thanks again for your reply and contributions to this site.
Hi Roger..
well said. your family and life will be enriched by you taking the lead and being a good steward of what you have learned.
This site gives you everything you need…..why can I say this…cause I get more from here than some subcriptions services or I get the same thing. I just get it here a day before they e-mail me.
Roger-
Thanks alot.
This sit is interesting. One of the things I struggle with gets exposed here. I have a hard time avoiding conflicts with certain personalities.
I was exhausted yesterday heading home. Went on a rant with someone here as if the world cares. Or as if I matter to him.
I really appreciate your thoughts…I’m working on staying focused on the topics to leverage you all here.
To that…I think we found a great mind along with many that post here. MACRO..has alot to offer. I encourage readers to pay attention to his comments.
We are right now investment wise…IN TOTAL NO WHERES LAND. I’m looking to close out our SPY at around 1230(my target here is 1250-1270) But…I’M REALLY CONCERNED ABOUT THE ISM DATA SEPT 1.(to that for anybody with money..i’ve only been this concerned once and I was dead wrong…2 months ago..ISM surprised)
The only thing I’m sure about right now…is that 2012 is going to be tough. Right now we can trade up and down…it’s not a bad micro time. But 2012….that trend in MY opinion is going to be down. The flip side of that…I’m excited about the opportunities that await at the end. We should all embrace 2012 as a time to clear out some excess, clear out some of these issues hanging over our country and others. We will have an opportunity to make the right long term choices…and I believe this time we will. -see winston churchil- When we have exhausted all other options we always choose correct-(not verbatim)
So I’m looking forward to investing in stocks with little risk at the end of 2012-Q1 2013. That is motivation to take care of the families that trust us here in my community.
VII
Thanks for the wisdom. As my returns from labor and investments dwindle a bit, I find myself devoting more energy to building social capital; at on line communities like this, in the neighborhood, and in traditional institutions like schools, church, sports.
These efforts are intrinsically rewarding, but the returns are hard to measure.
Roger sounds like something I could get behind. Wish you the best..please keep us informed.
since i am also getting the hebegebees it would help to know your newsletter name.
my view is that we will see $20 soybeans, $10+ corn and $30 rice before the next northern summer if not xmas. I’m talking my book obviously but the fundamental picture is compelling, global financial market instability aside.
Goodmorning TPC
A friend of Cullens is a friend of mine Dan Dicker. I’ll be checking you out tonight.
It looks like gold is at a critical test 1835. .618 fibonacci retracement. (Were short term bearish). I’m getting mixed information here. Was the speech on Friday in Jackson Hole the day central bankers turned off the printing presses and passed the buck to politicians to fix our problems? These same policiticians who are coming up for re-election? What does this mean for Gold? I don’t know….But if it is now a currency as some have called then we may look back here and say the speech on Friday was a turning point. To that Dr. Hussman..had some great comments. Run don’t walk to that lighthouse at hussmandfunds.com.
We don’t own any commodities today sold a while back. We are looking into all things Agriculture-FOOD, Water. Food is breaking out to new highs..hell I actually pissed myself on Sunday when I went to the grocer here in Southern California(L.A taxes stink)
We see a choppy rally then the market going lower into January(below 1100) then like 2008 a 2 month rally then…election correction. Cyclical bear plays wacka mo on the Bull from March-April 2012- all the way to 2013. Low short term of 850-900 on spx. We are also looking to short up around 1270 on SPX
Our positions havn’t changed…we did have an operational problem. We had not sold the amount of SPY..I have kept this. So we got lucky. Our trader made an error and I have NOT sold this postion. So some of our performance(17% SPY we held) was a bank shot from 45 feet away. It still counts..but it could have gone the other way. It does mean my monthly letter to clients will need to answer the difference in my earlier comments and what we own. …uh I called bank.
What do LA taxes and groceries have to do with one another? I don’t get it. California does not tax food groceries.
Adam2
I bought alot of stuff at a new market just opened which was supposed to be an alternative to whole foods(it’s called madi market??) The cost of where it is, the new mall, proximity to my development…it’s a tax. An indirect tax.
I have to drive a distance to get things that are cheaper. I see it as a tax. Sorry for the confusion.
h/t – Go to Trader Joe’s next time.
DBC unlike other market sectors has held the 200 day moving average. Oil and gold are components but since the rest of the market has given up the 200 day with ease I suspect it will also in spades at some point.
Oil and hard commodities have been driven by China, who have exported labour deflation and with some offsetting of commodity inflation. I remember a few years back looking at a chart of Asia oil consumption vs. US oil consumption, and the delta was more or less the (trade deficit)/10 in $oil, which tells me that it was mostly just moving manufacturing off-shore. The next few years will be the test, if the US trade deficit declines, and Chinese domestic consumption does take off, then I don’t expect commodities to correct. But, if not, then oil + hard comms, will be in for some pain. Also, will Americans continue their love affair with big trucks, or will new CAFE + a generational shift finally bring back oil thrift?
“Rather, an investor who is looking to benefit from a commodity bull market or the negative correlation of some commodities, is better off investing in the ingenuity of the corporations that benefit from these markets.”
Exactly!
What a real investor is always doing is buying into the ingenuity of people to find ways and techniques to do it better, make constant improvements and find cost effective product substitutions.
The real opportunity is in people.
And in managers that know how to bring out the best in their staff.
VII
Highly amusing and scary…!
I havent written on this website (or pretty much any website) as I actually write my own subscription based macro research publication but I am always impressed with the quality of discussion here versus other sites, whether I agree with the points of view or not. The only other place with sensible, high quality discussion is Gavyn Davis’s blog site on the FT site. Gavyn is a really great thinker, not that I agree with his views always. I used to work at the apparently newly named Evil Empire when he was the chief economist.
In summary of my views, for what it’s worth, I just do not see a way out of shut down of the European banking system, with governments unable to bail out the banks or themselves. They will try every trick in the book but the debt need to be reduced and defaults are the only way thats going to do it in an environment where global growth is super slow or negative. Clearly the knock on effects to world trade will be off the map as all trade financing shuts down too. We will find a a way out of it in the end but the world largest ever financial and economic crisis is right on our doorsteps. As I mentioned before I think the fractional reserve banking system will be the lamb that gets slaughtered and maybe, in the end, thats no bad thing.
Macro-
I am surprised by who comes here. I’ve read some posts from students here who make many of the issues we face seem manageable. We have some bright minds to help sort out the future. (Y, mdm)
And then your posts. Highly formulated body and conclusion. I hope you add your color here with out disturbing your agreement with your clients. Based on what I read..your a subscriptions service worth paying for.
Look forward to more from you Macro. Cheers
MMT in ancient times – the whole article is worth a read. Key quote:
“Taxes are also key to creating the first markets that operate on cash, since coinage seems to be invented or at least widely popularized to pay soldiers – more or less simultaneously in China, India, and the Mediterranean, where governments find the easiest way to provision the troops is to issue them standard-issue bits of gold or silver and then demand everyone else in the kingdom give them one of those coins back again. Thus we find that the language of debt and the language of morality start to merge.”
http://www.ritholtz.com/blog/2011/08/are-most-americans-debt-slaves/
If QE3.0 is going to materialize (as the market thinks), then commodities will go parabolic! If not, hedge accordingly.
Consumer needs a drop in commodity prices to offset a falling dollar and rising gas prices. Watch for a dollar for dollar transfer from commodities to energy.
Very interesting. Jim Rogers has absolutely opposite stats in his book: commodities outperform stock market including commodity stocks.
Commodity prices are still high because the market expects further monetary intervention. Nothing more, noting less.
I think that those “commodity” concerns are essentially unfounded thoughts. This website has been carping about the “financialization” of copper for how long? And yet here we sit over $4.
China consumes 50% of all copper. Assume a 5% annual growth rate in China (which of course IS MEASURED by its copper consumption) and do you realize that in about 10 years, China will be consuming ALMOST THE ENTIRE OUTPUT OF EVERY PRODUCING COPPER MINE IN THE WORLD.
And I’m not even accounting for India, let alone the developed countries, which, even if mired in low growth will still have to electrify their infrastructure once again.
And here’s an interesting thing about those advocating miners versus the commodity. A lot of times it’s a weird inverse relationship. Everyone goes to gold because of the financial crisis and yet the mining stocks GOT CRUSHED.
Even as gold was hitting an all time high. Bottom line, I disagree with a lot of what is in this article other than just a general thought to watch out for overvalued commodities. But we are nowhere near that point on pretty much every one I deem important.
The keyword here is “”leverage”". The trick here is buying goldmining stocks and hedge them by e.g. going short the Nasdaq, S&P or Dow Jones.
Now adjust that chart for the change in the size of the global middle class and the fall in the USD. Then consider peak oil and other commodities and the Export Land Model.
Australia’s Pilbara region is reported to have only about 50 years if iron ore left at current rates of extraction. Now factor in 7% growth in usage due to growing demand of China, India, Indonesia etc. I believe buyers are factoring in scarcity and additional costs of extraction and transport. The cheap to extract and transport stuff is largely gone.
Michael Pettis had A great post recently predicting that China will slow down significantly in 2013 and maybe even in 2012. The reason according to Pettis is that the decrease in consumption in the developed countries will ultimately hit China. For the time being China compensates for the shrinking global demand through a debt fueled investment boom. As they are running out of unproductive investment opportunities while piling a huge debt, this model of growth finds its limits. Instead of rising the share of consumption in GDP is actually shrinking and the transition to a new model will be, first, slow, and, second, this model fueled by rising consumption won’t require the same appetite for non agricultural commodities. Bottom line is that this spells trouble for commodity prices.
In prof. Pettis’ own words “By 2013-14 Chinese GDP growth will slow sharply, and by 2015-16 predictions of a sustained period of growth rates at 3% or lower will no longer seem outlandish.”
I think Pettis is going to be in for a surprise.
Why could that slowdown not happen already in 2011, this year ?
I’m quite convinced that the Ag boom was a thematic investment meme that the sell-side conveniently touted throughout the crisis. At best, it’s a secular theme that’s been pulled-forward and condensed. Consider the demographic headwinds in the developed world. Consider the potential for supply shifts, which can grow to meet demand (albeit slowly).
I think short Ag will be the next big short in the coming months/quarter.
http://thebuttonwoodtree.wordpress.com/2011/08/12/natural-resource-correction-a-surprise-ending/
I have one question: How does SocGen define “”Real price”". I have my own definition of the real price of gold. But how defines SocGen the real price of oil ?
Willy2′s question (which I have no direct answer for) reminded me of Dylan Grice’s formulation:
long commodities -> short human ingenuity.
long gold -> short human wisdom.
My take is that QE2 has pumped everything but dollars up – through the good offices of the usual suspects selling ‘inflation hedging’ to risk averse investors – into a correlated cross-commodity bubble.
ie inflation hedgers have caused the very inflation they aimed to avoid.
The China/India story of massive future commodity demand is finance industry spin to keep the inflation hedgers hedging and the ETF gravy train running. The fact is that these countries actually process huge amounts of commodities and energy into stuff that consumer nations can no longer afford to buy.
The massive backwardation in Brent Crude Oil is the smoking gun, since there is no shortage of physical supply and it is the absence of ‘inflation hedging’ forward buyers/oil lessors which is depressing the forward months.
Absent QE3 we will IMHO see a cross commodity and equity market decline at best, and collapse at worst (not that declining commodity prices are bad for consumers).
We will also see the next great regulatory disaster, as any number of inflation hedgers realise that if you buy inflated assets you can lose your a..e and that this was not a risk they were warned about (other than buried on page 46 of the boilerplate)….
“It’s tough to make predictions, especially about the future.”
~ Yogi Berra
I just wanted to note that investing and speculation are two words, which most of the time annotate the same thing. Investment would be an “investment”, if the cash flows were relatively stable and secure and predictable, the discount rate remained stable and one did not care about marking-tomarket risk (plus one has a big margin of safety).
All these equity plays are speculations, even on longer-term horizons. Even holding USTs is a speculation that the yield will not be eaten by inflation.
So on commodities:
– people speculate on shortages being difficult to overcome by new technology in the foreseeable future or misguided hedgers continuing their thing
– or people speculate that the underlying E&P companies will turn this into profit (depends wheher they are hedged or not, quality of management, market pricing of stocks, etc. -> so a speculation as well)
– or people speculate on alternatives having break-though technology or subsidies etc.(which involves a specualation that commodity prices will stay high)
Etc. So it is all speculation, one way or another.
As an add-on: I personally believe in:
- the shortage issue not being easily resolved soon, so there will be some secular bull market continuing in commodities, but probably at a lower trend line
- do not trust the misguided inflation hedgers, who like someone above noted caused themselves the inflation they feared of; these people will have to sell when their thesis is disproved
- see the chances of a recession / new epsiode of GFC looming with its deflationary impact, so think that the correction in commodities will continue short-term
- partly believe in gold as a currency substitute, but I think it became too speculative, when it went parabolic (on the other hand it was funny how the USD did not rally this time around in a risk off phase, so maybe gold had to play as a substitute for a USD that did not rise)
If instead, you are an investor with a long-term diversified focus you would be wise to focus on the underlying ingenuity that benefits from commodity markets by investing in the actual corporations themselves. Cullen Roche
Yep, corporations are a brilliant invention. Their common stock would be an ideal private money form. It’s a true crime that instead of issuing more common stock to “share” wealth that corporations borrow from the government backed counterfeiting cartel, the banking system, to steal it.
However, corporations have little choice but to steal since if they don’t their competitors will. Our money system is thus an example of “the tragedy of the commons”.
While I agree with this post’s general points about investing in commodities, the graphs here do not give us any information about the over or undervaluation of prices.
The historic price of gold before 1972 has nothing to do with commodity price trends, but instead shows the state of the gold standard.
The historic oil price is a bit more relevant to today’s commodity situation, but still the oil industry has gone through huge changes, it was heavily regulated during the Bretton Woods era, OPEC was able to set prices at will for much of the 70s and 80s, and oil futures markets didn’t take off until the 80s. The various contingencies are just too complicated to draw any clear long term trends.