Commodities still look good for the long-term
May 1st, 2009
The financial and industrial worlds have diverged again in the last six weeks. The markets have rallied well. The industrialists remain gloomy, making some more people redundant here, putting factories onto three or four day working there, closing a factory here, mothballing one for a week or a month there.
The change of mood was most marked on Wall Street this week. First quarter GDP figures came in lower than expected. The market rose for joy. Analysts found the silver lining in the dark clouds of falling output. Destocking had been stronger than expected. We are nearer to the point where industry receives some orders again from itself, to fulfil those new orders that remain. Soon they will have to order from their suppliers because their stocks are low.
There are still many expensive mathematicians in the City. The new buzzword is the “second differential”. Markets rise because the rate of collapse is decelerating. This is too clever a way of looking at it. Markets are rising because investors have cash and think we must be somewhere near the worst.
We last wrote about commodities at any length when oil was over $140 a barrel. It seems an age ago, but it is less than a year. We said then that oil over $140 a barrel was a sell. We thought energy and other commodities were overpriced. Prices had been inflated by speculative monies pouring into the markets.
We argued that we thought the bulls were correct in one respect. The medium-term future would see strong continuing growth in China, India and other parts of Asia. As people grew richer in these countries they would burn more fuel in all the new machines and heating and cooling systems they acquired. They would eat more meat which in turn would mean the need for more grains. Industrial metal demand would be strong to feed the factories making the products. We thought the bulls were wrong in anticipating further price rises from last August levels, given the amount of speculation in the market. We did not expect to see the forecast $200 oil barrel any time soon.
The collapse of banks, credit and some investment funds in the final quarter of 2008 and the first couple of months of 2009 brought many commodity prices down to earth with a bump. We have felt for a little while this adjustment was now largely over. The speculators have been squeezed out. We have been buying some investments in this area for clients as a modest diversification in the portfolios, managed on prudent lines through ETFs. We do not propose geared positions or positions based on borrowed money.
The bullish arguments about the longer-term last year have not gone away. The US and Asian economies will recover. As they do they will need to buy more commodities to replenish stock pipelines and supply the production lines. Several commodities and oil are now selling at prices close to or below the economic cost of finding and exploiting new reserves. The last year has seen a lot of new capacity projects cancelled or delayed.
We think there will be some more inflation in due course in a world where governments are so busy issuing debt and spending so much more than their incomes. In such a climate commodities are a possible additional investment.
