20 May 2009

Commodities will recover first and then roar on demand and inflation

This is my position, Don Coxe, Rogers and all those who recognise that the supercycle in commodities was about normalisation of prices, not high prices, historically speaking...

What some call the 'Commodity Super Cycle' is a simple rebound from extreme devalorization of commodities as an asset class over nearly 20 years. The process is intensified by extremely fragile and unrealistic world currency values, within which the Euro is likely the weak link, being a de facto money of resource-depleted Europe, forced into circulation in too many countries, too late. The US dollar’s plight needs no commentary.

Due to the massive fossil energy intensity of the current global economy’s structure, and low appreciation of the critical need for energy transition away from fossil fuels, we can be sure that near-term limits to world oil and natural gas supply capacity will have a strong impact on relative asset value sorting in a generally inflationary context. Even using IEA published data, world oil supply capacity could fall as much as 25 Mbd from now to 2025. Any small net increase in supply would need heroic investments, estimated by the IEA at about 26 000 Bn USD through less than 20 years. If we took an optimistic approach on the decline of world oil export supply or 'offer' from 2010, and assumed that net supply fell at a rate of 4% or 5% annual, perhaps due to energy saving and substitution programs in exporter countries (which at present is unlikely), this would translate to a long-term net annual decline in world export supply at well over 2.5 Mbd. This is close to German or South Korean oil import demand. Two years at this loss rate, would equal a little less than Japan's total import needs.

It is not difficult to identify what impact real structural undersupply will have on traded oil prices. The waiting period will be short. Oil prices can only show a massive rebound from almost the moment there is any sign of global economic recovery. The knock-on effect of higher energy prices on food prices will be rapid, as was shown in 2007-2008. This in turn and already poses a serious threat to the duration of sustainability of any global economic recovery, while also helping to rekindle inflation.

To be sure, this should also rekindle interest in Renewable Energy and Cleantech investing, itself a now highly financiarized asset sector, exposed to exactly the same tensions and volatility as 'mainstream' equities and other traded assets. The certain near-term return of Oil Crisis should however not mask the other resource-linked facets of the depletion crisis facing the straight majority of real resources – including the nominally renewable bioresources.

Raching its peak in the slow-growing real economy of the 1990s, an apparent oversupply of energy and natural resources helped push down the baseline for commodities relative to all other asset classes, in some cases to historic lows. This has dangerously masked the real, almost reverse video picture of hard asset production, supply and therefore price outlooks. To be sure, this ‘resource pinch’ is intensified by the extremely classic and conventional Henry Ford-style economic takeoff of the Emerging Economies. We therefore face accelerating depletion of key natural resources, plus structural resource-limiting factors like climate change and population growth.

Asset Value correlation

As already noted, the neat two-part division of hard asset commodities into ‘renewable’ and ‘non-renewable’ breaks down under the onslaught of current-structure global economic growth. Through 2005-2007, running at around 5%pa in a world of about 6600 million consumers and potential consumers, the pressure on real resource supply was easy to demonstrate. Conversely, equity and derived paper assets can be created in an electronic eyeblink, grow with little constraint, and avoid the problem of credibility as long as there is some growth of the ‘underlying security- - the global economy.

The unrealistic hopes embedded in the fragile ‘Chindia decoupling theory’ are based on the mirage of Decoupled Emerging Economy Growth at near double-digit annual average percentage rates, perhaps for 15 or 20 years, or more. In fact, this poses essentially impossible challenges for commodities production and supply. This concerns the near-term real world future, not some mythic Keynes-type long-term ‘when we are all dead’.

As noted above, there are decreasing numbers of ‘firewalls’ between the two theoretically-distinct asset classes inside the commodities sphere (i.e. renewable and non-renewable), as well as between Equities and Commodities. Due to present structure global economic growth, this trend is self-reinforcing. Thus price correlation and linkage, both inside the asset classes as well as between, is a strong real world trend. This again clearly supports the argument for near-term and possibly extreme of most Commodity prices.

This ‘re-linkage’ or new correlation can be observed with almost any real resource commodity. One example is the ags and softs, specially the grains and oilseeds, simply due to the 2005-2007 biofuels boom and slump. This left behind the price linkage of oil with food, but not the massive amounts of biofuels promised by various leaders, such as the RFS program of G W Bush. One major supply-side cause of this is the energy intensity of current agroindustrial production techniques, downstream processing, and transport of these commodities. For sugar and corn ethanol, and soybean or rapeseed biodiesel production, this’ energy price linkage’ is now powerful, providing another quick acting transmission vector for inflationary contagion within the real resources space.

To be sure there is considerable resistance on the part of economic and political deciders, but increasing reactivity and transparence in the pricing system, to pass-through upstream and absolute price rises for energy and food commodities. In other words this means there is now the certainty of ‘dam breaker’ surges in energy, food and fiber prices at the consumer level, both in OECD and in other countries. This sets the likely timeframe for a very sharp upturn in OECD country inflation, and fast growth of Commodity prices, to the near-term, probably Q2 2009 – Q2 2010. Prospects for the majority of real resource prices, as we noted in this article, include nearly stepwise upward change. Whenever there is clear break in price trends for Equities relative to Commodities – signaling deconvergence – this upward movement is likely to amplify and reinforce itself. This may start in Q3-Q4 2009.


No comments: