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pencilvanian
1000+ Penny Miser Member
USA
2209 Posts |
 Posted - 11/23/2006 : 13:05:19
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Commodities: Bust or Boom?
The American economy has been called a bubble economy. We have bubbles everywhere you look — from real estate and mortgages to bonds and consumption.
There are many on Wall Street who believe that commodities have become an asset bubble as well. Oil prices have risen from $20 a barrel to today’s prices of close to $60. Copper prices have gone from $.60 to over $3.00.
Some would argue that base metal prices don’t reflect the economics of production and are due for a sharp fall.
In the short term, prices may decline based on investor perceptions.
However, the bubble theory for commodity prices doesn’t hold up on closer scrutiny.
Unlike real estate or tech stocks, there aren’t large stockpiles of supply
and Larry Lawnmower and John Q aren’t buying commodities as they did in the late 1970s. And unlike most asset bubbles,
there aren’t any signs of excess supply and the public hasn’t come on aboard.
Talk to your neighbor. Is he buying sugar futures, cashing in the family silverware, or hoarding bullion coins? I doubt it. He may own an oil stock or two, but it is doubtful he is invested in commodities in the same way he owned tech stocks in 1999. He may have mortgaged the family castle to the hilt, but I don’t believe he is day trading currencies or commodities. The only participants in this commodity bull market have been institutions like hedge funds and pension funds.
Because the commodity markets are infinitesimally small in comparison to the financial markets, any influx of funds
—albeit a hedge fund or pension fund—
has a large impact on such a small market.
Therefore by leveraging or concentrating its investment, any institution of size can have a huge impact on a commodity's price whether sugar, copper, or natural gas.
Money coming in drives prices up precipitously and conversely in the opposite direction when hot money exits a trade.
This bull market in commodities is based on the simple economics of supply and demand.
Demand for basic commodities in the past few years has not been as strong in the western world.
However, that is only part of the story.
Prices move at the margin and that marginal demand is coming from developing countries from Asia to Latin America. It is this marginal demand that is driving prices as a result of limited supply. The 2.4 billion combined population of these two countries is adding to demand pressures in a world where supplies and stockpiles are shrinking. For example in the past decade Asia has accounted for 50% of the increase in global demand for oil and 80 % of the demand for copper.
Are we to believe
that if the U.S. economy slows down,
a new car owner in China will leave his car in the garage and ride his bicycle?
I don’t think so.
In fact as shown in the two charts below, there has been no demand destruction in the U.S.
………………(Couldn’t copy the charts, sorry. You can look up the charts yourself per the link posted at the top of the article. Just remember, charts show us what happened and what is happening, not Why its happening.)
So much for the myths of the marketplace.
In fact by 2012 China will surpass the U.S. in automobile production.
Oil consumption by the Chinese will also surpass that of the U.S. by the end of the next decade. More cars and more drivers mean greater consumption of oil.
…………………..(And higher prices)
On the supply side,
many commodities are running a supply deficit that is being made up from stockpiles or dishoarding from silver to uranium.
As shown in the charts below — despite higher prices — the build in stockpiles has been minimal whether nickel, copper, zinc, or oil.
………..(Again, sorry it didn’t copy)
Unlike the bull market in commodities of the 1970s, which was demand-driven, this bull market is supply-driven.
Since this bull market began back in 2001, it has been mainly driven mainly by inadequate supply.
What we have here is a structural deficit created by decades of neglect.
Inventories of many base metals and uranium are still low.
Capacity expansions are being curtailed by rising costs, shortages of skilled labor and equipment, and transportation bottlenecks.
What has been surprising in this cycle has been the unusually slow supply response to higher prices.
Many CEOs running commodity companies today have long memories and remember the two-decade bear market in commodity prices.
Yes, oil prices have gone up and oil companies have invested vast sums of money in oil and gas production. Last week's WSJ highlighted industry investment of $340 billion in 2005, up 70% from 2000.
However, factor in industry inflation, which ran as high as 35% last year, and real investment increased by only 5%.
That is nothing and hardly a figure that will generate the vast new supplies that will be needed to fuel global GDP growth in the next decade.
The perception in the financial markets is that a slowdown in the U.S. economy and a global economic slowdown will reduce demand for basic commodities.
However, decades of neglect and supply deficits will take time and money to correct.
This is a structural bull market, which is going to last for a lot longer than most experts predict.
If China sells 2,000,000 automobiles this year and next, that means there are going to be a lot more Chinese consuming larger amounts of gasoline.
China’s economy may slowdown from its breathtaking rate of 11%.
However, an 8-10% growth rate means more copper, more iron ore, more cement, more steel, and more gasoline consumption.
Let us also not forget India, whose economy is growing at 9% per annum.
As I have mentioned above, this is a supply-driven bull market where excess capacity has shrunk.
The less excess capacity
the sooner demand will overwhelm the system
which is why we have been experiencing price spikes from oil, natural gas to copper, lead and zinc.
You might ask yourself,
if there was really a commodity bubble,
would the Chinese be shopping around the globe trading their dollars for commodities?
Securing access to commodities like iron ore, uranium, oil and natural gas has now become a priority in foreign policy.
As an investor you have another opportunity.
Market valuations in the energy and the metals sectors are still cheap. And they have gotten cheaper as a result of investor fears and misperceptions.
Investor psychology is temporarily out of whack with the underlying economic realities.
This spells opportunity.
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Commodities: Bust or Boom?
Forum Locked
Posted - 11/23/2006 : 15:19:21
