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Published: August 13, 2009
Commodities prices are
surging.
World white sugar prices reached record levels on Aug. 10,
largely because of booming demand in India where the government
has lifted a ban on imports. Oil prices continue to hover around
$70 a barrel, and gold is in the mid-$900 range. Meanwhile the
CRB Continuous Commodity Price Index has surged to a level 30%
above its March low.
Finally, copper, supposedly a barometer of the global economy,
went above $6,000 per metric ton - up more than 96% this year.
And while prices for most commodities are still well below last
year’s peaks, the price spike is more dangerous than it looks.
Normally, commodities prices zoom at the top of a global
inflationary boom, as in 1973, 1980, or last summer. This time,
the surge is happening at the bottom of a recession. If it
continues, the commodities price resurgence could cut off global
recovery before it really gets going.
Commodities prices usually take off at the top of a normal
business cycle, as inflation is accelerating. The price rise
then causes commodity consumers to feel poorer. This reduces
demand and brings on a recession. Then, new production capacity
comes on stream after demand has fallen back, causing prices to
remain depressed for several years.
That’s what happened in 1973, with the first Organization of
Petroleum Exporting Countries (OPEC) oil price rise, and again
in 1980, with the second. After 1980, we didn’t see a real
commodities price surge until the middle 2000s. That’s because
the tech revolution caused consumer demand to move to things
like computer chips that used fewer raw materials than
traditional products.
Last summer, we had a similar price peak. Given the depth of the
current recession, you’d expect commodities prices to stay low
for several years, as new production capacity comes on stream.
But that hasn’t happened. Instead, prices have rebounded
sharply.
There are three possible reasons for this year’s surge.
First, it could be the result of very low interest rates and
loose monetary policy. In that case, it will soon lead to a rise
in general inflation.
It could also be due to the worldwide fiscal stimulus - in the
United States, China, the United Kingdom, India and most other
economies. Much of the stimulus - particularly in China -
consists of infrastructure spending. Infrastructure development
requires lots of steel, copper, cement and other commodities. If
that’s the case, the resulting budget deficits are likely to
cause bond market problems. That would restrict the supply of
funding for capital investment and other private sector needs.
Finally, the surge in commodities prices could be due to
continued rapid growth in India and China. The 2.4 billion
citizens of those countries, as they get richer, are demanding
more goods that require a lot of commodities to produce, like
automobiles.
Thus, when India and China grow faster than the rich West, we
can expect commodities demand to surge more than global gross
domestic product (GDP). If this is the cause, rapid commodities
demand will lead to a rise in general inflation and spot
commodities prices that will accompany shortages and price
spikes. That would have a deflationary effect on output.
We saw this effect in 2008’s third quarter, when real U.S. GDP
dropped 2.7%. That drop must have been the effect of $147 oil in
July, since the financial crisis did not hit home until the very
end of that quarter.
It’s impossible to tell which of these three is really causing
the current commodities price surge. We can, however, be sure
that it will choke off global recovery if it carries on much
longer.
That’s a miserable possibility, especially if it means we also
get inflation and higher interest rates. However, as investors
we can make some money from the commodities surge.
Here are some ideas:
Powershares DB Base Metals Fund (NYSE: DBB): This
exchange-traded fund (ETF) tracks the Deutsche Bank AG (DB) base
metals index, allowing you to invest directly in the price
movements of non-precious metals. With a market capitalization
of $308 million, it is reasonably liquid. Plus, a lot of money
has been flowing into it recently.
Vale S.A. (NYSE ADR:VALE): Vale is the world’s largest
iron ore producer and a key supplier to China’s exuberant
infrastructure growth. Historical P/E of less than 10; will
benefit hugely from price run-ups in steel.
iShares Silver Trust (NYSE: SLV): This ETF Invests
directly in silver bullion, which has been left behind somewhat
in its relationship to gold’s price rise and can be expected to
move up as gold does, possibly by a much greater percentage.
Market vectors Gold Miners (NYSE: GDX): Gold miners
benefit disproportionately from a rise in the gold price because
their production costs are fixed. They are thus a more leveraged
way to play it than the metal itself, particularly as surging
speculative demand can increase mining companies’
price-to-earnings (P/E) ratios.
-- Martin Hutchinson
Contributing Editor
MoneyMorning.com |
