It's been a while since we last wrote an in-depth article on commodity prices. Most readers of our weekly column do know, however, that we are big fans of strategic investments in commodities, sometimes directly, but preferably through companies active in the sector. The reason for the break is mainly the absence of clear price action. In quiet times, there's often not much to report. The longer break is obviously also news in itself, as volatility in price and commodities used to go hand in hand. Why is it so calm out there?
To answer this question, we'll take you on a little history trip. Commodities move in long cycles that last many years, also referred to as secular trends or super cycles. In the commodity sector, a secular cycle lasts 20 to 30 years. The last commodity super cycle was a declining trend that lasted 20 years, from 1980 up to 2000. After the turn of the century, the declining trend reversed and a marked leg up started. The graph of the Reuters/CRB index, an index with various commodity prices ranging from oil to metals and grains, shows this phenomenon quite clearly in the chart below. Prices of exotic products, like cocoa or orange juice, are also included in the index. In total, the CRB contains 28 commodities, 26 of which are listed on exchanges in the US or Canada.
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The chart of the CRB index even shows a parabolic increase from 2003 to 2008. After that, as was the case for many asset classes, a huge drop followed, which all but destroyed the earlier rally. Meanwhile, the CRB bounced back with the index again trading midway between the bottom and the top since the start of this secular trend. Of course, when referring to a phase, there should be a next phase. The question is, however, when will that happen?
To answer this question, we need a second trip through history. As a matter of fact, it is important to understand the origins of the initial increase of the commodity sector. The monumental twist after 2000 was caused by two factors: declining supply and increasing demand. The declining supply was caused by the long bear market for commodities. Mining companies stopped investing on a large scale, which put production under heavy pressure. The supply decline became evident fairly quickly when demand started picking up after 2000. Especially with a huge spike in demand for commodities from emerging markets, with China taking the lead. The country was growing by more than 12% annually, a growth rate most Western countries could only dream of. Commodities were on fire, because of the voracious demand from China, but the pace was impossible to keep up with.
Nonetheless, China also suffered a big blow during the 2008 global financial crisis . The country still managed to maintain its growth percentage above 7% at all times – still a multiple of its Western counterparts – but it failed to impress market analysts. Negative sentiment, combined with increased supply, has pummeled commodities in recent years. However, we are still far above the lows recorded at the beginning of the 21st century. That is not insignificant.
It heralds the end of the first phase and the start of the second phase for the commodities super cycle. We are convinced that we are once more on the verge of a new multi-year rally for commodity prices. We don't have to look very far for clues. Once again, China will trigger the next rally in the cycle. While in the first phase, China was mostly responsible for the increased demand for commodities – by investments in infrastructure, roads, bridges, and cities – this time, the Chinese consumer will be the main contributor. A good indicator is the disposable income of the average Chinese. In 2004 this was still only 8,500 Yuan per year, or about 1,400 dollars. Today, a Chinese employee earns close to 25,000 Yuan per year, or about 4,200 US dollar. Of course, this is still negligible compared to wages of Western employees, but still a fourfold increase of disposable income in less than ten years.
This translates directly into Chinese consumer behavior. The Chinese are spending their Yuans like never before.
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Source: TradingEconomics
As exhibited by the chart above, consumption and disposable income in China has risen substantially. Moreover, although the Chinese are known to be quite thrifty, we expect that the savings rate of the average Chinese family will gradually decrease in the next few years, setting off a rise in discretionary spending. Due to Chinese consumer demand, average prices of major commodities – oil, gas, copper, zinc, wheat, soybeans, … – will increase dramatically. We maintain our position that the next phase in the commodities super cycle will last longer, and more importantly, will reach greater heights than the first phase.
The first signals of an economic revival in China are surfacing weekly. The real estate market is stabilizing, demand for credit is increasing, and consumer trust is on the rise again. We believe that the biggest surprises will come from China in the coming years.
That's why we prefer a healthy position in commodities in the average investment portfolio. A good mix of producers, wholesalers and service companies can help maintain the purchasing power of your capital against the current financial backdrop.
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