Commodities are tangible real assets like lead, sugar, corn, copper, oil, natural gas or coffee. They are an excellent hedge against currency debasement. As they are "real" things, as opposed to a piece of paper that is a "promise to pay", they always have a "real" value. To the extent that governments continue to debase the underlying value of the specie they issue by running deficits and running up debt; and individuals continue to consume far more than they produce or save; commodities will be an excellent hedge to maintaining value and purchasing power of assets.
Yet, commodities have generally had a continuously declining real price, because technological advances inexorably and invisibly continue to grind locating, extracting and refining costs per unit ever lower over time. Prices for most commodities have fallen steadily, (with a few upside ‘bumps’ here and there) over the 50 year period ending in 2002.
The long 50 year bear market in commodities had another unintended effect related to prices. As commodity prices fell, producers had little incentive to add capacity to existing facilities to expand supply. Very few new oil fields have been discovered in the past 20 years. Very few new mines have been opened. Supply has become very inelastic in a number of markets, and is very unresponsive to short term price movements. Commodity extraction as a business has been capital starved and woefully underinvested in for decades, which will further exacerbate price volatility in the short term as demand continues to ramp up.
The steady calculus of continuously falling commodity prices began to change in 2002, as commodity prices abruptly and sharply broke out of their 50 year slump and began rising off their all time lows in a steady and sustained manner. Even factoring in the current rise in commodity prices from 2002, commodity prices would still appear to be at bargain levels when compared on a long term, relative basis to other benchmarks like stocks, bonds or real estate.
Hard Assets essentially provide the requisite raw materials needed for industrial growth and infrastructure development. Technologically induced globalization has unleashed powerful new forces which continue to fuel commodity-intensive global demand at ever accelerating rates. For several years now, developing countries, particularly in Asia, have consistently been growing at more than double the rates of the developed world.
Most of these emerging Asia economies are experiencing secondary domestic booms in consumption. Global outsourcing and the shifting of labor to lower cost population centers as well as falling telecommunication costs and the internet have created new revenue streams which are being pumped into the pockets of a new generation of young, hungry and upwardly mobile employee/consumers; these brand-new, affluent, local consumers are demanding better living conditions and access to the finer things in life. Local basic industries, like retailing, banking and finance, automotive, infrastructure, healthcare, hospitality, media, steel, cement, real estate and consumer electronic goods are all enjoying explosive growth. Many new businesses have sprung up to serve this emerging class of newly affluent people, and they are creating a heavy incremental demand for all sorts of raw materials to build products to sell to this new class of consumers. The incremental, newly created demand for all commodities has become enormous and is exerting rapid upward and sustainable price pressure across all classes of commodities.
The emergence of China as a global manufacturing powerhouse is one of the main drivers for the upward movement in commodity pricing. Chinese economic growth is centered around the commodity-intensive activities of infrastructure build-outs, urbanization and manufacturing and is likely to continue for the foreseeable future.
Ned Davis Research (November 2009) calls the multi-year uptrends in commodities and commodity-based markets and sectors the "China-Driven Commodity Demand Theme." Rapid growth from the world’s most populous country would be expected to increase demand for raw materials. But the composition of China’s growth increased demand even more. Total investment, which is resource-heavy, and commodity intensive, climbed from an already high (by global standards) 35% of GDP to a blistering 43% in 2008. That compares to a decline in the U.S. from 18% of GDP to 11%.
China’s demand for commodities has grown in connection with its economic expansion as evidenced by its consumption, production, and net imports of petroleum. Even though production has soared -- China is the world’s fifth largest producer -- it still has to import four million barrels per day.
India and China together represent 2.4 billion people, 37% of the population of the entire planet, which currently are only producing 13% of the world’s GDP. The US and the EU together with 12% of the world’s population at present produce 35% of the world’s GDP. This calculus is now changing forever, and the incremental demand on the earth’s resources to bring the developing world’s population up to the equivalent living standards enjoyed currently in the developed world is going to precipitate massive price adjustments and supply disruptions of previously abundant natural resources of all kinds.