 Great
Commodities Bull 2
Adam Hamilton
Archives
February 8, 2004
Seemingly eons ago in April
2001, I penned an essay called "The
Great Commodities Bull of the 00's." Its thesis, as
you can certainly guess from its title, was the notion that commodities
in general would enter a Great Bull market in this decade, creating
vast wealth for the prudent contrarian investors deploying their
capital into the commodities arena early.
While that was almost three
years ago, amazingly I still receive lots of inquiries on that
dusty old commodities-bull essay! In fact it may be one of my
most popular weekly essays out of hundreds
in terms of the number of sequel requests that I have received
to continue this line of financial research. I am not the only
one fascinated by the awesome prospect of a new Great Bull in
commodities!
With the benefit of almost
several more years of market data, not to mention priceless experience
watching and trading the markets as events unfold in real-time,
a follow-up essay is certainly overdue. We have reached a point
in time where the original Great Commodities Bull of the 00's
thesis can be checked against real hard data to see if it has
withstood the challenging test of time.
Why another 1970s-style Great
Commodities Bull this decade? I am not going to rehash entire
first
essay here, which discussed this in considerable depth, but
the general reasons are still very important to understand. There
are extremely powerful cyclical, psychological, fundamental,
economic, geopolitical, and inflation arguments underlying this
important thesis.
From a cyclical perspective,
the financial markets move in great waves throughout history.
This is easiest to understand in the common stock-market terms
with which we are all familiar. Once every third of a century
or so, a Long
Valuation Wave cycle runs through the stock markets. First
stocks are generally undervalued and loathed, but over the following
decade or two they eventually soar and are loved to crazy overvaluations.
Valuations oscillate in perpetual bust-to-boom-to-bust cycles,
all throughout history.
Commodities work the same way
as stocks, also running in great cycles running about a third
of a century each as well. There are times when commodities boom
to stellar new highs, such as in the 1970s, and there are other
times when their bottoms fall out in gut-wrenching busts, as
in the late 1990s. Not coincidentally, commodity waves tend to
be out of phase with the equity waves, meaning that a commodity
boom is most likely around an equity bust and vice versa. Tangible
and intangible assets are seldom both fashionable at the same
moment in history!
During the massive stock-market
superbull of the late 1990s, one of the worst commodity busts
in history was occurring. The extraordinarily important first
graph in my original essay of long-term real commodities
prices clearly outlines the abysmal depths of this particular
commodities bust. In inflation-adjusted real terms, commodities
prices hit their lowest levels in at least 80 years in the late
1990s! It was a horrific bust indeed.
As every contrarian instinctively
knows, it is out of this very belly of dark despair at long-term
bust bottoms where the seeds of a glorious brand-new boom are
sown. Only several years ago investors had the magnificent opportunity
to buy commodities near century lows in real terms, the ultimate
Buy Low proposition! The cyclical nature of commodities is an
important foundation for the Great Commodities Bull of the 00's.
Naturally market psychology
also plays heavily into these great commodities cycles that run
a third of a century or so each. During big commodity booms,
such as in the late 1970s, commodities are as hot and popular
as Internet stocks were in the late 1990s. Greed abounds and
everyday average investors scramble over themselves to buy into
the skyrocketing commodities realm. If you were an investor during
the late 1970s, you know exactly what I mean!
Conversely during the brutal
commodities busts, everyone hates commodities with a passion.
Back in 2001, when commodities were bottoming and I penned my
original essay, people treated you like a financial leper if
you were bullish on commodities. They ridiculed you by saying
that commodities were cheap and abundant, that their prices had
been plunging for decades, that they were so old-fashioned, etc.
Man I received a lot of flak for that essay!
But as contrarians, we want
to buy when everyone else hates an investment and it is so out
of favor that the mere mention of it draws heaps of ire and revulsion.
The second foundation for the Great Commodities Bull of the 00's
is the incredible depth of negativity surrounding its long-term
bottom in late 2001. I can think of no other major asset class
at that time that was so universally loathed. To this day, if
you mention commodities investing at a cocktail party you will
probably still get laughed at.
Fundamentally, this psychological
loathing near bust bottoms creates huge structural problems.
When everyone hates an investment class, it cannot capture the
necessary capital to grow and expand. With commodities in general
viewed as useless ancient relics during the go-go 1990s, commodity-producing
infrastructure decayed around the world. Who wanted to invest
billions of dollars in "boring" assets like oil refineries
that might return 15% a year when the Internet stocks were rocketing
up by hundreds of percents a year?
The net result was a choking
off of commodities capacity. Prices of commodities plunged to
such abysmal depths that it just wasn't profitable to invest
in producing them. Over time this created our present situation
today, where commodities demand is booming but the capacity just
isn't there yet to supply this increased demand. The best example
of this is natural gas in the US. In the late 1990s it was so
cheap that everyone thought it was free, but demand was soaring
and infrastructure still cannot keep up, so its price keeps on
rising.
In contrast, remember the massive
oversupply in fiber-optic cabling laid around the world in the
late 1990s? Everyone loved the New Era promises of unlimited
wealth so investors poured all their attention and capital into
high-tech ventures. Ultimately so much fiber was planted that
the vast majority of it remains dark, or unused, to this day
around the world. While the 1990s tech bubble voraciously sucked
in almost all capital like a financial black hole, commodities
infrastructure was starved nearly to death in a capital famine.
The capital-investment famine
in commodities in the 1990s helped create the enormous commodities-investment
opportunities today. Commodities demand is growing all the time,
but supplies are generally low since big money hasn't poured
into producing commodities since the 1980s. This creates a perfect
economic foundation for the Great Commodities Bull of the 00's.
When you witness rising demand chasing a supply that is low or
growing slowly, the only possible free-market solution is rising
prices.
And where is this demand coming
from? Worldwide, which is where the geopolitical foundations
for the Great Commodities Bull are found. Even our modern high-tech
world relies heavily on tangible physical commodities, from the
silicon in our computer chips to the steel in our cars to the
lumber in our homes to the oil that gets all this stuff delivered
to us, commodities are a crucial component of our lives today.
And, not surprisingly, people around the world are striving for
American levels of comfort and consumption, which will ultimately
vastly increase commodities demand.
Think of China and India, for
example. China is the world's leading exporter and is developing
an enormous manufacturing base unequalled in world history. The
Chinese people are slowly growing more prosperous over time and
are starting to demand more commodities, everything from oil
to transport goods to food to lumber to increase their standard
of living. With over a billion Chinese striving for American
standards of per-capita commodity consumption, this current Great
Commodities Bull ought to dwarf any other in history!
And India has another billion
people of its own, with the same hopes and dreams as the Chinese
or American people to create better lives for themselves and
increase the standard of living for their children. The Indians
are training the best engineers and scientists in the world today,
and their stellar standards of education make American public
schools look like illiterate day-care playgrounds. As the Indians
start to earn and consume like Americans, their demand for commodities
will be insatiable as well.
If you can imagine over two
billion Asians seeking to live and enjoy the abundances of life
like we Americans do today, and we are less than one-seventh
of this number, it is not hard to understand why we are almost
certainly in the earliest stages of a breathtaking commodities
superbull!
That is not all though! Governments
around the world insist on repeating the same deadly mistakes
as their predecessors by making worthless paper into legal-tender
currencies, under threat of force. Governments love this paper
at first, as it allows them to create new "money" out
of thin air at will so they can grow and spend and enslave their
people without restraint. Even many falsely-so-called "conservatives"
today have been hoodwinked into believing that governments and
their fiat-currency inflation schemes are good, a terrible folly
that history universally teaches is ultimately disastrous.
As the governments relentlessly
inflate their paper supplies, relatively more money chases after
relatively fewer goods, including commodities, and the nominal
prices of commodities rise as inflation devalues major global
currencies. Rampant fiat-currency inflation, and the disastrous
disastrous negative
real rates that it spawns, was one of the primary drivers
of the Great Bull in commodities in the 1970s, and it is back
with a vengeance today.
Did the fundamental case for
the Great Commodities Bull of the 00's withstand the test of
time since 2001? It remains rock solid friends!
Cyclically we are emerging
from a brutal bust and multi-decade commodities bottom in late
2001, with nowhere to go but up. Psychologically there was no
major investment class more hated than commodities only a few
years ago, a contrarian's dream. Fundamentally vastly insufficient
capital has been invested in commodities production for the past
decade, so economically commodity supply cannot keep up with
global demand for many years to come.
Geopolitically, there are over
two billion Asians working beyond hard to bring an American standard
of living to their families. They will need to collectively consume
unthinkable amounts of commodities to chase this dream. From
an inflation perspective, governments around the world are multiplying
their paper currencies like there is no tomorrow, so there is
more and more paper floating around for every given unit of commodities,
driving up their nominal prices around the globe.
Can you imagine a better recipe
for a commodities superbull? I doubt that we could craft a more
bullish scenario if we tried!
Now that the glowing fundamental
case is laid out, we can delve into the actual commodity prices
to see if this Great Commodities Bull thesis has been validated
in the past several years. The best place to search for this
confirmation is in the famous Commodities Research Bureau Commodities
Index, or the CRB index.
This CRB index is probably
the most widely followed commodities index on Earth, the Dow
30 of the commodities world if you will. It was created in 1957
and contains 17 commodities, the CRB 17. These 17 commodities
are generally representative of the hundreds of commodities that
trade around the world. The CRB 17 components are equally weighted
in the index, and broadly divided into Metals, Tropicals, Grains,
Meats, and Energies.
Just as we did in my original
essay, we will briefly examine each of the CRB 17 components
here, after we take a look at the flagship CRB index itself,
of course. While we are still in the very early stages of the
Great Commodities Bull of the 00's, the bull-market uptrend in
the CRB is already readily apparent and quite powerful.
The CRB index actually ended
up bottoming just under 184 on October 22nd, 2001. Its bull-to-date
high so far was witnessed just recently on January 20th, 2004,
about 271. As such, this flagship commodities index has marched
up almost 48% in its bull market to date thus far. This early
progress is not bad at all, and is exactly what we would expect
launching off of a long-term secular bottom where commodities
had few initial fans, even among the ranks of contrarians.
Great Bull markets, coming
off of ugly long-term busts, always start out slowly. As we witnessed
in general stocks in 1982, it takes a long time to undo the great
psychological damage done to investors after watching a decade
or more of relentless price declines. By the time the bust is
finally nearing its ultimate bottom, no one wants to believe
that a bull market is even possible anymore in the asset class
experiencing the bust. So fresh new buying migrates in slowly,
a trickle at first that may grow into a deluge many years later.
The CRB index fits this classic
profile perfectly. This basket of commodities isn't rocketing
up into the heavens like a NASDAQ bear-market
rally, but it is climbing up in a slow and methodical manner
as it ought to after an eight-decade-plus real low. In 2003 alone,
this index was up almost 9%, a nice slow healthy rate of ascent
that still reflects great popular skepticism in the concept of
a new Great Bull in commodities. We are probably still on the
ground floor today if the 2000s continue to play out like the
1970s in commodities terms, which looks increasingly likely with
each passing day.
It is interesting to not only
look at the CRB index in the aggregate, but to individually examine
its 17 component commodities as well. While the headline CRB
index certainly remains the best single number to use to keep
score on this unfolding commodities bull, there are all kinds
of fascinating sub-trends bubbling under the surface in its components
that contribute to the aggregate index.
The next 17 graphs detail the
2003 results of each of the CRB's components. This price data
is generally taken from the March 2004 futures contracts for
each commodity, and the 2003 gain or loss for each component
is listed. In addition, each commodity's prevailing support line
if it is rising or resistance line if it is falling is drawn
in as well. It is fascinating to see which commodities were up
and down in 2003, and how they contributed to the CRB's performance
as a whole last year.
Not surprisingly, all of the
CRB metals were up significantly last year. The precious metals
of gold, silver, and platinum are particularly interesting as
they represent the easiest ways to speculate in the new bull
market in commodities. While it is exceedingly logistically challenging
to buy and hold something like live cattle or orange juice as
a commodities investment, the precious metals are perfect for
investors and speculators so they ride out front as the cutting-edge
vanguard in commodities bulls.
Unlike every other CRB commodity,
gold, platinum, and to a lesser extent silver have extremely
high value-to-volume ratios. $1m worth of physical gold is vastly
easier to store than $1m worth of wheat! In addition, the precious
metals are non-perishable and last forever. No special care has
to be taken in the treatment or storage of these metals, as they
will indefinitely survive just fine in any normal human environment.
In addition, the precious metals
are ideal for indirect investors and speculators as well, from
a stock-market angle. It is easy to find publicly-traded companies
that specialize in mining the precious metals, that have fantastic
profits
leverage to gains in the underlying prices of the metals
that they mine. While you can quickly name a dozen gold-mining
companies I am sure, try to name even one dedicated publicly
traded company that does nothing but grow soybeans. I sure can't
think of one!
The fourth CRB metal, copper,
does not have a high value-to-volume ratio like the precious
metals and it is much less suited to investment and speculation.
Yes, you can buy stocks in copper mines, but copper generally
trades much more closely in line with pure supply and demand
forces than the precious metals. There are not legions of investors
and speculators clambering to buy physical copper for investment
and speculation purposes, so industrial supply and demand are
virtually unchallenged.
Copper prices are probably
soaring on increased global industrial consumption. The Asian
countries in particular are booming and need vast amounts of
copper to build up critical infrastructure. Even with wireless
telecommunications networks proliferating like rabbits in the
lesser-developed countries, the need for copper for everything
from wires to pipes is immense. It is interesting to note that
the gains in copper even exceeded those of the precious metals
last year!
Unlike the metals, most of
the CRB tropicals plunged in 2003. Not surprisingly there is
very little speculative interest in these commodities outside
of the dedicated futures world, as there is no way for ordinary
investors to buy, store, and speculate in coffee, sugar, cocoa,
orange juice, and cotton.
Unlike the immensely capital-intensive
minerals-mining industry, there are little or no barriers to
entry to growing most of the CRB tropicals. Coffee and cocoa,
for example, can be easily grown by even the smallest subsistence
farmers all over the Third World. I witnessed this first hand
in 1998, when I spent a few months in Jamaica doing consulting
work for a giant alumina-mining company and really started to
understand why the supply of tropicals can vary so dramatically
from year to year.
Driving from Montego Bay to
the center of the island it is amazing to see how every single
hillside is planted with crops like coffee! Entire families,
living in tiny corrugated-tin shacks that we would be embarrassed
to call garden sheds in America, planted crops on small plots
of less than an acre on hills so steep that many middle-aged
Americans probably couldn't even walk up them without having
a heart attack. It is the same way all over the Third World,
with people planting tropical commodities in order to survive.
If the weather is particularly
favorable in a given growing season, bumper crops of coffee,
sugar, cocoa, and oranges flood out of Central America and South
America onto the global markets. And since non-futures investors
and speculators have no convenient way of playing these markets,
supply and demand rule. I do not follow the tropicals closely
enough to know why these prices fell last year, but I have no
doubt that supply and demand is the key.
In contrast, it takes tens
or hundreds of millions of dollars to construct an operating
gold mine, so the barriers to entry to precious-metals production
are enormous. In addition, precious metals only exist in very
specific geological areas, unlike crops like coffee and cocoa
that can be easily grown in pretty much any tropical latitude.
All a farmer needs to grow tropicals is a little dirt and some
timely rains!
I do not find it troubling
at all that most of the CRB tropicals fell last year, since their
prices are more a function of third-world weather and growing
seasons than anything else. Indeed, the CRB index's aggregate
performance in 2003 is even more impressive when the tropicals'
considerable drag on its performance is considered. Since the
CRB 17 are equally weighted, the plunges in commodities like
cocoa and orange juice offset gains in other commodities like
the metals.
Cotton was the only CRB tropical
to rise last year, which is interesting since it is much more
difficult to grow cotton than coffee, at least in terms of capital
required up front. The CRB grains generally performed well, with
wheat and soybeans up substantially while corn was flat in 2003,
although it did see a big spike in January 2004 which is included
in all of these small graphs.
Having grown up in wheat country
in the Dakotas, I just love this wheat chart! Its uptrend in
2003 was textbook perfect and wonderful to see. Soybeans took
off like a rocket halfway through the year too. Once again though,
since these commodities have low value-to-volume ratios and are
difficult to store, all of the CRB grains are primarily driven
by the free-market supply of and demand for these crops, not
by interest from investors and non-futures speculators.
Both of the CRB meats should
have had up years as their trends were higher for most of 2003,
but they both plunged late in the year and ended 2003 essentially
unchanged. The plummeting cattle prices were particularly silly.
As you recall, one American cow out of millions was found to
have a neurological disease. As beef is a lifelong staple of
my own diet, I couldn't care less if a tiny fraction of the nation's
cattle herds were sick. My odds of eating an infected cow are
probably lower than my odds of getting struck by lightning and
winning a lottery on the same day!
Nevertheless, the futures markets
totally panicked and beef prices were hammered. But, once again,
beef is not very valuable relative to its volume, it is perishable,
and it is very hard to store, so this is a supply-and-demand
driven market, not one in which normal investors and non-futures
speculators can play. Still though, it is interesting to note
that beef would have had a great year in 2003 on increased demand
from low-carb Atkins-like dieting, if it wasn't for that silly
mad cow scare in December.
While the CRB tropicals, grains,
and meats are major components of this flagship commodities index,
in the real-world their importance pales in significance to energy.
Energy costs factor into everything we eat, everything we purchase,
and everything we do. Every physical item in your life was moved
to your house through energy expenditures, and energy is the
only reason that you haven't frozen to death yet during this
cold winter if you live in the northern US.
Energy prices surged dramatically
in 2003, with natural gas and heating oil both up by one third
or so. Natural gas is particularly interesting, since it was
trading around $2 in the late 1990s and fueling the tech boom.
As electricity demand skyrocketed with the proliferation of computers
and electronic equipment, the demand for natural gas exploded.
Gas-fueled electrical-generation facilities were very popular
when the gas prices were bottoming in the late 1990s.
Yet, at the bottom of the commodities
bust, there was no incentive to invest heavily in new gas supplies
since the prices were too low to cover the enormous capital costs
of exploration and development. As such, capital simply migrated
elsewhere in search of higher returns and gas infrastructure
withered and rusted. As demand rose and supply remained stagnant,
prices had to rise to keep demand in check and entice fresh new
supplies onto the markets. Now today, even the legendary Warren
Buffett is ready to invest billions in natural-gas infrastructure
to bring Alaskan gas down to the Continental 48 to help supply
insatiable US demand!
While natural gas is a key
commodity, the ultimate CRB commodity is absolutely without any
doubt crude oil. Crude oil, since its refined products are used
to transport pretty much every physical good and commodity on
Earth, is the single most important commodity in the world by
far. Like the CRB index itself, crude oil has also been traveling
in a well-defined bullish uptrend since late 2001.
Crude oil is also in a beautiful
textbook-perfect uptrend in US dollar terms. From its late 2001
low to its recent $35 highs in January, crude oil has been remarkably
consistent in powering higher. The only breakout above this methodical
uptrend happened leading up to last spring's annexation of Iraq
by Washington. Oil ran up on invasion fears but then quickly
collapsed once the bombs started flying and the world became
confident that the Middle East as a whole wasn't going to erupt
into flames.
While oil was only up a little
over 4% last year, primarily because war worries had driven its
price up in late 2002, it is up an amazing 100% in its bull market
to date, ignoring the war spike and measuring to January 2004.
The implications of a doubling in the price of oil are really
quite profound since it is the foundation of our modern global
industrial economy.
The continuation of oil's uptrend
following Washington's annexation of Iraq is particularly interesting,
since Wall Street and Washington were unanimous in early 2003
prior to the invasion in predicting that oil prices would plummet
once Iraqi oil was brought back online. This has not been the
case yet, however, as the plunging US dollar is causing great
concern among OPEC members.
The oil-producing countries
are witnessing the relentless downward spiral of the US dollar's
purchasing power in terms of their own local currencies, so they
want to ensure that they do not flood the market with excess
oil and drive prices back down to late 2001 lows. Back then the
US dollar was much stronger before its bear
market began in earnest and it went a lot farther in terms
of what it could buy on the international markets.
In summary, the technical evidence
from 2003 continues to support the Great Commodities Bull of
the 00's thesis. Of the CRB 17 commodities, 10 were up and 7
were down last year, and of the down ones 3 were effectively
unchanged with trivial drops.
Of the 7 that were down, none
of them were particularly important in terms of their impact
on the average American. For example, what percent of your income
do you think that you spent on orange juice last year as compared
to crude-oil products, such as gasoline? Coffee, sugar, cocoa,
orange juice, corn, cattle, and hogs were down, but none of these
commodities individually are particularly important to the economy
in general or investors.
Of the 10 commodities that
were up in 2003, however, many are crucially important to the
economy as a whole and to individual investors. All of the CRB
energies were up, which everyone absolutely needs to consume
in order to stay warm, have electricity, receive goods, and transport
themselves around. All of the CRB metals were up in 2003 as well,
even the pure industrial play of copper.
The easiest way for investors
and speculators to play this fabulous new commodities bull remains
in the precious metals, all three of which had outstanding years
in 2003. In addition to making ideal investments and speculations,
the precious metals are the most sensitive barometers of fiat-currency
inflation, where the governments print ever-growing bodies of
currency that compete for a finite supply of commodities.
With rising technical uptrends
in the most important components of the CRB 17 confirming the
glowing foundational fundamental bull-market drivers, there is
no doubt that the Great Commodities Bull of the 00's is finally
underway. We haven't seen anything yet though, as the early gains
are always modest since relatively small amounts of contrarian
capital are always first to the new investment table. But over
time as commodities prices continue to rise more and more investors
and speculators will gradually grow interested.
Coming out of a deep secular
bust, commodities can run many times higher before we witness
another commodities bubble as in the late 1970s. This future
bubble will be the time to dump long-term positions, when commodity
plays like gold stocks become as popular and hot among general
investors as tech stocks were in 1999.
Psychologically commodities
remain frowned upon and scoffed at by the vast majority of investors
today, so early opportunities still abound to Buy Low in a down-and-out
asset class.
While slowly improving, as
Warren Buffett's recent proposal to build a major natural-gas
pipeline in Alaska proves, capital investment remains woefully
inadequate in the commodities realm. Vast new supplies of commodities
will have to come online to meet growing demand, and it will
probably take a decade to flesh out this infrastructure.
Putting even more pressure
on finite global commodity supplies, over two billion Asians
are working hard and ramping up their consumption rapidly, seeking
American-type standards of living for their families. The rise
of Asia truly could make this the largest Great Bull in commodities
in world history before all the dust settles!
And, as if all these fundamentals
are not bullish enough, governments around the world are inflating
their paper currencies like there is no tomorrow. With each passing
day that money supplies grow faster than commodity supplies,
the prices of commodities in general can only continue to rise
in the future.
The Great Commodities Bull
of the 00's, merely a hypothesis only several years ago, is rapidly
becoming a reality. We have already been blessed with excellent
gains in precious-metals-related stocks, and we are probably
only in the very earliest stages of what could prove to be a
massive commodities boom lasting a decade or longer.
We will continue to zealously
search for outstanding commodities investment and speculation
opportunities in the months and years ahead in our popular Zeal
Intelligence monthly newsletter for our subscribers,
who continue to thrive as prudent early-bird contrarians.
If you have missed the first
few years of this legendary commodities feast, don't feel too
bad. If history is a valid guide, the best in this commodities
Great Bull is still yet to come. The Buy Low years are gradually
waning, but the Sell High years are still way off over the horizon.
Adam Hamilton, CPA
email:
zelotes@zealllc.com
Archives
February 6, 2004
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