 The Key to the Commodity
Boom
Chris Mayer
Feb 26, 2007
The Daily Reckoning PRESENTS: Since most commodities rose significantly
in price over the last several years, the recent slide begs the
questions: What does it all mean? Is the commodity boom over?
Chris Mayer answers those questions - and more - below...
The market has knocked the
stuffing out of many commodities of late. Crude oil is down 35%
from its record high of $78.40 in July to a 19-month low as I
write. The CRB Index of 19 commodities is off about 20% since
May. The only commodities holding up seem to be in the agricultural
markets (e.g., corn).
The key piece to understanding
the commodity jigsaw puzzle lies in that ever-baffling and wondrous
place, China, which never seems to stray far from our view. What
happens there has a huge impact on commodities worldwide.
China is already the world's
largest consumer of copper, nickel and zinc. It is among the
largest consumers of many other commodities, as well. But what's
really amazing is not so much the sheer quantity of commodities
devoured... what is really staggering is the growth rate of such
consumption - especially in the context of what the rest of the
world is doing.
For example, from 2002-05,
according to the International Monetary Fund, China alone accounted
for 48% of the increased demand for aluminum. Take a look at
the short table below, which shows the percentages for some other
commodities, as well:
*Aluminum, 48%
*Copper, 51%
*Lead, 110%
*Nickel, 87%
*Steel, 54%
*Tin, 86%
*Zinc, 113%
*Oil, 30%
Think about that. Worldwide,
when you look at the increased consumption of, say, steel, 54%
of that increase came from China alone. In Wall Street fancy
talk, they call that percentage the "commodity delta"
- try dropping that in conversation at the next neighborhood
barbecue. For lead and zinc, China's increased consumption actually
offset declines in the rest of the world. No single country has
been as important to the commodity bull market as has the Middle
Kingdom.
I traveled to China in late
2005, spending time seeing the sights around dusty Beijing in
the north, exploring the crowded streets of Shanghai and marveling
at the busy panorama in Hangzhou and Hong Kong. I also stopped
off at a small village between Shanghai and Hangzhou - called
Wuzhen - where I ate chicken feet and pigeon soup and saw another
side of China away from the big cities. All along the way, I
met with Chinese professionals and business people who helped
me gain a better understanding of what was happening on the ground
in China.
The whole experience made a
big impact on me. Ever since, I can't seem to stop talking about
China. With good reason, I think. The emergence of China's economy
on the world stage may be the biggest investment story of our
time. In 1990, China was the world's 10th largest economy. Today,
it is the fourth largest. That's mind-boggling growth.
The implications of that cover
just about everything I've written about over the past 12 months
- from strained water resources and bustling agricultural markets
to aging infrastructure and needed energy investment. These are
long-term trends that will take years to play out.
It would be a mistake to say
increased demand from China alone assures a rise in commodity
prices. There are always many variables, but China is unmistakably
a big one. If China went away, it would be like a fat guy getting
out of a hot tub. The water level would plunge. Let me put it
this way: It's hard to imagine a continued bull market in commodities
without China.
It would also be a mistake
to assume that China's growth rate stays at its hot pace of recent
years. "Only stand high a long enough time," the poet
Robinson Jeffers wrote, "your lightning will come; that
is what blunts the peaks of the redwoods." There is plenty
of potential for lightning - social unrest within China, political
tiffs with the U.S. and other policy mishaps. (I found it interesting
that 27 separate pieces of anti-China trade legislation have
made their way to Congress since 2005.)
However, even a slower-growing
China will still have a lot of sway in the market for commodities.
China is still in the early innings of industrialization. It's
in the midst of a massive shift of population to the cities,
the biggest the world has ever seen. Chinese officials expect
more than 300 million Chinese farmers will migrate from rural
areas to live in urban areas in the coming two decades.
As a result, China has big
plans for investment in infrastructure - such as water and wastewater
systems, power grids and much more. China will need a lot of
steel, copper, energy, etc., to build all that stuff. For example,
as Stephen Roach at Morgan Stanley notes, "There is an especially
tight link between homebuilding and copper." In the U.S.,
the average home contains 400 pounds of copper. We don't have
comparable numbers for China, but it seems reasonable to assume
China's numbers should be similar. It's
possible, given that Chinese efficiency lags behind the U.S.'s,
that China could require much more.
Nonetheless, we should expect
commodity prices to fluctuate, sometimes sharply. Even in the
last great commodities boom, from 1966-82, there were plenty
of setbacks. And these commodities won't all move together as
each responds to the unique tugs and pulls of its market. We're
seeing some of this already with corn rallying hard amid a nasty
decline in oil.
Regards,
P.S. The winners during times
like this, when prices take a big dip, are the investors-in-
waiting. The recent downdraft provides a nice buying opportunity
to pick up some quality commodity companies, if you can stomach
the volatility. See what companies made the cut here:
Capital & Crisis
http://www.isecureonline.com/Reports/FST/EFSTGC26
Feb 20, 2007
Chris Mayer
for
The
Daily Reckoning
Christopher W.
Mayer is a veteran of the banking industry, specifically in the
area of corporate lending. A financial writer since 1998, Christopher's
essays have appeared in a wide variety of publications, from the
Mises.org Daily Article series to The Daily Reckoning. He is also
the editor of the Fleet Street Letter.
321gold Inc
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