What About Commodities As An Investment?
It appears Merrill Lynch believes the metals super cycle is still in tact. This jives with an earlier call by Citigroup where analyst John Hill wrote that a "drumbeat of operating outages/shortfalls" could introduce an extended period prices at more than $2.50 a pound for copper, more than $7 a pound for nickel and more than $1.25 a pound for aluminum. "As a consequence, we (Citigroup) expect a wave of upward earnings estimates revisions, both short- and long-term, and a very favorable environment for the equities. which says metals are likely to make the most of a super cycle sweet spot.
After shares of Rio Tinto and BHP recently lost 20% of their value in a quick and nasty correction in metals, Merrill is recommending weakness as a buying opportunity saying there is a 60% chance metals extend their rally over the coming decade, a 30% chance shares will fall further in coming months and a 10% chance shares will make news highs in the next three months. Well, that adds up to 100%. But, I want to know how those percentages were calculated and what they were based on. Anyone who can predict the future with that much accuracy needs to buy me a few lottery tickets.
Then there's this. Citigroup said that investments in global commodity funds were around $200bn in February. For some time, Citigroup Smith Barney analyst Alan Heap had made out a case that speculators, not least hedge funds, had been key drivers in pushing metal and commodity prices to multi-decade highs. At the end of January this year, Citigroup warned loudly that “a flood of investment funds are driving base metal prices much higher than can be supported by fundamental analysis of supply and demand. It’s a bubble which could grow a lot bigger before bursting”. Noting that fund investments began to surge in early 2004, Citigroup illustrated how commodity markets “have always been strongly influenced by speculation”.
So, which is it? Is Citigroup analyst Hill or Heap correct? Or is Merrill correct? Why are different Citigroup analysts saying different things?
Or maybe Alan Heap is changing his mind again. Heap estimates that funds have invested more than $US200 billion ($263.4 billion) in commodities, up from less than $US10 billion
a decade ago. Here Heap also says it is a "stronger for longer" boom, a "supercycle," according to Alan Heap, commodity analyst with Citigroup.
So, let me get this straight. We are in a metals supercycle. Global synchronized growth is going to propel the price of industrial metals for ten to twenty years? So, copper seems to be the favorite for all of these metal lovers. I have the copper chart for the past 100 years. It just has never happened. Since 1960 every single economic cycle has started with copper at 60cents a pound or less. We've had these periods before where global growth has pushed the price of copper astronomically higher. Five times in one hundred years. All five ended with copper cratering after one business cycle. Yet, I am to believe a Wall Street expert that this is going to go on for twenty years? Copper went from 60cent at the beginning of this cycle to over $4 this year. Yet, even at $4 a pound people were calling it higher. Now picking the top can be difficult but how much higher? Higher than the price of silver, a precious metal?
Remember Wall Street is always wrong eventually. The key is to follow them until they realize they were irrational or wrong. Then bail when they bail. That is easier said than done for most investors. But, failing to take profits in sectors or stocks that are highly momentum driven will eventually cause tremendous wealth destruction for those who decide to buy and hold. Ok, let's be rational for a moment. Copper reached levels in 2006 that were nearly as expensive as the price of silver at times in history. It has seen a rate of change increase that has never been matched in the last 100 years. Silver is a precious metal which has limited availability. Copper is is a highly abundant resource that you make housing wire with. Ditto with iron ore, aluminum, nickel, tin, lead, etc. All of these metals have made incredible moves to the upside.
Let's look at some fundamentals. China is supposedly the driver for the metals boom. Their growing economy is using all of the metal the world can produce. Or is it? That's what we are told. Yet, China has been growing for two decades. So, why did metals start to rise right around the time the stock market bubble was being created in 2000? Well, for that matter, let's apply the same logic to oil. Oil was $10 a barrel right as the equity bubble was coming to a top.
Two things converged at that time to make these assets a worthwhile investment. 1) New mining and exploration had not taken place in quite some time. When commodities become undervalued over a period of years, there's no incentive to look for new sources or mine new product. ie, When oil is at $10 a barrel, why would an oil company drill for more product? There's no profit. So, what then happens is eventually global economic growth will drive demand for any commodity. Demand drives up the price. As the price rises, commodity company profits increase and those profits can be used to add mining or exploration capacity. Now, with oil at $30 or $40 or whatever, it becomes economically viable to search for more oil. Eventually, if demand becomes so great, the price continues to rise until demand is choked off. ie, At some price demand will abate because price itself becomes too much to absorb thus causing some type of slow down. Why a slow down? Because commodities are inputs to economic growth. They are used to make "stuff". Eventually as input costs rise, companies using these products must either raise prices or see their profits erode. Raising prices causes inflation and that makes central bankers very unhappy so they start raising interest rates. This starts the cycle of an economic slow down. I'm obviously simplifying this for the sake of not typing ad infinitum.
ie, Those who believe copper or oil can continue to go up for ten or twenty years in a super cycle are not economists. They are Wall Street "experts" who fail to realize the concept of a supercycle is ridiculous. If we have seen oil and copper go up for a handful of years and we see prices continue to go up for another fifteen years, we'll be paying $20 a pound for copper and $300 a barrell for oil. (Arbitrary numbers chosen to make a point.) Global economies will bust or are already busting because these prices are already causing economic problems. The concept is just plain stupid and there is zero historical precedence for it because in every other historical cycle, rising commodity prices destroyed the global economies. And that has either or will eventually happen again.
So, you may ask, well, what if commodities come down in price? Will we continue to have global economic growth? Well, that is surely plausible and possible. But, again there is no historical precedence for it. Why? This is point number two from above. 2) This is where Wall Street's role comes in. You see, if commodity prices were really going up only because of China or global growth, the price of oil and copper would have started to rise as China's demand started to build ten or twenty years ago. But, they didn't. Instead, they started going up just as the equity bubble was coming to an end. What is really driving commodities? Global growth is playing a role. But, what is pushing commodities to levels of a likely bubble? Wall Street. First, you need to understand how global investors work. Be it hedge funds, mutual funds, finance firms, professional traders, individual investors or whatever. There is massive pool of investment monies. These monies move from investment to investment over long cycles. They drive an investment higher and higher until it can be driven no higher (stocks in 2000.), then they look for the most undervalued investment to move to next. And on and on and on. And, there are times when there is so much global money available they drive and drive investments until we have bubbles. So, what was the cheapest investment in 2000 after they blew up stocks? Commodities that had been ignored for a decade or more. There are more traders trading oil, copper and other commodities than at any time in history. And, they are making billions upon billions of profits by driving these commodities prices up. Not only that, but they are courting retirement funds, pension funds and individual investors and telling them all it is different this time. That these assets are going up, up and away. So, can someone tell me how a person in India or China making $7 a day can afford copper at $4 or $20 or whatever a pound? Or gasoline at $4, 10 or 15 a gallon? Prices will eventually kill global growth. And, you can thank your favorite Wall Street firm because many are killing the global economies in the name of profits.
So, now you know the answer to the question of "will the global economies continue to grow if commodities come down in price?". From a historical perspective, the answer is the fast money won't quit riding these investments higher until they bust the global economies. And, when they do, pension funds, individual investors, hedge funds and others who thought prices could go up forever, will lose tremendous amounts of money. That is why there is zero historical precedence for a supercycle of commodities. It's a self regulating environment. Higher prices cause commodity companies to invest in more production. Eventually higher prices choke off economic growth just about the time more production of copper, nickel, tin, oil or whatever hits the market. So, with demand decreasing due to higher prices, the world now has much more capacity to product more commodities and you eventually have a commodity glut. Supply & demand. Or in the case of commodities............Boom. Bust.
Could it be different this time? Well, Freeport McMoran, a major copper producer said in 2006 it cost them 7 cents to mine copper. Copper was over $4 a month ago. Do you think these prices are rational? Are they being driven by fundamentals? I wouldn't bet my checkbook on it.
UPDATE ON JUNE 30th
Today, traders are at it again. It appears that the data on the economy is ambiguous at best giving commodity traders reason to believe economic growth is unaffected by their actions. Comments from professional commodities traders were again turning bullish. As long as the economy continues to do well or there is any inkling of such, they will continue to remain fascinated by input commodities as a new investment class thus continuing their drive to push energy and industrial commodities upward. This action will surely guarantee a self fulfilling economic slow down caused in large part by their actions. ie, Higher prices will eventually choke off demand and cause central banks to continue to raise interest rates thus killing the American consumer.
Behaviorally, it would take a change in trader's psychology that will only be permanent when they realize they were wrong and input commodities are not an investment that is sustainable. ie, A popping of the economy and along with it a popping of demand for input commodities will likely be needed to stop their bullishness. So, my suspicions are confirmed and it appears they will attempt to push energy and industrial commodities higher from here. In the end, whether the economy is cratering yet or whether it will just be an eventuality, we will all be punished.
After shares of Rio Tinto and BHP recently lost 20% of their value in a quick and nasty correction in metals, Merrill is recommending weakness as a buying opportunity saying there is a 60% chance metals extend their rally over the coming decade, a 30% chance shares will fall further in coming months and a 10% chance shares will make news highs in the next three months. Well, that adds up to 100%. But, I want to know how those percentages were calculated and what they were based on. Anyone who can predict the future with that much accuracy needs to buy me a few lottery tickets.
Then there's this. Citigroup said that investments in global commodity funds were around $200bn in February. For some time, Citigroup Smith Barney analyst Alan Heap had made out a case that speculators, not least hedge funds, had been key drivers in pushing metal and commodity prices to multi-decade highs. At the end of January this year, Citigroup warned loudly that “a flood of investment funds are driving base metal prices much higher than can be supported by fundamental analysis of supply and demand. It’s a bubble which could grow a lot bigger before bursting”. Noting that fund investments began to surge in early 2004, Citigroup illustrated how commodity markets “have always been strongly influenced by speculation”.
So, which is it? Is Citigroup analyst Hill or Heap correct? Or is Merrill correct? Why are different Citigroup analysts saying different things?
Or maybe Alan Heap is changing his mind again. Heap estimates that funds have invested more than $US200 billion ($263.4 billion) in commodities, up from less than $US10 billion
a decade ago. Here Heap also says it is a "stronger for longer" boom, a "supercycle," according to Alan Heap, commodity analyst with Citigroup.
So, let me get this straight. We are in a metals supercycle. Global synchronized growth is going to propel the price of industrial metals for ten to twenty years? So, copper seems to be the favorite for all of these metal lovers. I have the copper chart for the past 100 years. It just has never happened. Since 1960 every single economic cycle has started with copper at 60cents a pound or less. We've had these periods before where global growth has pushed the price of copper astronomically higher. Five times in one hundred years. All five ended with copper cratering after one business cycle. Yet, I am to believe a Wall Street expert that this is going to go on for twenty years? Copper went from 60cent at the beginning of this cycle to over $4 this year. Yet, even at $4 a pound people were calling it higher. Now picking the top can be difficult but how much higher? Higher than the price of silver, a precious metal?
Remember Wall Street is always wrong eventually. The key is to follow them until they realize they were irrational or wrong. Then bail when they bail. That is easier said than done for most investors. But, failing to take profits in sectors or stocks that are highly momentum driven will eventually cause tremendous wealth destruction for those who decide to buy and hold. Ok, let's be rational for a moment. Copper reached levels in 2006 that were nearly as expensive as the price of silver at times in history. It has seen a rate of change increase that has never been matched in the last 100 years. Silver is a precious metal which has limited availability. Copper is is a highly abundant resource that you make housing wire with. Ditto with iron ore, aluminum, nickel, tin, lead, etc. All of these metals have made incredible moves to the upside.
Let's look at some fundamentals. China is supposedly the driver for the metals boom. Their growing economy is using all of the metal the world can produce. Or is it? That's what we are told. Yet, China has been growing for two decades. So, why did metals start to rise right around the time the stock market bubble was being created in 2000? Well, for that matter, let's apply the same logic to oil. Oil was $10 a barrel right as the equity bubble was coming to a top.
Two things converged at that time to make these assets a worthwhile investment. 1) New mining and exploration had not taken place in quite some time. When commodities become undervalued over a period of years, there's no incentive to look for new sources or mine new product. ie, When oil is at $10 a barrel, why would an oil company drill for more product? There's no profit. So, what then happens is eventually global economic growth will drive demand for any commodity. Demand drives up the price. As the price rises, commodity company profits increase and those profits can be used to add mining or exploration capacity. Now, with oil at $30 or $40 or whatever, it becomes economically viable to search for more oil. Eventually, if demand becomes so great, the price continues to rise until demand is choked off. ie, At some price demand will abate because price itself becomes too much to absorb thus causing some type of slow down. Why a slow down? Because commodities are inputs to economic growth. They are used to make "stuff". Eventually as input costs rise, companies using these products must either raise prices or see their profits erode. Raising prices causes inflation and that makes central bankers very unhappy so they start raising interest rates. This starts the cycle of an economic slow down. I'm obviously simplifying this for the sake of not typing ad infinitum.
ie, Those who believe copper or oil can continue to go up for ten or twenty years in a super cycle are not economists. They are Wall Street "experts" who fail to realize the concept of a supercycle is ridiculous. If we have seen oil and copper go up for a handful of years and we see prices continue to go up for another fifteen years, we'll be paying $20 a pound for copper and $300 a barrell for oil. (Arbitrary numbers chosen to make a point.) Global economies will bust or are already busting because these prices are already causing economic problems. The concept is just plain stupid and there is zero historical precedence for it because in every other historical cycle, rising commodity prices destroyed the global economies. And that has either or will eventually happen again.
So, you may ask, well, what if commodities come down in price? Will we continue to have global economic growth? Well, that is surely plausible and possible. But, again there is no historical precedence for it. Why? This is point number two from above. 2) This is where Wall Street's role comes in. You see, if commodity prices were really going up only because of China or global growth, the price of oil and copper would have started to rise as China's demand started to build ten or twenty years ago. But, they didn't. Instead, they started going up just as the equity bubble was coming to an end. What is really driving commodities? Global growth is playing a role. But, what is pushing commodities to levels of a likely bubble? Wall Street. First, you need to understand how global investors work. Be it hedge funds, mutual funds, finance firms, professional traders, individual investors or whatever. There is massive pool of investment monies. These monies move from investment to investment over long cycles. They drive an investment higher and higher until it can be driven no higher (stocks in 2000.), then they look for the most undervalued investment to move to next. And on and on and on. And, there are times when there is so much global money available they drive and drive investments until we have bubbles. So, what was the cheapest investment in 2000 after they blew up stocks? Commodities that had been ignored for a decade or more. There are more traders trading oil, copper and other commodities than at any time in history. And, they are making billions upon billions of profits by driving these commodities prices up. Not only that, but they are courting retirement funds, pension funds and individual investors and telling them all it is different this time. That these assets are going up, up and away. So, can someone tell me how a person in India or China making $7 a day can afford copper at $4 or $20 or whatever a pound? Or gasoline at $4, 10 or 15 a gallon? Prices will eventually kill global growth. And, you can thank your favorite Wall Street firm because many are killing the global economies in the name of profits.
So, now you know the answer to the question of "will the global economies continue to grow if commodities come down in price?". From a historical perspective, the answer is the fast money won't quit riding these investments higher until they bust the global economies. And, when they do, pension funds, individual investors, hedge funds and others who thought prices could go up forever, will lose tremendous amounts of money. That is why there is zero historical precedence for a supercycle of commodities. It's a self regulating environment. Higher prices cause commodity companies to invest in more production. Eventually higher prices choke off economic growth just about the time more production of copper, nickel, tin, oil or whatever hits the market. So, with demand decreasing due to higher prices, the world now has much more capacity to product more commodities and you eventually have a commodity glut. Supply & demand. Or in the case of commodities............Boom. Bust.
Could it be different this time? Well, Freeport McMoran, a major copper producer said in 2006 it cost them 7 cents to mine copper. Copper was over $4 a month ago. Do you think these prices are rational? Are they being driven by fundamentals? I wouldn't bet my checkbook on it.
UPDATE ON JUNE 30th
Today, traders are at it again. It appears that the data on the economy is ambiguous at best giving commodity traders reason to believe economic growth is unaffected by their actions. Comments from professional commodities traders were again turning bullish. As long as the economy continues to do well or there is any inkling of such, they will continue to remain fascinated by input commodities as a new investment class thus continuing their drive to push energy and industrial commodities upward. This action will surely guarantee a self fulfilling economic slow down caused in large part by their actions. ie, Higher prices will eventually choke off demand and cause central banks to continue to raise interest rates thus killing the American consumer.
Behaviorally, it would take a change in trader's psychology that will only be permanent when they realize they were wrong and input commodities are not an investment that is sustainable. ie, A popping of the economy and along with it a popping of demand for input commodities will likely be needed to stop their bullishness. So, my suspicions are confirmed and it appears they will attempt to push energy and industrial commodities higher from here. In the end, whether the economy is cratering yet or whether it will just be an eventuality, we will all be punished.
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