Jim Rogers Claims 20 Year Commodities Boom to Replace Financial Crash
Commodities / Investing 2009 Oct 11, 2009 - 05:56 PMBy: Andrew_McKillop
In a Yang-Yin world where only two paradigms, models or states are possible - obviously not the real world - commodity boom should replace financial crash, like day follows night.
To some, including Jim Rogers, this is already in the works. Speaking from Singapore in interview with the UK Daily Telegraph on 8 October, he forecast a commodities boom able to last 20 years. He said: "Commodities are the best place to be, if you ask me, based on supply and demand". He also believes crude oil will run out in 15 or 20 years "unless something happens", despite quite large recent discoveries and slow growing demand.
"The supply of everything continues to decline," he said, adding: "If the world economy recovers, commodities will do the best, because supply is being restricted. If the world economy does not recover, commodities will still be the best place to be, because governments are printing huge amounts of money." (Daily Telegraph, 8 October 2009).
The reasoning is direct and simple, but assumes the massive Keynesian remedial spending, loans and guarantees engaged by most G20 countries, and especially by the OECD group, will trickle down to the real economy, and will not backfire. Gold and silver prices, for example, are driven upward by fiat money weakness as much as by mineral resource depletion, energy costs of production, industrial and private demand in China and India, and so on. Under a relatively robust set of scenario drivers, discussed below, the new commodity boom forecast by Jim Rogers could disappear almost instantly, like ships or planes swallowed in the Bermuda Triangle.
COMMODITY BOOM AND ECONOMIC RECOVERY
The commodities boom, exactly like the equities bounce depends on the economic recovery continuing to send reassuring signals. Another recession dip, or rapid slump in global real economy growth is far from impossible. This is shown by factors including the extreme high-end outturns for 2009 economic contraction data for many countries, such as Russia and Spain, and the IMF’s constant build of new resources to bail out increasing-sized countries faced with unmanageable budget deficits and national currencies under sharp attack on FX markets.
Double dip could come through a large, even increasing number of pressures. These start with unmanageable public debts in several countries, a run against the US dollar, defensive interest rate hikes due to returning inflation if the recovery builds, stubbornly high OECD unemployment and high budget deficits, geopolitical rivalries in the Mid East and West Asia. Trade conflicts could flare, now including possible or likely carbon tariffs and protectionism. The list of other possible causes is long.
COMMODITY PRICE VOLATILITY
As Jim Rogers, OPEC leaders and every commodity trader knows, a 3.5% decline in world oil demand year-on-year, in early 2009, led to a fall of around 75% in the oil price, from its 2008 highs. All other commodities, hard and soft, were hit by a wave of selling, during 2008-2009. Any faltering of economic recovery, or rise in interest rates when recovery comes with a sharp dose of inflation, will trigger rapid and large sell offs in commodities.
In the event of a new downturn in the global economy, the likelihood that G20 governments would react like they did in 2008-2009, and make a kneejerk return to printing more money, one more time, is of course possible. But due to accumulated debt racked up since 2008, this can only be less sure, and probably smaller, if governments are again forced to bail out the economy.
As we know, if the global economy slid back again and new deficit spending was not engaged but interest rates were raised, this would be the start of long recession, lasting at least 3 - 5 years. The potential for this to stretch far into the future for many countries is large. As in the 1979-84 sequence of extreme high interest rates, high oil prices, and high gold prices, ‘the Japanese syndrome’ of long-term semi-deflationary stagnation, and massive national debt could spread.
ASIAN DECOUPLING MEANS WHAT IT SAYS
Long commodity booms of the type Jim Rogers is forecasting depend not only on continuing recovery in OECD resource and energy demand, but also on 'decoupled growth' of Chinese and Indian resource and energy demand. This ignores the OECD group being forced to take the ‘Japanese option’. Long-term deflationary recession, Japanese-style, is however a distinct possibility for several OECD countries other than Japan. Inside Japan at least, this long-term economic management has proven manageable.
If generalized across the OECD, with low or zero growth of world trade, and long-term low growth of the economy, knock-on to China and India would be certain or very likely. Their trend towards real decoupling, relying on domestic-centered economic growth, would be reinforced. China and India’s external trade dependence would stop growing, and maybe regress on a continuing basis.
Continued growth of global resource and energy demand, at least of the 2004-2007 Petro Keynesian type, would disappear from view. Even for supply-constrained global oil supply, the 'long plateau' of world net export offer, that has bumped along since around 2005 and is only extended by gas liquids and condensates (not conventional oil), could be extended several years. World oil demand would shift to rigorous zero growth, and incremental if small replacement and substitution of oil demand by biofuels and green energy, as well as by cheap natural gas, and even cheaper coal would cap oil prices.
A three-to-five year plateau for world resource and energy demand growth could heavily impact the number of trading funds and pools believing in rational price growth opportunities, for what again could take on the look of "Sunset Commodities". While a repeat of the long trough for commodity prices through around 1986-2000 would be unlikely, commodity prices could fall from current levels and stay low for some while.
THE IMF TO THE RESCUE
The "objective allies" of believers in a near-term and coming resource boom include, in no uncertain way, the IMF. About 18 months ago, before the crisis really began to bite, the IMF was an almost forgotten, low budget agency loosely tied to the OECD and to the UN system - and short of funds. This was simply because its basic source of a return on its lending, its Third World borrowers, were paying back their loans, or even liquidating them with a flourish on the back of high commodity prices, high export earnings and faster economic growth.
Russia, not exactly a Third World country although that could be doubted in the early 1990s, was a spectacular case of an "IMF client state" liquidating its outstanding debt with a flourish.
The IMF has a rigorously Keynesian approach to financial and monetary troubleshooting or problem solving. This means that fiat and printed money are the rigorous means used by the IMF to restore national solvency and oppose what it calls 'cyclic trends' in the regional or local economy.
As recently as one year ago the IMF was still low profile, as its new director Dominique Strauss-Kahn continued edging his way into power, narrowly avoiding a sleaze scam. Total arrears owed to the IMF at end 2007 were no more than 1.9 billion SDR, the IMF's own "proxy money" supposedly close-linked to the US dollar, but drifting away - upwards - from this base for some time. In current USD, total arrears owed to the IMF at end 2007 by countries like Sudan were around 3 bn USD. This is a meager amount for running an institution with operating costs at close to 1 billion USD a year in 2007.
This has now changed, dramatically. The IMF is now the basic, or even the only bookkeeper and organizer for the international stimulus package, sold as another cog in the global recovery machine, for poor countries. With the CDM (Clean Development Mechanism) procedures to directly accelerate oil saving in lower income non-OECD countries, or to offset CO2 emissions in OECD countries, it is certain that IMF lending will grow in what is "climate linked" financing activity.
Countries with extreme high national public debts find a receptive ear at the IMF, today. The numbers of large borrowers and candidate countries is rising, and extends to countries such as Turkey, Ukraine, Pakistan and Indonesia. Under some scenarios, these borrowers and candidates could be joined by several EU countries in 2010.
CREATING CREDIT FROM NOTHING
By an interesting quirk of history, the last time the IMF was a large net emitter of essentially unsecured SDRs was in the 1980-1981 period, when both gold and oil prices were surging towards then-unprecedented highs. At the time, the IMF issued a total of around $ 30 billion in SDRs. Today, the IMF is issuing about $ 300 billion in SDRs, and this is only the beginning. Possible amounts are extremely high on the upside, and will only fall if there is strong and sustained economic growth through at least 2010-2011. Press reports suggest that the IMF already has a 'treasure chest' of at least $ 500 billion, to lend in extremis where this would be necessary.
The important factor is the real liquidity and interchangeability with 'real money' (i.e. fungibility) of these new resources produced and held by the IMF, and conferred or transferred to it by political decision in the G7 countries. Fungibility is very low. The government paper, usually derived from or related to 'sovereign debt' and able to be used by the IMF to create new SDRs, as an ersatz US dollar, will likely soon be joined by China, the GCC countries and perhaps other non-OECD G20 members. Continuing depreciation of the US dollar may in fact accelerate this process, simply by fear of remaining tied to the dollar, and seeing the SDR as a kind of Bancor.
What we can rationally expect is that fiat SDR creation by the IMF, in conditions of threatened double dip, could easily spiral, like fiat USD creation by the US Fed. Being the world's new central bank, run of strict Keynesian principles, we can easily say the sky will be the limit for creation and emission of new SDRs.
TRICKLE DOWN
In this context and with this outlook, Jim Rogers can be right for some while - but recession slump will come hard on the heels of his expected commodities boom. Real resource commodities, already and in fact traded exactly like increasingly virtual and unreal assets, such as interest rate futures or GM corporate debt, will receive a sharp dose of downside virtuality. Price collapses exemplified by crude oil futures in 2008-2009, can be generalized and predictable, after a seemingly long period of extreme volatility.
This volatility trend is already in place, in Fall 2009, we can note.
Betting on a new commodities boom, even short-term, is made riskier by the low visibility of the implied or imagined "recovery process" in the global economy, but more especially in the OECD countries. We could say, for oil among other commodities, we have moved from OPEC to opaque. Demand trends able to be interpreted as bullish, for a short while, can easily slip back to neutral or negative, due to the voracious appetite of financial players confronted with a literally fantastic "burn rate" from operations featuring the resolution or liquidation of accumulated bad bets. Inside the finance sector that we can set as including all banks, finance institutions, the insurance and mortgage industries, and allied trades, capital productivity has plummeted. This already is an unexpected spinoff from ever larger, more complex financial market operations.
Modeling this is difficult and challenging. Taking the admittedly extreme US case, probably $ 11 500 billion in loans, guarantees and borrowing has been operated or engaged by US government sources, for 2008-2010, and around $ 3 750 bn has been directly utilised, to date. Results inside what is called the 'real economy' are for the least ambiguous, for those expecting a sharp recovery in US economic activity - without inflation, to date. One reason for this lack of inflation is simple: real economy recovery has been weak and ambiguous, to date.
Put another way, when the return of inflation that is feared by Ben Bernanke arrives, signaling real economy recovery, the risk of extreme high rates of inflation are themselves extreme. Continuing the present semi-recovery could be hoped as a least-evil, but exuberant trading of assets across the vast financial space will itself tend to curtail the life expectancy of that hope.
The US case, though extreme, is mirrored by that of many other OECD economies, including larger countries such as the UK, Japan and Spain. Unemployment is tending to increase, economic activity outside those sectors directly favored by Keynesian support is only in weak recovery, several key sectors such as the automobile industry, iron and steel, shipping, house building and others remain depressed, visibility is low or extreme low. Expectations for a sustained recovery in commodity prices, in these circumstances, are as unreasonable as expecting record high US jobless numbers to fall in anything under 2 or 3 years - and in the rigorous absence of double dip.
THE GAS BUBBLE
Jim Rogers and others commodity boomers may also be mistaken in thinking that oil price recovery automatically translates to sustained price recovery for non-oil commodities. In the short-run, yes, but without sustained real economy recovery, no. The special case of oil, summarized by Peak Oil, is itself becoming less special and more complex, as multiple transitions gather pace. The long-announced 'decoupling' not of China and India from OECD economic trends, but of the global economy from oil is itself more possible, today, than previous.
One very near-term lever for this partial and transient change, within global energy transition, is the coming but only short term natural gas supply bulge. We can place this bulge at about 2010-2014. This can be compared with the previous bulge in oil capacity additions, taking place on a longer timeframe, in a context of low but regular growth of the global economy through about 1985-1995. Short-term impacts on oil prices through 1995-2000 were dramatic, in the sense of setting very low ceilings for each oil price recovery.
This could be the perspective for natural gas through about 2010-2014, with similar rates of global economic growth - that is around 2.5% - 3.25% a year, vastly less than in 2004-2007. With low or 'moderate' global economy growth, and relatively abundant natural gas supplies on a short term basis, and the strong policy shift to "low carbon fuels" favoring natural gas, oil prices can flatten, rather than repeat the 2007-2008 sequence that Jim Rogers and others forecast, that is oil prices exploding to $ 150 per barrel or more.
We can be certain this scenario is attractive to Ben Bernanke, J-C Trichet and other central bankers, as well as G20 political leaderships. Without another spike in oil prices, inflation could stay low while the economy edges forward, enabling interest rates to be held at current extreme low rates. The US dollar could or might stabilize, despite the onrush of new unsecured SDRs in circulation, and the crisis horizon could be pushed forward 3 or 4 years.
The Gas Bubble is however very similar to other parts of the economic, energy, environment and finance jigsaw, the puzzle itself is variable geometry and subject to rapid change of its contours and forms. The forecast bulge in world gas supplies heavily depends on continued massive investment in LNG trains and shipping, and transcontinental pipeline developments. The sustainability of the USA's own natural gas supply bulge, depending on about 33 000 new well drilled per year, with very high early depletion rates when placed in production, is questionable and probably low.
Oil substitution and substitutability by natural gas is to be sure higher than say wind electric substitution of oil burning, but T Boone Picken's plan for gas conversion of automobile and trucks is more obligatory than only desirable, to achieve real reduction in oil needs through real substitution by natural gas. The only other alternative is electric cars - which like reduction of US jobless numbers, or jobless numbers in other OECD countries, is only feasible on a long-term horizon, stretching far past 2014 or 2015.
THE ROGERS BOOM
Probably in the next Quarter, to end December 2009, the commodities boom forecast by Rogers and many others can come about, to a background of extreme high volatility. Oil may achieve the 100-dollar fear price threshold set by Ben Bernanke speaking at Jackson Hole, in August, and natural gas itself may transiently claw back towards $ 7 or more per million BTU. Other commodities, depending also on fundamentals, will follow suit. The boom will however be intrinsically unsure, and rigorously short-term due to the extreme high linkage of real economy inflation with real resource price inflation.
Totally unlike finance sector inflation, due to the finance sector's partition from the real economy by multiple and complex firewalls, and its extreme low capital productivity, inflation is quickly transferred from real resources, to the real economy. Oil price rises quickly generate food price rises. When combined, food and energy price rises have an unambiguous downward impact on the real economy - which for the least remains "in convalescence". The number of months that oil prices could remain well above $ 100/bbl, perhaps $ 125/bbl being the ultimate pain threshold, is low and predictable.
This is well known simply due to it being very recent real world experience. Ben Bernanke, for multiple and imperious reasons, cannot let inflation return. He may be too pessimistic in setting 100-dollar oil as the Rubicon, after which he says that he will think hard about raising interest rates, but the fear of runaway oil, energy, food and resource price rises is now ingrained. Any serious raise of US and European interest rates will signal a near instant sell-off for both equities and commodities, led by oil - and by natural gas.
Asian decoupling, as we have found through most of 2009, has little or no impact on the OECD economy, treated as a bloc. In fact, and as the word 'decoupling' means, Chinese and Indian economic growth has domestic recentered, already to a significant extent. The potential for 'BRIC' or 'Chindia' locomotives pulling the OECD economy out of recession has to be seen for what it is: low at best, and pipedreams at worst. Relative to the OECD economy, and despite radical growth in the last decade, resource and energy demand per person, outside the OECD, trails far behind the richer countries. Continued demand pressure on resource and energy supply, in a context of real decoupling, can therefore taper down for a few critical years, with an instant knock-on to prices.
This will be well reflected by the oil-heavy Rogers International index, and also shown by the CRB and other less oil-dependent indexes. Potentials for this sequence to play will rise with every dollar on the oil price, from around $ 75 to $ 85 a barrel. To be sure, an 'exogenous' double dip generated by runaway US dollar depreciation and non-recovery of the OECD bloc's economy, or by other events and issues, including the Middle East and West Asian geopolitics, can jumpstart the process leading to falls in commodity prices. Under most modeling scenarios conducted by my colleagues using different models, this bearish commodity outlook is for the period from Q2 2010.
By Andrew McKillop
Project Director, GSO Consulting Associates
Former chief policy analyst, Division A Policy, DG XVII Energy, European Commission
© 2009 Copyright Andrew McKillop
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