Developing Economies Driving Commodities Super-CycleCommodities / Commodities Trading Oct 18, 2011 - 05:50 AM GMT
The Reuter's CRB index reached record levels in 2010 - why?
- Raw materials shortages
- Infrastructure constraints
- Resource nationalism
- Emerging market demand
- Technological innovation
- Intense weather pattern changes
"Super cycles are extended periods of historically high global growth, lasting a generation or more, driven by increasing trade, high rates of investment, urbanisation and technological innovation, characterised by the emergence of large, new economies, first seen in high catch-up growth rates across the emerging world.
The world economy may now enjoy its third super cycle, after the first 1870-1913 and the second 1946 - 1972. Note that the first super cycle which coincided with America's industrialisation and Germany's Gründerjahre was stopped in the tracks on the eve of World War I. Note also the end to the second cycle which followed the World War II and coincided with Japan's and the Asian NIEs rapid convergence was stopped by the oil price shock." ~ Helmut Reisen shiftingwealthblogspot.com
Bull markets climb a wall of worry and there has been a sudden reversal in commodity prices because of:
- Ending of the US's Quantitative Easing caused markets to fall
- Sovereign debt risks created uncertainty
Speculators, who were already "dancing close to the exits" because of Chinese slowdown fears, left the space in a rush and caused prices to drop. Is it a permanent price correction, a temporary slowdown, or do we risk total derailment of the commodities super-cycle?
The shaded areas are QE1 and QE2. The red line is the S&P 500.
On the 25th of November 2008, QE1 was announced. On the 18th of March 2009 QE1 was extended.
There's no doubt Ben Bernanke's quantitative easing pumped up the stock market.
As soon as the QE program, part's 1 & 2, ended in June of this year, the markets had to get by on a lot less money and liquidity. Today the dollar is up because the EU, and the world, have an acute shortage of dollars for the necessary bailouts and needed liquidity. A rising dollar is noninflationary so the rising dollar produces lower commodity prices. Lower commodity prices lead to lower interest rates and higher bond prices. Higher bond prices are bullish for stocks.
It's this author's belief the US will return to Quantitative Easing (QE) early in 2012. A falling weaker dollar pushes up the price of commodities, rising commodity prices tend to push bond prices lower. A falling dollar is bearish for bonds and stocks because it is inflationary.
European Union Sovereign Debt Crisis
As previously stated, the dollar is up because there is an acute shortage of dollars for the necessary bailouts and needed liquidity.
The EU will use its bailout fund, the European Financial Stability Facility (EFSF), to purchase bonds and recapitalize banks. They are open to using "leverage" to expand the scope of the €440-billion ($611-billion) EFSF. Germany and France will propose a massive stimulus package similar to the US's QE's.
The US Federal Reserve, Bank of England, Bank of Japan, the Swiss National Bank and China are all going to provide dollars to European banks. The sheer size of the European bailouts would be inflationary and a market return to "normal" would be perceived as the double threats of a systemic breakdown and a return to the 2008 global crisis significantly receding.
A Dow Jones Newswire poll put the median expectation for third-quarter growth at 9.2%, growth was 9.5% in the second quarter and 9.7% in the first quarter. Slower growth is the result of the Chinese government attempts to cool down its economy and contain inflation, especially in the food sector.
Growth in sales to the European Union, China's biggest export market, have slowed. China's currency has strengthened against the euro since the Greece debt crisis - this makes Chinese goods more expensive and therefore less competitive - trade also slowed between China and the US in September, yet overall Chinese exports still increased in September by 17 per cent from a year earlier, this after a 25 per cent increase in August.
Chinese domestic demand is still strong - imports rose to $155.2 billion in September, after a record August, and purchases of copper climbed to the highest level in 16 months as restocking of inventories occurred taking advantage of lower prices.
"In terms of long-term structural trends, demand is now driven by an urbanization process that is far more structural than consensus generally believes. On our analysis, China is only 20 to 25 per cent along the path towards being a mature materials market and it may take at least six to nine years before demand intensity peaks." Andrew Keen, Thorsten Zimmermann and Lourina Pretorius, analysts at HSBC
Gus Gunn, of the British Geological Survey, has identified three main factors behind the steep rise in commodities demand:
- Urbanization that is accompanied by a rise in the standard of living
- Population increase
- Development of new technologies whose components and gadgets are based on an ever broader base of elements
By 2025, nearly 2.5 billion Asians will live in cities, accounting for almost 54 percent of the world's urban population. India and China alone will account for more than 62 percent of Asian urban population growth and 40 percent of global urban population growth from 2005 to 2025.
China had 172 million urban residents in 1978 when Deng Xiaoping started his economic reform program. By 2006 there were 577 million Chinese urbanites.
China set a goal of 65 percent urbanization by 2050. Over the coming 39 years that means 20 percentage points of urban growth per year which translates into 300 million rural residents becoming urban residents. By 2015, China's urban population is expected to exceed 700 million and China's urban population will surpass its rural population. China's current urbanization rate of 46 percent is much lower than the average level of 85 percent in developed countries and is lower than the world average of 55 percent.
By 2025 China's urban population is expected to rise to 926 million. By 2030 that number will increase to a billion.
BCG Consulting's November 2010 Report: "Big Prizes in Small Places: China's Rapidly Multiplying Pockets of Growth" says China is expected to become the world's second largest consumer market by 2015 and by 2020 China's consumer consumption nation-wide will amount to 22 percent of total global consumption, behind only the U.S. at 35 percent. The expected transition from an investment led economy to a more consumer focused model will bring about continued growth. The McKinsey Global Institute projects China's middle class will increase from 43% of the population to 76% by 2025.
"The shift from investment to increasing consumption overall - and as a share of GDP - is very important to sustainable growth in the long-term. China has maxed out on the input model." Diana Farrell Director, McKinsey Global Institute
"Every major industrialized country in the world has experienced a shift over time from a largely rural agrarian-dwelling population to one that lives in urban, nonagricultural centers. India will be no different. However India's urbanization will be on a scale, that outside of China, is unprecedented." McKinsey Global Institute's report India's Urban Awakening
India has 1.2 billion people and the second largest urban system in the world - almost one in three Indians now lives in areas classified as urban.
A report done by the McKinsey Global Institute called India Urban Awakening predicts that 40% of the population will live in cities by 2030. By that time, Asia's third largest economy would have 68 cities with populations over one million, up from 42 today, 12 cities are expected to cross the 2.5 million mark by 2015.
The decadal population growth rate for urban India was 31.8%, while for rural India it was 12.2% - a drop of six points.
31.16% of the country's people live in urban areas now, up 3.35 points from ten years ago - in 1901, 10.8% of the country was urban. The 2011 census data showed, for the first time, that the increase in population in India is more in urban areas, at 91 million, than in rural areas at 90.4 million.
The McKinsey Global Institute projects that India's middle class will grow to 583 million people in the next two decades. At the same time, the country will advance from the world's 12th largest consumer market to the fifth largest.
According to The Economist, between 2000 and 2010, six of the world's ten fastest growing economies were in Sub-Saharan Africa. The only BRIC (Brazil, Russia, India and China) country to make the top ten was China which came in second behind Angola - the fastest growing country in the world.
The International Monetary Fund (IMF) says Africa will own seven out of the top ten places for fastest growing economies between now and 2015. The World Bank raised its forecast for economic growth in Sub-Saharan Africa to 5.3% for 2011 - the highest forecast rate of growth outside Asia.
Africans, on a per capita basis, are richer than Indians and a full dozen African states have higher gross national income per capita than China.
A lot of this growth is driven by a blossoming domestic market - the largest domestic market outside India and China. In the last four years private consumption of goods and services has accounted for two thirds of Africa's GDP growth.
Today Africa has 14% of the world's population and by 2050 one in every four people on the planet will be African - by 2027 Africa will have more people than does China or India. Development expert Vijay Majahan, author of Africa Rising, said the rapidly emerging African middle class could today number almost 300 million people - that's out of a total population of one billion.
Since 1950, the world's population has gone from 2.5 billion people to 6.7 billion. No less than 75 million people a year are added to this number, the world's population is expected to exceed 9 billion by 2050 and reach 10.1 billion by the end of the century - according to the United Nations.
"It takes vast quantities of natural resources to build infrastructure to accommodate explosive growth in population, upward mobility, urbanization and industrialization.
Economic studies suggest that industrial metals and minerals consumption depends on the stage of development, the stages are normally divided in four, and are said to be dominated by 1) infrastructure development, defined by high use of cement and construction materials; 2) light manufacture, defined by high use of copper; 3) heavy manufacture, defined by high use of aluminum and steel; and 4) Consumer goods, defined by high use of aluminum, energy minerals and specialty steels (Source: USGS).
The stages are expected to take about 20 years each and begin at 5 year intervals, lasting for a total of 30 - 40 years, depending on political and macroeconomic conditions. China for instance, appears to have entered the heavy manufacture stage based on steel consumption, while India may be well into the light manufacturing stage." Luisa Moreno Investingthesis.com
The Global Middle Class
The newly emerging middle class are a major contributing factor to the fundamental demand shift in global commodity markets and per capita consumption of commodities in developing countries is still only a fraction of the level it is in developed countries. Infrastructure spending and increased discretionary spending by consumers are the key factors driving this rising demand - as more and more people in emerging markets move from rural areas to the cities, consumption will increase putting massive upward pressure on commodities.
The World Bank estimates that the global middle class is likely to grow from 430 million in 2000 to 1.15 billion in 2030. The bank defines the middle class as earners making between $10 and $20 a day - adjusted for local prices.
Most of the world's middle class has, until recently, been located in Europe, North America and Japan. In the 1970s and 1980s South Korea, Brazil, Mexico and Argentina built sizeable middle-class populations. Today its China, India, Asia and Africa adding to the world's middle class. In 2000, developing countries were home to 56% of the global middle class, by 2030 that figure is expected to reach 93%.
"By 2030, income per head in China - using market exchange rates, which include our view of a stronger CNY - could have risen from USD 4,166 in 2010 to USD 21,420. China, currently a big but poor economy, would become a middle-income economy - but on a vastly larger scale...Income changes elsewhere are no less impressive. India, for instance, is projected to go from USD 1,164 in 2010 to USD 7,380 by 2030, Latin America from USD 7,114 to USD 14,608, and Sub-Saharan Africa from USD 1,075 to USD 2,780." Gerald Lyons, chief economist Standard Chartered
Over the last few years the economic cycles of developed economies have become disconnected from the cycles of the developing world. A crisis in the US or Europe does not hurt development in Africa, India or China as much as many believe. That's because there's been a shift in global trade taking place with developing countries increasingly interacting with each other instead of their old trading partners, the developed nations.
Consumers in developed countries bought enormous quantities of foreign made goods. When the financial meltdown brought that spree to an end many predicted Asian growth would halt. Not quite.
Trade between China and South Asia is growing - hitting $80 billion in 2010 while China's trade with Africa hit $150-billion in 2010 and is expected to double by 2015. Over 50 per cent of India's trade is now with other Asian countries while only 32 per cent is with the United States and Europe.
The evidence is mounting markets will get back to "normal", the sovereign debt crisis be resolved and growth from China, India and Africa and other developing nations will continue - with or without the west.
There is no shortage of individual reasons, but when taken together the evidence starts to be overwhelming:
- Finite raw materials
- Unstable weather patterns
- Chronic supply constraints
- Increasing population base
- Growing global middle class
- Low real interest rates
- Shifting global trade patterns
- Continued monetization of European and US debt
- Persistent Dollar and Euro feebleness - our political masters attempting to devalue our way to prosperity
- The need for asset diversification
All of these reasons, working together, will translate into higher commodity prices. Today's worries have only temporarily unseated the commodities super-cycle with the recent sell-off being nothing more than a short downturn within a secular bull market for commodities.
- Have cut their debt
- Have built up their cash reserves to considerable levels
- Are generating solid cash flow
Based on actual earnings resource stocks are priced where they were at the bottom in 2008 and mining stocks are selling at single digit price earnings ratios.
The bottom lines? Bull markets climb a wall of worry and the most successful man in life is the man who has the best information. High quality resource stock picks should be on every investors radar screen. Are they on yours?
If not, maybe they should be.
By Richard (Rick) Mills
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