Commodites Bull Market Will Roar Like a Tiger in 2010
Commodities / Investing 2010 Jan 06, 2010 - 10:25 AMBy: Andrew_McKillop
Headline Trends
2010, a year of the Tiger for the Chinese starts with accentuated 'Asian decoupling' relative to OECD countries, where slow economic recovery from the 2008-2009 recession is presently the norm. Further into 2010 this may change, becoming inflation-pulled economic growth for the OECD group, with serious risks of 'interest rate medicine' being applied by central bankers.
Both China and India may attain 9% to 10% real GDP growth in 2010, according to many analysts, in different major banks, finance houses, the IMF and UN agencies, who hedge their bets by forecasting global economy growth as anywhere from below 2.5% to over 4.5% in 2010. This is a high-low difference in global output of around 1400 billion US dollars.
Underlying all forecasts of strong global recovery, interest rates are projected as likely to stay low, or extreme low, but with decreasing visibility from early 2010.
The debt overhang can only play through 2010. Massive state loans and financial support to the troubled bank and finance sector, in OECD countries, is everywhere recognized as the pull factor for OECD regional and national economic recovery. Unlike China and India, the OECD recovery is however, so far, episodic and "3W" for weak, wobbly and worrisome.
The big change through 2010 could be rapidly increasing economic growth in several OECD countries, including the USA, quickly followed by an inflation surge, probably preceded by large FX volatility. As Bernanke for the US Fed, and Trichet for the ECB have many times indicated, they could or might start raising interest rates, anytime that inflation publicly returns.
State aided recovery spending in the emerging economies, estimated at probably more than USD 500 billion through 2008-2009, has specially focused national infrastructures in 2009. This directly generates an outlook for knock-on to the downstream consumer economy in 2010, already clear in the massive figures for late-year 2009 car production and sales data, and energy demand growth in the emerging economies.
Back to the Commodity Cycle
One recurring basic theme for fund managers and analysts will be the relative performance of Equities versus Commodities, noting these two poles are more intermingled and interdependent than ever. Pure plays, either way, will however be frequent for performance-chasing asset managers, but the fragile and volatile global economic recovery process, overhung by two decades of "New Economy" financial power plays to the detriment of real resource production capacities, will continually shift investor interest and resources back to commodities.
Through 2010, both Commodities and commodity-linked Equities will tend to show volatile but high performance, with very strong gains in specific sectors and subsectors. Following the failure of the Copenhagen climate summit, harder assets than soft energy, or high leveraged and subsidy dependent alternate and renewable energy stocks will feature. This starts with oil, uranium, coal and perhaps natural gas, and will rapidly boost a wide range of food and bioresource soft commodities.
Failure of the Dec 2009 COP15 talkfest, where grandstanding OECD leaderships so heavily overworked the theme of "climate catastrophe" they made this conference a catastrophe, generates major uncertainty on 'low carbon strategies'. This will likely trim growth, and increase volatility in low visibility, highly speculative emissions credits and derived instrument trading. Harder and more real assets will benefit.
Fossil energy prices will however in no way be exempt from volatility. The coming bulge in LNG and pipeline gas supply will decrease visibility, and intensify energy asset price volatility right across the energy space. Following gains for oil, natural gas, coal and uranium linked equities, there will be continuing but unstable asset growth in utilities, and surely in the emerging economy alternate and renewable energy sector. Both utilities and alternate energy linked equities will show excellent growth in the emerging economies, but outside special opportunities such as M&A activity, this will be less marked, in these two sectors, inside the OECD markets.
The Big Risk: Inflation
Like commodities, inflation can also roar in 2010. The biggest risk to sustained global economic recovery is inflation, runaway devaluation of the US dollar and interest rate hikes, joined by or perhaps driven by reheating geopolitical stress in the Mid East and Central Asia.
Fast asset price recovery through H2 2009, led by commodities, could in this outlook be followed by oil prices attaining some 'psychological ceiling'. This was set by Bernanke in Aug 2009 at the easy-to-remember price of USD 100 a barrel, due to central banker folklore that high priced oil can only generate, and signal a sharp double dip back into recession, led by an inflation bulge until the interest rate medicine is applied.
To be sure, this is a nice monetarist theory, and has a pedigree stretching back to Volker, who as US Fed chairman in the early 1980s gouged US interest rates to more than 20% pa, in his heroic quest to beat inflation. This time around, we could surmise, US interest rates at even 7% pa could do the same job - that is generate a radical double dip, with high and persistent inflation.
Collateral damage would include officially admitted US unemployment beyond 12.5% and the destruction of hundreds of thousands of businesses, in return for benefits that might not include a saved and stronger US dollar.
This time around, doubt on vigorous interest rate medicine, in OECD countries, also comes in the shape of emerging economy growth and massive non-US holdings of the dollar. Resilience and resistance of the emerging economies, to high oil and commodity prices in 2007-2008, was well proven. Raising interest rates inside the OECD countries, in 2010 because oil prices breached some 'psychological ceiling' would concentrate the misery inside the OECD group, and also raise global inflation for a long J-curve period.
Adding the overhang of OECD country debt, now critical in a widening list of small and not-so-small countries and making economic growth the only solution, the high interest kneejerk reaction to high oil and commodity prices will be a last ditch option.
Stronger economic growth, with maximum hiding of inflation data, could therefore play right through 2010 and into 2011. The nice surprise would be that even if inflation is real and growing, so is economic growth.
The countdown to using the interest rate weapon will be measured by several indicators, and one key player will be oil prices. As noted above, Bernanke in Aug 2009 already set his "pain price", of USD 100 a barrel. This can be revised anytime: 110, 125 and perhaps other big numbers can feature, twinned by gold prices that may themselves be trimmed by the Euro falling faster than the US dollar - as measured by real resource prices in either USD or EUR.
In the real world, real economy, major change in FX parities will play its own two-part role: both driving inflation and growth, and hiding the real rate of inflation. Barring worst-case geopolitical outcomes, 2010 can therefore see a prolonged commodity price upsurge driving economic growth and directly benefiting linked equities across a widening spectrum, but also definitely generating inflation.
MAJOR ASSET VALUE THEMES
Why Another Commodity Price Surge in 2010 ?
Asset value change in 2010, as in 2007-2008, will likely be driven by natural resource and energy shortage, if there is no recession double dip. This traces to resource demand growth bumping against ceilings not only lowered by geological or other physical factors, but through the overhang of the "neoliberal age", through about 1985-2000.
This time, due also to many natural resources being pushed to near-limit spare capacity through the 2004-2007 global economic growth surge, the fuze will be shorter. The resource shortage will tend to be global and sector wide. Both food and energy, as well as agrochemicals, industrial materials, metals and minerals will be exposed to limited surplus production capacity, demand overload, rapid price growth, and high market volatility.
Catch up price growth for certain key commodities, including food and bioresources, uranium, possibly coal, and quick spillover to linked equities is easy to forecast.
One major driver for this, outside fundamentals like world population doubling, or adding 3 300 million (11 times US total population) in the period 1969-2009 we have the hangover from 20 or 25 years during which so-called “supply side economics” dictated strategy for natural resource, food, energy and minerals producers. This diktat featured financial and economic operations with generalized, sometimes strong supply-limiting impacts.
These included debt based M&A activity, minimized physical stock holdings, least-cost production strategies with slow and small capacity additions or replacement, effective acceleration of wastage and decline of output capacities, high remedial costs to restore capacities, and high rates of needed new capex spending.
The share of basic support infrastructures in private and public spending stagnated or fell worldwide, most intensely through the decade of the 1990s. This is reflected by high, or extreme high capex requirements and forecasts in many sectors, and specially in energy. (IEA forecast: global oil and gas capex needs will attain US$ 1000 bn a year by 2016).
For metals and minerals producer corporations and companies, and since 2007-2008 crop and food producers, the trend has been specially clearcut and somber. Through 2008-2009, world potash and mineral fertilizer utilization has fallen by as much as 20% on average. This context has clear implications for future supply and pricing of natural resources.
For 2010, surplus capacity and infrastructure indicators for key commodities will be more useful than ever, for tracking and predicting economic performance of linked equities. Due to soaring growth in the emerging economies, the context will remain one of rising global economy growth generating a heavier, resource-intensive profile for the global economy.
Food and Bioresources
Soaring food prices are the most traditional and basic cause of economic recession since the early 19thC. Classic textbook recessions, which in fact stretch back even before the Industrial Revolution in Europe, were food-price triggered. In this most-classic possible recession, per capita food supply drops due to bad weather, crop diseases, local or regional wars, food transport shortage and stock losses, or simple population growth.
Spending more on food (and energy) cuts consumer spending power in all other sectors, and can or should limit economic growth. Globally however, this trend has been amortized, if not eliminated by fast rising Asian exports of cheap industrial consumer goods. Having supply chains stretching 10 000 miles, and global traded goods volumes reaching more than 6 billion tons a year, generate inevitable energy and resource-intensive profiles for incremental growth. The globalized economy is energy and resource intensive.
Since 2008, world food producers have reacted to radical falls in net income, and remaining high input costs (fertilizers, seeds, transport, irrigation water), through dramatic cuts in fertilizer utilisation, reduced irrigation water utilisation, and low or zero increase in acreages planted. The sharp but temporary fall in oil prices in 2008-2009 did not cover or compensate remaining high input costs, outside energy, generating a classic supply pinch for the short term. World crop output in 2010 is unlikely to respond fast to rising food demand generated by economic recovery. Due to the turnaround time needed to recoup lost crop production capacity, 2011 will be the likely date for increased soft commodity output, if price rises in 2010 are sustained and trickle up to producers.
2010 will be a test year for calibrating the potential sustainability of global economic recovery, due to the certainty of food, energy and other natural resource price rises. Sustainable natural resource producers will reap continuing and long term benefits.
Interest Rates and Petro Keynesian Growth
World recession in 2008-2009 was quickly generated on the back of large price rises for energy, metals, minerals and food resources, with little in the way of advance warning. This scenario could be ripe for a remake as soon as 2011.
Maintenance of record-low interest rates, and extreme high government borrowing in many OECD countries is judged by many to be the main reason for recovery through 2009. Outlook for the structurally weak US dollar in 2010 is perhaps ironically strengthened by probably increasing weakness of the Euro.
Record economic growth in the 4-year period 2004-2007 was aided, or based on cuts in interest rates, and continually rising energy and resource prices, feeding the global macro growth process called Petro Keynesian Growth.. This operates mainly through rising commodity prices generating raised export revenues, and raised purchasing power of lower income resource exporter nations, generating increased trade, and increased world liquidity. Increased liquidity also helps maintain low or very low interest rates.
This is fast tracked by much quicker feed-through to increased spending of 'windfall commodity gains', since 2000, compared with the first oil shock period of fast rising hard asset prices, in the 1970s. IMF studies show that since 2000, fast rising revenues for commodity exporters are rapidly, and almost completely passed on and fed through to the global economy, rather than utilized to acquire monetary holdings. Petro Keynesian growth stimulus is high gain positive feedback from rising energy and ntural resource prices.
In 2009-2010, the Petro Keynesian process is operating again, from higher base levels for commodity prices, but with record low interest rates and a structurally weak US dollar. This means a lowered safety margin, or ceiling for financial, inflation, and interest rate blowback.
In the case of gold and oil, the legendary days of the yellow metal at 270 USD/ounce are as folklore-style as black crude oil at 20 USD-a-barrel, today. The upward range for commodity price rises is already relatively low, making the potential for a long period (more than 2.5 years) of Petro Keynesian Growth likely small or zero.
Asset Value Change Will Accelerate in 2010
2010 is set by a sure and certain revalorization process, in food, fiber and bioresource commodities, comparable to oil and energy asset price revalorization since 2000. Just like cheap gold or oil, still real in 2000 but unreal in 2010, wheat will never again cost 3 USD-a-bushel, but could fetch 12.50 USD. Vegetable oils can surely be used to substitute petrodiesel for the thrifty diesel car fleets of the world, or at least in Europe, but the basic feedstock costof the vegetable oils, in 2008, briefly attained about 170 USD/barrel. World total veg oils production, we can note, is around 125 million tons a year, and world diesel fuel demand runs around 1200 M tons a year.
Current inflationary policy by governments, always denied as inflationary, will continue but with increasing risk to the world economy if global economic growth is not restored to rates at least 3% - 3.5% annual. Through 2010, any attempt by central banks to raise interest rates beyond symbolic low single digit rates will be high risk, dangerous and unsustainable. Without the utilisation of the interest rate weapon, commodity price recovery and growth of commodity-linked equity values will surely continue.
Linkage of the Commodity and Equity spaces is now high, and will remain so.
Depending on the shape of the growth curve, or recession curve, asset value change will vary, but in 2010 some clear trends will dominate. Recent experience (2008-2009) provides clear quantitative data.
MAJOR RISKS - MAJOR OPPORTUNITIES
Several major risks to the global economy in 2010 can be described. Geopolitical risks extend to and include a possible "second Iranian revolution", with the Ahmedinjad regime taking extreme measures to hold power. Worst case scenarios could generate physical shortage of oil and/or temporary closure of the Straits of Hormuz.
To be sure, other geopolitical risks exist, and will be covered in the analysis, selection and management of assets.
Currency risks include a possibility of high or extreme weakness for either or both the US dollar and/or the Euro, with risk of raised interest rates.
Geographically, the emerging economies will tend to concentrate both opportunities and risks for asset portfolios focused on sustainable development and investing.
Major sustainable sectoral opportunities, in the absence of double dip, can be summarized as focusing equities linked with:
Food, bioresources, water Agrochemicals, seeds, biotechnology (including pharmaceuticals) Uranium, coal (including 'clean coal'), other fossil energy Infrastructures and transport (including new transport technology) Selected alternate and renewable energy assets, utilities
Asset search and selection will also focus other resource-linked assets, including the stock of companies able to exploit full value chain opportunities in the fast growing Sustainable Natural Resource asset space.
By Andrew McKillop
Project Director, GSO Consulting Associates
Former chief policy analyst, Division A Policy, DG XVII Energy, European Commission. Andrew McKillop Biographic Highlights
© 2010 Copyright Andrew McKillop
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