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Natural Resource Depletion Crisis, The Real Reason Commodities Beat Stocks

Commodities / Commodities Trading Mar 04, 2011 - 02:15 AM GMT

By: Andrew_McKillop


Best Financial Markets Analysis ArticleFebruary: Metals, food and fuel beat stocks, bonds and the US dollar for a third straight month, the longest winning streak since June 2008. Price rises fundamentally driven by short supplies lifted all soft commodities from the grains and vegetable oils to sugar, cotton and rubber, for a 2.2 percent gain over 28 days, lifting the UN FAO 55-item food index to a record high. Geopolitical threat to oil supply,  intensified by investors speculating that violence in the Arab and Muslim world will curb oil supplies lifted oil prices, while the only fossil energy resource bright spot – shale gas – kept a tight lid on gas prices in US markets, but not on oil-linked or indexed import dependent European and Asian markets.

Arguments why investors and speculators are still bidding up food prices usually avoid the basic fundamentals of arable land shortage, water resource depletion, rising costs of fertilizers, pesticides and fuels or slowing productivity gains on increasingly marginal land and focus the strictly short term where speculation is powerful. Market players are for the moment maintaining their bets that well-protected regimes in the region with few qualms about firing on civil protestors, like Iran's one party state, Algeria's military junta or Saudi Arabia's absolute monarchy and its smaller lookalikes along the Gulf coast will keep spending big on food imports. The main reason will be to try keeping a lid on their cellphone wielding youth revolutions, making this a short-run gambit.

Key commodity indexes like the Rogers International RICI, or the Goldman Sachs GSCI Total Return Index of 24 commodities gained as much as 4 percent in the 28-days of February – both of them rising for a sixth straight month. Compared to the commodity indexes, measures of global equity and bond  performance showed paper wealth did a lot worse. The 45-nation MSC equity index, for example, gained only 3 percent while indexes measuring government and big corporate bond performance, like Merrill Lynch’s Global Index gained less than 0.3 percent in the month.

The US dollar, despite heightened geopolitical tension that traditionally helps the greenback pare losses, or gain against other leading moneys fell nearly 1.2 percent in the month, as currency market players reasoned there is only possible strategy for US finances under Obama: print more money. Further US inaction in North Africa and the Middle East in its also-traditional role of saving reliable oil pumping allies, and keeping Arab export platforms in business turning increasingly expensive raw materials into less and less cheap consumer goods, will likely further erode confidence in the US dollar.


The business correct explanation of why commodity asset values are powering ahead is Emerging economy growth, and signs of recovery in the debt-strangled OECD countries. Faster global growth is however defined as raising the prospect of higher raw material prices until market magic generates new supply. Surprise shocks like the ouster of Libya's Muammar Khadafi (or the alternative: Libyan civil war) provide some excitement and opportunity to speculate on oil prices on the way up, when supplies from Libya are cut, and on prices going down when or if Libya's oil supply is resumed, possibly within weeks but with no certainty of this outcome.

The month-on-month rise of commodity prices at an annualized rate well above 50 percent however took place from before year end 2010, well before a single Arab dictator had bitten the dust, or fled to Saudi Arabia with gold bars in his airplane baggage hold. In brief, this is a sign of rising threats to the global growth process as we know it, threatening confidence in the all-new No Alternative economy, ushered in by US president Ronald Reagan and the UK's Margaret Thatcher far more than 30 years back in time. Although somewhat shop soiled, as it dates from well before cellphones became mass ownership items able to assemble a Flash Mob in quick time, this ideology bundle is still the basic source material for any G7 (if not G20) leader's slogan pack – but time moves on !


Linked to the growth of real resource prices with a related loss of interest in paper value and fiat money, central banks almost worldwide, including China and India, Russia and Brazil, are now raising interest rates and boosting the reserve requirements they set for commercial banks operating inside their territories. Their favoured explanation is to fight inflation and safeguard confidence in their own national paper currencies. Equity buying is an immediate collateral victim, due to easy credit being a basic for any paper asset bubble - but not being necessary for a real resource bubble, and for very simple reasons: any economic actor needs to buy food, wear clothes, heat their homes and cook their food before even thinking about buying a smart phone and pay-as-you-go ring tones to go with it.

Underlining this difference, both the emerging countries and a growing list of developed world central banks are buying  fiduciary gold. Including private purchases of gold, central bank buying of physical gold in January and February, 2011 by China and India likely exceeded 325 tons in 59 days. These purchases are physical metal – not paper.  In turn this sets major challenges for the entire system of gold and precious metals trading, worldwide, which depends on a large proportion of purchases never going physical, that is staying paper. In this cosy system that shelters paper money and paper equities, gold trading is limited to paper gold in the form of Exchange Tradable Funds (ETFs) linked to physical gold but not held by buyers, and gold mining shares, long-dated paper futures in gold, and so on. In all cases physical delivery is either avoided or delayed and for the very simplest reason: there is not enough physical supply.

Like the rush to buy real asset hard commodities, ever rising physical demand for gold and other precious metals due to fear of inflation and declining confidence in paper money is basically driven by resource shortage and its corollary: not enough production. To be sure, this has to be couched in market friendly talk by government-friendly media journalists and commentarists – if they want to stay in view. The trick is to admit the number of hard commodities facing a supply issue has only grown, since around 2005, and - yes – the only respite was a 12-month downward price blip at the deepest point in the 2008-2009 recession, but market magic will either destroy enough demand or create enough new supply to handle the problem. Tune in later.


The only surprise comes when denying the problem faces a real world that only gets worse. Facing the real world experience since at latest 2005, the default solution is so clear, simple and proven: commodity prices only turn down in free-fall recession.

Putting this another way, if the global economy does not re-enter recession at least as deep as 2008-2009 we can only look forward (if that is the right word) to more and further commodity price peaks until and unless we hit the recession slope. While higher gasoline prices may be the great fear of the supermarket masses in the rich world OECD countries – which count for 14 percent of world population – higher food prices in lower income countries soon threaten the comfortable single party regimes, juntas, dictatorships and theocracies which prop up the global system.

Finding the politician or the TV talking head who says that out loud is like finding a country willing to shelter Colonel Khadafi.

The last time commodities beat stocks, bonds and the dollar for three straight months was in June 2008 when oil prices hit their absolute highest peak in all time. Similar periods when this happened stretch back to the 1973-1974 Oil Shock, the 1979-1981 Oil Shock and their aftermaths. Market folklore always attributes oil price surge to any other cause except resource shortage. This can include violence in Iraq, the Iranian mollahs, African intrigue and folksy market insider plays like the 2008 goosing of the market by Goldman Sachs Co to bankrupt one of its clients, Semgroup Holdings. Simple supply/demand realities are always ignored, but they explain the long term price surge a lot better. In July 2008 oil futures reached a record US$147.27 for the August delivery, and US regular gasoline at the pump climbed to more than 4-dollars for a US gallon (3.785 litres).

At the time, and today, average European car drivers paid and pay around  US$ 8 a US gallon, but a part of their higher fuel prices are offset by the massive car subsidy payments they get from central governments trying to stem job losses in the car industry and keep consumers doing what they are supposed to do – consume anything, dont ask questions and above all pay taxes. This nicely classic Keynesian economic management was hysterically rejected by the Reagan-Thatcher duo more than 30 years ago, we can note, but Keynesian deficit spending has remained in real world daily use by all government spenders since that time, as before. The reasoning was and is: there is no alternative.

This changes little or nothing for the natural resource countdown, Outside the shale and fracture gas bubble, all the fossil fuels are resource constrained, and especially oil and uranium. All the soft commodities, especially the food grains, vegetable oils, sugar and non-food bioresources led by cotton and rubber are facing a severe uphill struggle to meet and match ever rising demand – due to declining land, water and bioresources to keep producing more. The non-energy minerals, from aggregates for concrete production through bauxite and iron ore for aluminium and steel, to copper, tin, lead and zinc, and all the high tech metals including vanadium, chromium and molybdenum, as well the Rare Earth metals have a one-way price track whenever the global economy is not in deep recession: up.


Whether in or out of ever deeper recession, average per capita OECD national iron and steel consumption stays high, at around 750 kilograms a year. One basic reason is the OECD national car fleet average of close to 400 - 450 cars per 1000 population in all 30 member countries.  Average cars need about 1 ton of iron and steel, 100 – 175 kilograms of plastics, and 5 tyres which are up to 40 percent oil by weight. From this we get a read-out on car oil dependence: about 4 to 9 barrels per car, only for its construction.

Operating the average OECD car then needs about another 9 barrels, every year. Trying these figures out on China and India – at 450 cars per 1000 population - delivers an instant killer hit to any fantasy ideas of the global economy muddling through to its supposed Nirvana conclusion of Universal Abundance.

Not only the oil limit, but limits on resources as basic as iron, steel and rubber, or lithium and rare earth metals for cobbling an ersatz electric car alternative, make it impossible for the Chinese and Indian car fleets to ever reach more than a fraction of the per capita car ownership of the OECD nations today. Any attempt at this impossible goal with regular-type oil powered cars as we know them would generate one-only forecast: worldwide economic meltdown and global economic implosion. Playing with a fake alternative called electric cars can generate nice paper asset equity bubbles, but does nothing to supply the hard assets needed to execute this so-called alternative plan. More important and a lot more basic: how are we going to feed even the present world population, let alone 1500 million more by 2030 ?

This helps explain why government friendly media and our great democratic deciders are so coy and discreet about giving us any answers, apart from not having them is the constant read out bottom line: you cant get there from here.

Liberal economic doctrine will not talk about resource depletion. Only with foot dragging was it able to get around to ideas like the diseconomies of pollution. When elite deciders found these are, in fact, a real nice way to levy new taxes their coming out was sure: making a splendid sudden change of mind and a 180-degree flip-around of their herd mindsets, pollution taxes became media-friendly and politically-correct. Exactly the same will apply to Zero Population Growth, the development of sustainable agriculture and food production, using less and enjoying it, moving to the society of knowing not buying, and a bundle of other alternatives linked de-growth and restructuring..

In the real world things are getting simpler, the choices clearer almost daily. The read out and bottom line is always the same: the process of rising natural resource and energy prices, and ever cheaper ersatz substitutes being generated as a stop gap alternative by market genius (as it is called) will continue until and unless there is deep global economic recession. At that point the decider elites declare tilt and wheel in the riot troops. The real solution is therefore Solving the Future from today onward, every day.

By Andrew McKillop

Project Director, GSO Consulting Associates

Former chief policy analyst, Division A Policy, DG XVII Energy, European Commission. Andrew McKillop Biographic Highlights

Andrew McKillop has more than 30 years experience in the energy, economic and finance domains. Trained at London UK’s University College, he has had specially long experience of energy policy, project administration and the development and financing of alternate energy. This included his role of in-house Expert on Policy and Programming at the DG XVII-Energy of the European Commission, Director of Information of the OAPEC technology transfer subsidiary, AREC and researcher for UN agencies including the ILO.


© 2011 Copyright Andrew McKillop - All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

© 2005-2019 - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.

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