Australia’s resource and energy driven economy is in for a spectacular commodity boom as prices surge…right?
That was the consensus at a recent editors’ virtual meeting anyway. And energy prices are indeed surging. As are select commodities.
But I’m not so sure about the boom just yet. This commodity price boom is not like the last one. And the differences have me worried.
Over the long term, 10 years say, I might agree that commodities are in for a boom that investors should position themselves for. At least, commodities are historically undervalued relative to financial assets like stock markets and bonds. The recent surges have only partially corrected this. And so commodities remain preferable to other investments.
Indeed, my own personal portfolio is dramatically overweight commodities. And it won’t change much for the next few years given the compliance burden placed on editors like me whenever we want to do anything.
But the price action we have seen in commodity markets lately is simply not the sort that actually benefits commodity producers like Australia.
To profit from a surging price, you need to sell volume. But, when we take a peek at why prices are actually surging, that doesn’t entirely square with selling more volume. At least, that’s not the big story behind the price moves.
It looks more like logistical and supply chain disruption, government bungles, and cost blowouts to me. None of those are good for commodity producers, even if prices are rising.
Let’s take a look at some examples of what I mean.
Many of the commodities that spiked over the past few months subsequently busted. Lumber and iron ore are the textbook examples.
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Do you think the UK’s petrol rationing is good for energy producers? I don’t…
Commodity production costs a lot of energy. And when energy costs a lot, what happens to commodity producers?
Moving commodities and energy around the world is a capital-intensive process. Right now, with shipping costs at extreme highs, commodity prices may simply reflect this increased cost.
Similarly, bottlenecks at key ports are holding up resources, especially in Russia, which is seeking to pressure the Europeans into approving the Nord Stream 2 pipeline.
Supply is down badly for many commodities due to underinvestment, green energy policies, and low prices. This is good news for companies with supply, but it is once again a constrained boom.
The price of coal, for example, seems to be surging because there isn’t enough of it to make up for the lack of gas and green energy. That’s different to a demand driven boom.
Green energy policies like Europe’s carbon credits have added an artificial expense into the mix. One which can, as ever, be invested in and speculated upon instead of performing its role.
In other words, this is not the commodity boom investors are looking for. Not yet anyway.
It is commodity chaos, with price spikes due to all sorts of reasons except those which occur during a healthy and sustainable boom.
Yes, we may well be at the turning point for the commodity boom to come — the moment when commodities finally start to recover their lost ground relative to other financial assets like stocks and bonds. It may be the perfect time to invest.
But even then, I’m not so sure we should be happy about the recent price action. Because rising commodity prices are not always a good thing for our quality of life.
The commodity chaos aside, there are two ways commodities can boom relative to stocks and bonds. One is a true boom — the sort we saw in Australia in the early 2000s. This was a demand-driven boom — a story of economic growth, investment, and consumption.
Something to keep in mind: during such a boom, Aussie investors suffer the consequences of a rising Australian dollar, which eats a lot of their gains. But that’s another story.
The demand story seems a lot less likely to me right now. China is demolishing developments, not building them. China’s population is set to peak before 2025. Economic growth around the world is poor generally.
There are offsetting forces for commodities, of course. The green energy boom may well increase demand for the likes of copper, cobalt, and more. And rare earth metals will be in demand as tech continues to take over our lives.
But, for the moment, the green energy boom looks to be more of a disruptor than a demand driver to me. And there are limited plays on rare earths for us to benefit from.
The second reason for a commodity boom relative to stocks is the one I’m worried about. It’s called inflation.
During inflationary periods, people flock to what Germans call ‘Sachwerte’. Which helpfully translates to ‘thing-value’. Something which has value merely for what it is, in other words.
This contrasts dramatically with financial assets like stocks and bonds, which are promises, not things of inherent value.
Inflationary periods make life tough for assets that promise money and so commodities come back into fashion in relative terms. But relative terms can imply that stocks and bonds crash relative to commodities, which merely keep up with inflation.
Inflation can be accompanied with a false economic boom as people mistake rising prices for prosperity. But this phase of inflation eventually ends. And you are left with stagflation again. This is also bad for commodity producers.
I do realise I’m not being helpful with all this. But, quite frankly, I see it as our job to tell you how we see it, not to tell you what you want to hear.
I continue to hope that Australia stands to benefit from the next commodity boom. And I continue to invest in the presumption that this will happen. But I’ll say it again: this commodity chaos is not the commodity boom you are looking for.
Not yet anyway.
Until next time,
Editor, The Daily Reckoning Australia Weekend
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