World growth is slowing and that means that not all commodities are equal. Commodities have 2 opposing forces at play determining their prices. The first, is a complex, global, supply and demand equilibrium. It’s complex because it takes into account population dynamics and preferences, time to bring new supply on line, transportation costs, and more, much, much, more. Assuming investors can get the supply and demand equations right (a stretch), the second dynamic also comes into play, namely, currency depreciation/appreciation, and relative moves. These factors sometimes magnify moves, so that world demand for beef increasing as eating habits change is magnified by currency depreciation. Sometimes, these factors oppose each other, such as copper demand decreasing when global GDP growth slows as compared to global central banks depreciating currencies. Thus, in the current environment, we are left to tease apart which factors will play a larger role in the different commodities. That being said, we’re already starting to notice some patterns.
Global demand for copper is slowing. China’s real estate growth is slowing (popping?) and the magnitude is so large globally, that depreciating currencies will not provide support.
Copper is often called Dr. Copper for its ability to give insight into the economy. Having this key metal roll over is definitely not a good sign for the economy going forward. I anticipate continued weakness from it and the entire industrial commodity space.
On the other hand, we have the agricultural commodities. As staples, the food sector is more impacted by population dynamics than by GDP, although, shifts in preferences can make large impacts over the long term. Additionally, when currency fears (inflationary) hit, people tend to rush out to buy food, not build another apartment. So I anticipate that the agribusiness sector should hold up relative to some of the industrial commodities.
All of that is good, but brings us to two of my favorite commodity groups: energy and precious metals. Energy is one of the more difficult sectors to value, but one of the most important. Here’s the bottom line, the world population is growing and using increasing amounts of energy. Against that, in the long long term, human ingenuity will help drive energy costs down. The question for investors is what happens before in the meantime? In my mind, the biggest factors investors need to prepare for is geopolitical instability and currency debasement. Both of those factors will lead nations and individuals to try to increasingly secure and develop sources of energy. China is buying strategic access, but also developing internal sources such as nuclear. Japan will continue to depend on nuclear to some extent because it’s the only way they can secure domestic supply, but it will take years to redevelop it and in the meantime, they’ll need to depend on natural gas. The US, in the meantime, will need to develop domestic access, which means natural gas, coal, and nuclear. The alternative space is still not a viable large scale source, and valuations are all over the place so, it’s not a large area of concentration for me.
The best ways to play long term access to energy are not through the commodities which are volatile, subject to wild speculative moves, and provide no yield. Instead, we concentrate on NLR, FCG, and KOL.
NLR offers an especially interesting opportunity because it comes with a 4+% yield and has significantly underperformed since the Japanese earthquake.
Lastly, just a quick note on precious metals, gold being the main one, but silver getting a lot of attention.
Notice that silver is still trading away from the group, and maybe that’s justifiable, but if so, I’m not sure why. The precious metals should not be viewed as commodities in the same breath as ag and metals. They are trading as currencies, and while commodities and currencies are integrally related, the dymanics in the current environment imply that gold needs to be looked alongside the USD and the euro rather than alongside pork bellies and coffee. In that vein, I continue to stay out of silver, but like the other precious metals.
Relevant ETFs: GLD, SLV, PALL, PPLT, JJC, MOO, DBA, XME