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Commodity prices can be very volatile, oftentimes
more so than just about any other asset class. These large price swings, which
have been particularly evident in recent years, have given commodities their
reputation for high risk. Those investors who lack a large buffer of
disposable risk capital are repeatedly advised to steer clear. But for those
investors who can bear the risk, and who look to invest in commodities as an
inflation hedge, there is some evidence to suggest that commodity prices move
in long term "supercycles," which play
out over years and even decades. By observing and understanding these
movements, these investors may be able to be more strategic in their
approach.
Commodity booms and busts
oftentimes last far beyond the time frame normally associated with a typical
business cycle. IMF analysis of historical price movements in commodities
filters out less significant short term movements to search for "trough
to peak" and "peak to trough" cycles. They found that between
1862 and 1999, long booms were followed by large slumps, resulting in cycles
of several decades.
For example, after
hitting lows in 1868, prices then followed an uptrend until 1907, when they
reversed course and drifted downward until 1915. That complete cycle lasted a
full 47 years. There is a 16 year cycle from 1915 to 1931, and a still
longer, nearly symmetrical 40 year cycle, which saw rising prices for 20
years between 1931 and 1951 and falling prices between 1951 and 1971.
 
For much of the late 1990s
and early 2000s, booming commodity prices lent powerful support to the idea
that the world was locked into an uptrend of a supercycle.
A World Bank index of commodity prices climbed 109% between early 2003 and
2008. From trough to peak, oil prices rose 1,145% in nominal terms between
December 1998 and July 2008. But when commodity prices suffered a significant
collapse in the latter half of 2008, many had assumed that the down leg of
the cycle had settled in. The stunning collapse in oil prices, with Brent
sinking from $146 per barrel in mid-2008 to $36 per barrel five months later,
was a decline of historic proportions. Having jumped aboard the train too
late, many investors booked staggering losses and wrote commodities out of
their asset allocations strategy for the post crash era.
But the rapid price
rebound from the lows of 2008 and 2009 has challenged these conclusions.
Between December 2008 and June 2009, the price of Brent crude oil more than
doubled, ultimately returning to $126 in April 2011, within spitting distance
of its 2008 peak. The recovery was not only in oil: the Rogers International
Commodity Index total return product also doubled between February 2009 and
April 2011. Given these rebounds, it is possible that the panic drops of 2008
were not in fact a fulcrum of a supercycle. Indeed,
the robustness of the price recovery has led some to wonder whether any
corners were actually turned and whether we are still locked in a commodities
uptrend that began more than a decade ago.
Indeed, key drivers like
global inflation are still in place to propel commodity prices upward for
what appears to be years to come. There now can be little doubt that overly
indebted nations in Europe and the U.S. will look to inflate currencies
rather than cut spending or raise taxes to solve their fiscal woes. To
maintain a global status quo, Asian economies will also inflate to limit the
rise in their currencies. At the same time, demand emanating from the
developing world has exceeded available supply on a near-continual basis
since the early 2000s, except during the depths of the Great Recession. In
addition, the marginal cost of production also appears to have increased
across a variety of commodities.
Even without these
drivers, there is ample historical precedent to allow for the continuance of
a multi-decade commodity boom. Even if commodity prices continue rising over the
next 20 years, as Jim Rogers has argued, the total boom period would still be
10 years less the boom between 1868 and 1907, and just a few years more than
the one that occurred after the Great Depression and World War II.
Certainly a global
economic boom between 2003 and 2008 was part of the story that pushed up
commodity prices so severely during the early part of the last decade. Real
world GDP grew by more than 4% each year from 2004 through 2007, which the
IMF points out was the first time that level of growth on a global level had
been achieved since the early 1970s. Many people who are negative on
commodities mistakenly focus solely on demand as a key driver. They argue
that a continuance of a commodity boom can't occur absent growth in the developed
world.
But a look at the
aluminum market over the course of the twentieth century makes clear that
demand is not the only, or even primary, factor in spurring a decades-long
increase in prices. Based on surging demand, global aluminum output rose
40-fold for a full three decade span, from 1939 to 1969 - yet real prices
trended downward over that time. The example of crude oil is even more
dramatic. Between the years 1965 and 1970, global oil consumption exploded
from 30.8 million barrels per day to 45.4 million barrels per day. But
according to BP data for Saudi Arabian crude, prices over those same five
years declined from $12.43 to $10.10. Despite the outward shift in the demand
curve, the supply response was more than sufficient, in both cases, to keep
prices tethered. Climbing demand is necessary, but not sufficient to provoke
an upward commodities super cycle. More thought should be given to supply
issues and monetary distortions.
Currently the actions of
central banks have supplanted private sector activities as the principal
driver of price movements. The price movement of the U.S. dollar is of
primary importance. Weighted against the currencies of the U.S.'s main
trading partners, the dollar is bumping along the bottom. Any political
solution to the chronic sovereign debt crisis in Europe should put much
greater pressure on the dollar, and push up commodity prices.
As a result, although we
do not expect the economies in the United States or Europe to suddenly
strengthen, we don't believe that the super cycle has turned south. As soon
as the situation in Europe finally shows a moderate degree of stability, long
term growth-oriented investors, who can tolerate the heightened volatility,
may consider adding weight to their exposure to a broad basket of commodities,
either through direct exposure to commodities or through a carefully selected
portfolio of commodity-related equities.
Peter Schiff is CEO
of Euro Pacific Precious Metals, a gold and silver dealer selling reputable,
well-known bullion coins and bars at competitive prices. To learn more,
please visit www.europacmetals.com or call (888) GOLD-160.
For the latest gold market news and analysis, sign
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