If you’re heavily invested in commodities then you’d better on the lookout for when this commodities bubble is going to bust. Because it will, and when the bubble busts it will get nasty.
No boom in history has gone on forever, regardless of the underlying reasons for the boom in the first place. Everyone thought that the internet was going to change the world forever, and they were right. But that didn’t prevent the internet boom from busting one fine day in March, 2000. Likewise, although China is fast becoming the world’s most powerful nation, it doesn’t mean that the commodities boom will last forever. Every asset-price boom in history has come to an end, and this one is no exception.
The chart below documents the Commodities Price Index (including fuel and non-fuel prices) over the past 15 years, showing the steep advance right up to late 2008, followed by a similar uptrend over recent years. Since April this year, the index has headed south, with a mild uptick between June and July.
It’s not easy to predict the end of a market boom, because the last thing investors want to do is to jump off too early, particularly if there’s still some money to be made. The commodities boom has been chugging along since 1999, and some predict it could have another 10 years in it.
Jim Rogers, a former partner of hedge fund manager George Soros, doesn’t see any immediate signs of the boom ending. No yet. Rogers, who markets a series of commodities indices, has been bullish on commodities for some 15 years. On the flipside, Rogers is bearish on emerging markets, which is slightly worrying considering emerging markets are hot on the back of China, and so are commodities.
The chart below shows the extraordinary growth rate of China, the world’s most resource hungry country. When viewing this chart it’s understandable why so many people have been buying the commodities story; speculators, institutional and retail punters, retirees, you name it have bought into the commodities boom to profit from China’s extraordinary growth story.
Realistically, it’s difficult to envisage another ten years of comparable China growth, particularly in the face of recessionary conditions in Europe and the US, the primary buyers of China’s manufactured goods. Indeed, China can continue to sell goods domestically, but this will hardly make up for the loss of sales in developed countries around the world.
The chart above was an anomaly, not just for China but for the entire globe. Over the past decade or so, the world’s citizens went on a debt-fueled spendathon. Now has come a time to pay the debt back.
Speculators such as hedge fund managers and professional traders have much to blame for rising commodities prices. There has been an explosion of participants in the commodities game, which is sending prices way beyond fundamentals. Investors seeking safe havens as well as a hedge against inflation have piled into commodities – and with interest rates at near zero in much of the developed world, there are few alternatives out there to make any money.
There’s been talk about boosting the regulation of commodities markets against the rising role of speculators in pushing up commodities prices. Hundreds of economists from research institutions and universities have petitioned to curb speculative investment in agricultural commodity markets, with French President Nicholas Sarkozy making volatility in food markets a top priority of his leadership of the G20 this year.
For Aussie punters in commodities and related stocks, it’s important to err on the side of caution. Although few are calling an end just yet, the risks of a commodities downturn are rising.
Copper prices, which are used by forecasters as a guide to the growth outlook, have taken a sudden turn for the worse. Copper prices have fallen considerably since their early 2011 peak with prices down some 30% between August and September. Although prices have recovered a touch, it will prove difficult to regain recent highs. It is said that declining copper prices are indicative of slowing demand from China and emerging markets
Ominously the International Monetary Fund (IMF) has downgraded its outlook for commodities prices due to slower global growth, while companies in China are commenting on slowing demand from the last bastion of China growth, its growing middle class. For example, Mercedes Benz reported that luxury car sales had fallen in July and August this year, compared to 60% growth in the first half of 2011; Shanghai real estate transactions are down by some 50% compared to the previous year, and banking problems are rising.
Few realise that China’s stimulus package following the global financial crisis dwarfed the US bailout, at a massive 12% of GDP. Rapidly rising inflation, escalating food costs and a overheated property market are today the after affects – resulting in a string of measures to cool an overheated economy and prevent the possibility of a hard landing. Does this sound like the perfect ingredient for rapidly rising commodities prices? You decide.
If your portfolio is big on commodities, that’s fine, just be aware of the dangers - and have your finger ready on the sell trigger when the time comes. Keep an eye on sales figures from discretionary consumer companies operating out of China as a measure of changes in consumer sentiment – just as Mercedes Benz above. These types of indicators are probably a truer measure of what’s happening in China than the actual value of commodity prices, which are buoyed by speculators and non-commodities users.
Also beware of relying on the opinions of investment managers and the like who may have an incentive to keep you invested, as they progressively exit. Even though a market can overshoot its underlying fundamentals for quite some time (the Australian property market is evidence of this) eventually the price will realign back to its true value.
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